Betting on Bitcoin: the law on directors’ duties and cryptocurrencies

Bitcoin has hit an all-time-high this week, breaching AUD$60,000 and appears to be in a new price-discovery phase. The rise is, at least partially, coming off the back of ubiquitous American electric vehicle automotive company, Tesla, confirming in SEC filings that the company purchased $1.5 billion US of the cryptocurrency in January 2021.

 

They are not alone. American business intelligence company MicroStrategy, which perhaps could have previously been described as an obscure company, has been making headlines for months for converting over $1 billion in its cash reserves into Bitcoin as a hedge against inflation (Bitcoin has been described as deflationary because its supply halves approximately every four years). CEO Michael Saylor has been outspoken about Bitcoin and in February 2021 hosted a "Bitcoin for Corporations" conference and published its "Bitcoin Corporate Playbook".

The surge in corporate interest in cryptocurrencies and the recent institutional investments invite the question: what legal issues may arise in Australia?

This article will canvass just a few of the many examples of the intersection of cryptocurrencies and the Australian law of corporate governance.

Duty of care and the business judgment rule

Imagine a scenario in which a director of an Australian company decides to jump on the train and convert some cash holdings into cryptocurrency. Whether as a hedge against inflation or as a speculative investment, the company decides to purchase a significant amount of Bitcoin. If the price of Bitcoin crashed, could the company directors be in breach of their duties? Could the company's shareholders be successful in a claim against the directors?

Unsurprisingly, there is no direct law on point, however, we can reason by analogy as to what may happen.

Directors of companies owe duties to it under the Corporations Act 2001 (Cth). One of those duties is found in section 180:

"A director … of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise [if they were a director in the circumstances]."

The question then becomes, if a director causes a company to purchase cryptocurrency are they acting with the requisite degree of care and diligence? Section 180(2) gives directors protection through the "business judgment rule", which provides that a director will have acted with the requisite degree of care and skill if they make a business judgment (that is, a decision about the business operation of the company) that:
  1. is in good faith and for a proper purpose;
  2. he director does not have a material personal interest in;
  3. the director informs themselves about the subject matter of the judgment; and
  4. the director rationally believes is in the best interest of the company.
The purpose of the business judgment rule is to limit the Court's ability to look at company affairs in hindsight and criticise legitimate business decisions that may have seemed sensible to the directors at the time.

Some factors that may be relevant in considering whether a purchase of cryptocurrencies on behalf of the company may be protected by the business judgment rule are considered out below:

  1. Why did the directors purchase the cryptocurrency on behalf of the company? What were they trying to achieve? Does the company typically hold large amounts of cash or other investments, or is this a significant departure from the operation of the business?
  1. How much of the company's cash was converted into cryptocurrencies? Is the company left with sufficient liquidity to meet its debts as and when they fall due (see also section 588G for a director's duty to prevent insolvent trading).
  1. Do the directors hold any significant amount of the specific cryptocurrency themselves? Whilst the total market capitalisation of Bitcoin is high (as of the time of writing it has just surpassed Facebook's market cap), large purchases of smaller cryptocurrencies (nicknamed "altcoins" because they are alternatives to Bitcoin) may result in significant price increases. Could it be said that the director is trying to manipulate the price of an altcoin they own for personal gain by using the company's resources to purchase them? This would almost certainly contravene other sections of the Corporations Act (and other legislation), and may also be a breach of a directors' duty not to misuse their position to make a gain (contained in sections 182 and 184 of the Corporations Act).
  1. Have the directors taken steps to inform themselves about the cryptocurrency in question and still consider it appropriate to proceed (for example different cryptocurrencies have different features such as use cases, scarcity, and transaction speed)?
  1. Has the director simply relied on their employees or advisors in making the decision, or have they actively taken steps to learn about what they are doing? Did they seek legal or financial advice about the decision to make the purchase?
  1. Can the director rationally explain the decision making process behind the purchase? For example, a director may consider that the company had excess liquidity and because of low interest rates when compared to inflation they decided to the make the decision that the company should move out of holding significant amounts of cash.
These are not exhaustive and no one factor will necessarily be determinative, but they are intended as a guide to some of the questions that may be on the Court's mind if this issue was litigated.

Burning a hole in your pocket

In 2016 Barack Obama described widespread cryptocurrency adoption as being "as if everybody has a Swiss bank account in their pocket". Perhaps a better analogy was given by British entrepreneur Andreas Antonopoulos as having an entire "Swiss bank in your pocket". Of course, both of these analogies have something in common: the pocket.

In January 2021, the New York Times reported that of the total 21 million Bitcoin that will ever exist, between 3 and 4 million (being 20% of the 18.5 million that have been mined to date) has been lost forever.

Bitcoin offers businesses and people the opportunity of "being their own bank". However, this comes with the risks associated with being your own bank. What if you lose the money? Lost passwords, damaged hard drives, phishing scams, rogue employees, or data breaches from third party wallet suppliers or cryptocurrency exchanges could result in a financial catastrophe for a business holding cryptocurrencies. All of these challenges may be overcome with proper systems, but what if those systems are not in place?

It is possible that if a significant amount of Bitcoin held by a business is lost due to inadequate systems to protect it, the directors may be liable for a breach of section 180 for failing to act with the requisite degree of care and skill to prevent this from happening.

The brave new world

This is a novel area, and it may be years before these questions are ever tested by the Courts. It may be that in the future, with the benefit of hindsight, the questions raised above will seem quaint and akin to asking if it is a breach of directors' duties for causing a company to invest money in securities. Only time will tell.

This will not be the only legal challenge that the development of cryptocurrencies as a new asset class will pose for the Courts. The sun is almost certainly going to rise on new issues such as blockchain smart contracts, forensic accountants reviewing public transactions recorded on a blockchain, and Courts having to reconcile how to give effect to freezing orders such as Mareva injunctions when there is no bank to do the freezing – nothing can stop the owner from moving it to anywhere in the world.

Our legal system will have to deal with what Forbes Magazine has described as the "separation of money and state" that is being presented by Bitcoin. We will continue to keep our eyes fixed on the new dawn for this technology and the law.

If any of the matters raised in this article have piqued your interest, do not hesitate to get in contact with us. Our Litigation and Dispute Resolution Group and Corporate Group have experience in advising on all manners of novel issues of corporate governance and disputes.

Contributors

Luke Dominish Associate