Podcast S4E5 | Cryptocurrency Frauds & Asset Recovery Remedies

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TRANSCRIPT

Tune in for Series 4 of The HIP Talks podcast: a series of discussions on legal issues hosted by Hugill & Ip Solicitors – an independent boutique law firm in Hong Kong providing bespoke legal services and exceptional client service to individuals, families, entrepreneurs and businesses, locally and internationally. Clients have diverse issues: some require immediate attention and speedy outcomes; others require the building of a long-term partnership between solicitor and client. In all situations and for all clients, Hugill & Ip provides clear practical advice to help achieve the best results. The firm has achieved outstanding recognitions in the most recent editions of the major legal directories, as well as remarkable results in the areas of Dispute Resolution, Corporate & Commercial, Trusts & Estates, Family, Employment & Business Immigration and Data Privacy.

Jeffrey Chan  00:53
Hello, my name is Jeffrey Chan. I’m a Trainee Solicitor of Hugill & Ip. I’m here today with Geraint Ho, Associate of our Dispute Resolution department. Good morning, Geraint.

Geraint Ho  01:02
Good morning Jeffrey, how are you?

Jeffrey Chan  01:04
I’m good Geraint so today we’re going to be talking about internet scams and cryptocurrency but before we get into that, Geraint, what are some common internet scams that people fall victim to?

Geraint Ho  01:14
That’s a good question, Jeffrey. Nowadays, internet scams and online schemes have evolved in recent years because people have been getting wiser to the older types of frauds and scams. But let us begin with a classic which is the Mainland (China) authority scam. What normally happens is that the victim will receive a phone call from someone who claims to be part of the Mainland law enforcement authorities and say that the victim is being investigated as part of sort of investigations into for example cybercrime or money laundering operations, they will ask the victim to normally transfer funds into a designated bank account, and claiming that this money will be returned after the investigation has concluded. And so obviously, once the victim transfers the money it’s never seen again. But Jeffrey, since today’s topic is about crypto currencies, one example I would give of a crypto scam would be the rock pool, which you might have heard of. So what normally happens is that a developer or a creator of a cryptocurrency project will spend a lot of time and effort to promote their cryptocurrency project. And this is done with the hope or intention of attracting transactions and basically raising the price on the market. Now the developer who normally already owns a substantial stake in this cryptocurrencies, waits for the price to go up, and then basically sells off his tokens on the market when the price is high. And then he just basically disappears and then abandons the project. This leaves all the other investors or people who buy into the cryptocurrency project with something that is basically worthless.

Geraint Ho  02:52
This is basically analog just to a pump and dump scheme, which you might see on the stock market. There are also things such as ransomware attacks on cryptocurrencies, where users’ computer systems or software might get locked out and then the hacker basically demands payment in cryptocurrency because it’s more anonymous than say if they if they wanted the ransom paid through a bank account. And relating to hacking. There’s also things such as hacking of email accounts, and cryptocurrency wallets, and the latter has become increasingly common nowadays.

Jeffrey Chan  03:04
Well, that’s terrible. But my understanding is that cryptocurrency it’s a relatively new concept, and it’s largely unregulated. So, in the event that someone does fall victim to one of these scams, is there anything that could be done to protect their interests?

Geraint Ho  03:42
The short answer is yes. Now, while the number of cases in Hong Kong addressing cyber fraud involving cryptocurrencies is very new, obviously, because the whole idea of a cryptocurrency is quite novel, cases regarding cyber fraud, for fiat currency or in other words, normal currencies have been around for a substantial amount of time. The Hong Kong courts like other common law jurisdictions, such as England and Wales, the US and Australia have legal tools and remedies in place to basically trace, freeze and recover the stolen assets. The most common tool that we litigators use is the freezing injunction and this comes in two forms.

Geraint Ho  04:23
One is a freezing injunction regarding money. And in legal terms, we call this a Mareva injunction and this can be obtained if the plaintiff has established there is a fraud. Now, the scope of the injunction can either be domestic, in other words, it’s limited to use in Hong Kong, or if it’s appropriate, it can be extended globally. Now, the way this injunction works is that it basically freezes defendants’ assets up to a specified amount and this reference amount is normally the amount of loss that the victim has suffered as a result of the fraud. Now to apply for the is freezing injunction, the plaintiff has to show that there is a balance of convenience tests, which is in favor of granting the injunction. And more importantly, that there is a real risk of this asset being dissipated if the injunction is not granted. And so this injunction needs to be in place pending the judgment so that the victim can eventually have something to recover.

Geraint Ho  05:23
The other type of freezing injunction is what is known as a proprietary freezing injunction where we the victim says that a certain asset belongs to him or her. And this needs to be kept in place while the court proceedings are ongoing. So because the victim is making a claim based on what we call a proprietary claim, in other words, asserting that the asset belongs to him and not the fraudster, the threshold for getting this injunction is less onerous than say getting freezing injunction through the Mareva route. The plaintiff basically needs to show that there is a serious issue to be tried on the merits. And there is no need to show a risk of dissipation, which normally is quite a substantial burden on the victim to show. In appropriate cases, the Hong Kong courts can and do grant both injunctions at the same time. So that gives a sort of added level of protection to the victim.

Geraint Ho  06:22
Now, obviously, the protection offered by a Mareva injunction is greater because it extends to all assets on by the defendant or the fraudster. And it’s only limited up to a specified amount rather than the proprietary injunction which is specified to a certain asset class. But as mentioned, the threshold for getting a Mareva injunction is higher.

Jeffrey Chan  06:43
Well, all right. But isn’t it quite common in cases of fraud for fraudsters to transfer the stolen monies across multiple different bank accounts in many different jurisdictions? So, when that happens, is there any way to track down where all this money has gone?

Geraint Ho  06:58
Yes, normally, in Hong Kong, what we do is we obtain a bankers trust order. Now, this is an order that allows the victim to find out how much money has gone to a certain bank, particularly to which account and whether there have been any further transactions into or out of that account. Now, this is an application made against the bank where the victim believes the money has gone to and normally once certain thresholds are met, normally, by proving that the victim has a proprietary claim against the money, the banks would generally not object too much to this application and they will give the needed disclosures. Alternatively, if the victim does not know the identity of the scammer, or even or perhaps where the proceeds have gone to, they can obtain what is called a Norwich Pharmacal order.

Geraint Ho  07:52
And this is a court application essentially for pre lawsuit discovery, as against the identity of the scammer, or fraudster and this is another application that is made against a bank to see whether they have any information as to the wrongdoing or whether proceeds have gone to their account.

Geraint Ho  08:13
For completeness. I should also mention that there was a previous practice, where if a victim reported a scam to the police, the police can identify and they can identify a bank account, the police can issue what is known as a letter of no consent, and this would effectively freeze the account without the victim having to go to court for a separate injunction order. However, in the beginning of 2022, the Hong Kong court has ruled that this regime of letters of no consent is not constitutional. And so it is quite doubtful whether the police will continue with this practice going forward. So the safest way – if not the only way – for ensuring that assets do not get dissipated in the meantime, is for the victim to apply to the courts for an injunction.

Jeffrey Chan  08:58
So once the fraudsters bank accounts have been properly identified, and the funds there and have been frozen, what’s next? How do you actually get your money back?

Geraint Ho  09:07
Well, the victim is going to have to go through legal proceedings in the civil courts to get a judgment. Now normally, these fraudsters do not respond to proceedings and so getting the judgment itself is not that complicated. Once the judgment is obtained, the victim can apply to enforce that judgment, unfortunately, is normally done in two ways. One is through a proprietary declaration or a vesting order. So what happens is that the court can make an order to vest the money or declare that the money belongs to the victim. And this basically avoids arguments if, for example, there have been multiple scams taking place, multiple victims, and the proceeds have all gone to the same location. And this allows the plaintiff to avoid arguments of who owns what and this vesting order can also compel the bank to transfer funds to a plaintiff.

Geraint Ho  10:04
Alternatively, there is a procedure called the garnishee application where if the fraudster has a bank account, the plaintiff or the victim can apply to the court for a declaration that the money held in the bank account should be used to pay for the judgment amount.

Jeffrey Chan  10:20
Well, it’s certainly reassuring to know that there are means to recover your funds after falling victim to a scam. But everything that we’ve talked about so far applies to fraud relating to fiat currency, what are the complications that can arise when cryptocurrency is involved instead?

Geraint Ho  10:35
That’s a very good question. Now, one of the main issues that we had to deal with in the past is can cryptocurrencies even be regarded as property? Now we’d like to think of cryptocurrencies as ledgers or transactions in a blockchain and this makes it completely intangible and for all intents and purposes, it’s a virtual assets. So there is the question of whether it’s something that the courts will sort of bite onto and allow to be enforced or made the subject matter of a lawsuit. Fortunately, there was an English case called AA vs Persons Unknown, which determined that Bitcoin was in fact a property, a form of property under English law, and we believe this can be extended to other forms of cryptocurrencies.

Geraint Ho  11:24
More recently, there is the Lavinia Deborah Osborne case also in the English courts, which determined that NFTs can be made the subject of freezing injunctions, and so they can be frozen in a wallet, pending proceedings for recovery. And this is obviously good news for holders of cryptocurrencies and NFTs, because this basically establishes that your assets can be made the subject of a lawsuit, and it can be protected with injunctions pending recovery from a scam.

Jeffrey Chan  11:55
Well, that’s certainly good to hear. Earlier, you mentioned that we can use proprietary claims to protect funds by putting the same on trust. Is this something that can be done with cryptocurrency?

Geraint Ho  12:07
Yes, and this is again, per English court decisions in recent years. And of course, as you mentioned, Jeffrey, this is very relevant because it enables reliefs such as proprietary injunctions, bankers trust orders and other proprietary declarations and vesting orders to be made in respect of cryptocurrencies, because those are dependent on cryptocurrencies and NFTs being able to be held on trust or made the subject of a proprietary claim.

Jeffrey Chan  12:35
Well, another issue is that cryptocurrency is a virtual asset. So it’s not really confined to a specific location. In this case, how do we pursue a claim or rather, where do we pursue this claim?

Geraint Ho  12:47
Well, Jeffrey, again, we want to follow precedents in other jurisdictions, as in Hong Kong, we don’t have that many cases. I want to mention the English courts decision called the ION Science case. And in that case, the court basically determined that the appropriate jurisdiction to bring a claim is the place where the owner of the cryptocurrency is domiciled. And I should also want to mention that in the ION Science case, and bankers trust order was given and that’s another example of relief that is available to victims of a cryptocurrency scam.

Jeffrey Chan  13:19
Well, so far, we’ve been talking about cases from overseas regarding cryptocurrency. What about Hong Kong? How do the Hong Kong courts view how to deal with a cryptocurrency fraud situation?

Geraint Ho  13:31
Now, Jeffrey, as I mentioned, Hong Kong courts regarding cryptocurrency disputes and frauds are quite uncommon given that the whole subject matter is quite recent. But I can give an example of a very, very recent judgment, named Samara v Dan, where the Hong Kong Court did grant various remedies in a case over Bitcoins that were misappropriated by a fraudulent agent. So to summarize, the plaintiffs case, that was that he got into an oral agreement with the defendant, where the defendant was to sell the plaintiffs Bitcoin on an exchange for a commission. So the plaintiff transferred a lot of his bitcoins into several wallets, or cryptocurrency wallets, belonging to the defendant. And this, these wallets were held with an exchange called gate coin limited, so it was functional back then, but it’s defunct now. Because the plaintiff couldn’t open his own bank account in Hong Kong to handle the sales proceeds. He also agreed with the defendant that the sale proceeds from these Bitcoins be deposited in the defendants bank account, also in Hong Kong, and then the defendant would give his login details and password for the plaintiff to login and make his own transfers to the plaintiffs personal accounts in other countries. So initially, this arrangement work and the plaintiff was able to get his sale proceeds, but he was subsequently locked out of the defendants bank account, so he basically was had no longer had access to the defendants account and could not retrieve the sale proceeds of his Bitcoin. So what the plaintiff did was he sued the defendant for a failure to account for the remaining bitcoins and sale proceeds. The defendants defense was that he was basically a Bitcoin trader, and he had previous transactions with the plaintiff and the relationship between them was simply buyer and seller dealing directly with each other. The defendant also said that the Bitcoins that were transferred to him were done so in his capacity as a purchaser, and he had paid for the Bitcoins himself, either through cash or wire transfers from his Hong Kong bank account. Now the plaintiff was successful in applying for a Mareva freezing injunction. And basically, the defendants assets were frozen up to the sum of around 2.5 million US dollars. And this included the Bitcoin that was held by the defendant. At the same time, the court also made a disclosure order against the Hong Kong bank account, and the Hong Kong based cryptocurrency exchange gate coin to ascertain what had become of the bitcoins and sort of the flow of funds regarding the sale proceeds. Using this information, the plaintiff was able to trace the sale proceeds and so he applied for and obtained proprietary injunctions over the relevant bitcoins and the sale proceeds. So the matter eventually went to trial. And the Court essentially found for the plaintiff, the court determined that the defendant was basically acting as an agent of the plaintiff. The bitcoins were transferred to him and were entrusted to him to sell on the plaintiffs behalf. And so the defendant basically owed fiduciary duties to the plaintiff as an agent. And so these duties and obligations had been breached, and in theory as to what was due and owed to the plaintiff. In terms of remedies, the court basically gave the following which is firstly, a declaration that the bitcoins and sale proceeds were held by the defendant on trust. Secondly, an order compelling the defendant to transfer to currency exchanges representing the proceeds of sale for the Bitcoins to the plaintiff. Thirdly, and order for the defendants provide an account.

Jeffrey Chan  17:14
It’s quite reassuring to know that the court has sided with the plaintiff in that case. But what does that really mean? What are the implications of this case?

Geraint Ho  17:22
Well, it’s a good thing you asked Jeffrey. This is one of the first cases in Hong Kong that involved cryptocurrencies that have actually gone to trial. And so, what is good news for us is that the Hong Kong court appears to accept that cryptocurrencies can be treated as assets, and the court is prepared to grant proprietary remedies and even in fact, other remedies in respect of cryptocurrencies, and this treatment is consistent with the cases that we have discussed in England. As mentioned again, the availability of these proprietary remedies is very important because a victim is entitled to recovery of their cryptocurrencies or the fruits of their proceeds and not merely damages, which are only assessed at a particular point in time. And we know that cryptocurrencies can be very, very volatile. And so, a victim would probably prefer to recover the currencies themselves if that is an option. So one of the things I want to mention is that it shows the Hong Kong court is very prepared to grant freezing orders and injunctions even on an interim basis, pending the trial of the proceedings. And so this is a one way that the victim can preserve the status quo while the dispute is being determined.

Jeffrey Chan  18:41
So Geraint earlier when we were talking about fiat currency, you’ve talked about using bankers trusts orders and Norwich Pharmacal orders to trace the proceeds of the funds. What are the differences in the steps that need to be taken in order to trace the funds in the case of a fraud involving cryptocurrency instead?

Geraint Ho  19:00
Well, I would say there’s actually an advantage to the victim if the fraud was conducted as regards to cryptocurrencies, compared to fiat currencies. This is because when there is a fraud or a scam involving a fiat currency, acting quickly, is very essential and time is of the essence. Oftentimes, we say that going through a recovery process is a race against time because once the money is with the scammer or fraudster, it can very quickly be transferred through multiple layers and basically put out of reach for the victim because the victim doesn’t know where to begin to even locate the proceeds of crime. Often times, victim might end up having to go to court multiple times against multiple banks for various bankers trusts or disclosure orders, just to even locate the proceeds of the scam. And this is actually a very time consuming and costly process and it might not even be worth for the victim to go through if the amount involved is not very substantial. And this is where the advantage of cryptocurrencies comes in because most if not all cryptocurrencies are based on blockchain technology, and basically blockchain technology would put every single transaction involving that cryptocurrency on the public ledger. So in theory, every single transaction is made public and even if the fraudster or scammer goes through multiple levels of layering with regards to the cryptocurrencies, and has it transferred to different wallets, different exchanges, it is in theory, able to track or trace where this cryptocurrency has gone through the public domain.

Geraint Ho  20:43
Finally, the fraudster scammer will eventually want to cash in on this cryptocurrency if assuming they don’t want to hold on to it forever, and the easiest way for them to do so for the time being is to transfer these cryptocurrencies to a public exchange, for example, Binance or Coinbase, and like so if the exchange is based in Hong Kong, or some other common law jurisdictions such as England, the US, Singapore., the traditional legal remedies that we discussed earlier, such as the Mareva and freezing injunctions can still be used to freeze the accounts at these exchanges.

Geraint Ho  21:23
So to conclude, while the law regarding cryptocurrency disputes and cryptocurrency scams is still quite novel and obviously still developing, we have a reassuring trend that the methods used for scams involving fiat currencies is also applicable in the cryptocurrency space.

Jeffrey Chan  21:44
Well, thank you very much, Geraint. That was a very enlightening conversation that we just had.

Geraint Ho  21:48
Thank you for having me, Jeffrey.

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This podcast is for informational purposes only. Its contents do not constitute legal or professional advice.