WAX tokens: Amendments to arbitration provisions still govern disputes

On August 13, the United States District Court for the Central District of California issued a stay of proceedings pending arbitration in the case of Crypto Asset Fund, LLC and Digital Capital Management, LLC (collectively, the plaintiffs) vs. OPSkins Group Inc., dba Worldwide Asset Exchange; Exposition Park Holdings SEZC; William Quigley; Jonathan Yantis; John Brechisci, Jr.; Malcolm Casselle; and Does 1-10, inclusive (collectively, the defendants).

The case revolved around the defendants’ sale of Worldwide Asset eXchange (WAX) tokens in an initial coin offering (the ICO) in 2017. The ICO was conducted in three phases, including a private presale, a public presale, and a “General Audience Main Sale.” Plaintiffs purchased $1.2 million worth of WAX during the private presale by transmitting US$1.2 million worth of Ether cryptocurrency to the defendants.

WAX tokens were released to certain investors in the ICO on or before December 19, 2017, while the plaintiffs received the tokens four days later. During those four days, the plaintiffs claimed that they “watched the price of a WAX token peak at over $5 while other favored investors realized millions of dollars in profits of which Plaintiffs were deprived due to Defendants’ failure and refusal to timely release the tokens they had purchased.” The plaintiffs were also asserting claims for violations of the Securities Act and Exchange Act, unlawful, unfair, and fraudulent business practices under California Business & Professions Code § 17200, breach of contract, breach of the covenant of good faith and fair dealing, unjust enrichment, promissory estoppel, fraud, and negligent misrepresentation, and were seeking compensatory damages including lost profits, restitution and disgorgement of profits, punitive damages, attorney fees, and injunctive and declaratory relief.

A terms of token sale (TOTS) was included in the set of transaction documents used in conjunction with the ICO. The TOTS included two key provisions examined by the court, arbitration and modification. The TOTS that was sent to the plaintiffs mandated arbitration by a single arbitrator in Los Angeles County, in accordance with the rules of the Judicial Arbitration and Mediation Services (JAMS). The draft TOTS also contained a modification clause stating that the terms would be modified at any time by posting a revised version on the defendants’ website, that it was the buyer’s responsibility to check the website for modification, and that the purchaser’s continued use of WAX tokens after any modification becomes effective constitutes acceptance of the modification.

Shortly after the plaintiffs’ purchase, the defendants modified the TOTS’s arbitration provision to mandate arbitration in the Cayman Islands, rather than Los Angeles, and under the American Arbitration Association’s Commercial Arbitration Rules, rather than the JAMS rules.

In this action, the court considered four separate motions brought by different groups of defendants asking to dismiss the claims because they are subject to arbitration, or stay the case pending arbitration. In examining this issue, the court first considered whether a valid arbitration agreement exists, then if the court or an arbitrator should decide the arbitrability of the plaintiffs’ claims, and finally if the court should dismiss or stay the case.

The court found that a valid arbitration agreement exists, overriding the plaintiffs’ claim that they are not a party to the TOTS after examining non-novel issues of agency and equitable estoppel.

The court also ruled that the arbitration agreement was not unenforceable on grounds of fraud, unconscionability and public policy, which requires both substantive and procedural unconscionability. The plaintiffs argued that the change of venue and ruleset to be used for arbitration was a “fraudulent bait and switch scheme,” and was used to induce them into buying WAX tokens. Here, the court found that the unilateral modification provision did not render the contract unenforceable, but even if it did, each version of the TOTS contained arbitration clauses.

The plaintiffs also argued that the TOTS was a contract of adhesion, “presented to prospective investors in a substantially weaker bargaining position on a take it or leave it basis with no room for negotiation.” Here, the court found there was no evidence of procedural unconscionability, as “the parties to this million-dollar exchange of cryptocurrency for a digital utility token were necessarily sophisticated individuals and entities.”

Interestingly, this conclusion by the court leaves open the issue of unconscionability due to a contract of adhesion with regards to individuals who invested less than the plaintiffs, because they would presumably not necessarily be considered sophisticated individuals and entities.

After concluding that a valid arbitration agreement exists, the court then considered whether arbitrability questions have been delegated to the arbitrator, and if so, whether the delegation clause is enforceable. The delegation clause in this case was found to be clear and unmistakable. The plaintiffs also stated that the delegation provision was procured by fraud and is unconscionable, but they made no arguments on the issue separate from whether the TOTS as a whole is unenforceable. Such arguments did not persuade the court that the delegation itself is not valid or enforceable, and thus the court concluded that the delegation clause is enforceable.

Finally, the court evaluated whether to stay or dismiss the case. The Federal Arbitration Act directs district courts to stay all proceedings pending completion of arbitration, and the court decided to do so, stating, “there is a ‘preference for staying an action pending arbitration rather than dismissing it.’”