Oct 11, 2018

Copytrack Pte Ltd. v Wall, and the need for caution regarding the use of tracing and other proprietary remedies in the cryptocurrency space

Copytrack Pte Ltd. v Wall, 2018 BCSC 1709 (CanLII)

Copytrack Pte Ltd. v. Wall, 2010 BCSC 1709 (CanLII) is one of the first decisions dealing with the tracing remedy in the context of cryptocurrencies.

The writer argues that the decision in Copytrack highlights the need for caution in the use of the tracing remedy when dealing with cryptocurrencies.

The facts in Copytrack

Despite being available for nearly a decade, there has been scant caselaw to date dealing with the legal nature of cryptocurrencies and the remedies available for their loss.

Copytrack may be one of the first cases in Canada to address the availability of tracing remedies for lost cryptocurrencies. In Copytrack, the court considered the loss of Ethereum tokens. Ethereum tokens, called “Ether” or “ETH”, are one of many different cryptocurrencies that have emerged following Bitcoin in 2009.

The Plaintiff, Copytrack PTE Ltd., conducted an Initial Coin Offering (“ICO”), in which investors sent ETH or other currencies to Copytrack, in exchange for a new token called CPY.

The Defendant, Wall, subscribed for approximately 530 CPY tokens.

Copytrack was supposed to send 530 CYP tokens to Wall, but instead, sent 530 ETH. The value of the CPY tokens at the material time was approximately $780 CAD, whereas the value of the ETH was approximately $495,000 CAD.

Copytrack asked Wall to return the ETH; Wall refused or failed to do so. Ultimately, Wall claimed that the ETH had been stolen from him by hackers and that he no longer controlled it.

The action

Copytrack brought an action in the Supreme Court of British Columbia, seeking various remedies in the alternative, including monetary damages, and a tracing order to facilitate the return of the ETH.

The matter proceeded for a hearing on the merits by way of a summary judgment application under Rule 9-6 of the British Columbia Rules. There was no serious factual issue to be tried as to whether Wall had received the ETH.

Copytrack argued its application on the basis of the torts of conversion and detinue.

Following Li v Li, 2017 BCSC 1312 (CanLII), the court considered whether conversion and detinue might provide an appropriate framework for analysis. The relevant passages from Li are:

[213] … Conversion is established when there is a positive wrongful act of dealing with goods, including funds, in a manner and with an intention inconsistent with the owner’s rights: Royal Canadian Legion, Branch No. 15 v. Burkitt, 2005 BCSC 1752 (CanLII) at para. 104; Ast v. Mikolas, 2010 BCSC 127 (CanLII) at para. 128; Drucker, Inc. v. Gui, 2009 BCSC 542 (CanLII) at para. 58; Dhothar v. Atwal, 2009 BCSC 1203 (CanLII) at para. 15.

[214] The requisite elements of the tort to be proven are:

(a) a wrongful act by the defendant involving his goods;

(b) the act must consist of the handling, disposing, or destroying the goods; and

(c) the defendant’s actions must have either the effect or intention of interfering with (or denying) the plaintiff’s right or title to the goods.

The court in Li noted that detinue, as typically pleaded in connection with conversion, was essentially a claim for monetary relief flowing from the conversion, rather than a freestanding tort. The court observed that a monetary remedy was not the only possible remedy, and that in certain circumstances, a plaintiff could establish an entitlement to a proprietary remedy – i.e. an entitlement to a remedial constructive trust or a tracing order, so as to be able to recover the wrongfully taken property, or its proceeds:

[226] A constructive trust is one of several remedies potentially available to Mr. Li. What is the remedy in cases where, as here, it is money as opposed to a tangible asset that has been converted? Where the funds remain with the tortfeasor, judgment is for the dollar amount converted unless a proprietary claim can be made out. The monetary claim is often referred to as one in detinue. In the case at bar, the parties did not distinguish between conversion and detinue, and instead referred to Mr. Li’s claim as one of conversion. The potential proprietary remedy is usually, but not always, looked at from the perspective of the nature of the loss to, and the reasons for recognizing a right of property in, the claimant.

[227] To establish a proprietary remedy, Mr. Li must prove a direct link between his misappropriated funds and the Townhouse. He must also prove that a monetary award is inadequate, inappropriate, or insufficient: Harraway at paras. 51-52; Kerr v. Baranow, 2011 SCC 10 (CanLII) at para. 50; Peter v. Beblow, 1993 CanLII 126 (SCC), [1993] 1 S.C.R. 980; Tracey v. Instaloans Financial Solution Centres (BC) Ltd., 2008 BCSC 669 (CanLII); Pro-Sys Consultants Ltd. v. Microsoft Corporation, 2013 SCC 57 (CanLII) at para. 92; Lac Minerals Ltd. v. International Corona Resources Ltd., 1989 CanLII 34 (SCC), [1989] 2 S.C.R. 574.

[228] In Kerr, the Court described the constructive trust remedy as follows:

[50] The Court has recognized that, in some cases, when a monetary award is inappropriate or insufficient, a proprietary remedy may be required. Pettkus is responsible for an important remedial feature of Canadian law of unjust enrichment: the development of the remedial constructive trust. Imposed without reference to intention to create a trust, the constructive trust is a broad and flexible equitable tool used to determine beneficial entitlement to property (Pettkus, at pp. 843-44 and 847-88). Where the plaintiff can demonstrate a link or causal connection between his or her contributions and the acquisition, preservation, maintenance or improvement of the disputed property, a share of the property proportionate to the unjust enrichment can be impressed with a constructive trust in his or her favour (Pettkus, at pp. 852-53); Sorochan, at p. 50). …

[Emphasis added]

[229] Where converted funds have been used to acquire an asset by the tortfeasor, as is the case in this action, another possible remedy may be a tracing order and an equitable lien: see, e.g., B.C. Teachers’ Credit Union v. Betterly, [1975] B.C.J. No. 1158 (S.C.).

The court in Copytrack cited Li for its approach to conversion:

[29] Copytrack points in particular to the decision of Mr. Justice Walker in Li v. Li, 2017 BCSC 1312 (CanLII) [Li], where he found that funds may be subject to a claim of conversion, which he described at para. 213 as a “positive wrongful act of dealing with goods, including funds, in a manner and with an intention inconsistent with the owner’s rights”. [emphasis added]

The court in Copytrack was not willing to make a determination as to whether ETH was a “good” which could be subject to conversion. Instead, Copytrack’s application for summary judgment was resolved as follows:

[34] In my view, the proper characterization of cryptocurrency, including the Ether Tokens, is a central issue in this case, and one that informs the analysis of whether Copytrack’s claims in conversion and detinue can succeed. However, the evidentiary record is inadequate to permit a determination of that issue on this application, and, in any event, it is a complex and as of yet undecided question that is not suitable for determination by way of a summary judgment application.

[35] However, as I have indicated, there would be no practical utility in sending this matter to trial given Wall's death. Further, regardless of the characterization of the Ether Tokens, it is undisputed that they were the property of Copytrack, they were sent to Wall in error, they were not returned when demand was made and Wall has no proprietary claim to them. While the evidence of what has happened to the Ether Tokens since is somewhat murky, this does not detract from the point that they should rightfully be returned to Copytrack.

[36] In the circumstances, it would be both unreasonable and unjust to deny Copytrack a remedy.

[37] In my view, the appropriate remedy is therefore that set out in para. 1(c) of Copytrack’s notice of application as follows:

An order that Copytrack be entitled to trace and recover the 529.8273791 Ether Tokens received by Wall from Copytrack on 15 February 2018 in whatsoever hands those Ether Tokens may currently be held. [emphasis added]

[38] That is the order that I am prepared to make. The balance of the relief sought in the notice of application, for example, disgorgement and/or damages, is not appropriate for summary judgment and those aspects of the application are dismissed. Those are my reasons.

The potential difficulties with the tracing order in Copytrack

The writer respectfully takes issue with the soundness of the decision.

No serious issue can be taken with the court’s reluctance to determine whether ETH and other cryptocurrencies are “goods”. This is a complex and nuanced question and it does not appear that an appropriate record was before the court to aid in answering that question. The question of whether cryptocurrencies are “goods” may have wider ramifications.

Moreover, it is unlikely that determining whether the ETH tokens were goods would have assisted the Plaintiff. If the essence of conversion is a “positive wrongful act of dealing with goods, including funds, in a manner and with an intention inconsistent with the owner’s rights”, there is a serious question as to whether receiving and then failing to return the ETH in question was a “positive wrongful act”.

With respect to receipt: transactions in Ether, as with most other cryptocurrencies, are generally unilateral. They are initiated by the sender. The Plaintiff took an erroneous step in sending ETH to the Defendant. Receiving the ETH required no positive action by the Defendant, wrongful or otherwise.

The Defendant’s misconduct, as it relates to conversion, was in his failure to return the ETH. Nevertheless, it is questionable whether failing to return the ETH was a “handling, disposing, or destroying the goods” with “the effect or intention of interfering with (or denying) the plaintiff’s right or title to the goods”.

Ether tokens have no physical existence. They exist online in a ledger maintained by a host of cooperating system operators; this online ledger is called the blockchain. Cryptocurrency tokens are commonly, but misleadingly, analogized as coins. Physical coins (or banknotes for the matter), though they may be fungible in most commercial contexts, are each unique and indivisible. Ether tokens, by contrast, are not unique, nor are they indivisible. ETH can be transferred from account to account – but unlike bank balances, ETH and other tokens do not represent choses in action or enforceable rights against a third party. Having ownership of a bank account with a $100 balance means that the owner has a legal right to compel the bank to pay $100. Having ownership of an Ethereum account (also referred to as a ‘wallet’ or ‘address’) is functionally synonymous with having the power, by use of a unique cryptographic password (the “private key”), to transfer the ETH in that account to another account. The holder of a private key does not depend on a bank or other third party to facilitate the use of that key to transfer ETH. The only third party involved is the Ethereum network and blockchain, which is not under any single party’s control. This lack of central control is a feature of most cryptocurrencies and is a part of their appeal – but also a practical impediment to the use of certain conventional remedies.

It is probably accurate to say that a person who possesses the private key to an Ether account has ‘possession and control’ of the Ether in that account.

By sending the ETH to the Defendant (albeit mistakenly), the Plaintiff divested itself of all of its possession and control of the ETH.

The extent to which the Plaintiff had “right or title” to the ETH, after it had voluntarily sent it to the Plaintiff, is probably an open question.

It is not clear from the decision in Copytrack whether the record established who had control over the ETH in question. The court noted that the Plaintiff had submitted as follows:

[30] Copytrack submits that the evidence establishes that the Ether Tokens have the following characteristics:

a) They are capable of being possessed, stored, transferred, lost and stolen;

b) They were, at the time the conversion and wrongful detention began, held in the Wall Wallet;

c) They are specifically identifiable and have been traced to five wallets in which they are currently being held; and

d) They can be used as a medium of exchange, a store of value, and a unit of account, like funds or currency.

The court did not comment as to whether this submission was accepted, but impliedly it appears to have been. The court appears to have made no finding as to whether the Defendant (or indeed any identifiable person) had control over the ETH. Indeed, it is quite possible that no identifiable person had control: the Defendant had passed away, and his evidence had been that he had been hacked and the ETH had been taken by persons unknown.

The nature of a public ledger cryptocurrency system such as Ethereum is that every user can see every transaction. It is impossible (at least at present) to obscure the recipient when sending ETH from account to account. However, knowing the electronic address of the recipient is very different than knowing who controls the ETH in question. There is no master table of owners. No central authority assigns addresses and obtains user information. A person controls the ETH at a particular address purely by virtue of having the unique private key (password) associated with that address. The account address, in fact, is derived from the private key, which is chosen by the user. It is therefore uncommon to be able to know with certainty who owns or controls the ETH at any particular address. When ETH has been stolen (for example, by a hacker), it is easy to see to which address it has gone – but often difficult to know who controls that address, and often impossible to ever gain direct control over that ETH again.

The court did not appear to have considered these features of the Ethereum platform and it is not clear as to what extent they formed part of the record.

By ordering “that Copytrack be entitled to trace and recover the 529.8273791 Ether Tokens received by Wall from Copytrack on 15 February 2018 in whatsoever hands those Ether Tokens may currently be held”, the court may have made an order that is functionally difficult, if not impossible, to enforce.

There are a number of problems with tracing orders in the cryptocurrency context:

  1. The court gave no instruction as to the form of tracing to be applied or the rules to be applied to the tracing exercise. Conventional tracing rules may be inappropriate when dealing with cryptocurrencies. A discussion of the practical problems is beyond the scope of this commentary – but an interested reader might begin by considering that crypto tokens are frequently held in or transferred to large pooled accounts operated by exchanges (brokers who facilitate the trading of crypto assets). Once tokens are transmitted to an exchange, they notionally become property of the exchange, and the user acquires a right to receive similar tokens upon request – in other words, the user trades his tokens for a chose in action against the exchange. That chose in action can then be exchanged or converted to a right to receive a different type of cryptocurrency, or even normal fiat currency – that is the whole point of the exchange. Tracing tokens as contemplated in the Copytrack order would quickly become inappropriate: it is the proceeds which should be traced. That would require knowledge of the internal ledger of the exchange.
  2. Even if the court had given clear guidance as to the tracing procedure to be applied, there is no guarantee that the holders of the accounts to which the ETH was ultimately traced could be identified. If the account holders were hackers (or other actors who preferred to remain anonymous), it is unlikely that they would be identified. A cynical observer might note that it could be quite difficult to distinguish between a loss of tokens as a result of a genuine hack, and a phony ‘loss’ which was really the result of a defendant’s deliberate decision to transfer the tokens to another account covertly within his own control. The latter manoeuvre is trivial from a technical perspective and can be accomplished within minutes.
  3. If the ETH could be traced and the owners of the accounts identified, the court would need to make an in personam order, directed at the current holder, requiring the ETH to be delivered to a specified address controlled by the Plaintiff. This method of enforcement is replete with practical difficulties. The cryptocurrency ecosystem is globally distributed. If the holder of the ETH was an entity outside of the court’s jurisdiction, a plaintiff might need to bring enforcement (and potentially contempt) proceedings.
  4. ETH and other cryptocurrencies cannot be garnished in the same way that funds in the bank can be seized. When cryptocurrencies are held in private wallets, only the holders of the private keys can move the tokens.
  5. Perhaps most problematically, the tracing order granted in Copytrack ignores the rights of third party who may have subsequently acquired the ETH for value. By ordering that Copytrack is entitled to recover the ETH from “whatsoever hands those Ether Tokens may currently be held”, the court has impliedly disregarded the potential interests of persons who acquired the ETH for value, either from the Defendant, from the putative hackers, or from any of their assigns. The court has treated the ETH as a piece of stolen property, liable to be recovered from any but its true owner. There is a serious argument to be made that this type of treatment is inappropriate for crypto assets. It means that crypto tokens, which would otherwise be entirely fungible, are not truly fungible, because some tokens may, by court order, acquire the taint of having been wrongfully acquired at some point in their history. A lack of fungibility undermines the certainty and reliability desired in crypto transactions and may be an impediment to growth of the industry.


What to do? Unjust enrichment may be a better approach

The dispute in Copytrack may have been resolvable without the need for recourse to either a conversion/detinue analysis, or tracing relief.

The writer would suggest that the facts in Copytrack lend themselves naturally to an unjust enrichment claim. The unjust enrichment approach has at least two advantages over the conversion/detinue approach:

1. It avoids the need to engage in an analysis of whether crypto assets are “goods”; and

2. It avoids the need to determine whether the Defendant’s conduct in receiving and retaining the ETH constituted a positive wrongful act aimed at depriving the plaintiff of title (as opposed to the Plaintiff having voluntarily, if mistakenly, deprived itself of title).

As noted in Kerr v. Baranow, supra, a cause of action in unjust enrichment has three elements:

1. The defendant has been enriched;

2. The plaintiff has suffered a corresponding deprivation;

3. There is no juridical basis for the enrichment (e.g. no contractual obligation to deliver the ETH).

The facts in Copytrack appear to fit easily within this framework.

Having found an unjust enrichment, the court would need to consider whether the proprietary remedy of imposing a constructive trust was appropriate, having regard to:

1. the potential adequacy of damages as a remedy, and

2. the practical difficulties imposing a trust over property which may have passed into the control of non-parties who may reside in other jurisdictions, who may not be readily identifiable, and who may have given value for their receipt of the now tainted tokens.

The writer suggests that it would be a rare case where tracing of the tokens themselves (a la stolen property) would be a desirable remedy. The tracing of proceeds may be equitable, but also may be impractical (particularly if the tokens are said to have been stolen, as was the case in Copytrack).

The assessment of monetary damages

In cases where monetary damages are an adequate remedy, courts will need to consider the method of assessment of damages.

Crypto asset prices have been notoriously volatile. The ETH transferred to the Defendant in Copytrack was said to be worth $495,000 CDN when transferred on February 15, 2018, when ETH traded at approximately $1,210. The same ETH today (8 months later) would be worth much less, with ETH trading at approximately $290.

Given that the Defendant had effectively chosen to expose the Plaintiff to the volatility of the market by refusing to return the ETH, monetary damages might reasonably be assessed as the value of the ETH on the date on which a reasonable person in the Defendant’s position ought to have realized the Plaintiff’s error and returned the ETH. That date would be a question of fact to be addressed by evidence in the proceeding.

In a falling market, the Plaintiff might readily accede to this approach.

In a rising market, a Plaintiff might reasonably argue that the damages should be assessed as the value of the ETH at the date of judgment. There is some appeal in that position, particularly if the evidence established that the Plaintiff was unable to mitigate its damages by getting back into the market (for example, if it lacked sufficient free capital).

The question of the appropriateness of these competing approaches is similar in some ways to the controversy over the appropriateness of awarding damages on a “value given” or “value survived” basis (see Kerr v Baranow). Courts do not appear to have adopted a universal approach, but rather tailor the approach to the facts of each case.

Summary

In view of the potential difficulties in enforcement of tracing type relief, and the potential commercial uncertainty that could flow from having ‘tainted’ tokens in circulation, the writer’s view is that the tracing remedy should be approached with caution in the cryptocurrency context.

A remedy in damages, where available, is likely to be preferable. That would not preclude plaintiffs from seeking to enforce via ordinary remedies such as garnishment, or even the appointment of a receiver, which might ultimately prove necessary if the defendant’s only assets consist of cryptocurrency.

Sarah Sutherland commented
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