Finance litigation update - July 2022

FINANCE LITIGATION UPDATE – JULY 2022 31 operates1. Secondly, they denied that they were under fiduciary or tortious duties to create the software patch requested. As all of the Developers were resident outside the jurisdiction, and Tulip Trading had no entitlement to serve proceedings on them without the Court's permission, an application for permission to serve outside the jurisdiction was sought and granted on an ex parte basis. Certain Developers subsequently sought to set aside that order. Falk J concluded that the order granting permission to serve the proceedings on those Developers out of the jurisdiction should be set aside as Tulip Trading had failed to demonstrate that the claim had a real prospect of success for the reasons detailed further below. Tulip Trading's claim for breach of fiduciary duty Tulip Trading argued that because the Developers had complete control over the underlying blockchain source code and the ability to re-write it, that imbalance of power translated into a fiduciary duty requiring them to take all reasonable steps to restore the private keys. The failure to take those steps was a breach justifying an order mandating the software amendment or, in the alternative, equitable compensation. Falk J rejected Tulip Trading’s argument that any imbalance of power that existed amounted to a fiduciary duty. While an imbalance of power, together with vulnerability to abuse of that power, may often be a feature of a fiduciary relationship, it was not determinative of the existence of such a relationship, and indeed not sufficient to establish a fiduciary duty alone. Further, Falk J was not convinced that the Developers were, in fact, in control of the four networks. The Developers had no "general contractual or other obligation to make changes to the networks in the future". They were not a wholly identifiable static group, and there was no continuing obligation for them to remain as developers into the future, nor to tend to the networks in the manner alleged by Tulip Trading. This reflects the real-life structure of the networks underlying bitcoin and highlights the challenges of applying established legal principles to such decentralised structures. Falk J also highlighted that the distinguishing feature of a fiduciary relationship is the obligation of undivided loyalty2 and that the action requested by 1 Falk J's judgment has a useful summary of these aspects at [16] – [22]. Tulip Trading would be inconsistent with that duty of loyalty. The steps it was asking the Developers to take were for its sole benefit (i.e. giving it access to the Bitcoin) but would not be for the benefit of the networks’ users more broadly, and in fact could be seen by some users as a detriment or compromise to the integrity of the networks. A key benefit of the bitcoin network for some users is that they can be accessed via private keys only, which feature Tulip Trading was effectively asking the Developers to circumvent. Accordingly, the court ruled that a duty of loyalty could not arise in favour of Tulip Trading to the "exclusion of the interests" of other users. Tulip Trading's claim in negligence Tulip Trading claimed that the Developers had acted negligently in failing to: (1) put in place sufficient protections against misconduct by third parties; and (2) restore access to users whose private keys were lost or stolen. It contended that a special relationship (necessary for the establishment of a duty of care in cases of pure economic loss) arose by virtue of the Developers’ voluntary assumption of responsibility for control of the networks. Alternatively, it argued it was a permissible incremental extension of the scope of established categories of duties of care, drawing an analogy with the Quincecare duty owed by banks to their customers to refrain from acting on instructions when on notice of the possibility of fraud. Falk J rejected both of these arguments. She noted that the alleged negligence related to failures to act but that the law does not generally impose a duty of care to prevent third parties from causing damage. Further, the duties of care which Tulip Trading claimed existed would have been open-ended, compelling the Developers to investigate and 2 Millet LJ in Bristol and West Building Society v Mothew [1998] CH 1.