Our recent blog on D’Aloia v (1) Persons Unknown (2) Binance Holdings Limited & Others considered Mr Justice Trower’s decision to allow service by NFT, however this was not the only significant development to arise from the case.

In this blog we consider how the English courts also found Mr D’Aloia to have a good arguable case for a claim in constructive trust against the crypto exchanges that operated or controlled the fraudsters’ wallets. This is significant news for crypto exchanges and should put them on notice that they may now have to reconsider the procedures they have in place to deal with misappropriated funds, or risk being held liable as a constructive trustee.

Background

Mr D’Aloia brought his claims after allegedly having his crypto assets fraudulently misappropriated by individuals purporting to be a legitimate online brokerage website. Mr D’Aloia opened an account with the fraudulent platform, transferred substantial sums of crypto assets, and when Mr D’Aloia later sought to withdraw his assets, his account was blocked. He was then induced to make further deposits to release them, without any success. Expert evidence adduced by Mr D’Aloia traced the crypto assets, showing that some 2.175 million of his Tether and USD Coins were transferred to several private addresses said to be controlled by the other six defendants, specifically crypto exchanges, and their holding companies.

The Constructive Trust Claim

A constructive trust is an equitable remedy in which a trust is deemed to have arisen by operation of law, and is declared by the court, in cases where a defendant has wrongfully obtained property or assets. The trustee of a constructive trust therefore holds any assets on behalf of the beneficiary, i.e., the claimant, and accordingly owes them duties – primarily to convey the property as the beneficiary directs, but other duties may also arise depending on circumstance.

In this case, Mr Justice Trower granted the injunction sought, and found that Mr D’Aloia had a good arguable case that his crypto assets were held on a constructive trust by both the defendant fraudsters (the ‘Persons Unknown’) and the defendant exchanges (except for Binance Markets Limited, the English Company, which Trower J found did not have sufficient control over the wallets at this stage).

This is not the first case in which the courts have found a claimant has a good arguable case that misappropriated crypto assets are held on a constructive trust. For example, in the recent case of Osbourne v Persons Unknown, the claimant, Ms Osbourne, had two NFTs transferred from her wallet without her consent. Ms Osbourne sought to bring a constructive trust claim against the Persons Unknown in control of the wallets to which the NFTs had been transferred. In allowing Ms Osbourne’s applications against Persons Unknown for, inter alia, injunctive relief and service out of the jurisdiction, HHJ Pelling QC stated, “the strongest cause of action which is available to the claimant in the circumstances of this case is the assertion that the assets, the subject of these proceedings, are held by the persons unknown on a constructive trust”. He went on to say that as soon as the NFTs “were removed from the claimant’s wallet” he considered that they were “impressed with a constructive trust.”

It is therefore clear that the courts are open to constructive trust claims as regards crypto assets, however Ms Osbourne did not go so far as to seek, as Mr D’Aloia has, to ask the courts to consider a claim in which – in addition to the alleged fraudsters – the exchanges are also said to hold the crypto assets on constructive trust. Mr D’Aloia’s case therefore appears to be the first in which the Court have found that there is a good arguable case for this claim against the exchanges themselves.

Significance

It should be borne in mind that this was only a hearing for an interim application, and not a fully contested trial. Mr D’Aloia has not yet succeeded with his claim, only having been granted a freezing order. Crypto exchanges, investors, and lawyers will undoubtedly continue to watch on with interest as these proceedings advance. Nevertheless, the fact that the courts are willing to entertain a constructive trust claim against crypto exchanges is significant, not only for victims of crypto fraud, but also for the exchanges themselves.

In simple terms, it means that an exchange in control of a wallet to which misappropriated crypto assets are transferred could potentially be found to be a constructive trustee for the assets, giving the claimant a direct action against the exchanges for breach of trust should they fail to comply with their duties as trustees. In situations where the other defendants to a claim, the fraudsters themselves, are ‘Persons Unknown’, it may well be far more attractive and feasible for a claimant to go after the known entity. 

In practical terms, where claimants have previously struggled to obtain disclosure from exchanges without a court order, it is potentially a useful negotiating tactic for claimants to remind the exchanges that they may now bring a claim against them directly. It has been commonplace for claimants to have to seek a Bankers Trust order against the exchanges to obtain information about the unknown fraudsters, however the threat of direct action against an exchange may well encourage them to assist in providing any information they hold, meaning the claimant avoids the time and legal expense required in seeking a court order. 

From the perspective of crypto exchanges, it means that they will likely have to review the mechanisms, if any, they have in place to deal with misappropriated funds held in wallets they could be deemed to have control over. Effective ring-fencing mechanisms will be necessary to ensure that when an exchange is notified, it can take effective action to ensure that any potential proceeds of fraud held are not dissipated, or else they may not risk direct action against them. 

It also worth noting that this case is another example of how important it can be for victims of fraud to obtain expert assistance as soon as possible. The expert evidence provided by the asset tracers in support of Mr D’Aloia’s applications was clearly of great assistance to Trower J as they were successfully able to identify for the Court the wallets in which the misappropriated assets had ended up. However, it will be interesting to see what approach the courts take in circumstances where fraudsters use techniques such as ‘tumbling’ and ‘mixing’ of crypto assets to obfuscate where their ill-gotten gains end up.