Crypto and Forum Selection Clauses
April 4, 2023
Over the past six months, the crypto industry has suffered setback after setback. In late 2022, the cryptocurrency exchange FTX collapsed. Its CEO and founder, Sam Bankman-Fried, has since been charged with wire fraud, money laundering and securities fraud, among other crimes. In 2023, the SEC filed a civil suit against persons involved in the collapse of the Luna cryptocurrency. The industry, to put it mildly, has taken a reputational battering of late.
A recent case involving a lawsuit against a company selling cryptocurrency tokens seems unlikely to burnish that reputation. In Rostami v. Hypernet Inc., a cryptocurrency company was sued by one of its investors in federal court in California. It sought to dismiss the case based on a forum selection clause selecting the Cook Islands. The company argued, in essence, that it was more convenient to litigate the case on a remote island in the South Pacific than in the district where its headquarters was located. The fact that the clause was written into the contract in the first place says a lot about the crypto industry. The fact that the court sided with the company and dismissed the case says a lot about the extreme reluctance of federal courts to invalidate forum selection clauses on the ground that they are unreasonable.
Rostami v. Hypernet Inc.
In 2018, Romein Rostami entered two Future Token Interest Subscription Agreements (“TSAs”) with Hypernet Inc. (“Hypernet”). Rostami was then a U.S. citizen residing in Puerto Rico. Hypernet was a company incorporated in the Cook Islands with its principal place of business in Palo Alto, California. Rostami paid $339,248 to Hyperlink in Ethereum cryptocurrency tokens. In exchange, he was promised a future right to as-yet-undeveloped cryptocurrency tokens known as Hyper Tokens.
In 2022, Rostami sued Hypernet in the U.S. District Court for the Northern District of California. He asserted claims for fraudulent inducement, unjust enrichment, and the breach of the implied covenant of good faith and fair dealing, among others. Rostami alleged that, as of the time the complaint was filed, no Hyper Tokens had been issued and that Hypernet never intended to produce them. Hypernet moved to dismiss the case based on the following provision:
The Purchaser hereby irrevocably agrees that all actions arising directly or indirectly as a result or in consequence of this TSA of the Tokens shall be instituted and litigated only in courts having situs in the Cook Islands and the Purchaser hereby consents to the exclusive jurisdiction and venue of any court of competent jurisdiction in the Cook Islands. The Purchaser hereby waives any objection based on forum non conveniens.
This case appears to be the first in U.S. history where a court was called upon to enforce a forum selection clause selecting the courts of the Cook Islands. The Cook Islands are a self-governing island country in the South Pacific Ocean. They have a population of roughly 17,000 people. The Cook Islands have been described as a “global pioneer in offshore asset-protection trusts, with laws devised to protect foreigners’ assets from legal claims in their home countries.” A New York Times article about the nation once invited its readers to “picture a paradise where you can be lawsuit-proof” and observed that the Cooks “generally disregard foreign court orders, making it easier to keep assets from creditors, or anyone else.”
Hypernet does not appear to have conducted any of its actual business in the Cook Islands; its headquarters were in Palo Alto and its executives all lived and worked in California. The company argued, however, that the fact that it was incorporated in the Cook Islands offered a valid reason for enforcing the forum selection clause.
Rostami disagreed. He argued that enforcing the forum selection clause was unreasonable under the circumstances because (1) the purpose of the clause was to deter future litigation by selecting a remote forum, (2) the clause was the product of “overweening bargaining power” on the part of Hypernet, and (3) the clause was not “reasonably communicated” because it appeared at the end of a lengthy document full of boilerplate. Rostami also argued that enforcing the clause would be contrary to California’s strong public policy against giving effect to unconscionable contract provisions.
The court (Judge Edward J. Davila) sided with the defendants and dismissed the case. It first noted that the plaintiff was an accredited investor with significant resources who could not plausibly be described as unsophisticated. It further noted that the clause was in the same font size as the remainder of the document, which undercut the plaintiff’s arguments that the clause was not reasonably communicated. The court also held that the forum selection clause was neither procedurally unconscionable nor substantively unconscionable under California law. With respect to the public interest factors that must be considered as part of a motion to dismiss for forum non conveniens, the court held that California lacked a strong interest in the action because the plaintiff was domiciled in Puerto Rico. It also held that a Cook Islands court would be more at home with Cook Islands law (selected in a choice-of-law clause) than a California court.
The court did not meaningfully engage with the argument that the clause was unenforceable because the forum selected was in a remote location that lacked any connection to the parties or the dispute apart from Hypernet’s incorporation. This is surprising because the U.S. Supreme Court observed in The Bremen v. Zapata Off-Shore Company that:
We are not here dealing with an agreement between two Americans to resolve their essentially local disputes in a remote alien forum. In such a case, the serious inconvenience of the contractual forum to one or both of the parties might carry greater weight in determining the reasonableness of the forum clause.
The court also declined to address the argument that the clause was unenforceable because the Cook Islands were selected for the purpose of making it difficult for the plaintiff to sue Hypernet. In the past, U.S. courts have signaled disapproval of forum selection clauses that are used as “a means of discouraging prospective plaintiffs from pursuing legitimate claims.” In this case, however, the court’s decision contained no discussion of whether such a use of the clause was appropriate.
On the one hand, the parties to the transaction were sophisticated businesspersons contracting in a freewheeling industry that has long operated on the fringes of the law. Through this lens, the court’s decision to hold the parties to their bargain is perhaps defensible. On the other hand, the case establishes a disturbing precedent. If a company headquartered in the United States can obtain dismissal of a case merely by incorporating in the Cook Islands and selecting that country’s courts in its contracts, it is easy to imagine a world where forum selection clauses operate as de facto shields from liability. It is a simple matter for a company to reincorporate. And few U.S. plaintiffs will have the time and resources necessary to litigate in the Cook Islands. It would be troubling if the court’s decision in this case leads other companies to reincorporate in remote jurisdictions as a means of discouraging litigation.
There is also irony in the court’s decision to dismiss the case based on forum non conveniens. While this is the doctrinally correct framework under the Supreme Court’s decision in Atlantic Marine, the effect of the decision is to move the case away from a courthouse just down the street from the defendant’s headquarters to a courthouse on a remote island 5,000 miles away from the defendant’s base of operations and 11,000 miles away from the plaintiff’s home. One suspects that not many witnesses and evidence are likely to be found in the Cook Islands in this case. And yet the district court concluded that the Cook Islands were a more convenient forum in which to resolve the dispute.