D'Aloia v Persons Unknown & Others: A welcome decision against crypto-asset fraud?

As news breaks of the collapse of a cryptocurrency exchange due to something as old fashioned as a bank run (aka a liquidity crisis), can we learn from the trajectory of modern banking as to what may be yet to come?

As international regulators are expected to step up their scrutiny, will the Courts permit the law to be applied to exchange houses in the same deregulated way?

It certainly seems that the English Courts are willing to apply the flexibility of the common law to grip issues arising from the often-frenetic sector and its technologies – such as service requirements, asset tracing and freezing proceeds of fraud. But what about the finding of a constructive trust where the exchange house is regarded as a trustee for the defrauded victim's funds?

This recent case suggests exchange houses will have to engage with Courts in the same way that the old-fashioned institutions have – to ensure they are afforded the same application of the common law which has, largely, allowed traditional finance institutions to prosper over the last century.

Key developments

  • The potential finding of a constructive trust liability against crypto exchanges in relation to misappropriated crypto assets.
  • Permission to serve proceedings by Non-Fungible Token (NFT).

The facts: Background of the claim

Mr Fabrizio D’Aloia, the Claimant, brought proceedings in June 2022 against Persons Unknown and six other parties, including the holding company of the well-known crypto exchange Binance, arising from what he alleged to be the fraudulent misappropriation of crypto assets totalling 2.1 million USD Tether and 230,000 USD Coins, so-called “stablecoins” which match their value to US Dollar FIAT money.

Mr D’Aloia alleges to be the victim of a scam which induced him to transfer crypto assets held in his accounts at Coinbase and Crypto.com to accounts operated by the Persons Unknown between December 2021 and May 2022, with the latter holding themselves out as an investment advisor operating through the website tda-finan.com. In February 2022, the claimant’s open trades were closed, and he submitted a withdrawal request to the platform which led to his account being blocked. Consequently, the Mr D’Aloia carried on communications via email with the address [email protected], and was then induced into depositing further deposits for various reasons into different accounts.

By May 2022, it became clear Mr D’Aloia was the victim of fraud, and he hired the intelligence investigator, Mitmark, who concluded a high likelihood that those behind tda-finan.com had been using the platform to imitate a well-known brokerage, TD Ameritrade, as a front to steal crypto assets from investors.  The investigators also established that 2.175 million of USDT and USDC had been transferred to a number of private addresses and exchanges, operated by, or under the control of, the second to seventh defendants. Significantly, the majority of the funds were in wallets held with the Binance crypto exchange, a platform owned by the second defendant – Binance Holding Limited – and one of the largest such exchanges in the world. The other amounts were held in wallets with four other exchanges which were operated, on the evidence, by the fourth to seventh defendants.

Claims advanced (causes of action)

  • Mr D'Aloia advanced claims against the first defendant, Persons Unknown, in fraudulent misrepresentation and deceit, unlawful means conspiracy, and unjust enrichment. Because the lex situs of a crypto asset is the place where the owner is domiciled, and the misrepresentations were made in England, there was a good arguable case that the claim was governed by English Law despite the suspected whereabouts of the claimant being Hong Kong.
  • A claim was also advanced in constructive trust liability, not just against the Persons Unknown, but also against the second to seventh defendant, who were the persons controlling the exchanges into which, according to the expert report, it was possible to trace the relevant crypto assets. Mr Justice Trowler agreed there was a good arguable such case against all seven defendants apart from the third, who on the evidence did not have sufficient control over the crypto wallets. The second defendant, Binance Holdings Limited - the holding company of the Binance Group - was deemed to have significant control over wallets holding the majority of the misappropriated assets.

Relief sought and the Judgment

Mr D'Aloia's application for interim injunctive relief, disclosure and ancillary orders was heard by Mr Justice Trowler on 24 June 2022. In keeping with a growing line of authority in such interim applications, such as AA v Persons Unknown, Ion Science, Re Bitcoin, Denisz and Foglia, Mr Justice Trowler granted the relief sought.

Firstly, an interim freezing injunction to prevent any of the defendants from disposing of his crypto assets, recognising damages would not have been an adequate remedy, given they would not prevent further dissipation of Mr D'Aloia's crypto funds.

Secondly, Mr Justice Trolwer granted Mr D'Aloia a Banker's Trust disclosure order against the exchanges, requiring them to provide documents which would enable him to locate the misappropriated crypto funds. The Bankers Trust order was granted on grounds that:

  • There was a real prospect the information would lead to recovery.
  • The applicant would pay reasonable costs incurred by the exchanges in providing the information was not disproportionate to risk confidentiality duties owed to third parties given the severity of the issue.

Permission to serve out of the jurisdiction

It was also found appropriate to serve the application outside of the jurisdiction through Gateway 9 applied under Practice Direction 6B, as there was a good arguable case that the damage would be sustained in the jurisdiction; this was where the cryptocurrency was immediately held before the misrepresentation and deceit. Further, there was a good arguable case that gateway 15 ('the constructive trust gateway'), and gateway 11 ('the claim relating wholly or principally to property within the jurisdiction') were also available.

Notably, the constructive trust gateway was available against the exchanges, as the claim arose out of "acts committed or events occurring within the jurisdiction or relating to assets within the jurisdiction" (PD 6B, para 3.1, (15)(a)).

Permission to serve out of Jurisdiction and by NFT

This was the first instance that claimant in the English Courts was granted permission to serve proceedings on a Persons Unknown via distributed ledger technology, in this case a Non-Fungible Token (NFT). This was in the form of an airdrop into the digital wallet which originally held the appropriated USD Tether coins, with the effect of embedding the service into the blockchain – the method most likely to put those behind the website on notice. Mr Justice Trowler was also satisfied that there was 'good reason for service on the exchange defendants to be by the alternative means' (i.e., by NFT), meaning exchanges such as Binance could in future be served notices in a similar way.

Constructive trusts

It has often been argued that banks through which fraudulently misappropriated funds flow should be treated as constructive trustees for the victim's assets - in the hope that such a finding may make them liable to restore lost trust assets. However, it has rarely been found that a bank is, in law and fact, affixed with this responsibility.

The Judge's comments in this application will give exchange houses reason to pause:

“…there is a serious issue to be tried that Binance Holdings Limited, which appears to be the holding company of the Binance Group, is able to control the relevant Binance wallets, whether directly or through its corporate status within the group. It is likely that when it is notified of this injunction and therefore of the claims that are made by the claimant in respect of the monies in those Binance wallets, that it will thereby come under the duties of a constructive trustee for the claimant in respect of those crypto assets.”

Foot Anstey comment

Although this was only a hearing for an application, with the full trial yet to be heard, lawyers, crypto exchanges and victims of crypto fraud will be looking on with interest at the outcome.

In particular, the finding of a possible claim in constructive trust liability against Binance – one of the largest crypto exchanges – has significant implications for crypto-asset stakeholders.

The federal trade commission shows that more than 46,000 people (globally) reported over $1bn of crypto lost to fraud in 2021. Although the exact UK figures are unknown, the finding of constructive trust liability against exchanges could have significant class action implications.

As banks engaged with such claims to ensure the law was applied in a workable fashion and adopted processes to avoid being liable for their customers misdeeds, so too will the exchanges need to improve mechanisms for identifying misappropriated funds, so they can freeze injuncted assets and identify information required for disclosure orders.

For the victims of crypto fraud, the opportunity to potentially pursue a direct cause of action against exchanges for breach of trust if they fail to disclose information about the whereabouts of funds misappropriated by fraudsters, will be seized upon.

You can find a copy of the judgment here.