The Claimant sought injunctive relief in the form of an interim freezing order and disclosure orders from the High Court against a number of defendants as part of his attempts to recover cryptocurrencies which had been taken from him fraudulently. The Claimant was the victim of a scam which induced him to transfer approximately 2.1M USDT and approximately 230,000 USDC from his personal wallets.

The Claimant believed that the website ‘www.tda-finan.com’ (the “Website”) (which is no longer available) was affiliated with TD Ameritrade (which is a regulated entity in the United States) due to the deliberate misuse of a corporate logo which was designed to make the Website appear legitimate. As a result of this deception, the Claimant deposited USDT and USDC into a number of digital wallets associated with the Website and also purported to make certain trades through his account. So as to prolong the appearance of legitimacy, the Claimant’s account appeared to reflect those trades.

In February 2022, the Claimant’s open trades on the Website were abruptly closed without any input from him. The Claimant naturally became suspicious and unsuccessfully attempted to withdraw funds from his account. The Claimant’s account was then blocked, and after a number of exchanges by email with a representative of the Website, it became apparent to the Claimant that he had been defrauded.

The Claimant instructed counsel and engaged an ‘intelligence investigator’ in an attempt to recover his assets. The investigators were able to trace, approximately, 2.175M of USDT and USDC to a number of addresses maintained with a number of large crypto-exchanges (all of which were named as defendants to the case) (the “Crypto-Exchanges”).

The Claimant sought to bring the following claims:

• a claim of fraudulent misrepresentation, deceit, unlawful means conspiracy and unjust enrichment against those who had operated the Website; and
• a claim in constructive trust against both those who had operated the Website and each of the Crypto-Exchanges, given they control the exchanges into which the misappropriated cryptocurrency had been transferred.

In order to proceed with these claims, the Court had to consider whether the freezing order and disclosure order should be granted, and if they should, whether the Claimant’s application to serve notice of proceedings outside of England and Wales (with English law being the governing law of the claim) using an alternative method of service, should be permitted.

Whilst the location of the fraudsters was unknown (albeit there was some evidence to suggest they were based in Hong Kong), the Crypto-Exchanges were located in the Cayman Islands, Panama, the Seychelles and Thailand.

The Court was satisfied that there was a serious issued to be tried in England and Wales on the basis that; (i) the misrepresentations regarding the Website were made to the Claimant in England and (ii) that (applying the principle in Ion Science Limited & Duncan John v. Persons Unknown, Binance Holdings Limited, Payment Ventures Limited[2]) the lex situs of the crypto assets that were the subject of the fraud is the country where the rightful owner is domiciled (in this case England). Finally, the Court concluded that the governing law of the claim was also English law on the basis that the loss sustained by the Claimant took place in England.

The Court also concurred that the Claimant had a prima facie case against each of the Crypto-Exchanges as constructive trustees as they had control of the exchanges to which the missing assets had been traced by the Claimant’s investigator.

The Court conceded that damages would not have been an adequate alternative remedy for the Claimant, because awarding damages would not prevent the further dissipation of the Client’s assets. Mr. Justice Trower noted that the “balance of convenience” came down “firmly” in favour of granting the relief sought.

On the topic of disclosure orders against the Crypto-Exchanges, the Court made the requested orders having considered that the disclosure of the information sought had a “real prospect” of helping the Claimant recover his crypto-assets and also noting that the order should be granted notwithstanding any duty of confidentiality owed by the Crypto-Exchanges to any third parties.

The Court then considered the means by which notice of the orders made would be served on the fraudsters. Counsel for the Claimant had requested service by email and also by NFT in the form of an airdrop into the accounts associated with the Website, into which the Claimant first deposited his crypto assets. The Judge, Mr. Justice Trower, was bold in his assertion that there “could be no objection” to the request, noting that service by this means would “embed the service in the blockchain” and would only enhance the prospect of the fraudsters being made aware of the Court orders and the proceedings more generally. However, Mr. Justice Trower did observe that it was important that service was also made by email and that he might not have been content to order alternative service solely by NFT.

The decisions in this case are to be welcomed as they only serve to enhance the prospects of recovery of lost assets for victims of fraud. The willingness of the Court to embrace the benefits of blockchain technology to serve notice on those who seek to hide behind its anonymity should be applauded and we can only hope that the Court will continue along this trajectory.

Indeed, as fraudulent activities in respect of cryptocurrencies and other digital assets are on the rise, the frequency of such applications will likely only increase and it is surely only a matter of time before crypto businesses established in the Cayman Islands are dealing with such matters on a regular basis.

The case also serves as a warning to those who operate crypto exchanges that the Courts are more than willing to entertain claims based on constructive trust where the misappropriated assets are traced to accounts hosted by them. One can only hope that this will spur these organisations into action to take all necessary steps to combat fraudulent activities, such as freezing the accounts into which misappropriated assets are transferred on receipt of notice.

[1] [2022] EWHC 1723 (Ch)

[2] (unreported) [2020] (Comm.)

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Digital asset litigation, please contact your usual Loeb Smith attorney or :

Robert Farrell
E:robert.farrell@loebsmith.com
T: +1 345 749 7499

The Report found that the most common jurisdictions where crypto open-ended funds are domiciled are:

Cayman Islands – is the preferred place with almost half of the market (49%).

British Virgin Islands (“BVI”) with 13%. The BVI has overtaken the United States as the second most popular location. Each location saw its share of the market increase slightly year on year, Cayman Islands from 48% to 49% and British Virgin Islands from 11% to 13%.

The United States saw their market share reduced from 46% to 10% during 2021.

The Report lists factors which influence the decision on crypto hedge fund domiciles and the most popular answers were due to ‘crypto friendly’ (22%), ‘regulations’ (20%) and ‘fund friendly’ regulations (17%). This indicates that as many governments and authorities still take a rather unfriendly or indifferent approach towards the crypto industry, or rather are still trying to figure out the correct mix of regulations, other jurisdictions like Cayman and the BVI have stepped up and provided solutions that appear to tick most of the boxes for making them attractive as domiciles for these types of investment funds.

As per the Report, the total assets under management (“AUM”) of crypto open-ended funds increased by 8% to about $4.1 billion in 2021, compared to $3.8 billion reported by respondents to the Report in 2020. According to the Report, there were fewer funds with lower levels of AUM at the end of 2021, while at the other end of the spectrum, the number of funds managing larger amounts of assets was considerably higher.

A significant detail shown in the Report is that 89 hedge funds accounted for an estimated US$436 billion in AUM.

According to the Report, the average management fees for 2021 in crypto open-ended funds remained the same (2.2%). The lack of significant change in management fees is likely to reflect the fact that running costs could have remained at a similar level in relation to previous years. The average performance fee slightly decreased (from 22.5% to 21.6%). The decreased performance fees are likely to be a result of competitive pressures starting to increase, as more funds enter the cryptocurrency space and compete to attract new investors, leading to slightly lower overall fees.

The Report raised concerns regarding the upcoming higher organizational cost of crypto open-ended funds as worldwide regulations are becoming more detailed and investors are demanding more professional and institutional set-ups.

The Report identified High-net worth individuals (“HNWI”) as the most common investor type in crypto open-ended funds, with more than 80% of surveyed funds stating them as their usual type of investor. HNWIs are followed by family offices accounting for 66% and fund-of-funds representing just over 53% in third place, where HNWIs are also the largest investors within these fund-of-funds.

Having in mind that the Report surveyed retail crypto open-ended funds, the average number of investors per fund is 54. However, a more representative value could be the median number of investors, which is 30.

The Report found that the average investment made into crypto open-ended funds is $1.63M but most funds have a ticket size of less than $0.5M.

The Report states that 29% of the crypto open-ended funds surveyed have at least half of their daily cryptocurrency trading volume in Bitcoin compared with 56% in 2020.

The top three sectors that crypto hedge funds have invested into are Store of Value (Bitcoin and Litecoin) with 86%, DeFi (Uni, Aave and Sushi) with 78%, and Infrastructure (Ethereum) with 74% based cryptocurrencies.

In 2021 more altcoins have been traded by over 40% of the funds compared to last year where only one altcoin (Ethereum) was traded by more than 40% of the funds. 2021 shows that Ethereum (ETH, 83%), Solana (SOL, 51%), Polkadot (DOT, 48%), Terra (LUNA, 45%), and Avalanche (AVAX, 42%), were the top traded coins (stable coins were excluded).

However, the recent incident of the collapse of LUNA could become a setback for the general crypto industry in the short term.

Market Neutral: The most common (30%) investment strategy among crypto open-ended funds is Market Neutral. These funds aim to profit regardless of the direction of the market, usually using derivatives to mitigate or eliminate broader market risk.

Quantitative Long Short: This investment strategy makes up for a quarter of all currently active crypto funds with a 25%. Quantitative funds, also called quant funds, are investment funds where crypto are chosen based on numerical data compiled through quantitative analysis. Liquidity is key for these strategies and restricts these funds to only trading more liquid cryptocurrencies.

Discretionary long only: This investment strategy represents a 14% of all the crypto fund. For crypto open-ended funds involved in investing in early token and coin offering and investing and holding in other more liquid cryptocurrencies and digital assets.

Discretionary long/short strategy: This investment strategy represents a 12%. For crypto open-ended funds, discretionary long/short strategy involves buying cryptocurrencies and digital assets that are expected to increase in value and selling short cryptocurrencies and digital assets that are expected to decrease in value.

Multi-strategy funds: Lastly, the multi-strategy funds (a combination of all the above) represent a much smaller proportion with barely 12% of the market.

In terms of performance these strategies had very different results. Market Neutral funds gave an average performance of +37%, Discretionary Long an average performance of +420% and Quantitative Long/Short an average performance of +116%. Against the trend from previous years, the crypto hedge funds had a median performance of 63.4% in 2021, slightly outperforming BTC’s price, which went up about 60%.

Custodian: Interestingly, as the crypto ecosystem continues to mature and institutional investors’ demands are allocated, the Report shows that the digital asset custody market has expanded. This has led to the utilization of independent custodians. Compared to the 2020 data, the use of independent custodians has increased from 76% to 82%, with funds opting either for third-party, or exchange custodians. For example, quantitative fund, discretionary long/short and multi-strategy funds may have their cryptocurrencies and digital assets directly with the exchanges that they use to trade continuously. Therefore, having a well-defined and updated risk management policy is more important than having a custodian.

Independent Directors:  The Report reflects that in 2021, there has been an increase in the percentage of crypto open-ended funds with an independent director on their board from 38% to 51%. This number increased due to three main reasons:

A growing number of newly formed, governance-conscious funds driving demand for independent directors;

existing crypto hedge funds becoming more structured and financially capable of hiring senior talent; and

A growing supply of board directors possessing industry-specific expertise and knowledge as the industry further matures.

Administrator: 91% of the crypto open-ended funds surveyed for the Report have appointed and use independent third-party administrators. The main service required by these funds from the administrators is to independently calculate and verify the net asset value and prepare all the required information for the auditor.

Institutional and/or sophisticated investors are increasingly unwilling to invest in a crypto open-ended fund that has not appointed an independent fund administrator.

Regardless of the choice of fund administrator, the valuation policy needs particular focus. Most funds will have their valuation methodologies and frameworks set out in the Private Placement Memorandum (PPM). It is important for any fund to ensure that it complies with the key terms of the offering set out in its offering documentation.

Institutional and Sophisticated investors are familiarized with the Cayman Islands and BVI and the regulatory regime for open-ended funds. These investors feel more comfortable investing in crypto open-ended funds established in Cayman and BVI as these two offshore jurisdictions have a track record, infrastructure and regulation that facilitate the operation of these funds.

The investment funds industry is slowly starting to consider the cryptocurrencies and other digital assets as other underlying assets that an open-ended fund can invest in.

The tax neutrality of the Cayman Islands and the BVI provides the perfect location for crypto open-ended funds and investors to manage their tax affairs in the most effective manner.

The laws of the Cayman Islands and the BVI are a combination of common law and statute and are based heavily upon English common law. This gives Cayman Islands and BVI law and their respective legal systems a common origin with those of many of the jurisdictions of its users, including the United States. It also means that a fund registered in the Cayman Islands or the BVI and its participating shares are well recognised and accepted around the world.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Crypto open-ended funds, please contact your usual Loeb Smith attorney or :

Santiago Mtnez-Carvajal
E: santiago.carvajal@loebsmith.com
T: +1 345 749 7593

The Grand Court of the Cayman Islands has recently offered additional, useful guidance in the growing jurisprudence on the insolvency of Segregated Portfolio Companies (“SPCs”). We have previously discussed the applicable test of insolvency that applies to the appointment of a receiver in respect of a segregated portfolio (“SP”) of an SPC here.

In this article, we will consider the recently handed down judgment in In the Matter of Performance Insurance Company SPC (in official liquidation)[1] and the implications of this for SPCs and SPs as well as the impact that the new Restructuring Officer regime might have in cases of insolvent SPCs and SPs.

An SPC is a legal entity incorporated pursuant to Part XIV of the Cayman Islands Companies Act (2022 Revision) (the “Act”). SPCs can create one or more SPs but crucially, whilst an SPC has its own legal personality, SPs do not.[2] However, the assets and liabilities of an SP benefit from a statutory “ring-fence” from the assets and liabilities of any other SPs of the SPC and from the general assets and liabilities of the SPC.[3] Therefore, a creditor of one SP, does not have any recourse to the assets of other SPs or, subject to any contrary terms in the SPC’s Memorandum and Articles of Association, the general assets of the SPC (and vice versa).[4]

To reinforce this principle, s.219(6) of the Act states that:

It shall be the duty of the directors of a segregated portfolio company to establish and maintain (or cause to be established and maintained) procedures –

a. to segregate, and keep segregated, portfolio assets separate and separately identifiable from general assets;

b. to segregate, and keep segregated, portfolio assets of each segregated portfolio separate and separately identifiable from segregated portfolio assets of any other segregated portfolio; and

c. to ensure that assets and liabilities are not transferred between segregated portfolios or between a segregated portfolio and the general assets otherwise than at full value.”

In the Cayman Islands, SPC structures are commonly used to establish investment funds, given their inherent flexibility to, among other things, facilitate the pursuance of multiple strategies and/or hybrid funds. For example, a single SPC could establish separate SPs to pursue multiple investment strategies or to invest in different asset classes (e.g. public securities, private equity and cryptocurrency).

However, this structure is not without its complexities, particularly in the event of insolvency. For example, if an SPC and some, but not all, of its SPs are insolvent, what is to become of those that are solvent and should their assets be available to affected creditors to make good any shortfall in the insolvent SPs? These issues were recently considered by the Grand Court in the matter of Performance Insurance Company SPC (in official liquidation).

The case relates to Performance Insurance Company SPC (the “Company”) and certain of its SPs, in particular Bottini SP (“Bottini”) and SSS SP (“SSS”). The Company was placed into voluntary liquidation in February 2021 after the Company and certain of its SPs (but not Bottini or SSS which both remained solvent and continued to operate as usual) were the victims of an alleged fraud.

The Joint Official Liquidators (“JOLs”) of the Company intended to wind up the Company and the insolvent SPs. It was further intended that the solvent SPs (including Bottini and SSS) would be novated to new structures which they would themselves select. However, the JOLs would not permit such novation to take place unless and until the solvent SPs agreed to be responsible for a pro rata share of the costs and expenses of the liquidation, which amounted to hundreds of thousands of dollars.

The shareholders of Bottini and SSS therefore sought the appointment of an additional joint official liquidator (“AJOL”) as they considered the JOLs to be conflicted, and which was prejudicial to the interests of the solvent SPs. It was submitted that the nature of the conflict arose from the fundamental feature of SPCs that segregates assets and liabilities of each SP from other SPs, as the JOLs were effectively attempting to prioritize the funding of the costs of the liquidation over the interests and entitlement of the stakeholders in the solvent SPs.

In their submissions, the shareholders of Bottini and SSS cited s.223(1) of the Act which requires liquidators to “deal with the company’s assets only in accordance with the procedures set out in section 219(6)”, which is quoted above. It therefore follows, they argued, that a liquidator’s ability to pay an insolvent company’s liabilities and expenses (including the liquidator’s remuneration) does not automatically extend to the SPs of the company in question. They argued that to find otherwise would undermine this part of the Act and would render s.219(6) in particular, meaningless.

The Grand Court accepted the submissions of the shareholders of Bottini and SSS and ordered the appointment of the AJOL with their powers and those of the JOLs to be limited such that: (1) the JOLs were no longer empowered to act in respect of either Bottini and/or SSS; (2) the AJOL has sole and exclusive responsibility for Bottini and SSS; and (3) the fees and expenses of the JOLs are not the responsibility of Bottini and/or SSS, whose sole responsibility for costs is those of the AJOL.

Further, the Grand Court affirmed that the principles set out in s.219(6) of the Act (whereby the assets of SPs are not available to guarantee or ‘back stop’ the general liabilities and expenses of the SPC) apply equally where the SPC in question is in liquidation.

Commenting on the appointment of the AJOL, the Grand Court considered that it would be “necessary and appropriate” to make such an order in other cases where the joint official liquidators in question are “reasonably perceived to be conflicted” and where such conflict causes difficulties “in respect of the allocation of their fees and expenses as between the insolvent SPs and solvent SPs”.

In our view, the Grand Court reached the only logical conclusion based on the Act as it is currently drafted. This judgment is certainly welcome in casting light on the issue of conflicted joint official liquidators and illuminating the remedies that stakeholders in solvent SPs have available to them, should they consider that the liquidators in question are over-stepping.

We have previously considered the full implications of the proposed amendments to Part V of the Act here. The Restructuring Officer Regime will of course apply equally to SPCs and it will be interesting to observe how practice develops in this space, especially in circumstances similar to those described in Performance Insurance Company SPC (in official liquidation).

For example, if an SPC and certain (but not all) of its SPs are insolvent, what role will any solvent SPs be able to play in a restructuring? It would seem to be illogical to exclude them as this would be tantamount to splitting the SPC and its SPs up; but one can foresee that it will be easy for the waters to be muddied further between the solvent and insolvent SPs whilst the restructuring is negotiated and implemented.

Whilst in the context of joint official liquidators, it is, as we saw in Performance Insurance Company SPC (in official liquidation), sometimes ‘necessary and appropriate’ for an additional joint official liquidator to be appointed to address actual or perceived conflicts of interest, will it also be appropriate for an interim restructuring officer to be appointed in respect of solvent SPs for similar reasons where it is in the interests of the relevant SP to do so.

The clarity provided by Performance Insurance Company SPC (in official liquidation) and the procedural efficiencies which it is hoped and expected will be delivered by the Restructuring Officer Regime are welcome and possibly very timely.

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[1] FSD No. 70 of 2021 (RPJ).
[2] s.216(2) of the Act.
[3] s.216(1) of the Act.
[4] s.220 of the Act.
[5] Per s.91C of the Companies (Amendment Bill), 2021, Supplement No.1 published with Legislation Gazette No.58 dated 21 October 2021

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on insolvency of Segregated Portfolio Companies, please contact your usual Loeb Smith attorney or:

Gary Smith
E: gary.smith@loebsmith.com
T: +1 345 749 7590

Robert Farrell
E: robert.farrell@loebsmith.com
T: +1 345 749 7499