Application of civil remedies to cryptocurrency

February 2023  |  SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION

Financier Worldwide Magazine

February 2023 Issue

From the collapse of FTX and the fall of Ontario’s self-described ‘crypto king’, to calls from regulators demanding that cryptoasset trading platforms bring their operations into compliance with securities laws, the rapid growth of digital assets and cryptocurrency continues to give rise to novel legal issues. Despite the rapidly-evolving crypto landscape, it appears that Ontario courts remain willing to apply more conventional civil remedies, modified to fit the circumstances where necessary, when problems arise in the crypto space.

The Mareva injunction

Several decisions of the Ontario Superior Court of Justice in 2022 demonstrate that this half-century old common law tool for responding to traditional monetary fraud is equally applicable to frauds involving digital or cryptocurrencies.

By way of background, the plaintiff in Li v. Barber successfully sought an ex parte Mareva injunction or freezing order, against the alleged organisers, supporters and participants of the so-called ‘Freedom Convoy’ that blockaded downtown Ottawa for over three weeks. The injunction granted by the court froze digital assets held by the defendants, preventing those defendants from dissipating or removing the assets from Ontario.

As noted by the court in Li, the defendants raised a considerable amount of money through the fundraising platform GoFundMe. However, after concluding that the protest violated its terms of service, GoFundMe froze the funds and returned them to the donors. As a result, the defendants turned to cryptocurrency, such as bitcoin, to fund the protest.

The plaintiff sought to freeze the cryptocurrency held by the defendants in digital wallets. The question before the court was whether the cryptocurrency stored in the digital wallets was legally held by the defendants, and whether the digital assets could be considered within the jurisdiction of the court.

In granting the injunctive relief sought, the court held that the defendants were in legal possession, power and control of the target cryptocurrency. Based on the evidence of an expert investigator, the court found that certain of the defendants were the owners of the digital wallets that stored the cryptocurrency at issue, and that those defendants had the ability to distribute or dissipate those funds, much like conventional currency.

The court also held that the target cryptocurrency was within the jurisdiction of the court and, as such, within the reach of a Mareva Order based on findings that many of the crypto exchanges used to convert the cryptoassets were located within the jurisdiction of the court or in jurisdictions where Ontario judgments and orders are capable of enforcement. As such, the court rejected any notion that the digital assets were immune from execution, drawing comparisons to funds stored digitally in a bank account.

On the heels of the decision in Li, on 7 August 2022, another judge of the Ontario Superior Court issued a Mareva Order in Dario v. Pleterski. The Mareva Order in Dario was issued in relation to an alleged fraud in which Ontario’s self-described ‘crypto king’ allegedly defrauded investors out of millions of dollars. The order restrained the defendant from dissipating or removing funds held in a specified cryptocurrency digital wallet, among other things.

Anton Piller Orders and preservation orders

In a 2021 decision, the plaintiff in Cicada 137 LLC v. Medjedovic, successfully obtained an Anton Piller Order permitting a civil search of specified premises, demonstrating that Ontario courts will apply a broad spectrum of remedies in cases involving crypto fraud. An Anton Piller Order, often colloquially referred to as a civil search warrant, is an order that permits a plaintiff through an independent supervising solicitor to enter a defendant’s premises, either personal or business, in order to seize relevant documents, electronic storage devices and items that may be at risk of destruction.

In this case, the plaintiff was a decentralised financial platform (operating as ‘Index Finance’) that held digital assets on behalf of investors. The plaintiff alleged that the defendant had wrongfully taken $15m in cryptocurrency and stored the tokens in a digital wallet under his control by hacking into the source code used by the plaintiff. The Anton Piller Order was intended to locate and preserve the password to the cryptocurrency accounts and wallet to which the defendant had allegedly moved the tokens.

Ultimately, the court was satisfied that the plaintiff had established a strong prima facie case on the merits, and noted that, absent the granting of the order, “the defendant is likely to hide the password… in a computer or stored on a memory device” such that the search and seizure was necessary to prevent the destruction of the evidence.

In its reasoning, the court specifically commented on what it viewed as the importance of ensuring that traditional interim injunctive relief, and the law more generally, was being applied to digital assets in order to protect the investing and transacting public at large, observing that: “As this new form of investing and commerce grows, it is fundamentally important to the stability of the economy and the online market place that that the integrity of these assets be maintained. The investing and transacting public need assurance that the law applies to protect their rights. Despite what some might think, the law applies to the internet as it does to all relations among people, governments, and others.”

Cicada also sheds light on the availability of preservation orders in the context of cases involving cryptocurrency. Rule 45 of the Ontario Rules of Civil Procedure provides for the granting of orders for the interim preservation of property relevant to an issue in a proceeding.

In this case, rather than resorting to a Mareva injunction to freeze assets, the court granted the plaintiff’s request for a Rule 45 interim preservation order to freeze the specific assets in issue, given that the plaintiff had demonstrated a claim to ownership in the allegedly stolen cryptocurrency, rather than seeking to freeze all of the defendant’s assets writ large.

Interpleader order

An interpleader order is a tool under Rule 43 of the Ontario Rules of Civil Procedure that an innocent party can use to extricate itself from a proceeding in which competing claims have been made against property it holds. In Canadian Imperial Bank of Commerce v. Costodian Inc., the bank successfully obtained an interpleader order in respect of $25.7m that it had frozen related to intended cryptocurrency transactions by hundreds of customers. An issue of competing claims of entitlement arose regarding the funds, resulting in the bank bringing the application for a straightforward interpleader order to have the bank pay the funds into court. The court granted the order.

Conversion, detinue and tracing

Despite the recent willingness of Ontario Courts to apply traditional common law remedies, decisions of courts in other Canadian jurisdictions suggest there may still be some gaps in the case law. In one such example, a British Columbia court, in the context of an application for summary judgment, grappled with the question of whether cryptoassets should be considered ‘goods’ for the purpose of the doctrines of conversion and wrongful detention. In summary, conversion is an intentional, strict liability tort which is made out where an ownership interest is purportedly taken, intentionally, in a manner that is inconsistent with the real owner’s right of possession. Wrongful detention, or detinue, is a cause of action available in British Columbia to recover in the event of the wrongful taking of personal property.

In Copytrack Pte. Ltd. v Wall, the plaintiff conducted an initial coin offering (ICO) in which investors exchanged cryptocurrency for a token called ‘CPY’. The plaintiff alleged that while it had contracted to send 530 CPY tokens to the defendant, valued at $780, it had inadvertently delivered to the defendant 530 Ether tokens, valued at $495,000. The plaintiff requested that the defendant return the funds; however, the defendant failed or refused to do so, claiming that the Ether tokens had been stolen from him by an unknown third party and that he no longer controlled them.

In arguing that Ether tokens were ‘goods’, Copytrack cited case law which held that ‘funds’ may be subject to a claim of conversion. The court was not, on the facts of this case, willing to make a determination as to whether cryptocurrency was ‘goods’ as, at the time of the hearing, the defendant had passed away and so there would have been no practical utility to send the matter to trial. However, the court noted that it would be unjust and unreasonable to deny Copytrack a remedy, and thus, granted an order that Copytrack be entitled to trace and recover the Ether tokens that had been received by the defendant.

What prospective litigants should look out for

While the civil remedies discussed in this article are increasingly proving to be versatile in adapting to the world of cryptocurrency, litigants should take note of their limitations. Digital assets, by their very nature, are difficult to trace and are not limited by geography. The plaintiffs in both Li and Cicada hired experts to help explain the complexities of digital assets and to investigate and monitor the activities of digital wallets and the movement of funds in order to elicit the evidence required in seeking injunctive remedies.

Additionally, with the increased scrutiny of regulators in Canada and the US, litigants should also be cautious about how new rules and regulations may apply to cryptocurrency. What is clear is that the world of cryptocurrency and digital assets is new and growing at a rapid rate, presenting novel legal issues to the courts and investors alike.

 

Jim Patterson and Amanda McLachlan are partners and Sidney Brejak is a student at law at Bennett Jones LLP. Mr Patterson can be contacted on +1 (416) 777 6250 or by email: pattersonj@bennettjones.com. Ms McLachlan can be contacted on +1 (416) 777 5393 or by email: mclachlana@bennettjones.com.

© Financier Worldwide

BY

Jim Patterson, Amanda McLachlan and Sidney Brejak

Bennett Jones LLP

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