Bitcoin, a "duty of care" and the lex situs

In-depth analysis

The Court of Appeal recently permitted the appeal of the High Court decision in Tulip Trading v Van der Laan and Ors [2022] EWHC 667 (Ch), on the basis the case advanced a serious issue to be tried. This allows the Court of Appeal to now consider the potential application of a duty of care in relation to bitcoin, which if applied would represent a significant development in this area. It also raises issues of jurisdiction and lex situs over assets that do not, by their nature, have an easily identifiable jurisdiction.

What is the case about?

Tulip Trading Limited (Tulip) (a Seychelles company) stated that it suffered a loss of $4.5 billion in bitcoin following a hack on the computer of its owner and the stealing of private keys (knowledge of which confers practical control over the asset), which resulted in Tulip being unable to access the bitcoin. The UK nexus is provided by it being the long term residence of Dr Craig Wright, CEO and indirect owner of Tulip, and according to reports, an individual who has claimed, in the past, to be Satoshi Nakamoto, the inventor of bitcoin.

Tulip issued proceedings against the source code developers of the bitcoin (the Developers) alleging that the Developers had breached fiduciary and tortious duties owed to Tulip and seeking to force the Developers to implement a software patch to negate the alleged fraud/hack, which would result in the return of the "stolen" bitcoin to Tulip. The Developers are all resident outside the jurisdiction of England and Wales and Tulip obtained permission to serve proceedings upon them.

Tulip asserts that it owns (but has no control over) the bitcoin that was stolen in the hack. Tulip claims that the Developers should assist with the recovery of these assets, as it is within their power to do so. There is no submission or suggestion that the Developers had anything to do with the hack. The Developers assert that their assumption of the duties suggested by Tulip would be unworkable and unduly onerous.

What happened in the High Court case?

Mrs Justice Falk in the High Court ruled in March 2020 that Tulip had no realistic prospect of proving that the Developers owed them any fiduciary or tortious duties, on the facts as presented. The following issues were discussed:

Imposition of fiduciary or tortious duties: Falk J noted that there is an arguable case that Tulip did own the bitcoin and that a hack occurred, but that this was not a strong enough link to impose fiduciary duties on the Developers.

Tortious duty: Falk J rejected the thought pattern that the Developers, in their role as developers of a network, should have created software to reverse a hack on the basis the creation of such software would not be intended to address a defect, but instead to impose changes on how the network was intended to work. Falk J considered the imposition of a duty in relation to failures to make changes to how the networks work would go beyond an extension of the current law in relation to tort. Falk J also noted that Tulip could have taken other steps (e.g. insurance of the cryptocurrency or the retention of multiple copies of the private key in multiple locations) to mitigate its own risk in relation to this.
Fiduciary duty: Falk J noted the requirement of undivided loyalty in a fiduciary relationship and noted that the steps the Developers would have had to take would have to have been for Tulip's benefit only.

Appropriate forum for trial: Falk J concluded that, given there was no realistic prospect of establishing that the Developers owed any tortious duty to Tulip, there was no serious issue to be tried on the merits of the case and, therefore, no need to consider the question of service of proceedings outside of the jurisdiction. In any event, Falk J was satisfied that, had this case proceeded to court, England would have been an appropriate forum. This is an interesting statement regarding jurisdiction over assets that, by design, do not have an easily identifiably jurisdiction.

Court of Appeal

Earlier this year, in Tulip Trading v Van der Laan [2023] EWCA Civ 83, the Court of Appeal unanimously decided to allow Tulip's appeal of the High Court decision, reversing Mrs Justice Falk's earlier order indicating that, in the opinion of the Court of Appeal, there is a serious issue to be tried, and also accepting that the courts of England do have jurisdiction.

This was not a trial in itself (that is set for 2024), but an order to allow the appeal to go to trial. Lord Justice Birss notes that Mrs Justice Falk's rationale that the courts of England had jurisdiction relied on the reasoning (the summary of which is detailed in paragraph 7 of the judgment) which states that: [t]here was no dispute that the cryptocurrency in issue was property … there was a good arguable case that Tulip was resident in the jurisdiction (despite being a Seychelles incorporated company) and that the property was located [in England].

Therefore, Birss LJ comments (in the same paragraph) that: "[t]he property gateway 11 (Civil Procedure Rules Practice Direction 6B) (Gateway 11) was satisfied. For similar reasons gateway 9(a) (damage within the jurisdiction) was satisfied (paragraphs 159-164). In terms of forum, the conclusion (paragraph 168) was that there was no other jurisdiction with which the dispute had a closer link than England, or was even arguably the proper forum." References to Gateway 11 are explained below.

Situs – jurisdiction

The overwhelming majority of international legal systems have some concept of situs for cross-border disputes. The asset type often determines how to determine its situs, with the law having developed over time to address this point in relation to different types of asset that have come into commercial use. The determination of situs is a much easier task in relation to tangible property as the country in which the asset is located is easily identified and apparent to third parties. An artificial location may be allocated to intangible property; often the place in which control over the asset is exercised, but this is an uncertain area and often difficult to ascertain.

What are the rules on situs for immovable property, movable property and shares?

Gateway 11, mentioned above, gives jurisdiction to English courts where assets are physically located in England and Wales. Beyond that, rules have evolved in relation to different types of asset as discussed below:

Immovable real assets: there is likely to be no challenge to where that asset is located.
Movable property: as discussed in Dicey, Morris and Collins on the Conflict of Laws (16th ed), during the 19th Century the law moved on to determine that movable tangibles should be governed by the law of the jurisdiction of the owner's domicile. This also made sense as these types of transfer were common for inheritance or marriage, with land still being the primary valuable asset.
Shares: A share could be regarded as being situated in the location of where the register of members is kept. There may however be multiple registers in multiple countries. Where registers are kept in different countries, a court may look at the place where such shares are effectively dealt with between the company and a shareholder – if there are competing claims to jurisdiction, a court will need to decide jurisdiction on rational grounds (R v Williams [1942 ] AC 541 (Privy Council, per Viscount Maugham)).

Cryptoassets and situs

Challenging questions are posed when trying to determine the situs of a crypto-asset – a product that, by its inherent nature and design, exists everywhere and nowhere all at once. There are no straightforward answers, but options are available as we discuss below. One question that is particularly relevant in considering the question of situs, is what the proprietary status of cryptoassets is, given their novel characteristics which distinguish them from other assets. The UK Jurisdictional Taskforce considered those features and confirmed in their Legal Statement on Cryptoassets and Smart Contracts in 2019 (the 2019 Statement) that cryptoassets possess all of the characteristics of property set out in the relevant authorities and that cryptoassets are therefore to be treated, in principle, as property.

What are the options?

In recent years, HMRC has commented that the situs of the crypto-asset should be the residency of the beneficial owner (as per its December 2019 guidance).

The Society of Trust and Estates Practitioners (STEP), a private body for practitioners, published a guidance note in September 2021, differing in approach from that of HMRC. STEP's view is that: "its location should be linked to the location of the private key or of the person who has control of the private key (who may or may not be the beneficial owner)".

The UK Jurisdictional Taskforce's confirmation that cryptoassets are a form of property under English law suggests that a crypto-asset must have a location assigned to it notwithstanding its inherent design to be locationless. This is a paradox that needs further understanding. The 2019 Statement suggests that the following factors might be relevant in determining whether English and Welsh law governs the proprietary aspects of dealings in cryptoassets (in no particular order):

whether any relevant off chain asset is located in England and Wales
whether there is any centralised control in England and Wales
whether a particular cryptoasset is controlled by a particular participant in England and Wales (for example due to a private key being stored here)
whether the law applicable to the relevant transfer (perhaps by reason of the parties' choice) is English law.

What about an artificial situs?: A further option would be the imposition of an artificial situs on a crypto-asset by following the English law legal position on non cryptoassets.

In a similar way to a share, cryptoassets rely on a form of register to document transfers: it is not therefore inconceivable that a crypto-asset may be categorised as a registered asset as all transactions will be recorded on the relevant register or blockchain.
Tulip's argument centres on the fact the Developers are those who are responsible for the underlying source code for the commercial banking ledgers as set out in the bitcoin protocol/ledger. It is not a huge leap to put forward the possibility that the crypto-asset could, given the control the Developers have, be situated in the jurisdiction of the Developers. This goes against every previous form of asset class under English law, but that does not necessarily mean it is incorrect – crypto as a concept is unlike any asset class ever examined before and it may well be that common law will need to adapt to its unique characteristics. This does however raise the possibility that a foreign court may reject any ruling of an English court, on the analysis that the English courts did not have jurisdiction in the first place.

It remains to be seen if this will be addressed in the Court of Appeal case – if it is, the reasoning could move forward the current law on localisation of assets and may well be a welcome guide when considering this point in future cases – that being said, this appears to be an incredibly complicated issue and there are a number of pitfalls that need to be overcome both in this jurisdiction and internationally on this question.

Ownership and remedies

Aside from the complicated situs arguments, the question of who owns the cryptocurrency needs to be resolved. Logically, it makes sense that the ownership would need to be the first point the Court of Appeal need to decide. If the Court of Appeal determines that Tulip are not the true owners, then it is unlikely that the English courts would have jurisdiction on the case.

Who are the potential owners?

Tulip: Tulip has asserted it is the owner of the lost cryptocurrency, however this has not been definitively determined. It has not added any third parties to its claim and asserts that it is the legal owner, despite this never being proven in a court of law. Tulip's claim to ownership would need to be analysed by a court, applying legal and equitable principles in the context of crypto.
The person who has access to the private key: STEP's approach would result in the person who has access to the private key being the owner. This would not be Tulip. The hack, albeit "illegally", has removed its access to the private key. The private key may therefore now be in the possession of the hacker and that person could, therefore, be considered to be the owner.
A bona fide purchaser for value without notice: Mrs Justice Falk noted that there could be rival claims to ownership from a third party who has no prior knowledge of the hack. The hacked cryptocurrency could be in the possession of a bona fide third party purchaser for value without notice. If this is the case, that purchaser may well be fall into an equitable maxim and be referred to as "Equity's Darling". In such a case, the court would need to decide how to deal with this, as equitable rights bind the entire world, save Equity's Darling. Were a court to agree that the Developers owe fiduciary duties, and determine the true owner to be Equity's Darling, those fiduciary duties would be owed to Equity's Darling and not to Tulip.

Concluding thought

By allowing the case to go before the Court of Appeal, it is possible that the Court of Appeal may find that developers owe a duty of care to their users in the crypto space, which would be a distinguishing development in tort law. Practically speaking (and for the everyday person who has crypto), it may also offer additional protections to the consumer, in a space that (currently) offers very little protection. That being said there is no guarantee of Tulip's success in the court case and Lord Justice Birss commented that any victory by Tulip would involve a significant development of the common law of fiduciary duties. This is a case to watch out for in 2024 not only to in relation to the law on fiduciary duties, but also in relation to the lex situs of cryptoassets and, therefore, the location of competent courts.