Cryptocurrency Insufficient To Satisfy Test For Security For Costs – Technology

In granting security for costs against a claimant company owned
by Dr Craig Wright (who claims to be the creator of the Bitcoin
system) and his family, the High Court has refused to allow the
security to be paid in Bitcoin as that would not result in
protection equal to a payment into court or first class
guarantee: Tulip Trading Limited v Bitcoin Association for
BSV   [2022] EWHC 2 (Ch) and [2022] EWHC 141 (Ch).

This judgment marks an important step in a case that could be of
vital interest to cryptocurrency holders and developers. At the
centre of the substantive claim lies the question of whether an
owner of cryptocurrency has any recourse against the developers of
the cryptocurrency systems if they lose control of cryptocurrency,
either accidentally or due to a hacking incident. It brings to the
fore the question of the nature and scope of any fiduciary duty on
the part of developers either to restore access, or at least take
all the necessary steps to do so.

One of the defendants in this case, the BSV Bitcoin Association,
released a statement that the “digital currency and blockchain
industry should strive to develop technical mechanisms and industry
best practices to provide remedies, upon valid proof of ownership
and with judicial due process, to restore control of lost or stolen
coins to their rightful owner – just as there are remedies
available for any asset or property (physical, digital, intangible
or otherwise).”

The statement further mused that the introduction of such
solutions would only build trust in Bitcoin and may lead to its
wider adoption. It could be seen as a stepping stone towards
building an honest and transparent “lawful digital currency
ecosystem”. The Association does not, however, accept that the
defendants owed the claimant company the duties alleged in this
case.

This is, to our knowledge, the first time a party to litigation
has sought to offer Bitcoin as security for costs. The court’s
principal focus in refusing to allow the use of cryptocurrency was
on Bitcoin’s volatility, rather than the principle of using
non-fiat currencies as security for costs. It would be interesting
to see what the court would do if a claimant offered security in
the form of a more substantial deposit of cryptocurrency, or a
stablecoin (a non-fiat currency specifically designed to have a
relatively stable price, typically backed by a reserve asset like a
government issued currency).

Background

The applications were filed by the defendants to seek security
for the costs of their jurisdiction applications, where they
challenged a court order permitting that they be served the claim
documents despite being domiciled outside the court’s
jurisdiction.

Dr Wright (through the claimant Seychelles company) claimed to
own Bitcoin worth in the region of US$4.5 billion, which he
accessed and controlled from his computer and network in England.
The access was facilitated by secure private keys.

In February 2020, these private keys were deleted by hackers who
accessed Dr Wright’s computer and caused Dr Wright to lose
access to his Bitcoin. The defendants are the open-source software
developers who developed the Bitcoin Core and Bitcoin Cash ABC
software on a non-commercial basis.

The substantive claim

The claimant claims that the defendants owed it a fiduciary or,
in the alternative, tortious duty to re-write or edit the
underlying software to enable it to re-access the Bitcoin. It
submitted that the claimant had requested the defendants to do so,
but they did not consider themselves to be bound by any such duty
and thus refused to take the requested steps.

The claim raises questions surrounding the ownership of the
Bitcoin, the defendants’ ability to restore the claimant’s
access in the present circumstances and whether they had any duty
to restore access as requested. Three possible fiduciary/tortious
duties were described as follows:

• The duty to restore the claimant’s access to and control of
  the Bitcoin;




• The duty to take all reasonable steps to restore the
  claimant’s access to and control of the Bitcoin and;




• The duty to take all reasonable steps to ensure that the fraud
  carried out by the hackers is not given effect to.

The claim further raises the issue of the breach of any (or all)
of the above duties, and possible relief.

The security for costs application

The defendants challenged the court’s jurisdiction over the
claims and sought security for their costs of the jurisdiction
application.

CPR 25.13 provides that the court may make an order for security
for costs if it is satisfied, having regard to all the
circumstances of the case, that it is just to make such an order
and one or more of a number of conditions applies. The conditions
relied on in this case were:

• The impecuniosity condition, ie that there is reason to believe
  the claimant company would be unable to pay the defendants’
  costs if ordered to do so;




• The nominal claimant condition, ie that the claimant is acting
  as a nominal claimant and (again) there is reason to believe it
  will be unable to pay the defendants’ costs;




• The non-residence condition, ie that the claimant is resident
  outside the jurisdiction and not resident in a state bound by the
  Hague Convention on Choice of Court Agreements 2005; and




• The enforcement avoidance condition, ie that the claimant has
  taken steps in relation to its assets that would make it difficult
  to enforce an order for costs against it.

Decision as to grant of security

The impecuniosity condition

The court observed that, as per Dr Wright’s own witness
statement, the claimant was a holding company for the Bitcoin,
which was its main asset. It did not conduct any trade, have any
customers or bank accounts and did not file any accounts or tax
returns. While the claimant argued that the defendants had not
adduced any evidence to support their assertion that the claimant
would be unable to pay costs, it had failed to provide any details
of the assets it claimed to own.

The claimant sought to distinguish its position
from Sarpd Oil v Addax [2016] EWCA Civ 120 in
which the court held that where a foreign company was reticent in
revealing or declined to reveal its financial position it was
“sound practice” to grant security against it.

The claimant submitted that, unlike in Sarpd
Oil,  it had not declined to provide evidence of good
financial standing. It argued that no such request had been made at
all. However, the court rejected this argument. The claimant had
not only failed to demonstrate its ability to pay in inter-party
correspondence, but also in response to the application. In such a
circumstance, the court ruled, the claimant could be said to be
“deliberately reticent” as stated in Sarpd
Oil.

The claimant further sought to argue that it had “strong
prospects” of being able to access some of the Bitcoin
(referred to as BSV) worth about £13.7 million. It had
enlisted a company called nChain Limited (nChain) to modify the
client software which would enable the owner to re-gain control of
the Bitcoin. Once this was successful, the claimant would have
control over assets that could easily cover the costs of the
defendants.

However, the court observed that ownership of the BSV was itself
at issue in the claim. The BSV was administered by one of the
defendants, who had expressed an intention to defend the claim.
Control over and access to the BSV was therefore reliant on the
defendant, who would have to implement the software that nChain
would develop. There was no evidence as to how this would be
managed, and if the defendant would be willing to undertake the
task. This solution was therefore not viable.

Further, the court noted that the security was required by the
defendants at the very moment, and there was no indication as to
how soon the claimant would be able to access the BSV. The court
consequently ruled that the impecuniosity condition was
satisfied.

The other conditions

The court rejected the contention that the claimant was a
nominal claimant, since it could not be said that it was
incorporated purely for the purpose of bringing the claim at hand;
especially since it had claimed to hold Bitcoin since 2011.

On the condition of non-residence, the court concluded that
though the claimant was incorporated in Seychelles, no significant
management and control of the claimant’s affairs was carried
out in that jurisdiction. Since Dr Wright exercised such control,
and was based in England, the claimant could be determined to be
resident in England. In any case, the court held that the claimant
could be said to be a resident in both countries.

The court also rejected the argument on the enforcement
avoidance condition, as the mere act of the claimant in continuing
to hold digital assets (as it always had) could not be reasonably
construed as taking a positive step to put its assets beyond the
reach of creditors.

Exercising discretion

As to whether it was just to make the order, the claimant had
failed to adduce evidence as to whether making the order would
stifle the claim; and there was a further consideration of all the
served defendants being private individuals residing outside the
court’s jurisdiction.

While not making any determinative observations on the merits of
the claim, the court nevertheless commented that the
“…merits of the claim that the defendants owe the claimant
the duties alleged are not on their face strong.”

The claimant put forth two core arguments to justify refusal of
security:

1. That its inability to access (at least some of) the Bitcoin was
   due to the defendants’ conduct in refusing to help it regain
   access, despite having provided them with a prima
   facie  case that it is the owner of the digital assets.
   This was rejected by the court as it was premised on two
   assumptions: first,  that the claimant was the
   owner; and second,  that the defendants owed the
   alleged duties to the claimant. Both of these assumptions could
   very well be held to be wrong at trial.




2. That the claimant had made an open offer to the defendants to
   transfer some of the Bitcoin to be held by a trusted third party
   pending the outcome of the claim. The court rejected this argument
   as well, as the proposal would require the defendants to write a
   new code to transfer that Bitcoin, which would then be frozen to be
   used as security. The court elaborated, giving three reasons for
   rejection of the proposal:

• First,  if the claimant lost and had to pay
  costs, it would have no legal right to the segregated Bitcoin. The
  Bitcoin then would not be an asset owned by the claimant against
  which a costs order could be enforced.




• Second,  the proposal assumed that the defendants
  could legitimately and legally transfer the Bitcoin, which was a
  key issue at hand in the claim; and




• Third,  even if technically possible, the
  proposal would require the defendants to expend their resources to
  re-write the relevant software code and persuade users of the
  Bitcoin system to adopt those changes. This was a technical matter
  at issue in the claim. Nevertheless, there was no legal basis for
  requiring the defendants to expend their time and energy in order
  to produce their own security.

The court ordered the provision of security for costs.

Application to provide security in the form of Bitcoin

The claimant sought to provide the security in the form of
either Bitcoin Satoshi Vision or Bitcoin Core, by transferring the
relevant cryptocurrency (together with a 10% ‘buffer’ to
address concerns as to volatility) to its solicitors, who would
give written confirmation to the court and the defendants that they
held the Bitcoin. They would also give an undertaking that it could
be used to satisfy any adverse costs order made against the
claimant. The proposal also included a mechanism for topping up the
value of the Bitcoin, if necessary, to the value of the security
ordered plus the 10% buffer.

The claimant argued, citing Infinity Distribution
Limited (in administration) v Khan Partnership LLP [2021]
EWCA Civ 565, that payment via Bitcoin was the least onerous form
of payment to the claimant because it did not have a UK bank
account and converting Bitcoin into fiat currency would incur
capital gains tax liabilities.

The court held that Bitcoin did not meet the criteria for
payment of security set out in Monde Petroleum SA v
Westernzagros Ltd  [2015] 1 Lloyd’s Rep. 330. In
particular, the Bitcoin would not result in protection for the
defendants equal to a payment into court or first class guarantee.
Further, the security would “expose [the defendants] to a risk
to which they would not be exposed with the usual forms of
security: namely a fall in value of Bitcoin, which could result in
their security being effectively valueless”. The top-up
provision did not fully meet the risk because, if the defendants
did not comply with that obligation, there was a substantial risk
that it could not be enforced before judgment in the jurisdiction
applications.

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