The High Court has released its decision in Ruscoe v Cryptopia Limited (in liquidation) CIV-2019-409-000544 [2020] NZHC 728, the first significant decision as a result of the liquidation proceedings of Cryptopia Limited (Cryptopia).
Who needs to read it? Why?
This decision is relevant for cryptocurrency market participants as it addresses the legal status of cryptocurrencies (we also refer to these as digital assets in this article) and whether the digital assets were held on trust for Cryptopia’s account holders. This is the first known occasion on which issues of this type concerning cryptocurrency have been before the courts in New Zealand. The particular findings in relation to the legal nature of cryptocurrencies as property also represent one of the most direct legal analyses of this point in the common law world to date.
Background of the decision
Cryptopia operated a cryptocurrency platform established in 2014 which suffered a large scale hack in early 2019 resulting in the loss of somewhere between nine and 14 per cent of digital assets held through the platform (valued at around NZD30 million). Consequently, Cryptopia was placed into liquidation in May 2019.
The liquidators applied to the High Court to seek directions on:
- whether the various digital assets held by the liquidators of Cryptopia constitute “property” as defined in section 2 of the Companies Act 1993;
- whether the digital assets are held on trust for any or all account holders;
- if the answer to question a. or b. is no, then to the extent that such digital assets are not “property” whether the applicant liquidators should satisfy claims of account holders and unsecured creditors by converting the digital assets into fiat currency;
- if the answer to question b. is yes, then when did the trust/s come into existence, what are the terms of the trust/s and what basis are the digital assets held on trust; and
- what is the consequence of the liquidators being unable to identify an account holder, and what consequences flow in relation to any digital assets associated with that account.
What are the findings?
Gendall J made the following findings:
The digital assets situated in Cryptopia’s exchange are a species of intangible personal property and meet the definition of “property” outlined in section 2 of the Companies Act 1993 (and also probably more generally).
In reaching this decision, Gendall J made reference to Lord Wilberforce’s standard criteria to be considered a species of “property” put forth in National Provincial Bank Ltd v Ainsworth [1965] AC 1175 (HL). Digital assets meet the criteria as follows:
- Digital assets obtain their definition as a result of the public key (essentially the digital wallet address) recording the unit of currency.
- Digital assets have the control and stability necessary to ownership and for creating a market in the coins through the private key (similar to a password, that is known only to the user). attached to the corresponding public key and the generation of a fresh private key upon a transfer of the relevant coin.
Gendall J was satisfied that digital assets are more than merely digitally recorded information.
The digital assets situated in Cryptopia’s exchange are capable of being the subject matter of a trust and Cryptopia acted as a bare trustee for all account holders under a separate trust for each individual cryptocurrency held on its platform.
Gendall J determined that an express bare trust came into existence for every different type of currency as soon as Cryptopia came to hold a new currency for account holders and the trust applied to any currency of the relevant type subsequently acquired by Cryptopia as part of the running of the platform.
All the accountholders for that one particular currency were simply beneficiaries under that one trust and held their interests on exactly the same terms as other accountholders of that particular currency.
The key details of those trusts and of their changing subject matter and membership were held in the SQL database (Cryptopia’s internal database that recorded transactions carried out on the exchange and the digital asset balances of each account).
If the digital assets were not property and not held on trust for account holders, they would be an asset of the company and could be realised by the liquidators and the proceeds distributed in accordance with the Companies Act 1993. In which event account holders’ claims would rank with ordinary unsecured creditors of Cryptopia.
As for next steps for the liquidators, the High Court laid out the following process:
- As at the date of the hack, the liquidators should determine the account holders affected and their relative shares in any trust of the digital assets which are the subject of the hack. The liquidators should then apply the loss from the hack pro rata to those existing holdings. It should not therefore be necessary for the liquidators otherwise to discriminate amongst those account holders, although the default position might be seen as pari passu distribution of the loss;
- To the extent that subsequent to the theft any accountholder acquired digital assets of the type that suffered the hack and those assets were added to the relevant trust assets, no reduction for the theft should be applied to that account holder’s share in the trust assets;
- Where liquidators are unable to identify particular account holder they should deal with the digital assets in accordance with section 76 of the Trustee Act 1956 (which relates to the distribution of shares of missing beneficiaries); and
- Any recoveries of cryptocurrency lost as a result of the hack should be applied pro rata to make up the loss suffered by such account holders.
Our view
The decision of the High Court provides a useful guide of the legal classification of digital assets and when they may be subject to a trust arrangement. It does leave several questions unanswered such as:
- whether digital assets are ‘assets’ in terms of the general definition of this word under the Companies Act 1993.
- whether digital assets more generally constitute ‘property’ – Gendall J acknowledged that they probably do, but the question for the case was limited to the definition of property under section 2 of the Companies Act 1993.
- whether Cryptopia, as a beneficiary of the express trusts (because it was an account holder in its own right), can share in the distribution of the digital assets – the issue of any fault on the part of Cryptopia was not addressed in this case.
Cryptocurrency platforms must ensure that their terms of operation clearly specify whether or not digital assets are held on trust for account holders.
What next
This decision that cryptocurrencies are assets in the liquidation is the first step. The liquidators intend to advance a further application to propose methods of distribution of Cryptopia’s assets.
If you have any questions in relation to the decision, please contact one of our experts.
