Syedur Rahman of Rahman Ravelli details the legal and practical issues affecting the freezing of virtual currencies.
If we were to consider the areas of international business that have developed quicker than others over this past decade, cryptoassets has to be at the top or very near the top of that list.
But while this development has been rapid it has brought with it a number of legal issues – and the addressing of some of those issues is very much in its infancy. Arguably, the major issue is the use of cryptoassets (or cryptocurrency as they are often referred to) by those looking to commit fraud.
As with all fraud, those who have been defrauded will want to seek ways to recover what is theirs. With the increased popularity of cryptoassets it can only be a matter of time before civil litigation relating to fraud involving such assets becomes commonplace. And, as with other civil fraud litigation, part of bringing a claim will involve the tracing and, where possible, freezing of the assets in question. The issue, therefore, is how to trace and then freeze cryptoassets.
From the outset, it should be noted that cryptoassets can (like any other asset) be frozen. In Vorotyntseva v Money-4 Limited t/a Nebeus.Com [2018] EWHC 2596 (Ch), a worldwide freezing order was granted in relation to Bitcoin and Ethereum with an estimated value of approximately £1.5M. In this case, the claimant, had deposited the Bitcoin and in a cryptocurrency platform as she wanted to test the platform against one she had previously used. She later became concerned that the funds could be dissipated and sought the freezing order. Birss J satisfied there was a real risk of dissipation and noted that there had been no suggestion that cryptoassets cannot be a form of property. He was satisfied that the court could make a freezing order.
The legal status of cryptoassets
In November 2019, the UK Jurisdiction Taskforce published an authoritative statement on the legal status of cryptoassets that made the UK the first jurisdiction to clarify that cryptoassets can be treated as property. Taskforce Chair Sir Geoffrey Vos, Chancellor of the High Court, described this as “a watershed for English law and the UK’s jurisdictions. Our statement on the legal status of cryptoassets and smart contracts is something that no other jurisdiction has attempted.”
The Taskforce stated that cryptoassets have all the legal indications necessary to constitute being “property” under English law, adding that the unique features of such assets do not disqualify them from being treated as property. But the Taskforce did conclude that cryptoassets are not “things in possession” because they are virtual and intangible and so cannot be considered goods for the purposes of the Sale of Goods Act 1979, for bailment or the object of a pledge or lien (as such types of security require a transfer of possession).
In law, property is usually considered to be something in possession or something in action. As cryptoassets are virtual they cannot be possessed and the nature of them makes it difficult to categorise them as being something in action. The Taskforce’s statement, however, indicates that while cryptoassets are neither something in possession or something in action, the English law’s definition of property does not limit itself to these two categories. In making this point, the Taskforce refers to two decisions: Dairy Swift v Dairywise Farms Ltd [2000], which saw a milk quota held to be the subject of a trust, and Armstrong v Winnington [2012] EWHC 10; [2013] Ch 156, where the subject of a tracing claim was an EU allowance for carbon emissions which was considered a form of “other intangible property’’.
The Taskforce also stated that it believed cryptoassets satisfied the important and authoritative description of the necessary characteristics of property found in National Provincial Bank v Ainsworth [1965], where Lord Wilberforce said that, before a right or an interest could be admitted into the category of property, it must be definable, identifiable by third parties, capable in its nature of assumption by third parties and have some degree of permanence or stability.
At this stage there is a large amount of opinion and a body of material that considers cryptoassets as property that can be frozen, although this has yet to be determined at the Court of Appeal level. The issue, therefore, is how they should be frozen.
The process of freezing cryptoassets
Service of any Order
Unlike other assets, cryptoassets are not held in a conventional bank account that enables a worldwide freezing order to be served on the bank. With cryptoassets being decentralised and held across the distributive ledger, this use of a freezing order is not an option. But an order can be served on coin exchanges. This was the approach taken by digital asset fund manager Liam Robertson. He served the order on Coinbase UK Limited as part of his action that saw him obtain a $1.1M settlement in relation to stolen Bitcoin.
Cross undertaking in damages
When securing a freezing order, cross undertakings are provided to the Court by the applicants. In general terms, the cross undertaking would require the applicant to compensate the respondent for any losses if it is found that the freezing order was wrongly granted. In these circumstances, you should err on the side of caution. It is widely known that the value of cryptocurrency can be unpredictable. As such, consideration should be given to any undertaking in damages to the Court.
Disclosure
Disclosure is also an area where cryptoassets present their own set of challenges. A respondent faced with a worldwide freezing order form is required to disclose the value, location and details of assets. Yet location is an area that cannot be clearly addressed with cryptoassets as they are not located in one specific place.
It may, however, be possible for the order to ask for details of:
- the number of coins held
- the transaction code / hash by which they were acquired
- how they are held (coin exchange or third party)
- in which account they are held
- whether other parties have the private key to them.
Tracing cryptoassets
Cryptoassets must be traced in ways that differ from those used when tracing other assets. But this does not necessarily make tracing them more problematic. The processes by which cryptocurrencies are traded are transparent: blockchain enables anyone to obtain a copy of every transaction involving a particular cryptoasset by downloading it. Information about cryptocurrency addresses and transactions can be sought using certain services in order to avoid downloading everything. As a result, applicants can trace the movements of cryptoassets from address to address in permissionless systems (although permissioned systems will be a different proposition).
One issue that has not yet been addressed is which law relates to the tracing of cryptoassets. Lex situs - the doctrine that the law governing the transfer of title to property is dependent upon and varies with the location of the property – presents difficulties as cryptoassets are on a ledger that is by its very nature not centralised. Lex fori - that the law of the jurisdiction where the legal action is brought applies – may be more appropriate. Arguably, the law of the underlying transaction or the law governing the underlying fiduciary relation may provide the legal basis for allowing a tracing exercise.
The Financial Markets Law Committee took the view in its “Distributed Ledger Technology and Governing Law: Issues of Legal Uncertainty’’ of 2018 that elective situs - where the governing law is chosen - should be the starting point for any analysis of a conflicts of law approach to what it termed virtual tokens. It took this view on the grounds that this would meet the requirements of being objective and easily ascertainable by the parties themselves and would provide the clearest route for establishing the governing law in such circumstances. The Taskforce, however, talked of legislation being needed to resolve the difficulties in establishing “which rules would be used”.
At this stage, the freezing of cryptoassets is possible. But a number of issues surrounding the procedures that are involved appear to be in need of clarification.
This article was also featured on Lexology.com.
