Monday, March 09, 2015

Bitcoin, Baby Jets and the Refund

This post examines an opinion a U.S. District Court Judge who sits in the U.S. District Court for the Northern District of California issued at the end of February:  Morici v. Hashfast Technologies, LLC, 2015 WL 906005. The judge begins the opinion by explaining that the lawsuit is
about Bitcoin and `Baby Jets.’ Plaintiff Pete Morici . . . alleges that he placed an order with Defendants Hashfast Technologies LLC and/or Hashfast LLC (the `Hashfast Entities’) for two Bitcoin mining computers, fittingly named `Baby Jets,’ but did not receive them when promised. When he finally did receive a shipment, he was no longer interested in `Baby Jets’ and requested a refund. He did not receive one, though, because he would not sign a release.
Morici v. Hashfast Technologies, LLC, supra.
He goes on to explain that Morici filed the Complaint in this case on January 7, 2014,
against the Hashfast Entities and its officers, Simon Barber (`Barber’) and Eduardo deCastro (`deCastro’) for breach of contract, fraud, violation of the Unfair Competition Law (`UCL’), CaliforniaBusiness and Professions Code § 17200, and declaratory relief. Presently before the court is a Motion to Dismiss filed by Barber and deCastro. . . . Plaintiff has filed written opposition to the motion. . . . .
Morici v. Hashfast Technologies, LLC, supra.
The judge then outlined how the lawsuit arose, noting that Morici is a resident of
Maryland and, importantly for this lawsuit, is a member of the Bitcoin community. . . . So are Barber, deCastro, and the Hashfast Entities. . . . They develop specialized computers to conduct Bitcoin mining. . . .

In conjunction with their enthusiasm for Bitcoin, [Morici] and Defendants were participants in an internet message board known as Bitcoin Talk. . . . Starting in July, 2013, Defendants made several posts about their soon-to-be-launched Bitcoin mining computer (the aforementioned `Baby Jet’), and further posted, on August 5th and August 8, 2013, that they would begin shipping the product in October, 2013. . . .

On August 10, 2013, [Morici] visited Defendants' website and decided he wanted to purchase a `Baby Jet’ after viewing the computer's technical specifications. . . .  He relied on a statement on the website which listed the `Baby Jet’ model as `in stock,’ and noted that shipments of the product would begin `October 20–30.’ . . .   Since the website could not process orders electronically, [Morici] ended up placing an order manually during which process he was assured that the October, 2013, delivery dates were `firm.’ . . . He ordered two `Baby Jets’ for a total transaction cost of $11,507.38. . . . [Morici] paid a deposit of 110.647885 BTC that same day. . . .
Morici v. Hashfast Technologies, LLC, supra.
The opinion then outlines what happened next:
[Morici] explains that the delivery date of the `Baby Jet’ was crucial due to how Bitcoin works. Bitcoin miners are incentivized to process payment transactions `by allowing miners to create new Bitcoins for themselves based on the number of ‘blocks' discovered.’ . . . `Blocks are files containing data regarding Bitcoin transactions that have yet to be recorded in the public ledger,’ and are discovered by `calculating a SHA256 hash, an algorithm that is very difficult to solve, over and over again until the miner finds an input that matches an expected output.’ . . . Since a miner's chances of discovering a Bitcoin relative to another miner is `based on the miner's hash rate relative to the total hash rate of all Bitcoin miners on the network,’ miners are continuously seeking to increase their rate of processing through acquisition of the latest technology. . . .

However, because the `difficulty of Bitcoin mining is continually adjusted based on the rate at which blocks are created,’ `a Bitcoin mining computer continually becomes less valuable over time, as it becomes relatively less efficient at processing Bitcoin blocks.’ . . . . `Eventually, without upgrading technology, the electricity required for processing will cost a miner more than the Bitcoin computer is able to generate.’ . . .

Despite previous reassurances, Defendants informed [Morici] on October 23, 2013, that his order would be delayed. . . . On November 7, 2013, Defendants told [Morici] that his order would be delayed further and would not be shipped until mid-December. . . . In response, [Morici] notified Defendants on November 11, 2013, that he was cancelling his order, and requested a full refund of his deposit in Bitcoin. . . . Defendants did not respond to [his] notification until over a month later. . . .
Morici v. Hashfast Technologies, LLC, supra.
Finally, the judge explains what, exactly, let to the filing of this lawsuit, noting that on
December 27, 2013, Defendants sent an email to customers stating `Baby Jet’ shipments were `on track’ for December 31st, but that customers interested in a refund `could initiate refunds and be paid Bitcoin [Morici], since Defendants had previously represented that refunds would be paid in Bitcoin. . . .

On December 31, 2013, Defendants sent another email to [Morici] stating it still would not be able to fulfill his order until a later date. . . . Attached to the email was a `detailed and onerous’ release that had to be completed in order to obtain a refund. . . .

Defendants eventually did send a shipment to [Morici], which he alleges was partial and `too late.’ . . . He therefore refused it and cancelled the order. . . .This action followed.
Morici v. Hashfast Technologies, LLC, supra.
The judge then outlined the legal standard he was required to apply in ruling on the defendants’ motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure.  Morici v. Hashfast Technologies, LLC, supra.  He noted that
Federal Rule of Civil Procedure 8(a) requires a plaintiff to plead each claim with sufficient specificity to `give the defendant fair notice of what the . . . claim is and the grounds upon which it rests. Bell Atlantic Corp. v. Twombly, 550 U.S.544 (2007). . . . A complaint which falls short of the Rule 8(a) standard may be dismissed if it fails to state a claim upon which relief can be granted. Rule 12(b)(6). `Dismissal under Rule 12(b)(6) is appropriate only where the complaint lacks a cognizable legal theory or sufficient facts to support a cognizable legal theory.’ Mendiondo v. Centinela Hospital Medical Center, 521 F.3d 1097 (U.S. Court of Appeals for the 9th Circuit 2008). Moreover, the factual allegations `must be enough to raise a right to relief above the speculative level’ such that the claim `is plausible on its face.’ Bell Atlantic Corp. v. Twombly, supra.

Causes of action based in fraud require more detail. `In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.’ FederalRules of Civil Procedure 9(b). These allegations must be `specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong.’ Semegen v. Weidner, 780 F.2d 727 (U.S. Court of Appeals for the 9th Circuit 1985).

To that end, the allegations must contain `an account of the time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentations.’ Swartz v. KPMG LLP, 476 F.3d 756 (U.S. Court of Appeals for the 9th Circuit 2007). In other words, claims of fraudulent conduct must generally contain more specific facts than is necessary to support other causes of action.
Morici v. Hashfast Technologies, LLC, supra.
The judge went on to explain that when a judge is deciding whether to grant a
motion to dismiss, the court generally `may not consider any material beyond the pleadings.’ Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542 (U.S. Court of Appeals for the 9th Circuit 1990). However, the court may consider material submitted as part of the complaint or relied upon in the complaint, and may also consider material subject to judicial notice. See Lee v. City of Los Angeles, 250 F.3d 668 (U.S. Court of Appeals for the 9th Circuit 2001).

In addition, the court must generally accept as true all `well-pleaded factual allegations.  Ashcroft v. Iqbal, 556 U.S. 662 (2009). The court must also construe the alleged facts in the light most favorable to the plaintiff. Love v. U.S., 915 F.2d 1242 (U.S. Court of Appeals for the 9th Circuit 1988). However, `courts are not bound to accept as true a legal conclusion couched as a factual allegation.’  Love v. U.S., supra.
Morici v. Hashfast Technologies, LLC, supra.
The judge then began his analysis of the motion to dismiss, noting that

Barber and deCastro argue for dismissal of all claims in the Complaint. However, [Morici] indicates that the claims for breach of contract and declaratory relief are not being asserted against Barber and deCastro. . . . Thus, the court examines only the fraud and [Unfair Competition Law] claims.

Morici v. Hashfast Technologies, LLC, supra.
The judge began his analysis of the adequacy with which Morici pled the fraud claim by noting that Barber and deCastro argued that the fraud claim against them should be dismissed because
the factual allegations do not satisfy the heightened pleading standard imposed by Rule 9(b). Specifically, they contend [Morici] improperly lumped all of the defendants into one designation in the Complaint -- namely, `Hashfast’ -- and then failed to differentiate the fraudulent conduct attributable to each defendant. The court agrees with Barber and deCastro that the claim for fraud is deficient under Rule 9(b).
Morici v. Hashfast Technologies, LLC, supra.
He goes on to explain why he agrees with them, noting that a plaintiff alleging
fraud under California law must plead facts demonstrating five elements: (1) a misrepresentation; (2) the speaker's knowledge of falsity; (3) the intent to defraud or induce reliance; (4) justifiable reliance; and (5) resulting damage. See, e.g., Lazar v. Superior Court, 12 Cal.4th 631 (California Supreme Court 1996).

In federal court, it is undisputed that these elements, save for perhaps certain aspects of the second and third, must be plead with particularity. The purpose of this requirement is to ensure that adequate notice is provided to the parties accused of fraudulent conduct in order to allow for a meaningful defense. Indeed, `[w]ithout such specificity, defendants in these cases would be put to an unfair disadvantage, since at the early stages of the proceedings they could do no more than generally deny any wrongdoing.’ Concha v. London, 62 F.3d 1493, 1502 (U.S. Court of Appeals for the 9th Circuit ).
Morici v. Hashfast Technologies, LLC, supra.  The judge goes on to explain that
Rule 9(b)'s heightened pleading requirement also acts as a barrier to weak or unfounded -- and potentially costly -- claims of fraudulent conduct. See Bly–Magee v. California, 236 F.3d 1014 (U.S Court of Appeals for the 9th Cir.2001). Because they must provide more than just the superficial `short and plain statement’ permitted for other claims, plaintiffs who seek to assert fraud must consider whether the facts known at the time of filing can withstand a Rule 9 challenge. Indeed, by requiring extra detail, `the rule requires the plaintiff to conduct a precomplaint investigation in sufficient depth to assure that the charge of fraud is responsible and supported, rather than defamatory and extortionate.’ Ackerman v. Northwest Mutual Life Ins. Co., 172 F.3d 467 (U.S. Court of Appeals for the 7th Circuit 1969).

It is therefore unsurprising that allegations suggesting `everyone did everything’ or that `all defendants made every misrepresentation’ are insufficient. See Destfino v. Reiswig, 630 F.3d 952 (U.S. Court of Appeals for the 9th Circuit 2011). Although `there is no absolute requirement that where several defendants are sued in connection with an alleged fraudulent scheme, the complaint must identify false statements made by each and every defendant,’ plaintiff must nonetheless offer enough factual matter to establish each defendant's participation in the fraudulent scheme. Swartz v. KPMG LLP, supra. . . .

Here, after collectively defining all of the named defendants, including . . . Barber and deCastro, as `Hashfast,’ [Morici] attributes nearly every fraudulent statement to this `Hashfast’ conglomerate without distinguishing which entity or individual was actually responsible for the misrepresentation. For example, [he] alleges that `Hashfast’ stated the `Baby Jets’ would ship in October, 2013. See Compl., at ¶ 17. Similarly, he alleges that `Hashfast’ represented that `Baby Jets’ were `in stock’ and that `Hashfast’ misrepresented the computing power of its product. . . . But under this style of pleading, Barber and deCastro are left to wonder which statements they are alleged to have made as individuals, and in turn, which statements they must defend against as individuals. Indeed, it cannot be, without something more, that both are responsible for making each and every statement ascribed to `Hashfast,’ since [Morici’s] definition of `Hashfast’ includes two business entities in addition to Barber and deCastro.
Morici v. Hashfast Technologies, LLC, supra.
The judge outlined what this involves, noting that Morici argued that the
`something more’ -- or the fact that makes Barber and deCastro liable for every misrepresentation of `Hashfast’ -- is their positions as corporate officers or directors, which he alleges in the Complaint. He further alleges that `Hashfast’ was a participant in Bitcoin Talk and made several posts about the launch of `Baby Jet.’

These allegations . . . because they are not specific enough to satisfy Rule 9(b). Indeed, as [Morici’s] own authorities establish, `[t]o maintain a tort claim against a director in his or her personal capacity, a plaintiff must first show that the director specifically authorized, directed or participated in the allegedly tortious conduct; or that although they specifically knew or reasonably should have known that some hazardous condition or activity under their control could injure plaintiff, they negligently failed to take or order appropriate action to avoid the harm.’ Frances T. v. Village Green Owners Ass'n, 42 Cal.3d 490 (California Supreme Court 1986) (emphasis added). . . . What is missing from Plaintiff's Complaint is the `specific’ part, which is required both by the legal standard for director liability as it exists under California law and by Rule 9(b). These allegations are important because, in general, directors are jointly liable with the corporation only `if they personally directed or participated in the tortious conduct.’ Frances T. v. Village Green Owners Ass'n, supra.
Morici v. Hashfast Technologies, LLC, supra.
The judge on to note that Morici had not alleged “sufficient facts under Rule 9(b)” to
establish that Barber and deCastro were the agents of the Hashfast entities. `To allege an agency relationship, a plaintiff must allege: (1) that the agent or apparent agent holds power to alter legal relations between principal and third persons and between principal and himself; (2) that the agent is a fiduciary with respect to matters within scope of agency; and (3) that the principal has right to control conduct of agent with respect to matters entrusted to him.’ Palomares v. Bear Stearns Residential Mortg. Corp., 2008 WL 686683 (U.S. District Court for the Southern District of California 2008). . . .

[T]he agency relationship must be pleaded with particularity when a claim for fraud. . . purports to impose liability on such a theory. See RPost Holdings, Inc. v. Trustifi Corp., 2011 WL 4802372 (U.S. District Court for the Central District of California 2011). . . . [Morici’s] conclusory and formulaic agency allegations, which merely state that `defendants, and each of them, were an owner, a co-owner, an agent and/or later ego of their co-defendants’ . . . have been rejected by other courts as insufficient. See, e.g., Buchanan v. Neighbors Van Lines, 2010 WL 4916644 (U.S. District Court for the Central District of California, 2010).
Morici v. Hashfast Technologies, LLC, supra.
Finally, the judge explained that the statements that were “specifically” attributed to
Barber and deCastro in the Complaint cannot support a claim for fraud against either individual based on the factual allegations overall. Specific to Barber, [Morici] alleges he posted a statement on Bitcoin Talk on August 10, 2013, in which he advised refunds would be issued in Bitcoin. . . . As to deCastro, [Morici] alleges he posted a statement on Bitcoin Talk on August 11, 2013, that `Hashfast’ would meet its October, 2013, shipping deadline and would protect its customers against `hashrate increases.’ . . . 

But [Morici] does not allege that he relied on these statements when he decided to order `Baby Jets,’ and, notably, these allegations follow those describing how he placed his order.  Accordingly, the claim for fraud against Barber and deCastro will be dismissed. [Morici] will be permitted leave to amend because he may be able to supply additional factual content to satisfy the Rule 9(b) pleading standard.
Morici v. Hashfast Technologies, LLC, supra.
Finally, the judge took up Morici’s claim under California’s UCL law, which Morici said was based on “the unfair practice of selling a product while making misleading claims about the availability of the product.”  Morici v. Hashfast Technologies, LLC, supra. He found that the UCL claim was
deficiently plead for the same reasons described above. [Morici’s] use of the `Hashfast’ moniker for all defendants, corporate and individual, is especially problematic for this claim because an `unfair practices claim under § 17200 cannot be predicated on vicarious liability.’ Emery v. Visa Int'l Serv. Ass'n, 95 Cal.App. 4th 952 (California Court of Appeals 2002). Furthermore, this claim is not saved by [Morici’s] agency allegations because, again, they are nothing more than formulaic conclusion.
Morici v. Hashfast Technologies, LLC, supra.  He therefore held that the UCL claim against Barber and deCastro would be “dismissed with leave to amend”.  Morici v. Hashfast Technologies, LLC, supra.  In other words, Morici can try again. 

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