May an online digital currency platform compel arbitration in a proposed class action brought by a former customer of a now-defunct cryptocurrency exchange?

No, the U.S. Court of Appeals for the Eleventh Circuit has ruled, finding that the plaintiff’s allegations were based not on the user agreement at issue but on violations of federal statutes and regulations such as the Bank Secrecy Act (BSA).

What happened

As part of its business, Coinbase Inc. operates a website where its customers may purchase, exchange and sell digital cryptocurrencies, such as bitcoin. One of the services provided by the company is a “Conversion Service” through which its customers may convert their cryptocurrencies into cash. For a fee, Coinbase will buy its customers’ bitcoin at a predetermined “Conversion Rate” published on its website.

In May 2013, Paul Vernon opened two accounts with Coinbase: one for himself and one for his company, which did business under the name Cryptsy. The business, of which Vernon was the founder, president and CEO, was a cryptocurrency exchange where customers could trade bitcoin and other digital cryptocurrencies. To open his accounts with Coinbase, Vernon accepted the company’s user agreement, which included an arbitration clause.

Over the course of almost three years, Vernon used Coinbase’s services to convert more than $8 million of Cryptsy’s customers’ bitcoin into cash, which he deposited into his personal account. Vernon then fled the country.

Cryptsy customer Brandon Leidel was one of the individuals who filed a putative class action against Vernon and Cryptsy; Leidel and the court-appointed receiver of Cryptsy then filed suit against Coinbase. The plaintiffs brought claims alleging the company aided and abetted Cryptsy’s breaches of its fiduciary duty to its customers and Vernon’s theft of customer assets, as well as claims for negligence and unjust enrichment. Coinbase had these duties pursuant to various federal statutes and regulations, the plaintiffs claimed, particularly the BSA and its implementing regulations.

Coinbase then moved to compel arbitration pursuant to the user agreement. The defendant argued the receiver was bound by the arbitration clause that Cryptsy, through Vernon, entered into because the receiver stepped into Cryptsy’s shoes with respect to the agreement. As for Leidel, the doctrine of equitable estoppel bound him to the arbitration clause because his claims relied on a duty owed by Coinbase to Cryptsy’s customers that arose—if at all—under the user agreement, the defendant told the court.

The district court denied the motion to compel arbitration, and Coinbase appealed. The Eleventh Circuit affirmed the denial, applying both California and Florida law.

Under Florida law, the party seeking to compel arbitration must show both that the plaintiff is relying on a contract to assert its claims and that the scope of the arbitration clause in that contract covers the dispute. Coinbase failed that test, the court said, because Leidel’s claims were based on the defendant’s alleged failure to adequately monitor or investigate Cryptsy’s and Vernon’s use of the Coinbase website, detect Vernon’s theft of Cryptsy’s customers’ bitcoin and report suspicious activity to the appropriate authorities.

“According to the complaint, these duties were imposed on Defendant by the Bank Secrecy Act and its implementing regulations not for the protection of Defendant’s customers, but to detect money laundering and other suspicious or illegal activities by Defendant’s customers,” the court ruled. “Because Leidel’s claims rely on obligations allegedly imposed by law and in recognition of public policy to persons who are strangers to the User Agreements, his claims neither rely on nor bear a significant relationship to those agreements.”

The appeals court reached a similar conclusion with regard to the application of California law, where the focus was on the nature of the claims asserted. “Leidel does not seek to enforce the terms or obligations of the User Agreements entered into by Vernon and Cryptsy,” the court said. “Instead, Leidel seeks to enforce obligations allegedly imposed on Defendant by federal statutes, federal regulations and state common law. Because Leidel does not rely on the User Agreements to establish his cause of action, he is not estopped from avoiding the arbitration clauses in those agreements under California law.”

If Leidel’s claims are viable, the panel noted, it is without reference to the user agreements, as the duties Coinbase allegedly breached were not imposed by those agreements.

As arbitration could not be compelled under either California or Florida law, the Eleventh Circuit affirmed dismissal of the defendant’s motion to compel arbitration.

To read the opinion in Leidel v. Coinbase, Inc., click here.

Why it matters

While the Eleventh Circuit’s opinion denying the order to compel arbitration is a clear battle victory for the plaintiff, he faces an uphill struggle to win the suit on the merits, and thus the ruling is not quite as impactful as it may appear. Leidel must now argue that Coinbase had a duty under the statute to combat the underlying fraudulent activity of one of its customers that harmed a third party. While regulators have had success with similar theories, Leidel’s status as a private party—and the fact the BSA lacks a private right of action—may provide him little to hang his hat on.