When are cryptocurrencies held on trust?

In Zi Wang v Graham Darby [2021] EWHC 3054 (Comm), the English Commercial Court added to its recent string of judgments considering the legal position of cryptocurrencies and associated proprietary claims.

The English courts addressed the question of whether cryptocurrencies were held on trust. The case involved an agreement between two individual cryptocurrency traders. The Claimant argued that the Agreement (defined below) created a trust over the specified cryptocurrencies and sought various proprietary claims against the Defendant for breach of trust and fiduciary duties. The Defendant contested the existence of a trust and sought reverse summary judgment or strike out of the proprietary claims for breach of trust and fiduciary duty.

The Court also addressed the Claimant’s application to continue a Worldwide Freezing Order against the Defendant in respect of the cryptocurrencies held under the Agreement.

Background

The case involved two contracts between the Claimant and Defendant (the “Agreement”). Under the Agreement, the Claimant transferred 400,000 Tezos to the Defendant in exchange for 30 BTC. Over a minimum two-year period, the Defendant was to keep the Tezos in a specific digital wallet to establish and maintain a blockchain node for the 400,000 Tezos (known as ‘baking’). After two years, the Claimant could exercise an option for the Defendant to return the Tezos to him which was conditional on the Claimant restoring the 30 Bitcoins or an equivalent sum of USD$110,000 to the Defendant.

Contrary to the Agreement, the Defendant stopped baking the Tezos during the two-year period and used the Tezos for trade. The Court subsequently ordered a Worldwide Freezing Order (the “WFO”) and proprietary injunction over the Tezos.

The Claimant sought damages and proprietary remedies against the Defendant for breach of the Agreement. In particular, he claimed that by ceasing to ‘bake’ the Tezos and instead using it for trade, the Defendant was in breach of trust and/or his fiduciary duties under the Agreement.

In this case, the High Court addressed two applications:

1. The Defendant’s application for reverse summary judgment or strike out of the claim that the Defendant had breached any form of trust or fiduciary duty to continuing ‘baking’ and transfer back the Tezos to the Claimant at the end of the two-year period (the “Summary Judgment Application”); and
2. The Claimant’s application to continue the WFO (the “WFO Continuation Application”).

Did the Agreement constitute a trust?

It was agreed between the parties that, as a matter of English law, a unit or token of Tezos constitutes property which can in principle be the subject of a trust. Therefore, this principle was not subject to debate on this occasion.

The Claimant alleged that the Tezos were held on trust for him by the Defendant in one of three ways: express trust, Quistclose-resulting trust or constructive trust. The Judge examined whether the Agreement constituted each alleged type of trust within the context of a commercial transaction and relationship. The Judge held that the Agreement did not create a trust:

• The Agreement’s “essential economic reciprocity”: As the Claimant is only entitled to the Tezos if he returns the Bitcoins or corresponding value, the agreement had “essential economic reciprocity” which precluded the existence of a trust.
• There was a transfer of ownership: Both parties characterised the agreement as one of a sale or purchase back arrangement where each sale or purchase of the cryptocurrencies transfers its ownership to the other party. Such an arrangement is the “antithesis of a trust” as the full transfer of ownership gives a party freedom to deal with the cryptocurrency as he sees fit.
• A trust would create an asymmetric arrangement: The Claimant alleged that whilst there was a trust created over the Tezos, ownership of the Bitcoins had transferred in full and as such, he had freedom to deal with the Bitcoins as he saw fit. The Judge raised concerns that this interpretation of the agreement creates an asymmetric arrangement. The Judge noted that for the Tezos to be held on trust, the Bitcoins must be held as a loan. However, it was clear that the Bitcoins were not on loan to the Claimant.
• There was no necessity for a trust: A trust over the Tezos was not deemed necessary to give effect to the parties’ legitimate expectation or commercial interests as they were sufficiently served by personal rights and obligations – the Defendant had a personal obligation to keep the Tezos under specific conditions for the two-year period and the Claimant had a personal right to buy back the Tezos after the two-year period and receive any ‘baking’ rewards generated during that period.

Did the Defendant owe the Claimant any fiduciary duties?

Where there was no trust, the fiduciary duties were limited to those that support only personal claims for equitable compensation and account of profits. These were likely to be linked to the breach of agreement.

WFO Continuation Application

At a previous hearing, the Claimant obtained a WFO against the Defendant to stop the Defendant from disposing of or dealing with the Tezos. The Claimant sought to extend the WFO in light of new evidence.

The Judge granted the WFO Continuation Application as there was a real risk of unjustified dissipation of assets by the Defendant which may render the enforcement of any future judgment against the Defendant more difficult to enforce or less effective. The Judge held the following information to be relevant when assessing the risk of a dissipation of the Tezos:

• The Defendant’s experience as a cryptocurrency trader;
• The quantities of Bitcoins which the Defendant holds or held in comparison to the quantities of Bitcoins in his disclosed net worth;
• The inconsistencies and omissions in the Defendant’s explanations given throughout the case so far; and
• That the Defendant appreciated his actions did not honour the terms of the Agreement.

Looking to the future

Whilst the question of whether cryptocurrency is capable of being held on trust is yet to be finally determined by the Court, this case demonstrates the Court’s willingness to apply the principles of trusts to a proprietary claim over cryptocurrency. This is an encouraging step for proprietary disputes over cryptocurrencies.

Please click here for a copy of the judgment.

This article was co-authored by Ellie Lifely (Trainee Solicitor) and Mehdi Lilani (Solicitor Apprentice).