Chapter 15 of the Bankruptcy Code provides a mechanism for United States cooperation and coordination with insolvency proceedings abroad, often affording foreign debtors wide-ranging relief and expansive rights through the United States Bankruptcy Court system.  Not all proceedings in foreign jurisdictions are eligible — in order to be so, a proceeding must constitute a “foreign proceeding” under the Bankruptcy Code. The Bankruptcy Code defines a “foreign proceeding” as “a collective judicial or administrative proceeding in a foreign country…  under a law relating to insolvency or adjustment of debt in which proceeding the assets and affairs of the debtor are subject to control or supervision by a foreign court, for the purpose of reorganization or liquidation.”  It is generally understood that the definition should be interpreted liberally. Recently, the Bankruptcy Court for the Southern District of New York tested the limits of Chapter 15, providing important guidance regarding the eligibility of proceedings that do not involve “insolvency or the identification, classification, or satisfaction of debt.” See In re Global Cord Blood Corporation, Case No. 22-11347 (December 5, 2022).

Continue Reading A Line in the Sand: Caymans Proceeding Ineligible for Chapter 15

BlockFi Inc. and eight of its affiliates followed the paths of crypto platforms Voyager, Celsius and FTX by filing for bankruptcy protection.  The case, commenced in the District of New Jersey, on November 28, 2022, is off to a fast start. BlockFi filed a plan of reorganization on the first day of its case. The plan proposes a standalone restructuring but allows the company to toggle to a sale of all or substantially all of the company’s assets. The company had its first day hearing in New Jersey on November 29th and expressed an interest in exiting bankruptcy expeditiously.  

BlockFi’s financial advisor pointed out in a “first day” declaration that, while the company’s downfall came as a result of FTX contagion, it does “not face the myriad issues apparently facing FTX.”  The declaration highlights BlockFi’s efforts to lead the digital assets industry in compliance and transparency in an obvious attempt to distinguishing itself from FTX. BlockFi’s liquidity crisis was, at least in part, due to its exposure to FTX through financing provided by FTX US, loans the company advanced to Alameda, and cryptocurrency held on FTX’s platform.  BlockFi was also heavily exposed to Three Arrows Capital, the crypto hedge fund that collapsed earlier this year. Three Arrows was one of the company’s largest borrower clients and its failure led to the FTX rescue financing.  Based on testimony of the hearing, it seems that BlockFi had lent approximately $680 million to Alameda and has approximately $355 million frozen at FTX.

In its schedule of largest unsecured creditors, BlockFi listed a $729 million unsecured claim on account of an indenture (although does not mention any bonds in the declaration).  It also listed a $250 million unsecured loan from FTX US (which is purportedly subordinated to customer obligations) and an undersecured “institutional loan” in the amount of $21.67 million.  The remaining claims were identified as client claims and the customers were not identified.

In conjunction with the US cases, BlockFi International Ltd., a Bermuda company, filed a petition with the Supreme Court of Bermuda for the appointment of joint provisional liquidators.  It is fair to expect that a Chapter 15 proceeding will be commenced in New Jersey once the liquidators are appointed.

Shoba Pillay, the Examiner appointed in Celsius’ bankruptcy cases, filed her interim report on November 19, 2022.  The Celsius Examiner’s report provides some important insight into a crypto-exchange’s operational and risk management failures which may provide investors and creditors some insight into what to expect in FTX.

The initial report provides important insight on the financial management at Celsius and treatment of various types of customer accounts. Given Celsius’ management of the different accounts, and the commingling of assets between and among them, “customers now face uncertainty regarding which assets, if any, belonged to them as of the bankruptcy filing” as explained by the Examiner. Her report is extremely thorough and can be accessed here. We highlight a few high-level observations from the report below.

  • Earn Program. Pursuant to its “Earn” program, customers purported to lend cryptocurrency to Celsius in exchange for certain “rewards” plus the return of their principal. The terms of use, while changing over time, were largely consistent with respect to Celsius’ ownership of all cryptocurrency deposited. While each customer’s account reflected the amount of each digital asset deposited (plus rewards), Celsius did not have individual wallets holding those assets. Instead, when amounts were deposited by a customer they would be swept into one or more “Main” wallets that pooled many customers’ assets. Celsius accessed those accounts at its discretion for purposes of funding its many investments — needed to generate its customers’ expected returns. When needed, Celsius effectuated withdrawals related to the Earn program by transferring assets from any one or more of its many commingled Main wallets to its customers’ external wallets.
  • Custody Program.  This program was launched in April 2022 in response to investigations then underway by various state regulatory authorities. The program was designed to allow the company a mechanism to maintain relationships with unaccredited customers in the US, purportedly holding their assets in “custody” without the benefit of rewards. Generally, all deposits of US customers following April 15 would go to Custody accounts (and accredited customers could then move them to an Earn account). The terms of use with respect to Custody accounts were clear — title remained with the customer (although they also identified bankruptcy risks). Hastily developed however, the Custody program did not provide customers with individual wallets that segregated assets.  Instead, the company sought to maintain an aggregate level of deposits in commingled wallets (as expressly permitted by the terms of use) that roughly matched the assets held in such program. When first deposited by a customer, assets would be directed to the company’s Main wallets at which time it lost any ability to trace an assets to a customer. From Main wallets, assets were periodically, and manually, transferred to Custody wallets. The aggregate amount contained in these commingled Custody wallets did not necessarily correspond to the aggregate customer balances allocated to them. Reconciliations occurred from time to time. When a shortfall existed, Celsius would transfers coins from a number of sources into Custody wallets to regain balance. In the days leading up to the filing, the swings in liabilities to customers with Custody accounts and the amounts maintained in the Custody wallet swung by millions of dollars in value. The Examiner reports that the deficit reach $45 million by June 28th. When it came to withdrawals to Custody customers, Celsius effected transfers, not from Custody wallets, but instead from wallets located in a different workspace.
  • Withhold Accounts. Celsius was unable to offer Custody accounts to users in nine states due to regulatory issues. For customers in those states, the company purported to maintain Withhold accounts as a temporary substitute. These funds were unavailable for either Custody accounts or the Earn program, and customers were advised to withdraw them. Unfortunately, customers could not withdraw funds through the Celsius app but rather need to contact customer care. In the interim, rather than be treated similarly to Custodial accounts, assets supposedly held in Withhold accounts were held in the Main wallets and available for use by Celsius as those in the Earn program.

Based on the Examiner’s initial report, it appears that Celsius’ ability to match the cryptocurrency deposited by a customer, whether in an Earn account, Custody account or Withdrawal account, was non-existent shortly following deposit and that assets were commingled with other Debtor assets for a short period of time.  While certain customer accounts were being tracked by accounting ledgers, the facts revealed by the Examiner’s report will provide the Bankruptcy Court with additional factual guidance in determining whether account holders can claim that their assets were being held in trust or “constructive trust.”    In other non-crypto bankruptcy cases,  whether or not trust funds can be identified or traced after such funds have been commingled (sometimes using a technique called the “intermediate balance rule”) helps to determine how much a beneficiary can actually recover.   Under this standard, if the amount of the commingled deposit equals or exceeds the amount claim to be in trust, then a constructive trust may be imposed. The Examiner’s report provides important factual backdrop for that rapidly approaching litigation, the outcome of which will certainly have dramatic consequences of customers’ ultimate recoveries.

Relatedly, while an examiner has yet to be appointed in the FTX case, it will be important to monitor and understand the severity of record keeping and segregation failures by FTX and the impact it will have on their account holders and creditors.

FTX has warned its investors, customers and the crypto-world that they may have to file for bankruptcy protection without rescue financing to address its immediate liquidity crisis. Unlike the bankruptcy cases of Celsius and Voyager, FTX’s case, should it file, will likely involve many institutional investors with secured and unsecured claims. These institutional investors are now having to take steps to limit their exposure in the face of such uncertainty while considering the consequences of an FTX filing. While history rarely repeats itself, it does rhyme quite often, and lessons learned from Lehman’s epic bankruptcy in dealing with securities trades, loans, swaps, repos, customer property and dozens of other structured transactions may be useful guidance.  Of course, adding the novelty and complexity of digital assets and absence of regulatory clarity, an FTX case could be a tangle of confusion.

The legal questions that investors will face include:

  1. How will my digital assets or investments be classified in an insolvency proceeding?
  2. In a US Bankruptcy proceeding, do any traditional safe harbors apply which would allow termination, liquidation and set-off of claims?
  3. How will my claims or assets be valued?
  4. What should a counterparty do with any collateral they hold?
  5. What are the risks of withdrawing my digital assets today (assuming I still have access)?
  6. Do I have any legal recourse against management in connection with my potential losses?

This is a gut check moment for institutional investors in the cryptocurrency space and may be the first real test of how market, counterparty and legal risk management should respond to these types of events in digital asset investing and trading.

FTX’s insolvency will have repercussions on Voyager as well. As has been widely reported, Voyager’s exit from Chapter 11 is premised on the consummation of a sale of substantially all of its assets to FTX US (or West Realm Shires, Inc.).  Very generally, under the transaction FTX US would acquire the cryptocurrency on the Voyager’s platform and pay additional consideration which the company estimated to provide at least approximately $111 million of incremental value.  In its disclosure statement, the company reported that “the FTX US bid can be effectuated quickly, provides a meaningful recovery to creditors, and allows the Debtors to facilitate an efficient resolution of these chapter 11 cases, after which FTX US’s market-leading, secured trading platform will enable customers to trade and store cryptocurrency.” After this week’s news of FTX’s severe liquidity constraints and its own bankruptcy risk, Voyager’s prospects for a quick wind-down, and the associated recovery for customers and other creditors, have dimmed considerably.

It has been reported that Binance was a leading competitor of FTX US for Voyager’s assets. Binance has now backed out of any purported agreement to provide rescue financing to FTX, leaving FTX US’s ability to close on its acquisition in grave doubt. If unable to close, Voyager will surely look to Binance to revisit their interest in the  platform. While this will certainly cause a delay, the framework of Voyager’s plan to exit bankruptcy may hold.

The excitement in the distressed digital assets markets may only be in the early innings.

Over a decade after Lehman’s insolvency, the English High Court handed down a key judgement in Grant v FR Acquisitions Corporation (Europe) Ltd [1] on 11 October 2022. The judgement provides commentary on when certain Events of Default have occurred and are “continuing”.

Although the court addressed these issues in the context of interest rate swaps entered into pursuant to an ISDA Master Agreement (the “Transactions”) and the impact of Lehman’s UK entity, LBIE, coming out of administration, the judgement may have implications beyond the derivatives market, for example in the context of financing agreements, corporate documentation, and distressed debt trading, as well as cross-border restructuring or insolvency situations.

Continue Reading When Is an Event of Default “Continuing”?

In an earlier post we discussed the bankruptcy filing of Compute North Holdings, Inc., a bitcoin miner felled by high electricity costs and falling cryptocurrency prices (see here). It may be followed shortly by another miner, Core Scientific, Inc., which announced on October 26, 2022 that it has similarly been severely impacted by rising electricity costs and the price of bitcoin. It also noted increases in the “global bitcoin network hash rate” as well as ongoing litigation with Celsius Networks and its affiliates. The company, whose stock is listed on NASDAQ under the symbol CORZ, is engaged in a battle with Celsius regarding the latter’s failure to pay certain “utility tariffs” purportedly owing in relation to the hosting of Celsius’ mining equipment at Core Scientific’s data centers, among other things. In a filing earlier this month in Celsius’ bankruptcy case, Core Scientific asserted that it was “losing approximately $1.65 million per month subsidizing Celsius’s business.” A hearing on Core Scientific’s demand that Celsius pay these administrative expenses, among other things, has been scheduled for November 9, 2022 in Celsius’ case.  Core Scientific may have commenced its own case by that time. 

In its 8-K, Core Scientific announced that it will be unable to make certain upcoming payments under financing arrangements. Such failure may lead to defaults under its other indebtedness, including two series of convertible notes. They have hired restructuring advisors and announced that alternatives include the filing for bankruptcy. As of the date of the 8-K, the company was holding 24 bitcoins and approximately $26.6 million in cash. 

Meanwhile, Compute North Holdings’ case has progressed rapidly.  The company is engaged in a sale process and has scheduled an auction to begin on November 1, 2022.

We will provide further updates as on these matters as circumstances warrant. 

Secured lenders who include personal property assets as collateral in lending transaction structures have long relied upon the regularity and clarity of the Uniform Commercial Code (“UCC”) provisions which provide a roadmap for creation, perfection and enforcement of security interests in personal property. Revisions made to the UCC since 2000 have recognized and incorporated concepts to address changes in marketplace reality driven by technological advances.  The creation of cryptocurrencies, however, has posed challenges to entrepreneurial lenders and their counsel who desire to reach a level of comfort that a perfected security interest in a cryptocurrency can be achieved within the existing UCC framework.  The mere fact that a new Article 12 of the UCC, tentatively entitled “Controllable Electronic Records”, is in the early stages of adoption in state legislatures is proof enough that current law is at best inadequate to address issues peculiar to digital asset classes, including cryptocurrencies. The Wyoming legislature amended its version of UCC Article 9 effective as of July 1, 2019 with the intent of permitting perfection by control for cryptocurrencies (by controlling the applicable private key, including through a multi-signature arrangements) without addressing significant legal, practical and policy issues addressed in the proposed new Article 12 and its conforming amendments to other UCC articles.  It is presently unclear if Wyoming will follow other jurisdictions in adopting the Article 12 regime.

Secured lending against cryptocurrencies as collateral is but one of the topics addressed by the proposed UCC revisions.   Lenders who are currently taking  cryptocurrencies as collateral and their counsel have followed two basic approaches to achieve security interest perfection to the extent possible under current law:

Approach 1: The cryptocurrency is transferred to a securities intermediary, the securities intermediary agrees to treat the cryptocurrency as a “financial asset” which is then credited to the borrower’s “securities account” held at the “securities intermediary,” and the securities intermediary, the borrower and the lender enter into a control agreement as to the “securities account” and the “securities entitlement”; or

Approach 2: The lender files a UCC financing statement indicating the cryptocurrency/general intangible as collateral, the borrower provides the lender with the private key, and the lender transfers the cryptocurrency into its own public address or “wallet”. Note that absent the filing of the financing statement, the lender will be unperfected; having the cryptocurrency in the lender’s “wallet” alone does not perfect the security interest. Often, lenders may have no option under current law other than to perfect via Approach 1 as borrowers may be apprehensive about transferring the cryptocurrency to the lender and having a public record by filing of a financing statement tying the borrower to ownership of cryptocurrency, especially if the public address or amount of cryptocurrency is disclosed in the financing statement.  

Neither of these approaches, however, provides the securities intermediary or the secured party with any legal or practical assurance that the borrower owns the cryptocurrency free of other claims, nor that the securities intermediary will acquire the cryptocurrency free of other claims. Under the current version of Article 9 of the UCC there is also no way to ensure priority of the security interest without obtaining a release or subordination from all other secured parties, even if they are disclosed.  While the Wyoming non-uniform UCC amendments offer some additional protections, these uncertainties cannot be fully resolved under the current state of the law.

Therefore, lenders may need to simply rely on representations and warranties from the borrower as to its ownership of the cryptocurrency being free and clear of liens and other adverse claims encumbrances. In addition, in order to provide some comfort to the lender until the law catches up with the marketplace, the lender may need to engage in a factual diligence process to protect itself from other claimants to the cryptocurrency that may exist at the time of the transfer to the securities intermediary or the filing of the financing statement, such as examining the on-chain transactions and inquiring about the prior owners and prior public addresses of the cryptocurrency being used as collateral. In practice, while not fully resolving these concerns, some lenders have required borrowers to incorporate a borrowing entity in Wyoming to utilize Wyoming’s amendments to Article 9 to make use of the perfection by control rules available in that jurisdiction.

The revisions to the UCC, once enacted, will as a legal matter, create uniform rules for perfection of “controllable electronic records” (a new asset class that includes digital assets broadly defined and most, but not all, cryptocurrencies) via a “control” regime aligned to the peculiarities of this new asset class and rules that will either cut off prior claims or that will give the secured lender with control a priority over other claims.  These revisions are more clear and robust than the non-uniform Wyoming amendments. Wyoming, for example, provides for a cut off of prior claims only after two years following perfection by filing provided the secured party does not have actual, as opposed to constructive, notice of an adverse claim during  two-year window. Unlike the very familiar account control agreements for deposit accounts and securities accounts currently in use where parties can look for the magic language that imparts “control” to the secured party, the new Article 12 paradigm will  require careful analysis to determine if in fact the asset in question is a “controllable electronic record” and whether it is meets the newly developed tests for “control” of a “controllable electronic record” set out in the new Article 12. It is unlikely that a “form” document like an account control agreement will be the one size fits all mechanic to gain perfection by “control” for this asset class.

The purchase and sale of assets by a debtor is governed by Section 363 of the Bankruptcy Code. So-called “363 sales” are typically attractive from a buyer’s perspective (and may be a primary reason for a bankruptcy filing). Perhaps the most important benefit afforded to buyers in 363 sales is the ability to acquire assets “free and clear” of claims and interests of third parties. Section 363(f)(5) of the Bankruptcy Code provides that a debtor can sell property free and clear of any interest in such property when a third party “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.” But what constitutes an “interest” remains the subject of some debate, particularly as it relates to successor liability claims. One category of successor liability claims that may arise in traditionally unionized industries are the claims of pension funds that are triggered by a participant’s withdrawal. “Withdrawal liability” arises under the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”) and may, at times, be asserted against a purchaser of the participant’s assets, typically where it had notice of the claim at the time of the acquisition and where there exists a “substantial continuity” in the business operations following the purchase. 

Continue Reading Successor Liability and Section 363: A Broad Interpretation of an “Interest in Property”

On September 22, 2022, Compute North Holdings, Inc. and certain affiliates filed bankruptcy in the Southern District of Texas in Houston.  The company describes itself as “a leader in data centers, focused on delivering sustainable, cost-effective infrastructure for customers in the blockchain, cryptocurrency mining and distributed computing space.”  See Declaration of Harold Coulby, Chief Financial Officer and Treasurer of the Debtors (Doc. 22). It owns and operates three operating facilities that provide remote computing capacity and has rights to two others that remain in development. Its main business lines include (i) hosted cryptocurrency mining services, (b) bitcoin mining, and (c) cryptocurrency equipment sales. See Id.

The company attributes its predicament to a severe liquidity crisis that constrained its ability to complete development of two facilities that had begun prior to the distress that has marked the digital assets markets in 2022. In particular, it points to the drop in bitcoin prices to levels almost 75% below its peak in late 2021 and the doubling of costs for electricity required for bitcoin mining. See Id. The company also encountered extreme difficulties with one of its lenders, Generate Lending, LLC (“Generate”), the lender on a $300 million credit facility. Following a number of alleged defaults under the facility, among other things, Generate effectively ceased control of a non-debtor subsidiary that indirectly owns two critical facilities, including the so-called “crown jewel.” The company says that it had disputed the existence of the alleged defaults and remains in discussions with Generate regarding financing. See Id.    

With regard to its mining operation, the company says that it maintains cryptocurrency wallets which contain customer “subaccounts or subwallets” — the mining gear that is awarded bitcoin “could belong to a customer.” The wallets are maintained on the Genesis and Bitstamp exchanges. See Id. Given the opacity in this largely unregulated environment, it is unclear whether there will be any dispute regarding the ownership of bitcoin maintained in those wallets.

Like Voyager and Celsius before them, the company filed bankruptcy without arranged financing. The case will be funded at the outset with the company’s limited unrestricted cash (approximately $8.7 million).Also similar to those cases, the company plans to pursue a dual path process, either a sale of the business as a going concern or a stand-alone plan.  See Id.  

We will continue to provide updates as circumstances warrant.

On September 14, Crowell partners Rick Hyman and Gregory G. Plotko, together with Dawn Haghighi, General Counsel of PVC Murcor, published an article on the Association of Corporate Counsel’s ACC Docket, “Your Counterparty Filed Chapter 11 – Make Sure to Check These 10 Boxes.” The article provides valuable insight for in-house counsel who find themselves dealing with a bankrupt counterparty, and are unsure of their next steps. For the full article, view it here on the web, and remember to subscribe and check back soon for more posts on Restructuring Matters.