When life takes your crypto, give LMN aid

Mark Watson considers the recent judgment in LMN v Bitflyer Holdings Inc. and others[1].

Lemonn [“LMN”] is a cryptocurrency exchange that was hacked in 2020.  

The hackers managed to allegedly take cryptocurrency, valued in the millions of dollars.

These included the familiar Bitcoin, Ethereum, Ethereum Classic, and Ripple, Tether and ZCash.

Crypto experts traced $10.7m of the assets to 26 accounts, all of which were owned or operated by one of the six exchanges.

The company engaged authorities to locate the assets, with no success.  

It then initiated civil proceedings against Bitflyer, Binance, Payward, Luno PTE, Coinbase Global and Huobi Global, whom LMN believed controlled exchange addresses that had allegedly received the stolen assets.

The company made applications:

1. for permission to serve court documents on the defendants out of the jurisdiction;
2. for service by alternative means; and
3. for the defendant to provide specific information regarding customer accounts, within the defendants’ respective control or possession.

Service out of the Jurisdiction

In October 2022, paragraph 3.1(25) of Practice Direction 6B was amended to:

“A claim or application is made for disclosure in order to obtain information

(a) regarding:

(i) the true identity of a defendant or a potential defendant; and/or

(ii) what has become of the property of a claimant or applicant; and

(b) the claim or application is made for the purpose of proceedings already commenced or which, subject to the information received, are intended to be commenced either by service in England and Wales or pursuant to CPR rule 6.32, 6.33 or 6.36”

This created a new jurisdictional gateway for service out of the jurisdiction in circumstances where the paragraph applies.

Judge Mark Pelling QC stated in July 2022 that the objective behind the amendment was to assist victims of crypto-currency fraud in overcoming such difficulties. 

In cases involving those sorts of allegations, it is often very difficult to establish the identity of defendants, how any fraud may have taken place, and the location of any of the assets, especially where several jurisdictions are involved.

Prior to the amendment, an applicant could face issues where the respondent, and the information or documents that the applicant sought, were outside England and Wales.

The paragraph reads:

“A claim or application is made for disclosure in order to obtain information

(a) regarding:

(b) the claim or application is made for the purpose of proceedings already commenced or which, subject to the information received, are intended to be commenced either by service in England and Wales or pursuant to CPR rule 6.32, 6.33 or 6.36” 

The court granted the application to allow the company to serve the relevant documents outside the jurisdiction.

In doing so, the court had regard to the test in Altimo Holdings and Investment Ltd v Kyrgyz Mobil Tel Ltd[2] which identified the following requirements:

a. that there is a serious issue to be tried on the merits;
b. that there was a good arguable case that the claim fell within one of the gateways in CPR PD 6B para. 3.1;
c. and that England and Wales was the appropriate forum for the claim to be tried.

Service by alternative means

The court granted the application for service by alternative means, pursuant to CPR 6.15, 6.27 and 6.37(5)(b).

The Court determined that there was a “good reason” for such permission to be granted.  

Consideration was given to the nature of the alleged fraud and the need to move quickly in order to attempt the recovery of the assets.

Bankers Trust Orders

A Bankers Trust order comes from Bankers Trust Co v Shapira[3] and is directed at financial institutions which have received the proceeds of an alleged fraud.

A Bankers Trust order is similar to a Norwich Pharmacal, with the difference being that while a Norwich Pharmacal order is directed towards discovery of information to identify wrongdoers, a Bankers Trust order is aimed at protecting the applicant’s property, in allowing that party to locate and protect said property from being dissipated.

The power to compel disclosure of information is not limited to the identity of the wrongdoer but may also be used to obtain other information to facilitate the seizure and recovery of assets.

An aggrieved party who wishes to seek discovery orders against a financial institution would ordinarily apply for both a Norwich Pharmacal order and a Bankers Trust order simultaneously.

There are five conditions that need to be met before the court will exercise its discretion to grant a Bankers Trust order. These are:

1. There must be good grounds to conclude that the assets, in connection to which information is sought, actually belonged to the claimant;
2. There must be a real prospect that the information sought will lead to the location or preservation of those assets;
3. The order must, so far as possible, be directed at uncovering the particular assets which are the subject of the tracing claim;
4. The interests of the claimant in obtaining the order must be balanced against the potential detriment suffered by the respondent in complying with the order; and
5. The applicant must provide undertakings to pay the respondent’s costs of compliance, to compensate the respondent for damages if loss arises out of the order, and to only use the information obtained for the proper purpose of tracing the assets.

The court granted LMN’s application for a Bankers Trust order in respect of the Defendants.

The order granted by the court required the defendants to provide:

“in respect of any customer account(s) which the Target Cryptocurrency [i.e. the misappropriated assets] was allocated to and/or received on behalf of: (a) the name the account is held in; (b) all ‘Know Your Customer’ information and documents provided in respect of the account(s); (c) any other information and documents held in relation to the account(s) which does (or which the relevant Defendant consider is likely to) identify the holder of the account(s), including email addresses, residential addresses, phone numbers and bank account details […].”

The court also directed the defendants to provide “to the best of the Defendants’ ability:

(a) an explanation as to what has become of the Target Cryptocurrency; 

(b) the balance in the customer account referred to under sub-paragraph (a) above:

(i) immediately before it was allocated and/or received the Target Cryptocurrency; and

(ii) at the time of that Defendant’s response pursuant to this order”.

Companies and/or individuals that may take custody of, or deal with involving crypto-assets, should pay close attention to the scope of the court’s orders as they indicate the sort of information that may reasonably expect such entities to hold regarding their customers and their assets.  

Any failure to comply with orders like in this case would need to be justified with extremely compelling reasons in order to avoid being held in contempt or sanctioned in any way.

Bank or trust?

One issue that the litigation brought up was the status of the assets being held by any company and in what manner.

LMN submitted that a cryptocurrency exchange:

“does not hold the cryptocurrencies on trust.  Rather, it holds cryptocurrency in its own name and, in a manner analogous to conventional banking, owes a personal obligation to pay the relevant amount to each customer.”  

The court did not rule on this.

However, the question of if a crypto-exchange is similar to a bank, or holds the digital assets on trust, one can see this may provide fertile ground for future litigation, in an area that is already seeing a glut of legal intervention.

Mark Watson is a member of Mountford Chambers who specialises in financial crime and was called to the Bar in 2011. In addition to his criminal practice, Mark regularly represents professionals before their regulators. He is the Secretary of the Criminal Bar Association.

[1] [2022] EWHC 2954 (Comm)

[2] [2011] UKPC 7

[3] [1980] 1 WLR 1274