Crypto Caselaw Minute #6 — 10/11/18

The end of the Zug Shuffle? When Crypto met Federalism? No TRO for you! This week’s crypto caselaw minute focuses on Tezos, one of the larger 2017 ICOS. It in turned spawned large litigation, much of which has been consolidated in a single consolidated class action in federal court in the Northern District of California. While no doubt unpleasant (and expensive) for the Defendants, it has provided many reported opinions already. (Summaries by Palley are “SDP”; those by Rosario are “NMR”).

As always, any opinions expressed here are our personal opinions only, are not legal opinions, are not authorized or endorsed by any past, present or future client or employer. And we may change our minds — we contain multitudes).

In re Tezos Secs. Litig., 2018 U.S. Dist. LEXIS 157247 (D.N.D. Cal. August 7, 2018) [SDP].

Is Switzerland a get out of Court free card for blockchain promoters who raise money using a Swiss Foundation? The latest ruling in the Tezos class action litigation suggests that the answer is not so much. (The case also discusses some securities law issues — to keep things brief we focus on jurisdictional issues and give securities law shorter shrift).

There are four buckets of defendants in the case— Arthur & Kathleen Breitman and their company, Distributed Ledger Solutions (“DLS”); Tim Draper and his venture capital vehicles (“Draper”); the Tezos Foundation (“Tezos”); and Bitcoin Suisse AG (“Bitcoin Suisse”). DLS and Tezos remain defendants, Bitcoin Suisse and Draper remain.

The opinion starts with a lengthy factual summary, taken from the lawsuit (link to consolidated class action) [1]. The Breitmans started on the Tezos project in Northern Califronia in 2014. DLS’ Corporate headquarters “at all relevant times” was in the Breitmans’ home in Norther California. Draper had taken a stake in DLS since 2017 or so. Around the same time, DLS created the Tezos Foundation in Switzerland.

DLS worked closely with the Foundation to prepare for and then launch the Tezos ICO, with Mrs. Breitman depicting herself as the “one woman band” charged with promoting the protocol’ in a scheduled chatroom appearance.” Tezos raised $232 million in Bitcoin and Ether as of July 2017. Contribution terms drafted by the Foundation but not included in any of its English sites had a forum selection clause choosing Europe for litigation.

Bitcoin Suisse acted as an intermediary for Tezos and ICO Participants, converting dollars to bitcoin and ether, transferring crypto to the Foundation, creating Tezos digital wallets, and serving as a cosignatory on post-ICO transactions for the Foundation.

The Court dismissed Bitcoin Suisse for lack of personal jurisdiction. It had submitted a sworn declaration stating that it did not provide services for the Tezos ICO to any US investors. Plaintiff failed to adequately respond. Nor did Plaintiff allege that he had been injured by this defendant’s forum related contacts.

No such luck for the Foundation. While having a website hosted in Arizona and accessible to US Citizens wouldn’t have been enough to create personal jurisdiction in California, Plaintiff had alleged the Foundation kept at least one employee in the US, that the California based Breitmans were the de facto marketing arm of the Foundation, and that a significant number of the 30,000 ICO contributors were US Citizens. This was enough for US personal jurisdiction against the Foundation.

The Court also rejected — for now — application of a Swiss forum selection clause. The Court says that absent actual notice of the existence of a forum selection clause in “a browserwrap agreement”, the plaintiff would not be bound by it, though defendants might be able to later “breathe life into the argument” if he can be shown to have had actual knowledge. Also, the Court noted the “local interest” in having US Securities laws litigated in the US. Furthermore, as an American company run by Americans in the US, the Court said that DLS has an even weaker argument for forum non conveniens than the Foundation.

The Foundation also argued it should be dismissed because U.S. Securities laws don’t have extra-territorial jurisdiction. The Court didn’t buy this argument here: there was simply too much U.S. activity alleged by a U.S. Plaintiff. The fact that you exist outside of the U.S. doesn’t mean that you can sell unregistered securities to people in the U.S. — either from outside the country, or using people acting on your behalf inside the country.

The Court dimissed Draper based on argument that the Complaint failed to state a claim against him arising under U.S. Securities laws. To keep this simple — there wasn’t a sufficient allegation that he was either a statutory seller or had control person liability. His connection and financial interests were too remote for exchange act liability, as pleaded. This was not the case for DLS — the company and the Breitmans remain in the case.

What does all of this mean? Pretty simple — the Zug shuffle, that is the notion that a token sale could be launched from Switzerland and thereby be protected from U.S. Securities laws was never a good idea, and this is the first case, perhaps of many, to show why. On the other hand, the mere fact that you have a connection to an allegedly improper securities offering— like Draper and Bitcoin Suisse — doesn’t mean you are liable in a U.S. court or necessarily subject to U.S. jurisdiction.

[1]. Because this is a Motion to Dismiss, the Court treats the facts as true for purposes of deciding the motion. It doesn’t mean that the Court agrees that the facts are true or that they have been so adjudicated.

In re Tezos Sec. Litig., 2018 U.S. Dist. LEXIS 88513 (N.D. Cal., May 25, 2018) [SDP]

Link to opinion: https://www.gpo.gov/fdsys/pkg/USCOURTS-cand-3_17-cv-06779/pdf/USCOURTS-cand-3_17-cv-06779-2.pdf

Not every fight in a lawsuit is between the Plaintiff and Defendant. If you’re the Plaintiff you might actually be happy to see Defendants fighting amongst themselves — the lack of a common defense creates tactical weakness. This opinion arises out of a skirmish between competing plaintiffs’ lawyers about where the Tezos litigation should be fought.

The in re Tezos case consolidates four class actions pending in Federal Court in San Fransisco in front of Judge Seeborg. (The lead plaintiff is named Anvari so we’ll call this “the Anvari case”). A fifth action (“the Baker case”) was filed in state court and removed to federal court. For reasons totally unrelated to crypto-currency — not everything is about crypto — the Baker case was sent back to state court. Anvari asked Judge Seeborg to order the enjoin (prevent/stop) the Baker case from going forward.

It is very unusual for a federal court to order a state court to do anything in the United States, for reasons having to do with the nature of our federal system. But there are limited circumstances where it is permissible. Here, Anvari argued that a federal statute, the Private Securities Litigation Reform Act (“PSLRA”) “expressly authorizes district courts to enjoin state proceedings by providing a mechanism for appointing a lead plaintiff in federal securities class actions.”

While the Court agreed that there might be instances where such an injunction might be authorized by statute, they did not exist here. Baker is not a “copycat” lawsuit but was in fact the first Tezos lawsuit. Also, the fact that Baker has a smaller financial stake isn’t dispositive either. Finally, there was little support for a claim by Anvari that Baker’s counsel had engaged in any sort of misconduct, which was used as an argument by Anvari for an injunction.

Bottom line: a state court action against Tezos is pending in California; a consolidated class action is too. While dueling defendants isn’t a bad thing for a plaintiff, I’m not sure that this outcome is great for defendants here. From a cost and case management standpoint, a consolidated action with ALL plaintiffs included might have been preferable.

Bruce MacDonald v. Dynamic Ledger Solutions, Inc., № 17-cv-0095-RS, (N.D. Cal, December 20, 2017) (Order Denying Application for Temporary Restraining Order) [NMR]

The law offers many types of relief for those that feel they’ve been wronged. One such type of interim relief is known as temporary restraining order (“TRO”). These tools are deployed by judges in cases where a plaintiff can show, among other things, that they are likely to suffer irreparable harm unless their requested restraining order is granted. This bar doesn’t move just because you’ve initiated a class action lawsuit against one of the largest ICOs in existence, namely, the Tezos project.

The Tezos project and its founders are parties to a lot of lawsuits. A lot. Accordingly, many people are familiar with their story, and the general characteristics of their project. For our purposes, certain facts in the tale bear repeating.

The Tezos project was conceived of by the Brietman’s, the wife-husband duo out of San Fran, as a plan to build a self-amending crypto-ledger. They raised a gazillion dollars. Actually, $232 million USD, that at the time of this order was valued at $1 billion USD. After the raise, they began converting some ICO funds to fiat currency, they had a nasty board fight, and the project was delayed.

All these purported shenanigans led MacDonald to file a class-action lawsuit alleging the defendants engaged in an illegal sale of unqualified securities, and violated unfair competition laws. MacDonald asked for a TRO to essentially freeze the assets raised in the ICO preserving the status quo. The problem with allegations is you have to prove them up to a particular standard for other lawyers, and or judges, to buy your argument. In this case, the judge felt like MacDonald did not meet that burden.

Taking the Plaintiff’s allegations as true, the Court was still unable to find a reason as to why the plaintiff would suffer “irreparable harm” if the TRO was not granted. Why you say? Well, despite converting ether/bitcoin to fiat on a regular interval, the board disagreements, and the delays in the projects, that was not enough for a couple of reasons.

Bottom line: the court didn’t buy any of MacDonald’s arguments. It said that “the lack of updates regarding the project, the infighting amongst Tezos leadership, the firing of an auditor, and the delayed launch of the project are all worrisome.” Worrisome doesn’t equal irreperable harm. Second, you usually don’t get equitable relief like a TRO where monetary damages are available. Here, the Court was convinced that Bitcoin Suisse, which acted as a signatory on Foundation cryptocurrency transactions, provided adequate security against funds being improperly liquidated. It also saw nothing wrong with converting volatile crypto assets into more stable fiat.

What’s the takeaway? Don’t go for a TRO if you don’t have airtight claims. Accept the fact that big-raise ICOs may be able to legally start converting cryptocurrency into fiat currency right after they close and that a Court might actually view that as prudent. Finally, the fact that regulators are able to secure asset freezes doesn’t mean that private litigants can easily do so — the standards are very, very different.