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High Court Applies Trust Analysis in Cryptocurrency Case

Author: Syedur Rahman  18 November 2021
5 min read

The recent decision in Zi Wang v Graham Darby [2021] is an example of how cryptocurrency cases are slowly but surely finding their way into various legal practice areas, including trust law.  

On 17 November 2021, Stephen Houseman QC, sitting as a Deputy Judge of the High Court, considered the above case. It was one of the first contested hearings in the UK (if not the very first) regarding the issue of whether, on the facts of the case, a trust existed over cryptocurrency. 

The court ultimately dismissed the claimant’s arguments that the defendant held the relevant cryptocurrency on trust for the claimant. In doing so, the court first recognised that cryptocurrencies are indeed ‘property,’ before proceeding to apply well-established trust principles. 

The question of whether the relevant cryptocurrency was held on trust was considered in the following context:

  • The claimant’s applications to continue a worldwide freezing order (WFO) and a proprietary injunction.
  • The defendant’ application for summary judgment regarding the proprietary claims pleaded against him (the SJ Application).
  • The claimant’s application to vary the terms of the WFO as regards the Defendant’s expenditure allowance. 

For the purpose of this article, the abovementioned applications will not all be covered in detail. This short article focuses on the SJ Application, with regard to the court’s application of trust principles in its analysis of the cryptocurrency transfers.

Case Background

The key issue in the SJ Application was whether a trust arose, as a matter of objective common intention, in respect of 400,000 Tezos transferred by the claimant to the defendant. The claimant alleged that the 400,000 Tezos in the hands (i.e. digital wallet) of the defendant were held on trust for him by the defendant in one of three ways: express trust, Quistclose-resulting trust, or constructive trust (notwithstanding that the claimant himself was free to use or dispose of the 30 Bitcoins he received from the defendant). 

The core issue can be summarised as the proper legal characterisation of the contracts between the parties, pursuant to which the claimant made the following transfers:

  1. 200,000 Tezos to the defendant, in return for the defendant transferring 13 Bitcoins (the First Contract or First 200k); and
  2. 200,000 Tezos to the defendant, in return for the defendant transferring 17 Bitcoins (the Second Contract or Second 200k).  

The defendant was then obliged to make the following transfers at the end of an agreed, two-year period:

  1. Transfer the First 200k back to the claimant in consideration for the re-transfer by the claimant to the defendant of 13 Bitcoins. (The claimant had asked the defendant to vary the obligation to sell the first 200k back to the claimant for 13 Bitcoins); and
  2. Sell back to the claimant the Second 200k in consideration for the Bitcoin equivalent of USD 60,000. 

The defendant relied on the nature of the transactions – bilateral exchange and obligatory re-exchange (upon demand after two years) of different cryptocurrencies – to argue that this constituted a sale and buy-back arrangement akin to a 'repo' transaction which, by definition, precluded any trust arising in respect of the Tezos.

Court Analysis

As regards the issue of ‘property’ for the purposes of trust law, the court held 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. This is so notwithstanding its entirely fungible character and non-identifiable status: no single unit bears any unique serial number or means of identification’.

Regarding the nature of the transactions, the court observed that:

  • The subsequent alleged variations to the First Contract and the additional specific terms agreed for the Second Contract did not alter the legal characterisation of the First and Second Contracts; and
  • The parties appear to regard them as a single composite transaction in their communications. 

The court went on to identify the ‘essential economic reciprocity of the transactions’ as ‘the fundamental problem’ regarding the existence or imposition of any kind of trust over the 400,000 Tezos. On the facts, for the claimant to become entitled to (the return of) the 400,000 Tezos, he first had to return to the defendant the corresponding value in (or equivalent to) Bitcoins. By contrast, in a basic trust situation, the beneficiary has an interest in and a right to receive the trust property. In other words, there is no obligation to transfer economic value to the trustee in order to obtain the trust property.

Elaborating on the above, the court held that it did not matter whether this swap reversal should be characterised as a sale and re-purchase, or a repo transaction, for the purposes of the case. Instead, it is the ‘essential economic reciprocity’ that precludes any trust argument from succeeding. In addition, a sale and purchase-back of an asset (akin to the ‘off leg’ in a repo transaction) was considered by the court to be fatal to the trust analysis as this ‘presupposes its original or prior sale/purchase in the other direction’ (akin to the ‘on leg’ in a repo transaction). Indeed, the Court remarked that it was in the claimant’s own pleaded case that both contracts involved a sale and buy-back of 400,000 Tezos. 

In addition, the discussions between the parties as recorded in the telegram transcript that was heavily relied upon by the court in the case) ‘would suggest that the basis of the swapping arrangement was a sale and buy-back. It was not intended to be a loan arrangement given the prior discussion’. Thus, the use of ‘possessive or proprietary language’ alone to describe the Tezos was not sufficient for the Courts to infer (from the parties’ discussions) that they intended to create a trust. The court was mindful that this was language used by laypersons during conversational online messaging.

In particular, the constructive trust argument was quickly dismissed as the court observed, among other things, that it was ‘difficult’ to see how a constructive trust could arise on the facts in respect of ‘entirely fungible and non-identifiable digital assets’. Specifically, it was difficult to argue that the defendant’s (conditional) obligation to return the 400,000 Tezos would be enforceable by specific performance, given the fungible and non-identifiable nature of the digital currency. 

Thus, the defendant was granted summary judgment with regard to the claimant’s proprietary claims and the proprietary injunction was discharged. 

Our Analysis

It should be noted that the court’s analysis was a factual one - which predominantly focused on whether any trust arose on the facts of the case - rather than a legal discussion of whether trust principles could or could not apply regarding cryptocurrency. Thus, having confirmed that the cryptocurrency could properly be considered ‘property’ under trust laws, all that remained was to apply established trust principles and general rules regarding ‘trust language’ to the facts. Indeed, the court stated:

‘If there were serious controversy as to whether cryptocurrency constitutes property under English law, that submission may have more force. But that juridical substratum is common ground.’

The court certainly did not write off the possibility that cryptocurrency could form the subject matter of trust property. Whilst in the case the court declined to embark upon a hypothetical discussion of the non-reciprocal scenario, it observed that ‘the transfer of digital assets from one account-holder to another for the purpose of baking or stake bonding could involve or constitute a trust’.

Another interesting point to note is that the constructive trust argument was discarded: not because it could never apply to cryptocurrencies in general, but because it was not applicable to the cryptocurrency in question – the Tezos were regarded as entirely fungible, i.e. one Tezo could not be distinguished or identified from another. 

Legal practitioners may be aware of the basic trust principle that states a trust may only be established where the ‘Three Certainties’ are present, including certainty of subject matter. A simple illustration may be that an order of bullion subject to a trust should be segregated from the general stock of bullion in order to be separately identifiable from the rest.

In other words, one can see how the fungibility or non-fungibility of cryptocurrencies as well as other crypto assets is an important factor in analysing trust cases. Thus, it remains to be seen whether non-fungible assets (the most well-known of which is NFT) could disrupt traditional legal principles, definitions and analysis related to trust properties. 

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Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, civil recovery, cryptocurrency and high-stakes commercial disputes.

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