BACKGROUND
This month, the Commercial Litigation Division of the Delaware High Court Complex answered a new question about Delaware law: “When the consideration to be paid on a contract is in cryptocurrency and the contract is violated, how does the Court calculate the decision to be made?”1 Considering that the issue was a “novel matter for Delaware,” Judge Paul R. Wallace, as the first matter impressed, pinned down the value of the typically liquid cryptocurrency and awarded US $ 25 million in damages for issuing the contract.2
ANALYSIS
At Diamond Fortress Technologies Inc. v. EverID Inc.Defendant EverID, Inc. (EverID) failed to provide compensation to the plaintiff, Diamond Fortress Technologies, Inc. (Diamond Fortress) and CEO Charles Hatcher II, for his work helping develop the EverID cryptocurrency trading platform.
Diamond Fortress is a biometric software company that develops software to allow smartphone cameras to detect and verify users with fingerprint recognition. EverID is an active entity in the blockchain and cryptocurrency industry. This creates a cryptocurrency called an “ID token.” EverID licensed Diamond Fortress software to be integrated into the EverID cryptocurrency platform for verification and confirmation of user identities. EverID also retained Mr. Hatcher to serve as an advisor to the integration process. Under the terms of the license agreement, Diamond Fortress will receive 10 million ID tokens and Mr Hatcher will receive 2.5 million. Both parties will receive an ID token after the initial coin offering (ICO).3
The ICO happened on February 8, 2021. However, EverID failed to pay the tender. Diamond Fortress tried to contact EverID several times between February 8 and March 4, but received no response. Diamond Fortress and Mr Hatcher then filed a lawsuit for breach of contract. EverID did not respond to the complaint or defend itself, and the plaintiffs sought standard punishment.
As Judge Wallace noted, the case of indirect contract breach poses a novel problem: What is the remedy if the consideration is a new cryptocurrency with a “volatile and unregulated” value,4 and when calculating its value, should the court classify the cryptocurrency as a “security / investment contract, commodity, property, or currency?”5
First, the court noted that the other “[c]Ourts generally classifies cryptocurrency as a security when economic damage is directly related to or arises from the ICO.6 Here, the court concluded, EverID’s failure to distribute ID tokens on the ICO date was the direct cause of plaintiff’s injury.7 The court further noted that the license agreement provided for the distribution to be subject to regulations under Rule 144 of the Stock Exchange Act of 1933. Therefore, the court viewed the ID token in those circumstances as security.
Next, the court is required to find a reliable cryptocurrency valuation source to determine the value of the ID token. The court noted that other courts have used CoinMarketCap as a reliable valuation tool to determine the value of cryptocurrency tokens and Wall Street Journal with Financial Times also uses CoinMarketCap to report the price of a virtual currency.
Finally, the court is required to determine the appropriate way to calculate the damages so that plaintiffs in the same position will be dealt with once the license agreement is concluded. The court noted that in the case of “failure to deliver securities,” the Delaware court calculated damages by determining “the highest market price of the security within a reasonable period of time when the plaintiff was found guilty of the breach.”8 The court ruled that the three -month period from March 4, 2021 to June 3, 2021 was “sufficient time”. According to CoinMarketCap, the highest market price of an ID token between March 4 and June 3 is US $ 2.01.
Hence, using this analysis, the court calculated damages for 10 million Diamond Fortress ID tokens to be US $ 20,100,000 and damages for 2.5 million Mr. Hatcher ID tokens to be US $ 5,025,000.
KEY takeaways
As Judge Wallace said, “[b]For the novelty of the subject instrument as a cryptocurrency unit, this setting reflects another failure to submit a run-of-the-mill securities-action case to Delaware courts.9 The court’s decision – in which Judge Wallace noted the “lack of cryptocurrency regulatory policy” “in full view” – was reached when Congress considered the Digital Asset Market Structure and the Investor Protection Act, which would regulate digital assets and digital asset securities. . The U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission will be required to issue proposed rules within 150 days after the bill classifies major digital assets by the highest market capitalization or daily trading volume. The law, Judge Wallace also observed, referred two federal agencies to CoinMarketCap as a relevant public source for data on digital assets.
The decision reflects the proliferation of digital assets, cryptocurrencies, and other applications powered by blockchain technology and provides useful guidance on how courts will respect cryptocurrencies when tasked with calculating compensation awards.
Footnote
1 Diamond Fortress Technique. Inc. v. EverID Inc., CA N21C-05-048-PRW-CCLD (14 April 2022).
2 Id.
3 As explained by the court, an ICO occurs when “a new species of cryptocurrency token is issued in exchange for fiat or has been circulating virtual currency to raise capital.” Id. at 12.
4 Id. at 30.
5 Id. at 14.
6 Id. at 23 (citing AS Sec. & Ex. Comm’n v. Kik Interactive Inc., 492 F. Supp. 3d 169 (SDNY 2020)).
7 Id. at 24.
8 Id. at 32 (citing Am. Gen. Corp. v. Cont’l Airlines Corp., 622 A.2d 1 (Del. Ch. 1992)).
9 Id. at 32–33.
