Mt. Gox Responds To CoinLab Lawsuit With $5.5M in Counterclaims

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On Tuesday, Mt. Gox filed a response to the lawsuit brought against them by CoinLab. The two companies planned to work together as providers of bitcoin exchange services, but both parties have ultimately claimed a breach of contract by the other. We were first alerted of the latest filing here.

Summary of Claims

According to the contract, Mt. Gox would turn over all North American bitcoin exchange operations to CoinLab. The original negotiations for the deal took place during the Summer of 2012 and the contract was signed on November 22, 2012. After the signing date there would be a Transition Period through March 22, during which the companies would work together to transition operations to CoinLab.

CoinLab’s Original Complaint

CoinLab’s complaint, filed May 2 of this year, claimed Mt. Gox was in breach of the exclusivity provision of the contract by directly servicing North American accounts since the agreement took effect. Per the original contract, if either party was in breach of this provision, damages of $50M would be paid to the other, forming the basis of CoinLab’s $75M lawsuit, the remainder of which is the result of less clearly quantified damages from additional claims. The exclusivity provision in the original contract read as follows:

“During the Term, MtGox and Tibanne shall not grant anyone the right to use the Licensed Materials to provide the Services, or any part thereof, in the Territory.”

CoinLab also asserted that Mt. Gox did not provide the necessary and agreed upon access to technology, records and required funds by the end of the Transition Period to enable CoinLab to service the North American accounts. The suit also claims failure to adhere to the revenue sharing agreement originally set forth.

Mt. Gox’s Response

Mt. Gox responded to CoinLab’s complaint earlier this week. The core argument made by Mt. Gox is that the entire contract is invalid as a result of CoinLab not being compliant with state and federal regulations by the end of the Transition Period. According to the filing, CoinLab claimed full regulatory compliance as a provider of prepaid access during negotiations leading up to the signing of the deal.

On March 18, FinCEN issued guidance clarifying that digital currency exchanges are considered money transmitters. WIth no such licences and just four days before the conclusion of the Transition Period, CoinLab’s regulatory compliance could now be called into question. From March 19 to April 20, Mt. Gox reportedly asked for a detailed explanation of how CoinLab planned to obtain the proper licences, but was allegedly met with only vague statements from CoinLab, without a schedule or plan to finance the application process. According to the FinCEN website, CoinLab filed as a Money Service Business (MSB) on April 9.

Mt. Gox also filed a counterclaim for $260,000 (equivalent) across a mixture of USD, CAD and bitcoin. According to the original agreement, Mt. Gox and CoinLab were to periodically settle revenue imbalances caused by one counterparty in each of their jurisdictions trading with each other. Mt. Gox is asking for restitution of the funds it sent to CoinLab during these reconciliations before the contract was allegedly breached.

The counterclaim also asks for $5.3M of customer funds to be transferred to Mt. Gox accounts. According to the document, $12.8M was deposited by customers into CoinLab accounts during the Transition Period. When the Transition Period ended, Mt. Gox requested the money be sent to Mt. Gox accounts, to which CoinLab sent $7.5M. Mt. Gox is currently seeking the remaining $5.3M.

Additional Commentary

Due Diligence

Mt. Gox’s response claims that CoinLab CEO Peter Vessenes asserted during negotiations in Summer 2012 that he was compliant as a provider of prepaid access and that he could not disclose any more about his compliance due to “trade secrets.” Mt. Gox then reiterates throughout their response that Mt. Gox “had a right to rely on [CoinLab] and did rely on them” with regards to the adequacy of CoinLab’s compliance.

This means Mt. Gox accepted at face value that someone could use regulations, a matter of public record, as a secretive means of competitive advantage. It also implies that Mt. Gox did not take upon themselves the responsibility of performing due diligence on the regulatory environment. Had they determined that CoinLab would need to be a registered MSB, as they imply CoinLab should have, they also may have realized that the timeframe to obtain all necessary state and federal money transmission licences is generally 12-24 months.

For CoinLab, who had no such licenses when the contract was signed, to obtain full licensing by the end of the Transition Period would be effectively impossible, making the whole exercise moot. While CoinLab’s potential lack of licenses may be beneficial to Mt. Gox in this case, it also illustrates the level of diligence Mt. Gox feels is required before offering someone access to millions of dollars of customer funds.

Registration Grace Period

Most states offer a 180-day grace period after the beginning of operations to file for a money transmitter license. If CoinLab began operations as an exchange on November 22, the first day of the contract, it’s theoretically possible they were not necessarily in violation of the law by the end of the 120-day Transition Period on March 22. There are abundant scenarios depending on when their original business entity was registered or at what point each state determines they started operations that could invalidate this defense, but it warrants discussion at the very least.

Incentive to Get Out of Contract

During 2012, the year the contract was signed, Mt. Gox had an estimated $550K in USD fiat revenue. By March 22 of this year, bitcoin’s popularity was just beginning to explode. Over the course of the Transition Period, the price of bitcoin climbed from $12 to $70 – a 580% increase. Over the same period, average USD-BTC trading volume on Mt. Gox increased approximately 900% from $350K per day to $3.3M, making the business more appealing and licensing costs more viable. While this doesn’t necessarily impact the legal implications of the events that occurred, it may provide insight as to why Mt. Gox wouldn’t have more adamantly tried to maintain an agreement that assigns 90% of revenue from new North American customers to another party.

contract vs price

Unknowns Surrounding The $5.3M Figure

In the filing, Mt. Gox claims that $5.3M of customer account money should be turned over to them. What is not yet known are the full details around how that figure was calculated. Mt. Gox appears to have taken total customer deposits, less the amount subsequently transferred to Mt. Gox accounts by CoinLab, and included the balance in their counterclaims. There’s no mention of the amount that has since been withdrawn from those deposited balances by customers, or the effect on the net value of those accounts as a result of trading bitcoin and bitcoin price fluctuations.

Gox May Have Maintained Exclusivity

One of CoinLab’s core claims is that Mt. Gox breached the exclusivity provision in the initial agreement by directly servicing North American clients, which would trigger the $50M Liquidated Damages provision of the original contract. In regards to Mt. Gox’s responsibilities, the Exclusivity provision merely states that Mt. Gox “shall not grant anyone the right to” use their data and infrastructure to service exchange accounts in North America. While it will be up to the courts to decide, continued service to existing customers by the original company does not seem to constitute a breach of the stated terms.

Gox Looking for Compliant Partners

One takeaway from this ordeal is that Mt. Gox is looking for a compliant partner in North America. The original deal with CoinLab appears to have been pursued to help them reduce liability in what was largely considered a legal grey area prior to the FinCEN guidance (not by all) – and they may still be looking. In their counterclaims Mt. Gox states, “Because CoinLab cannot legally provide the Bitcoin exchange services called for under the Agreement Defendants should be free, if they so choose, to find other persons who are legally able to do so.”

The relevant documents for this case can be viewed here:

Original Agreement – November 22, 2012
CoinLab Initial Complaint – May 2, 2013
Mt. Gox Response & Counterclaims – September 10, 2013

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