ROLE OF ENGLISH COMMON LAW IN CRYPTO ASSETS REGULATION | by Digital & Analogue Partners | Coinmonks | Dec, 2023

Let’s delve into the intersection of English law and crypto regulation. How do principles, established over centuries, remain relevant and effective in the emerging and rapidly evolving crypto space? This piece offers insights into the adaptability of English law, demonstrating its crucial role in shaping the legal framework for the future of digital assets.

TO THE ROOTS OF ENGLISH LAW

The evolution of English common law, beginning with the Norman Conquest of 1066, marked a significant transformation in the legal landscape of England. Before the Conquest, English law was a patchwork of local customs and practices, varying significantly from one region to another. However, after 1066, William the Conqueror and his successors began centralising legal authority, integrating Norman legal concepts with existing Anglo-Saxon laws. This blend of Norman and Saxon elements gradually evolved into a more uniform and coherent system.

One of the pivotal developments in the evolution of common law was the establishment of royal courts that traversed the country to administer justice, replacing the localised and often inconsistent feudal courts. These itinerant courts helped standardise legal principles across the country. Furthermore, the 12th and 13th centuries saw the emergence of common law as a distinct body of law, separate from canon law and the more codified civil law used in Europe. The principles of common law were developed and refined through judicial decisions, and these case precedents became a critical source of law, continuing to hold significant influence up to the present day.

Another critical aspect in developing English common law was its interaction and eventual integration with equity law. Originating as a corrective system to address the rigidity and potential injustices of common law, equity law emerged as a means to ensure fairness and justice. Administered by the Court of Chancery under the Lord Chancellor, equity law focused on principles of conscience and fairness, offering remedies where common law might be silent or inadequate. Equity introduced unique remedies, such as injunctions, specific performance, and the creation of trusts, which were unavailable in common law courts.

The convergence of common law and equity significantly advanced with the Judicature Act of 1875, which unified the administration of both systems within a single court system. This integration meant that courts could apply legal and equitable principles and remedies in their judgments, allowing for a more comprehensive and just legal process. This synthesis ensured adherence to established rules while addressing the nuances and complexities of individual cases with fairness, contributing to the adaptability and resilience of the common law system. As it evolved over the centuries, influenced by changing social, economic, and political conditions, common law became known for its flexibility and reliance on judicial precedent.

FROM ENGLAND TO OTHER JURISDICTIONS

Building on its origins in England, the principles and structure of common law have significantly influenced the legal systems of various nations, notably the United States and the member states of the Commonwealth. The transplantation and adaptation of English common law to these regions occurred primarily through British colonisation and the subsequent development of independent legal systems in these countries.

English common law was integral to the legal framework during the colonial period in the United States. After independence, while the US developed its unique legal system, it retained the core principles of common law, particularly its reliance on judicial precedents and case law. Similarly, in the nations of the Commonwealth former territories of the British Empire, English common law forms the basis of their legal systems.

Countries like Canada, Australia, and New Zealand have adapted the common law framework to suit their specific legal and cultural contexts. While they have incorporated their statutes and sometimes blended them with other legal traditions, the foundational principles of common law, such as the importance of precedent and the judiciary’s role in interpreting the law, remain central. Although specific rules and applications may differ across these countries, the established legal principles of common law continue to underpin their legal systems, ensuring consistency and continuity in legal reasoning and decision-making. Nevertheless, in making decisions on cases, common law courts tend to consider their case law primarily; yet, in case of the absence of relevant decisions, Commonwealth courts may turn to English law precedents.

FINANCIAL FREE ZONES CHERISH ENGLISH LAW

Financial free zones have become increasingly attractive to businesses and investors around the globe, offering a unique combination of economic and regulatory benefits. These specialised zones provide an ideal environment for financial activities, featuring tax efficiencies, simplified legal frameworks, and enhanced operational flexibility. Tailored to support the financial services sector, these zones cater to the specific needs of international businesses and investors, creating a dynamic, competitive financial ecosystem that promotes innovation and growth in key sectors. As such, they are recognised as strategic hubs in the global finance landscape, drawing various financial institutions and investment opportunities.

A key aspect contributing to the attractiveness of financial free zones (e.g. Abu Dhabi Global Market (UAE) and Astana International Financial Centre (Kazakhstan)) is their adoption of English law, which further cements their status as global financial hubs. Known for its fairness, predictability, and transparency, English law offers a reliable legal foundation that international investors and businesses trust. This choice ensures that complex financial transactions are governed by a well-established and widely understood legal system, complementing the zones’ economic and regulatory strengths with an added layer of legal security and predictability.

Furthermore, the adaptability of English law to market trends and financial innovations ensures that these zones remain at the cutting edge of global finance. This adaptability is particularly evident in the zones’ approach to crypto assets, as they attract crypto enthusiasts by offering clear and contemporary crypto regulations. English law’s ability to seamlessly integrate new classes of assets and respond to evolving economic conditions renders it an ideal legal framework for these rapidly developing financial centres. Consequently, financial free zones governed by English law provide economic and regulatory benefits and a dynamic and robust legal environment.

ABU DHABI GLOBAL MARKET IS NO EXCEPTION

From its inception in 2013, the Abu Dhabi Global Market (ADGM) has functioned under the framework of English law. This formalisation was enshrined in the ADGM Application of English Law Regulations 2015. However, it wasn’t until November 17, 2023, that the ADGM Court of Appeal issued a landmark judgment on AC Network Holding Ltd. v. Polymath Ekar SPV1 that provided a detailed interpretation of how English common law applies within the ADGM.

“Among the advantages of ADGM’s approach that are mentioned in the Guidance Notes that have been issued about English Law in ADGM are that English law has direct precedential value in the ADGM Courts and that the body of precedent that it contains provides predictability to the law. The way this rule is to be applied by the ADGM judges is therefore a matter of some importance. They are not sitting as English judges. But they are bound to apply the rule laid down by the Article. This case provides us with an opportunity to explain the relationship between this rule and the English common law doctrine of precedent and how it is to be applied.” — AC Network Holding Ltd. v. Polymath Ekar SPV1 (2023) ADGMCA 0002

Interestingly, Lord Hope drew differences with the legal regime of its neighbour, Dubai International Financial Centre (DIFC), another UAE financial free zone.

“The rule which the Article lays down lies at the heart of the system of law that was created for ADGM. The position in the Dubai International Financial Centre (the “DIFC”) is different. Common law rules in various areas have been codified, and it is only if those rules or the laws of other relevant legal systems do not provide an answer that the laws of England and Wales are applied. In Forsyth Partners Global Distributors Limited, Forsyth Partners Group Holdings Limited and Forsyth Partners (Middle East) Limited (2007) DIFC 005/006/007, para 40, Justice Michael Hwang said that there was no natural presumption that UAE law or English law was intended to apply in the DIFC.” — Lord David Hope, Chief Justice of the Abu Dhabi Global Market Court of Appeal, 17 November 2023

While ADGM embraces English common law as the core of its legal framework, DIFC adopts a different methodology. Unlike ADGM, DIFC has not directly incorporated English law statutes nor explicitly enshrined common law principles, including equity rules, into its legal framework. Instead, the adoption of English law in DIFC is more a result of its laws being primarily based on, or derived from, English statutory law. DIFC possesses its distinct legislation, with Article 8(1) of the DIFC Law №3 of 2004, also known as the DIFC Application Law, stating that DIFC law prevails within its jurisdiction. In cases of gaps in DIFC law, particularly in civil and commercial matters, resolution can be sought by referring to (i) laws of a jurisdiction recognised by DIFC Law as applicable, (ii) laws of a jurisdiction mutually agreed upon by all relevant parties, (iii) laws of a jurisdiction deemed suitable by the DIFC Courts or arbitrators, and lastly, (iv) the laws of England and Wales. It indicates that for DIFC legislators and the judiciary, referencing the laws of England and Wales is a measure of last resort. Secondly, it provides them with enhanced flexibility to diverge from English law.

WHY IS ENGLISH COMMON LAW VITAL FOR CRYPTO REGULATION?

The rapid evolution of the crypto industry, which is advancing by days, if not hours, presents a significant challenge for legislators worldwide. Since the emergence of Bitcoin in 2008, it has taken most countries almost a decade to begin developing regulations for this new and complex sector, and the process is still ongoing. As the industry grows, the need for legal intervention in criminal and civil cases, ranging from fraud and economic crimes to contract law issues, becomes increasingly apparent.

In this context, the case of AC Network Holding Ltd. v. Polymath Ekar SPV1, although not directly linked to the crypto asset industry, holds substantial significance for its regulation. The case explicitly states that English law applies within the ADGM, enabling ADGM to rely on the well-established principles and extensive case law of English law. This finding is particularly crucial for ADGM, as this free zone is recognised as one of the most crypto-friendly jurisdictions in the world. ADGM adopted crypto regulations in 2018 and needed an established case law.

The relative novelty of the crypto industry means it needs to have the advantage of long-standing precedents or extensive practice to guide legal decisions. That is why the reliance on English law becomes vital. ADGM can now draw upon the rich experience and comprehensive case law developed over hundreds of years under English law. This foundation is especially beneficial in an industry that is new and rapidly evolving. Moreover, as English case law continues to evolve and adapt, the legal framework within ADGM will automatically update in tandem, ensuring that it remains current and relevant. This alignment with English law provides a robust and adaptable legal structure that is well-equipped to address the unique challenges and complexities of regulating the burgeoning cryptocurrency sector.

HOW OLD PRINCIPLES APPLY TO NEW CONCEPT

In 1965, Lord Wilberforce elaborated four criteria essential for defining property in the case of the National Provincial Bank v Ainsworth. These criteria state that:

“before a right or an interest can be admitted into the category of property, it must be definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability.” — National Provincial Bank v Ainsworth (1965) AC 1175

In 2019, the UK High Court applied these principles in a groundbreaking decision in AA v Persons Unknown and others. For the first time in common law, crypto-assets were defined as property. The court held that

“A crypto asset such as Bitcoin is property. They meet the four criteria set out in Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth (1965) as being definable, identifiable by third parties, capable in their nature of assumption by third parties, and having some degree of permanence.” — A v Persons Unknown and others (2019) EWHC 3556

The application of these decades-old principles to crypto assets has significant implications. For instance, recognising crypto assets as property clarifies their treatment for tax purposes, confirming that they should be considered property under tax laws. Furthermore, the judicial rationale behind classifying crypto assets as property appears to be geared towards protecting victims of crypto theft or fraud. The English courts now permit proprietary injunctions as a form of relief for such victims, a legal remedy that would not be available if crypto assets were not classified as property. This classification provides a legal framework for addressing disputes involving crypto assets and is crucial in enhancing the security and legitimacy of transactions involving digital currencies.

Another well-known and well-applied concept of common law derives from the US legal system, from the SEC v. W.J. Howey Co., 328 U.S. 293 (1946) case.

In SEC v. W.J. Howey Co., the United States Supreme Court developed the Howey Test, a crucial legal standard used by the U.S. Securities and Exchange Commission (SEC) to determine whether a given asset qualifies as a security. This test emerged from a dispute involving W.J. Howey Co., a Florida corporation that planted and sold orange groves, and its affiliated service company, which offered maintenance contracts for these groves. The case centred on whether the sale of orange grove plots and a service contract for cultivating and harvesting the oranges constituted an “investment contract” and thus a “security” under the Securities Act of 1933.

The Howey Test identifies an investment contract as a security if four elements are satisfied:

• There is an investment of money.
• The investment is in a common enterprise.
• There is a reasonable expectation of profits.
• These profits are to be derived from the efforts of others.

This test applies to any contract, scheme, or transaction, irrespective of whether it resembles traditional securities. It emphasises economic reality over form, focusing on the substance of the transaction.

The application of the Howey Test to crypto assets has significant implications. If a crypto asset is classified as a security under this test, it falls under the regulatory purview of the SEC. This classification means that the offering and sale of such assets must comply with federal securities laws, including requirements for registration and disclosure. The determination that a crypto asset is a security can impact the legal responsibilities of the issuers and traders of these assets, potentially subjecting them to regulatory scrutiny, reporting requirements, and legal obligations typically associated with securities transactions. This recognition also provides a framework for investor protection, as securities regulations are designed to ensure transparency, fairness, and accountability in financial dealings.

It is worth noting that the economic reality test based on the Howey Test applies in the US and worldwide. Therefore, if a crypto asset is deemed a security, it becomes subject to the financial and securities laws of the jurisdiction in question. By applying this test, regulators worldwide can ensure that the issuing, trading, and management of crypto assets comply with local securities laws, providing investor protection and maintaining market integrity. This uniform approach helps create a more stable and trustworthy environment for international crypto-asset transactions.

CONCLUSION

English common law is crucial in regulating crypto assets due to its adaptability and established principles. Its historical depth allows for the application of time-tested legal concepts to contemporary issues in the crypto space. This adaptability is theoretical and has practical implications, enhancing legal clarity and security in digital assets transactions.

Moreover, incorporating English law into financial free zones, such as the Abu Dhabi Global Market, exemplifies its global influence and the trust it commands in the international finance community. The blend of economic benefits these zones offer, coupled with the legal security of English law, creates an environment conducive to innovation and growth in the crypto sector.

The historical depth and flexibility of English law, capable of addressing both traditional legal issues and emerging technological challenges, make it an invaluable resource for businesses seeking a legal framework that can adapt to the rapid evolution of digital markets and technologies. Therefore, in scenarios where jurisdiction is unclear, or an election of applicable law is possible, opting for English common law offers businesses a robust legal foundation, enhancing their ability to navigate the complexities of the global digital landscape effectively.

This article was written by Liza Lobuteva & Yuriy Brisov of Digital & Analogue Partners. Visit dna.partners to learn more about our team and the services.

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