Crypto fund investor loses injunction bid after court finds it would cause more harm than good

We’re used to seeing disgruntled cryptocurrency investors sue issuers and, for the most part, do pretty well for themselves.

That said, not every case goes the plaintiff’s way. 

A recent opinion involving a fund investor and a temporary restraining order is an example, and provides a window into the requirements for injunctive relief to be granted (temporary restraining orders and preliminary injunctions), where the rules don’t care if you’re a crypto investor or a peeved parakeet purchaser. It also shows what happens when you overreach, name too many parties, and seek more relief than you may be entitled to (or as we say in the business, “pigs get fat and hogs get slaughtered.”)

This case involves a dispute arising out of an investment in a cryptocurrency venture. In particular,  plaintiff KDH Consulting (“KDH”) wants to prevent Iterative Capital Management, L.P. (“Iterative”) and a number of associated companies from converting Iterative Capital, L.P. into a limited liability company.

KDH made a $1 million investment in Iterative in January 2018.  Defendants allegedly took the money that was supposed to be invested in cryptocurrency investments — including “network tokens”  — and instead put the money into mining operations. 

The Court summarizes the allegations in the lawsuit as follows:

"KDH alleges that Defendants fraudulently induced it into investing in a cryptocurrency investment and trading fund by misrepresenting the purpose of the fund, its prior performance history, and the liquidity options. Brandon Buchanan and Christopher Dannen (the "Individual Defendants") allegedly promised a highly liquid fund with quarterly withdrawal rights, with 70 percent of the assets invested in trading cryptocurrencies and network tokens and the remaining 30 percent invested in cryptocurrency mining operations including cryptocurrency mining equipment. To the contrary, KDH alleges, Defendants knew at the time KDH entered the Partnership that cryptocurrency trading was no longer viable, and planned to use KDH's funds for "highly illiquid mining operations." For example, KDH points to a statement made on December 10, 2019 by a principal of Iterative, Leo Zhang, indicating that Iterative's strategy of focusing on mining (instead of trading cryptocurrencies and network tokens) was formed in 2016-2017. According to KDH, Defendants' offering documents failed to disclose their primary investment objective and strategy and failed to reflect Iterative's actual prior performance."

Of course, January 2018 was the last top of the market, and soon after the investment was made, prices declined. KDH asked for its money back but alleges that it was told that its money had not been invested yet and could be withdrawn at any time. At the same time, however, Defendants invested half of the fund’s total assets in mining equipment, which “led to losses including $3,400,000 in depreciation to the mining equipment by the end of 2019.”

KDH says that the defendants hid information about this change in investment strategy, engaged in self-dealing with their affiliated cryptocurrency entities and breached a duty of good faith and fair dealing by putting their own interests about those of investors. KDH also complained about and tried to stop a proposed restricting of the Fund into an LLC:

"In December 2019, Defendants told KDH and the other investors of their plan to convert the Fund Complex to an LLC through a series of transactions. The Restructuring would also consolidate the Fund Complex with Escher/Iterative OTC. On March 1, 2020, Defendants gave KDH and the other investors three options: (1) continue as an investor in the new venture, (2) withdraw from the Fund Complex in exchange for a refund based on the remaining assets less a deduction for Restructuring expenses, or (3) receive a pro rata share of assets-in-kind (digital assets and cryptocurrency mining equipment) less shipping expenses. Defendants asked for KDH's and other investors' consent for the Restructuring by midnight on April 28, 2020[.]"

KDH didn’t file suit to block the restricting until late April 2018, at which time it filed suit in federal court in Manhattan and sought emergency injunctive relief.  The Court granted KDH’s motion for a temporary restraining order which, among other things, prevented the defendants from moving forward with the restructuring. Defendants asked the TRO be dissolved for a number of reasons, including the fact that “while two thirds have chosen to convert their investment into an interest in the new entity, one third opted to liquidate, but cannot do so while the TRO is in place; these investors' funds may be imperiled by the TRO due to the volatility of the market.”

In order to receive injunctive relief, a plaintiff also has to show a number of things, including that they would suffer irreparable harm for which money damages would not make them whole. Defendants said that was clearly not the case here, and that money damages could be calculated to compensate for any harm suffered. 

The Court agreed with this, and found that KDH could be compensated with an amount of money “consistent with the economic harm suffered.” On the other hand, the Court found that the Defendants would be irreparably harmed by not being able to close a complex restructuring transaction. Furthermore, the Court found that the scope of the TRO caused irreparable harm to an affiliated company which is a FinCEN regulated MSB, causing its accounts to be flagged by trading partners and “thereby limiting its liquidity pool, access to markets and ability to offer competitive pricing.”

Another significant strike against KDH, per the Court, is that it received notice of the potential restructuring in December 2019 but waited until April 14, 2020 to request books and records from the defendants. Before it can order injunctive relief, the Court is also required to “balance the equities” and take into account the impact of the TRO on other investors. Because one-third of the other investors had chosen to liquidate their investment, the TRO would stop that from happening. This factor was a bother that persuaded the Court to dissolve the TRO.

In short, what started as a win for the plaintiff turned into a loss after the Court received briefing and argument from the other side, which convinced it that the requirements for injunctive relief were not satisfied. 

Is it possible that a different result might have obtained if Plaintiff had named fewer parties and reduced the scope of their requested TRO? Perhaps, but the availability of money damages may have made this a dead letter from the outset.