Cryptocurrency exchanges recognised as constructive trustees of misappropriated assets
Locations
D'Aloia v Persons Unknown and Others [2022] EWHC 1723 (Ch)
The High Court has further demonstrated its desire to support victims of cryptocurrency fraud by granting injunctions over misappropriated cryptoassets in the recent case of D'Aloia v Persons Unknown.
Background
Mr D’Aloia alleged that persons unknown posing as a cloned online brokerage had fraudulently misappropriated cryptocurrency totalling approximately 2.1 million USDT and 230,000 USDC into two wallets between December 2021 and May 2022. The fraudulent brokerage imitated a website, misused a legitimate logo and represented that it was associated with a legitimate cryptocurrency business, TD Ameritrade. Mr D’Aloia applied for urgent injunctive relief once he became aware of the sham.
Decision
The High Court ordered freezing injunctions over the misappropriated assets, due to Mr D’Aloia being domiciled in UK when the fraud had been perpetrated. To give effect to the freezing injunction and ancillary orders, the court allowed Mr D’Aloia to serve out of the jurisdiction and by alternative means.
The reaction to this judgment has predominantly focussed on the first use of an NFT as a means of serving a court order on persons unknown. The novel approach of allowing service through the blockchain to the fraudster’s digital wallets shows that the courts are willing to tackle the issue of anonymity of blockchain users and to embrace new technologies.
However, victims of cryptocurrency fraud should pay more interest to the High Court's determination of there being a good arguable case that the cryptocurrency exchanges hold these proceeds of fraud as a constructive trustee on behalf of the victim. Given that the identities of fraudsters are frequently unknown, it is likely that the exchange may be the preferred target against which to recover losses.
A constructive trust is an equitable remedy imposed by a court to benefit a party that has been wrongfully deprived of its rights due to a person obtaining or holding a legal property right which they should not possess due to unjust enrichment or interference.
If a cryptocurrency exchange holds funds on constructive trust for a defrauded investor, that defrauded investor may have an action for breach of trust against the exchange and a direct avenue to seek relief against the exchange in the event the cryptocurrency exchange fails to comply with duties of trustees when put on notice that they may hold the proceeds of a fraud.
Consequences of decision
Cryptocurrency exchanges should take heed of this decision. These online platforms can be constructive trustees with responsibilities to ensure that stolen cryptoassets are properly ring-fenced and not withdrawn when on notice of the fraud. An inherent challenge is that cryptocurrency deposited into an exchange will typically be mixed with other customers’ assets, either in the way such assets are received by an exchange or the manner in which the exchange pools assets internally. If exchanges fail to comply they may find themselves being liable for breach of trust, and subject to a future claims themselves, providing a further avenue of redress to victims of crypto fraud.
Mr D’Aloia alleged that persons unknown posing as a cloned online brokerage had fraudulently misappropriated cryptocurrency totalling approximately 2.1 million USDT and 230,000 USDC into two wallets between December 2021 and May 2022. The fraudulent brokerage imitated a website, misused a legitimate logo and represented that it was associated with a legitimate cryptocurrency business, TD Ameritrade. Mr D’Aloia applied for urgent injunctive relief once he became aware of the sham.
Decision
The High Court ordered freezing injunctions over the misappropriated assets, due to Mr D’Aloia being domiciled in UK when the fraud had been perpetrated. To give effect to the freezing injunction and ancillary orders, the court allowed Mr D’Aloia to serve out of the jurisdiction and by alternative means.
The reaction to this judgment has predominantly focussed on the first use of an NFT as a means of serving a court order on persons unknown. The novel approach of allowing service through the blockchain to the fraudster’s digital wallets shows that the courts are willing to tackle the issue of anonymity of blockchain users and to embrace new technologies.
However, victims of cryptocurrency fraud should pay more interest to the High Court's determination of there being a good arguable case that the cryptocurrency exchanges hold these proceeds of fraud as a constructive trustee on behalf of the victim. Given that the identities of fraudsters are frequently unknown, it is likely that the exchange may be the preferred target against which to recover losses.
A constructive trust is an equitable remedy imposed by a court to benefit a party that has been wrongfully deprived of its rights due to a person obtaining or holding a legal property right which they should not possess due to unjust enrichment or interference.
If a cryptocurrency exchange holds funds on constructive trust for a defrauded investor, that defrauded investor may have an action for breach of trust against the exchange and a direct avenue to seek relief against the exchange in the event the cryptocurrency exchange fails to comply with duties of trustees when put on notice that they may hold the proceeds of a fraud.
Consequences of decision
Cryptocurrency exchanges should take heed of this decision. These online platforms can be constructive trustees with responsibilities to ensure that stolen cryptoassets are properly ring-fenced and not withdrawn when on notice of the fraud. An inherent challenge is that cryptocurrency deposited into an exchange will typically be mixed with other customers’ assets, either in the way such assets are received by an exchange or the manner in which the exchange pools assets internally. If exchanges fail to comply they may find themselves being liable for breach of trust, and subject to a future claims themselves, providing a further avenue of redress to victims of crypto fraud.