Worldwide: Civil Litigation Risks For Offerors Of Digital Tokens And Cryptocurrencies

On the heels of Bitcoin's rapid rise in value, 2017 introduced financial markets to the initial coin offering (ICO), a novel method of raising capital modeled loosely on the traditional initial public offering and facilitated by the emergence and proliferation of distributed ledger technology, known commonly as the "blockchain." In an ICO, the offeror typically accepts an established cryptocurrency, such as Bitcoin or Ether, in exchange for digital assets in the form of tokens or new cryptocurrencies to be exchanged via the offeror's new blockchain. Since 2016, more than 300 entities have raised an estimated $4 billion to $6 billion in capital through digital token sales and ICOs—figures that, according to some sources, surpass amounts raised through traditional early-stage venture capital financing during the same time period.

Government authorities, including the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission, and the Department of Justice, have significantly ramped up enforcement measures to rein in perceived abuses and reduce market risk. SEC leadership, in particular, has spoken publicly about wanting to root out alleged fraud and unregistered offerings of securities as a means of protecting retail investors in this space. With the tech and legal communities focused so heavily on regulatory compliance and enforcement, offerors in this space risk overlooking civil litigation as a primary and, in many respects, equally serious, source of liability and reputational harm. In many cases, particularly close cases that are unlikely to draw the attention of government enforcement bodies, private civil actions are bound to be the primary, if not exclusive, legal touchpoint for many issuers and owners of digital assets. Recent class actions and other private litigation activity reflects that investors and customers are not waiting for the government to take action against digital asset sellers and developers who fail to meet their expectations.  

Against this backdrop, both new and established offerors should understand that compliance with securities, commodities and other federal laws are the beginning, not the end, of legal compliance. While the technology and offerings may be novel, the legal claims at issue are largely familiar terrain in civil class actions, including common law fraud, concealment and breach of contract. Two recent digital asset-sale litigations—one involving Tezos and the other involving BitConnect—showcase the great breadth of legal and practical concerns facing token issuers irrespective of their status with the federal and state authorities. Together, these proceedings provide a roadmap for offerors to plan for, and deal with, civil litigation in the aftermath of digital asset-based fund raising and sales.

BitConnect – Between January and February 2018, three separate putative classes of purchasers and investors filed suits against BitConnect, a U.K. company, and its affiliates and representatives in federal courts in Florida and Kentucky. These suits variously assert civil claims ranging from the unregistered sale of securities under federal and state law to breach of contract, fraudulent concealment, conversion, conspiracy and violations of state consumer protection statutes. BitConnect's business model allowed users to exchange established cryptocurrencies like Bitcoin for BitConnect's own coin, "BCC," which users then "lent" to the platform and received interest-like payouts based on the size of the loan. The class action claims arose primarily from marketing representations made by BitConnect about specific returns that investors could expect. Notably, at least one of the suits (Paige v. BitConnect et al, No. 18-cv-58 (W.D. Ky.)) also targets an unaffiliated individual promoter who used YouTube to market the coin and earn money from followers who purchased BCC using his personal referral code.

Tezos – Between November and December 2017, five separate putative class actions were filed against Dynamic Ledger Solutions, Inc. (DLS), its founders and representatives, and its affiliate the Tezos Foundation, a Swiss nonprofit entity used to raise and manage the funds that would eventually be used to purchase DLS once it developed and launched the Tezos network. In exchange for "donations" of cryptocurrencies, early adopters would receive a claim to a certain number of "Tezzies," the proprietary Tezos cryptocurrency designed to ultimately rival Bitcoin and the Bitcoin network's market dominance. Investors in the Tezos suits argue, among other things, that the "Tezzie" rights purchased in the ICO were actually unregistered securities, for which refunds and rescission are appropriate remedies in light of a number of failed promises made by DLS and the Tezos founders in anticipation of the token sale. In addition to claims rooted in securities laws, at least one of the suits (which has since settled) also asserted state law claims under consumer protection statutes barring unfair and deceptive trade practices.

Aside from the potentially novel securities law questions that produced and remain central to these suits, the BitConnect and Tezos lawsuits highlight a number of other independent concerns—both legal and practical—for companies raising capital through digital/crypto-asset sales:

  • Class action waiver provisions and choice-of-law provisions, to the extent valid at all, may have little practical impact on legal expenditures – A notable feature of the Tezos litigation—which has spawned more class suits than any other ICO—are the provisions in its "donation" agreements requiring waiver of the donor's right to bring a class action suit, as well as clauses requiring the application of Swiss law (in the "ordinary courts" of Zug, Switzerland). Whatever the ultimate merits, these provisions have had little practical impact on the course of litigation to date, and they are not a reliable means for eliminating or, for that matter, mitigating, short-term legal expenditures.
  • Boilerplate investment risk disclosures are unlikely to affect contract- and fraud-based claims – In the Kentucky BitConnect litigation, plaintiffs note in their complaint that the company's generic warnings and risk disclosures failed to account for the ultimate sources of their losses: alleged concealment of key information about the internal mechanisms of the company and broken contractual promises to maintain the company's operations and trading platform. As in traditional consumer litigation, offerors can neither expect to rely on basic disclaimers regarding customers' contractual rights and expectations nor contract around common law fraud.
  • Defending and/or complying with a preliminary injunction may be difficult, if not impossible, in some cases – Both the Tezos and BitConnect lawsuits have involved requests for temporary restraining orders (TRO), a procedural mechanism that can be used to freeze assets pending the outcome of the litigation. Plaintiffs were successful in their TRO request against BitConnect, where the court found that the plaintiffs were likely to succeed on the ultimate merits and had adequately demonstrated a threat of irreparable harm (notably characterizing BitConnect's activities as, among other things, a "massive consumer fraud"). In its order, the court barred the defendants from moving assets without court approval and, in a novel twist, required the defendants to disclose all Bitcoin and other cryptocurrency wallet addresses, trading account addresses, and the identities of the holder/owner of any wallet or cryptocurrency addresses used to transfer Bitcoin or any other cryptocurrency in the past 90 days. The court's disclosure requirements raise unique questions about the feasibility of monitoring compliance in the event that tokens are exchanged for "private" or untraceable cryptocurrencies, as well as the practicality of forcing defendants themselves to monitor and report financial activity. On a more conventional note, the threat of a TRO also poses a variety of accounting, recordkeeping, asset management and cash flow challenges for what ordinarily, at least in the case of ICO-based sales, will be a fledgling company that simply cannot afford to have its operating capital frozen.
  • Organizational distinctions or statements of nonaffiliation do not necessarily preclude liability or personal involvement in civil litigation – Among the novel aspects of the Tezos ICO was its use of a Swiss nonprofit entity to accept "donations" and manage funds while the founders centralized network development and engineering responsibilities in the independent entity, DLS. As evidenced by the long list of individual defendants thus far named in the litigation, legal and organizational divides are unlikely to deflect individual liability, or at least, individual involvement and reputational risk, in meaningful ways.

To be sure, all of these issues are, by definition, subject to litigation and, in many cases, may well be resolved in the defendant's favor (as noted, at least one of the Tezos class actions has settled, and the companies involved were ultimately successful in defending against the class plaintiffs' request for a TRO). That said, companies and individuals considering a token sale or similar digital asset issuance as a means for raising funds should consider the broad range of substantive and procedural issues that can arise from private litigation, and plan their operations and budgeting accordingly to anticipate and mitigate (or even eliminate) these risks.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions