Sunday, August 23, 2020

FYI: Cal App Ct (1st Dist) Rejects Claims Against Digital Currency Exchange Regarding Unsupported Currency

The Court of Appeals of California, First District, recently held that online digital currency exchange platforms have no obligation, in contract or in tort, to honor "forked" cryptocurrencies unless affirmatively provided for in a user agreement or otherwise.


A copy of the opinion is available at:  Link to Opinion


In October 20017, a consumer stored 350 Bitcoin in his account with an online digital currency platform exchange (Exchange).


As you may recall, online digital currency platforms or exchanges allow customers to send, receive, and store certain digital currencies. A digital currency (also known as " cryptocurrency") is a type of currency maintained by a decentralized network of participants' computers. Anyone can be part of such a network by running software that allows the computer to interact with the network. Transactions between network participants are recorded on a "blockchain," which is a public ledger of digital currency transactions.


Bitcoin is among the most well-known, but there are thousands of digital currencies, each on its own unique network and blockchain ledger.  Anyone can create a new digital currency, and new digital currencies are created almost daily.


On October 23, 2017, a third party launched a new cryptocurrency, "Bitcoin Gold," as a "fork."  A fork is a way of creating a new digital currency by copying the source code of an existing digital currency's blockchain and repurposing it into a new digital currency network. When a developer creates a fork, the existing ledger of transactions from the original currency is used, and holders of the original currency are assigned equivalent units of the new currency on the new network. The new currency then "forks" into a separate blockchain ledger that records transactions of the new currency between participants in the new network.


Shortly after the Bitcoin Gold fork, the Exchange evaluated Bitcoin Gold's network and informed its customers via its website: "At this time, [the Exchange] cannot support Bitcoin Gold because its developers have not made the code available to the public to review. This is a major security risk."


On March 27, 2018, the plaintiff consumer filed suit against the Exchange based on its failure and refusal to allow him to receive his forked Bitcoin Gold currency. The Exchanged filed a demurrer with only the consumer's claims for negligence, conversion, and breach of contract surviving the demurrer.


The Exchange filed a motion for summary judgment and in support presented evidence that upon registering an account in February 2014, and again in April 2015, the consumer signed a "User Agreement" with the Exchange. The User Agreement contained no provision requiring the Exchange to provide support or services related to any particular digital currency created by a third party.


Thereafter, the trial court granted summary judgment for the Exchange on all three causes of action concluding "[t]he fact that [the Exchange's] User Agreement with [consumer] contains no provision requiring [the Exchange] to provide services related to any particular digital currency created by a third party is dispositive, requiring the Court to grant this motion."  The plaintiff consumer appealed.


The Appellate Court began its review by first examining consumers breach of contract claim, and noting a breach of contract claim requires the existence of a contract, plaintiff's performance, the other party's breach, and damages. In addition, a claim for breach of contract requires plaintiff specifically plead breach of agreed upon contractual provision.


The Appellate Court noted it is "undisputed that the User Agreement does not contain a provision requiring it to support or provide services for any particular digital currency created by a third party."  Moreover, the Exchange presented evidence that it "issued a public statement that it would not support the new currency due to security concerns."  Consumer was unable to identify any representations, oral or written, by the Exchange that it would support Bitcoin Gold, or that it would provide "usual and customary services" in any way relating to Bitcoin Gold.


The plaintiff consumer argued, through his expert witness, that the Exchange was able to transfer Bitcoin Gold to him via the information it already had and through existing software without the need to develop additional software. The Exchange presented counter evidence that it could not do so because it had not developed the software and the Bitcoin Gold Network was unreliable and unsecure.


The Appellate Court discounted the consumer's argument, noting whether the Exchange could provide consumer "with access to the forked currency is not dispositive; the pertinent question is whether [the Exchange] had a contractual obligation to do so, and the undisputed evidence submitted by [the Exchange] shows it did not."


In sum, consumer "failed to establish the existence of a disputed issue of material fact showing [the Exchange] agreed to provide [consumer] access to his forked Bitcoin Gold currency."


The Appellate Court next examined consumers conversion claim again restating the elements of a claim for conversion which are "(1) the plaintiff's ownership or right to possession of the property, (2) the defendant's wrongful act or disposition of the property that interferes with the plaintiff's possession, and (3) damages." 


Furthermore, conversion requires the defendant to take some affirmative action to exercise dominion over or deprive a plaintiff of his or her property.  To establish a conversion, it is incumbent upon the plaintiff to show an intention or purpose to convert the goods and to exercise ownership over them, or to prevent the owner from taking possession of the property.  . . . [C]onversion requires affirmative action to deprive another of property, not a lack of action."


The Appellate Court was quick to note that the plaintiff consumer's "declaration in support of his opposition to the summary judgment motion admits [the Exchange] took no affirmative action to possess his property, stating:  By [the Exchange] taking no action, knowing I had no ability to access my Bitcoin Gold on my own, [the Exchange'] inaction was tantamount to direct conduct depriving me of my property and was [the Exchange's] way of exercising complete dominion and control over my property thus depriving me of it."


As this issue was a matter of first impression in California, the Appellate Court looked to the reasoning of a federal trial court in Georgia considering a similar claim. In that matter, the Georgia federal trial court granted summary judgment for the digital currency exchange on the plaintiff's claim for conversion of a forked digital currency on the exchange's failure to give the plaintiff its Bitcoin Gold.


In explaining its ruling, the Georgia court reasoned:


"[I]n order for a bitcoin owner who holds [his or] her virtual currency in an exchange (or other type of shared wallet) to access the forked currency, the exchange must take some affirmative action. The Court would be imposing a major new duty on all cryptocurrency exchanges operating in Georgia to affirmatively honor every single bitcoin fork.  Bitcoin investors are aware they are operating in an unregulated market, and therefore it seems more reasonable to place the burden to ensure access to forked currency on the investors themselves.  There is no requirement that investors keep their coins in exchanges; they can always withdraw the coins to their own private wallets. In the unregulated cryptocurrency market, potential investors are well advised to ensure that the terms of service of the exchange they are using clearly spell out what the exchange's obligations are with respect to forked currency, if any."


BDI Capital, LLC v. Bulbul Investments LLC, supra,_ F.Supp.3d at p. _, fn. omitted [2020 WL 1161100 at p. *10].


The Appellate Court found the Georgia federal trial court's opinion persuasive and declined "to impose a major new absolute tort duty on digital currency exchanges to honor forked currencies."


Finally, the Appellate Court addressed consumers negligence claim noting to prevail in a negligence action, a plaintiff must establish the defendant owed a legal duty, the defendant breached that duty, and the breach proximately caused the plaintiff's damages.


In his amended complaint consumer argued the Exchange owed him a duty to allow him to acquire all cryptocurrency to which he was entitled, based on his opening an account with the Exchange and complying with the Exchange's terms and conditions for the account.


The Appellate Court noted that "[a] person may not ordinarily recover in tort for the breach of duties that merely restate contractual obligations."  Thus, consumer may not recover in tort based solely on allegations that the Exchange negligently performed its contractual duties.


Consumer argued the Exchange was required to provide "the usual and customary" services, including services for "fork occurrences," but identified no basis for the alleged duty, nor evidence of any written or oral representation by the Exchange that it would provide such services, as alleged in the first amended complaint.


Accordingly, the judgment of the trial court was affirmed on all three counts.




Ralph T. Wutscher
Maurice Wutscher LLP
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