A whole new world – Hong Kong court declares crypto assets are property and can be held on trust

Crypto exchange

From January 2015, Gatecoin, a Hong Kong company, operated a cryptocurrency exchange platform. To access and use the platform, a customer had to open and register an account with Gatecoin and deposit cryptocurrencies and/or fiat currencies (such as U.S. dollars and Pounds Sterling) which could then be used for trading or making withdrawals. Gatecoin also engaged in trading of cryptocurrencies in its own right, including trading with its customers. The company was wound up by the court on 13 March 2019 and joint and several liquidators were appointed the following day. The value of the cryptocurrencies on the exchange was in excess of HK$140 million as at 31 October 2022.

The joint and several liquidators of Gatecoin applied under section 200(3) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) for directions as to the characterisation of cryptocurrencies held by the company as well as to the allocation of currencies, including fiat currencies, to its customers.

The liquidators had contacted 102,600 creditors but only 1,132 of them had lodged proofs of debt, representing 75 percent of the amount owed to creditors. The liquidators sought directions as to whether the cryptocurrencies held should be regarded as being held on trust for the customers, or whether, if no trust existed, the digital assets should be made available to the general body of creditors.

Linda Chan J began by reviewing the nature of blockchain technology and cryptocurrencies, the types of digital wallets operated and controlled by Gatecoin and the way digital assets are transferred from one wallet to another during the course of business.

Coming to terms

The liquidators had identified three different sets of terms and conditions (T&Cs) that were in force at different time periods,  the supposed "2016 T&C", "Trust T&C" and "2018 T&C". Those who had signed the 2016 T&C were described as "Group A" customers, those who had signed the Trust T&C, "Group B" customers and those who had signed the 2018 T&C, "Group C" customers.

The liquidators considered that only the terms of the Trust T&C had the effect of creating a trust over the currencies in favour of Group B customers. Linda Chan J said that in her view, the question as to whether the currencies were held by Gatecoin on trust for the customers should be determined by construing the terms of the 2018 T&C as the 2018 T&C had superseded the Trust T&C.

Customers who had signed up to other T&Cs were required to acknowledge and accept the 2018 T&C before they could continue to access and use Gatecoin's website. She saw no reason why the court should ignore the contractual bargain reached between the parties and allow customers to rely on the terms of the Trust T&C.

While one could not rule out the possibility that there may be some customers who had registered their accounts before the 2018 T&C came into effect and did not access or use the platform from March 2018 up to the date of Gatecoins liquidation (such that they did not accept or agree to the terms of the 2018 T&C), on the facts it was unclear whether there were any such customers.

Property?

Section 197 of CWUMPO imposes an obligation on a liquidator to take into custody all "property" upon a winding-up order. The question therefore (which we foreshadowed would likely arise in an insolvency situation in our previous alert Into the Unknown – cryptocurrency is property says English Court in blackmail dispute) was whether cryptocurrency fell within the meaning of "property".  As "property" is not defined in CWUMPO, the court turned to the wide definition set out in section 3 of the Interpretation and General Clauses Ordinance (Cap.1).

In Hong Kong, the courts have granted interlocutory proprietary injunctions over cryptocurrencies without any party suggesting that cryptocurrencies were not "property" (see Hogan Lovells alert Cryo-currency? Hong Kong Court grants freezing injunction over bitcoins).

In England and Wales, the court in AA v Persons Unknown [2019] EWHC 4556 (Comm) had held that bitcoin met the four criteria of being definable, identifiable by third parties, capable in their nature of assumption by third parties and having some degree of permanence (again see Hogan Lovells alert Into the Unknown – cryptocurrency is property says English Court in blackmail dispute). The courts had reached similar conclusions in the BVI, Australia, New Zealand, Singapore, Canada and the United States (U.S.).

Linda Chan J noted that "like other common law jurisdictions, our definition of 'property' is an inclusive one and intended to have a wide meaning." The court felt it appropriate to apply and follow the lines of reasoning adopted in other jurisdictions that cryptocurrency was "property" and was capable of forming the subject matter of a trust.

Trust?

While the court determined that cryptocurrencies are capable of forming the subject matter of a trust more generally, on the facts in this particular case it found that a trust had not been established. The court considered the three essential pre-requisites for a trust to be created – certainty of subject matter, object and intention.

Subject matter

Linda Chan J found there to be sufficient certainty of subject matter, in spite of the fact that the assets were placed into a common pool. There was a "compelling reason" for the court to draw an analogy between cryptocurrencies with a trust over shares or securities as "in both cases, the right conferred upon the beneficiary would not depend on the precise identification of the asset owned".

On the basis that a trust could exist over a proportionate share of all cryptocurrencies, the "subject matter of the trust vis-à-vis each customer is sufficiently certain, as the account balance represents the proportion of the cryptocurrencies over which such customer has a beneficial interest in the pool."

Object

A trust would be valid so long as there was no conceptual ambiguity or uncertainty in the definition of the class of beneficiaries. Here, there was certainty of object as the beneficiaries of the trust and the extent of their claim could readily be seen from the exchange ledger.

Intention

Whether a trust had been established hinged on the mutual intention of the parties, a question "to be ascertained by an objective assessment of the terms of the agreement or relationship (between the parties) with reference to that property". Here, the court held the terms of the 2018 T&C showed there was no certainty of intention to create a trust over the cryptocurrencies held by Gatecoin.

The 2018 T&C contained no express declaration of trust and to the contrary, made clear that the currencies were not held on trust for customers. Furthermore, two clauses within the 2018 T&C expressly disclaimed any fiduciary relationship between Gatecoin and the customer.

All the cryptocurrencies deposited by the customers were not segregated but were transferred to and pooled with others. Gatecoin was able to use the cryptocurrencies kept in wallets it controlled in the way it saw fit including for the purpose of carrying on trades in its own right. Cryptocurrencies it held were treated as its assets in its audited financial statements, whilst "customer deposits" were treated as liabilities.

Separately, it seemed that a Quistclose trust had arisen in favour of Gatecoin, in respect of sums it had advanced to a market maker for the purpose of purchasing cryptocurrencies on Gatecoin's behalf, in much the same way that such a trust would be imposed on the fiat used to acquire cryptocurrencies.

Final thoughts

The ruling should give Hong Kong insolvency practitioners greater clarity as to the nature and breadth of a company's digital assets in a winding-up scenario. The confirmation that holdings of cryptocurrencies constitute "property" that is on a par with other intangible assets such as stocks and shares, brings Hong Kong into line with other common law jurisdictions whose courts have already decided the issue.

The dismissal of claims by account holders that their assets were held for them by Gatecoin on trust once again serves to point out the importance of the contractual bargain made between the parties, even when the most novel of legal points are being decided.

Authored by Byron Phillips and Nigel Sharman.