Category: Bankruptcy

740,000 Reasons to Think Twice Before Putting a Company in Bankruptcy

A recent decision from a bankruptcy court in Delaware provides a cautionary tale about the risks of involuntary bankruptcy.

In the Delaware case, the debtor managed a group of investment funds. The business was all but defunct when several investors, dissatisfied with the debtor’s management, filed an involuntary Chapter 7 petition.  They obtained an order for relief from the bankruptcy court, then removed the debtor as manager of the funds and inserted their hand-picked manager.  So far, so good.

The debtor, who was not properly served with the involuntary petition and did not give the petition the attention it required, struck back and convinced the bankruptcy court to set aside the order for relief. The debtor then went after the involuntary petitioners for damages.  After 8 years of litigation, the Delaware court awarded the debtor $740,000 in damages – all of it attributable to attorneys’ fees and costs.

If you file an involuntary petition and the bankruptcy court dismisses it, then a debtor can recover costs and reasonable attorneys’ fees.  The legal fees include the amount necessary to defeat the involuntary filing.  In addition, if the court finds that the petition was filed in bad faith, then the court also can enter judgment for all damages proximately caused by the filing and punitive damages.  The Delaware court awarded the debtor $75,000 for defeating the involuntary petition.

The debtor also sought a judgment for attorneys’ fees in pursuit of damages for violating the automatic stay.  The involuntary petitioners had replaced the debtor as manager without first obtaining leave from the court to do so.  The investment fund was barely operating and had little income to support a claim for actual damages.  Nevertheless, the Delaware court awarded $665,000 in attorneys’ fees related to litigating the automatic stay violation.

Because the debtor had no “actual” damages from the stay violation, the involuntary petitioners contended that the debtor was not entitled to recovery of attorneys’ fees.  The Delaware court pointed out that “actual” damages (e.g., loss of business income) are not a prerequisite to the recovery of attorneys’ fees, much to the chagrin of the defendants.  The court held that attorneys’ fees and costs are always “actual damages” in the context of a willful violation of the automatic stay.

The Delaware court also rejected defendants’ argument that the fee amount was “unreasonable” since there was no monetary injury to the business.  In other words, the debtor should not have spent so much money on legal fees because it lost on its claim.  The court held that defendants’ argument was made “with the benefit of hindsight” – at the end of litigation when the court had ruled, after an evidentiary trial, that debtor suffered no actual injury.  The court pointed out that the debtor sought millions in damages for the loss of management’s fees, and even though the court rejected the claim after trial, it was not an unreasonable argument for the debtor to make.  The court concluded that “the reasonableness of one’s conduct must be assessed at the time of the conduct and based on the information that was known or knowable at the time.”

The involuntary petitioners likely had sound reasons to want the debtor removed as fund manager.  But by pursuing involuntary bankruptcy and losing, they ended up having to stroke a check to the debtor for over $700,000.  Talk about adding insult to injury.  The upshot is that involuntary bankruptcy is an extreme and risky action that should be a last-resort option undertaken with extreme caution.

© 2024 Ward and Smith, P.A.. All Rights Reserved.

by: Lance P. Martin of Ward and Smith, P.A.

For more news on Bankruptcy Litigation, visit the National Law Review’s Bankruptcy & Restructuring section.

Large Corporate Bankruptcy Filings Surged in First Half of 2023

Increase in large corporate bankruptcy filings driven by companies in retail trade, services, and manufacturing.

The increase in large corporate bankruptcies in the first half of 2023 marked a reversal from a gradual decline in filings since the start of 2021, according to a report released today by Cornerstone Research.

The report, Trends in Large Corporate Bankruptcy and Financial Distress—Midyear 2023 Update, found that the number of bankruptcies filed by public and private companies with over $100 million in assets increased during the first half of 2023 to 72 filings, already surpassing the 53 bankruptcy filings in 2022. While the number of bankruptcies increased, the average assets at the time of filing, $780 million, were well below the 2005–2022 average of $2.05 billion and the 2022 average of $1.62 billion.

The surge in large corporate bankruptcy filings in the first half of 2023 is consistent with economic conditions posing heightened bankruptcy risk for highly leveraged companies.

Retail Trade, Services, and Manufacturing saw the most notable increases in bankruptcy filings in the first half of the year, while Mining, Oil, and Gas continued to decline. Manufacturing has already seen nearly twice as many bankruptcies as in the previous year (24 filings in 1H 2023 compared to 13 in 2022) and accounted for 33% of all bankruptcies filed in the first half of 2023.

“The surge in large corporate bankruptcy filings in the first half of 2023 is consistent with economic conditions posing heightened bankruptcy risk for highly leveraged companies,” said Matt Osborn, a principal at Cornerstone Research and coauthor of the report. “Along with a general rise in interest rates, credit spreads for highly leveraged corporate issuers compared to investment grade issuers began widening in mid-2022, a shift that generally persisted into the first half of 2023.”

The number of mega bankruptcies, those filed by companies with over $1 billion in reported assets, also increased. In the first half of 2023, the number of mega bankruptcies already matched the full-year total for 2022 of 16 and surpassed the 2005–2022 half-year average of 11. The largest bankruptcy was filed by SVB Financial Group, with $19.68 billion in assets at the time of filing. The largest non-financial-firm bankruptcy filing was by Bed Bath & Beyond Inc., with $4.40 billion in assets at the time of filing. Six mega bankruptcies were filed by companies in the Services industry.

Additional Statistics and Trends

  • The first half of 2023 saw an average of 12 bankruptcies per month, nearly twice the monthly average between 2005 and 2022 of 6.4.
  • The average assets at the time of filing among the largest 20 bankruptcies in the first half of 2023 ($32 billion) were 41% lower than that of the 20 largest in 2022 ($3.95 billion).
  • The most common venues for bankruptcy filings were Delaware and the Southern District of Texas, which accounted for 39% and 32% of all bankruptcy filings in 1H 2023, respectively.
  • The second half of 2022 saw a large number of corporate bankruptcies involving crypto lending companies, exchanges, and related businesses, with such bankruptcy filings continuing in the first half of 2023.

Click here to read the full report.

Copyright ©2023 Cornerstone Research
For more news on 2023 Bankruptcy Filings, visit the NLR Bankruptcy & Restructuring section.

Upstream and Affiliate Guaranties in NAV Loans

Guaranties are a common feature in fund finance transactions. Particularly in NAV loans, upstream and affiliate (or “sideways”) guaranties are used. Below we discuss some of the context for the use of these types of guaranties, as well as some of the issues that lenders should consider in relying on them.

Upstream Guaranties

It is not uncommon in NAV loan transactions for the borrower to hold the underwritten assets for the financing (i.e., the fund’s portfolio of investments) through one or more controlled subsidiary holding vehicles (each, a “HoldCo”). Lenders may take a pledge of the management and economic interests in the HoldCos (rather than the underlying investments). In order to get as close to the underlying investments as possible (without taking a pledge), lenders may require that a HoldCo issue a guaranty directly to the lenders (or the administrative agent, on behalf of the lenders), guaranteeing the borrower’s obligations under the NAV loan facility. This “upstream” guaranty provides the lenders a direct claim against the HoldCo for amounts due under the loan, mitigating some of the risk of structural subordination to potential creditors (expected or unexpected) at the level of the HoldCo.[1]

Affiliate Guaranties

It is also common in NAV loan facilities for the borrower’s portfolio of investments to be held by multiple subsidiaries and/or affiliates of the borrower. Each such subsidiary or affiliate may be designated as a guarantor for repayment of the loan. As a result, such entities end up guaranteeing the obligations of their affiliates. The purpose of these affiliate guaranties is the same as the upstream guaranties discussed above – namely, to provide the lenders with a more direct enforcement claim in a default scenario.

Use of Such Guaranties

Motivations for the use of such upstream and affiliate guaranties may include:

a lender’s desire to underwrite a broader portfolio of investments, mitigating concentration risk to the portfolio of a single holding entity;
a lender’s desire to ensure that it is not subordinate to creditors that may arise at the level of the entity that directly owns the investment; or
a borrower’s desire to obtain a higher loan-to-value ratio than the lenders would otherwise provide based on the investments alone.
While upstream and affiliate guaranties can help to address these issues, they may raise nuanced legal issues that should be discussed with counsel in light of the relevant facts and circumstances.

Enforceability Considerations

Guaranties constitute the assumption of the liabilities of another entity and are contingent claims against the guarantor. Under certain insolvency laws, guaranties may be subject to challenge, and payments under guaranties may be subject to avoidance. Upstream or affiliate guaranties may be subject to heightened scrutiny and challenge in a bankruptcy or distress scenario. Below are a few potential issues lenders should bear in mind with respect to upstream and affiliate guaranties.

1. Constructively Fraudulent Transfer Avoidance. Under Bankruptcy Code section 548 and certain state laws, (a) transfers of property (including grants of security interests or liens), or (b) obligations assumed (such as incurring a loan or guaranty obligation) may be avoided as constructively fraudulent if BOTH of the following requirements are satisfied:[2]

  • (i) the transferor/guarantor does not receive reasonably equivalent value; AND
  • (ii) the transferor/guarantor is insolvent or undercapitalized or rendered insolvent, undercapitalized or unable to pay its debts because of the transfer or the assumed liability.

A guaranty by a parent of the obligations of a wholly owned and solvent subsidiary, a so-called downstream guaranty, is generally regarded as providing the parent with reasonably equivalent value through an enhancement of the value of its equity ownership of the subsidiary.

Upstream and affiliate guaranties require more scrutiny than guaranties by a borrower parent to determine whether any potential enforceability issues are present.

a. Reasonably Equivalent Value. The determination of value is not formulaic or mechanical, but rather generally determined by the substance of the transaction. Value or benefits from a transfer may be direct (e.g., receipt of loan proceeds) or indirect. But if indirect, they must be “fairly concrete.”

In each of the above scenarios, we are assuming that the upstream or affiliate guarantor would not use the proceeds of any loans and, consequently, would not be added to the loan facility as a borrower. However, other indirect but tangible benefits or value to the guarantor should be identified, e.g., favorable loan terms or amendments, use of the NAV facility proceeds that may indirectly but materially benefit the guarantor, maintenance of the entire fund group of entities that benefits the guarantor, etc.

b. Financial Condition of Guarantor. The financial condition of the transferor/guarantor is evaluated at the time of the incurrence of the guaranty. The evaluation is made from the debtor/guarantor – in what condition was the guarantor left after giving effect to the transfer or assumption of the obligation. Diligence regarding a guarantor’s financial condition may demonstrate that such guarantor is sufficiently creditworthy to undertake the guaranty and remain solvent and able to conduct its respective businesses. Representations from the guarantor may be sought to confirm its financial condition.

c. Potential Mitigants. In addition to performing diligence with respect to the above points, lenders and their counsel will often include contractual provisions to mitigate the possibility that a guaranty may be found to constitute a fraudulent transfer. Savings clauses, limited recourse guaranties, and net worth guaranties are all tools that can be used to address the issues noted above. The scope and appropriateness of such provisions is beyond the scope of this article and should be discussed with external deal and restructuring counsel.

2. Preference Challenge. Under Bankruptcy Code section 547, a transfer made by a debtor to a creditor, on account of an antecedent debt, that is made while the debtor was insolvent and within 90 days before the bankruptcy case has been commenced may be subject to avoidance as a preferential transfer. Certain defenses may apply to a potential preferential transfer, including the simultaneous exchange of “new value” by the creditor. However, note that any pre-bankruptcy transfers of value, like payments under a guaranty, may be subject to scrutiny and potential challenge by the guarantor/debtor or a bankruptcy trustee.

Guaranties can be an important element in structuring NAV loan transactions to achieve the terms desired by the parties and to provide necessary protections for the lenders, but consideration needs to be given to the legal issues, such as the ones mentioned here, that their inclusion can present.

[1] Lenders will typically also require the HoldCo to pledge its accounts to which proceeds of the underlying investments are paid, allowing lenders to foreclose on such cash at the HoldCo level, without the need for such cash to first be distributed up to the borrower.

[2] Note that the precise language of certain state fraudulent transfer laws may differ, but conceptually, most state statutes require a showing of (i) insufficient or unreasonably small consideration in exchange for the transfer or liability incurred, and (ii) the transferor/debtor being insolvent at the time of the transfer, or becoming insolvent or subject to financial distress as a result of the transfer.

© Copyright 2023 Cadwalader, Wickersham & Taft LLP

Navigating the Business Landscape After Silicon Valley Bank and Signature Bank

NOTE: The information contained in the following alert is up-to-date as of March 15, 2023. News and events are evolving, so check the websites for the FDIC and the applicable banks for updates and announcements.

Start-up, emerging, middle market and other companies and their founders, executives, and investors, are facing heightened demands in the wake of recent developments involving Silicon Valley Bank (SVB) and Signature Bank. You can navigate the situation and be well-positioned for continued growth and success by considering the suggestions below.

We banked with Silicon Valley Bank or Signature Bank. How can we get our funds?

  • All funds, including those above Federal Deposit Insurance Corporation (FDIC) insurance limits, were transferred to Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A., respectively, and depositors have full access to their money beginning March 13, 2023

  • You may continue to use the same online banking access, checks and/or ATM/debit cards to access your funds

What are the applicable FDIC insurance limits generally?

  • The FDIC exercised its authority under the systemic risk exception to cover uninsured deposits at Silicon Valley Bank and Signature Bank, but has not otherwise modified the FDIC insurance thresholds

  • Deposits are insured up to at least $250,000 per depositor, per FDIC-insured bank, per ownership category

  • Legal entities with independent operations are generally entitled to $250,000 in FDIC-insurance per FDIC-insured bank

  • Bank customers do not need to purchase deposit insurance; it is automatic for any deposit account opened at an FDIC-insured bank

  • Funds swept into money market funds on an overnight basis are not treated as deposits of the bank, are not subject to FDIC insurance, and the FDIC will honor the banks obligation to convert the money market funds back into cash the next day

  • Banks may also offer a multibank sweep vehicle, often via IntraFi’s ICS or CDARS program, which allows balances in excess of the $250,000 amount to be transferred to other banks to take advantage of each bank’s $250,000 FDIC insurance limit

  • FDIC Link to Are My Deposit Accounts Insured by the FDIC

  • FDIC’s Electronic Deposit Insurance Estimator

We have venture debt or another form of loan from Silicon Valley Bank or Signature Bank. Do we need to continue to make payments? Are the terms of the facility or any security interest modified? Can we continue to draw on a line of credit? Is a letter of credit issued by one of those banks still valid?

  • Payment obligations continue, and the terms of any arrangements are unchanged

  • The FDIC can repudiate contracts under certain circumstances, and so it may not honor advances or letters of credit

  • The FDIC’s general policy is that its role as receiver generally precludes continuing the lending operations of a failed bank

  • The FDIC will consider advancing funds if it determines that the advance is in the best interest of the receivership

  • Upon receiving a funding request, the FDIC may: make all or a portion of the requested loan advance, undertake discussions to reach a mutually satisfactory agreement to restructure the loan, or exercise its statutory right as receiver to repudiate its funding obligations with respect to the loan

  • Accordingly, letter of credit counterparties may  not view Silicon Valley Bank-issued or Signature Bank-issued letters of credit as creditworthy in the current circumstances, and it may be beneficial to take proactive steps to make alternate arrangements where possible

  • However, Silicon Valley Bridge Bank has indicated that it will honor all commitments to advance under existing credit agreements

  • As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

What about any warrants issued to such institutions?

  • Warrants issued to a bank in receivership should remain valid and outstanding with no change impacting the cap table

  • As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

Can we leave our current bank or at least diversify our deposits across financial institutions?

  • Examine banking relationships and review loan agreements and lines of credit for restrictions and covenants that may require you to maintain primary banking relationship or certain deposit accounts (e.g., your receivables) at the lender

  • Look into ICS or CDARS programs at network banks, which provide FDIC insurance coverage for certain business deposits of $250,000 or more

  • New bank relationships require “Know Your Customer” processing, which requires lead time that could be even more protracted in the current climate

  • An international company considering cash repatriation will want to consider tax implications

Payroll is coming due. Can we delay payments to employees? What should our company do if it is tight on cash?

Labor and wage payment laws and regulations impose requirements on when employers must pay employees

  • Under the Federal Fair Labor Standards Act, employers must pay non-exempt employees for hours worked and exempt employees for their regularly weekly rate of pay on regularly scheduled pay days for the covered pay period

  • Where state law imposes higher standards regarding unpaid wages, minimum wage, and other wage payment obligations, consider furloughs or changes for future wages to avoid violations

  • Failure to pay wages when due can subject U.S. employers to, among other things, fines and liquidated damages including double or treble damages, attorney fees (for litigation) and individual personal civil and, in some cases, criminal liability on owners and executives

  • Employers remain obligated to deduct and remit payroll taxes from wages even when under stress caused by the insolvency of its bank

  • If company has employees or independent contractors outside the United States, consult local lawyer(s)

Assess payroll, legal and contractual requirements and alternatives

  • Identify other available funds to ensure that payroll requirements can be met and, if not, explore alternative sources of funding

  • Request company owners, senior executives and board to consider pay cuts

  • Consider measures ranging from furloughs of nonexempt employees to pay cuts and/or reductions in hours in compliance with labor and employment laws, and clearly communicate changes to employees

  • Consider use of retention/stay bonuses

  • If an employee decides to leave or a decision is made to let an employee go, consider separation agreement issues and limits on use of non-compete, non-solicitation, non-disclosure, non-disparagement and appropriate release terms in specific context, including in light of existing employee agreements

  • Confirm and comply with prior employee documentation, including employment agreements, offer letters, employee handbooks and policies, IP assignment terms, confidentiality terms, and option or other equity terms

  • Consider governance and contractual requirements with respect to changes in compensation, bonus plans, etc.

  • Take control and communicate with employees as appropriate, to manage the situation and help allay fears and risk of departures and to enhance productivity

What are our options for payments owed to lenders, landlords, suppliers, vendors and other creditors?

  • Consider contacting creditors to negotiate short-term credit and payment extensions in light of cash flow needs and credit risk issues

  • Consider drawing existing and available lines of credit to shore up working capital position

  • Consider strategically stretching out payments to certain other non-critical trade creditors

  • Consider reaching out to investors for short-term liquidity or equity infusions

How can we identify and secure alternative sources of funding?

  • Focus on maintaining current payments to lifeblood sources

  • Consider reaching out to investors for short-term liquidity or equity infusions

  • Consider straight loan or promissory note if the company is in a position to pay a fixed sum or interest, and evaluate valuation, dilution and cap table impacts if considering SAFE, convertible note, warrant, preferred or other equity

  • Consider governance issues including necessary board and investor approvals, creditor consents, intercreditor and tax issues

  • Consider selling non-core assets

How do we obtain a line of credit in this environment?

  • New bank relationships require “Know Your Customer” processing, which require lead time that could be even more protracted in the current climate

  • New lines of credit require lead time for underwriting, credit approval and documentation and, if you have other debt facilities in place already, potential consent from existing lenders

  • Consider expanding existing banking relationships to shorten potential lead times,

What else should we take into account if we are considering bridge financing or other funding from our investors?

  • In addition to above, consider SAFE, convertible note or a preferred stock round and extending any repayment terms

  • Obtain interested party transaction approvals and addition to typical governance requirements such as board and investor approvals

What are my company’s reporting or disclosure obligations? What information should we share internally?

  • Your obligations depend in part on whether the company is public or private, accounting standards, securities laws, exchange rules, state corporate law, and your governance documents

  • For a private company, managing the situation through open and informal communications with stakeholders may provide insight and useful information for financial and operational issues and reporting to the Board

  • A public company affected by a bank shutdown or experiencing a liquidity challenge may have SEC disclosure obligations, and communications with stakeholders will be governed by securities laws

What should I keep in mind about board decision-making

  • Maintain acute awareness of the possibility of self-dealing or even the appearance of self-dealing, and obtain appropriate approvals for any insider transactions, such as disinterested director or stockholder approval

We are focused on conserving and managing cash. What should we be doing?

  • Engage or hire experienced financial and accounting advisors (whether an outside consulting or other firm, or a fractional or full-time experienced finance employee or independent contractor)

  • Track financial position and obligations closely, with an eye on foot faults that could arise in the near, medium, and long-term horizon

  • Challenge assumptions: long-term risks might suddenly become near-term ones.

  • Focus on liquidity issues (cash position, cash flow and burn rate) and forecast for several months to meet obligations to creditors, considering limits on access to significant deposits or credit lines if a banking partner has closed and potential changes in the credit market more broadly

  • Assess availability of alternative funding sources

  • Update financial statements, plans and projections and underlying assumptions, and consult with board, advisors and key investors about appropriate adjustments

  • Consult with advisors and partners on appropriate cash management, financial institution diversification and risk management strategies for your situation

How do we know if our business insurance is the right kind and amount to cover the risks our company and its directors and officers may face?

  • Determine whether losses from a bank closure are covered by business interruption or other insurance

  • Review current D&O insurance coverage, including the applicable limits and periods of coverage

Our company’s insurance premium payment is coming due. Can we delay or defer payment if we are tight on cash?

  • Insurance premiums should be paid when due, as failing to pay an insurance premium could cause the policy to lapse leaving it without coverage

  • Consider contacting the insurance company to clarify any grace period or adjust any deductible

  • Consult with an insurance broker and the board to evaluate whether there is a more affordable option. Review governance terms to see whether changes to insurance may require investor approval

Article By Lori Anne Czepiel, Robert Klingler, James W. Bartling, Mitch Boyarsky, Jason L. Watkins, Paul Z. Rothstein, Joe Daniels, Jackson Hwu, Neil Grayson, Benjamin Barnhill, J. Brennan Ryan, Dowse Bradwell Rustin IV, Richard Levin, and Craig Nazarro of Nelson Mullins.

For more financial and banking legal news, click here to visit the National Law Review.

Copyright ©2023 Nelson Mullins Riley & Scarborough LLP

The Silicon Valley Bank Failure: Implications on Commercial Leasing

This past Friday, March 10, 2023, the Federal Deposit Insurance Corp. (FDIC) announced its takeover of the failed Silicon Valley Bank (“SVB”) after a run on the bank late last week caused the largest-scale U.S. bank failure since Washington Mutual in the 2008 financial crisis. Two days later, New York regulators shuttered Signature Bank (“Signature”). The federal government has made it clear that, while FDIC will guaranty all deposits, including uninsured ones, bailouts of these banks will not occur. The failures of SVB and Signature are likely to have widespread ramifications across many industry sectors, including commercial leasing.

How will the bank failures impact landlords in the commercial leasing sector?

  • SVB was a very common issuer of tenant letter of credit security deposits. A letter of credit security deposit is the issuing bank’s contractual obligation to pay the landlord beneficiary the amount that such landlord’s tenant is in default.
  • Landlords holding tenant letters of credit issued by SVB or Signature as security deposits will be directly impacted by the bank failures. Any undrawn standby letters of credit issued by SVB, Signature or any other bank under FDIC receivership may be repudiated by the FDIC, making any such letter of credit worthless. Any affected landlord will want to act promptly to provide proper protection of their interests under any applicable lease.

How can landlords protect their interests under such leases?

  • Any landlord holding a letter of credit security deposit should identify the issuing bank.
  • In any lease where the security deposit is a letter of credit issued by SVB or Signature, the landlord should carefully review the terms of the lease regarding the security deposit and the landlord’s approval rights over the issuing bank, but in any event require the tenant to provide it with a letter of credit issued by a different financial institution.
  • All landlords should review the terms their lease agreements relating to landlord approval rights over issuing banks, draw procedures and requirements and the process for replacing a letter of credit.
  • In the event the lease agreement in question does not provide landlord with adequate approval rights over the issuing bank, clear draw procedures and stringent replacement requirements, the landlord should consider amending the lease agreement to so require.

Article By Jeff Bates and Blake Young of Winstead

For more finance and banking legal news, click here to visit the National Law Review.

© 2023 Winstead PC.

Information for Borrowers with Loans from Silicon Valley Bank or Signature Bank

This alert provides information for borrowers with loans from Silicon Valley Bank (“SVB”) or Signature Bank (“Signature”) based on information available from the FDIC and our clients’ experiences over the last few days. We have also included information regarding the FDIC’s general policies and procedures when selling and administering loans of failed banks. We will update this alert as additional information becomes available.

Borrowers with loans from SVB or Signature continue to wait for information from the FDIC, and the new bridge banks it formed, with respect to their loans, including any information regarding the sale of their loans, new bank contact information and updates to borrowing procedures and payoff logistics. At present, we understand that the bridge banks are attempting to operate in the same manner with respect to their borrowers (and depositors) that SVB and Signature operated prior to their failures, including through use of the existing relationship managers/bank contacts and online platforms and consistent borrowing and payment mechanics.

Systemic Risk Exception

As widely reported, on Sunday, March 12, the Federal Reserve, the FDIC and the Treasury Secretary announced a systemic risk exception and created Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A. (together, the “Bridge Banks”). The systemic risk exception is an attempt to avoid a widespread bank run and to ensure that all of SVB and Signature Bank’s depositors would be made whole after the failures of the two banks. The systemic risk exception is an exception to federal law that otherwise would require the FDIC to resolve a bank failure at the lowest cost to the Government’s deposit insurance fund.  See Crisis and Response: An FDIC History, 2008-2013, p. 36. Otherwise, the FDIC would not have been in a position to backstop uninsured deposits beyond the $250,000 insured limit per depositor per ownership category. For more information about FDIC deposit insurance limits please see our prior alert: SVB Receivership – What You Need to Know.

Prior to Sunday, the only uses of the systemic risk exception occurred in 2008 and 2009.  Id., pp. 35-36. The systemic risk exception has never before been used to create bridge banks at which loans at failed institutions would then be sold or administered by the FDIC.

Sale of SVB and Signature Loans

The general expectation after a bank failure is that the failed bank’s loans will be sold to a new lender as expeditiously as possible. The FDIC conducted an auction for the assets of SVB (including its loan portfolio) on Sunday, March 12. The Wall Street Journal reported on Monday, March 13 that, while none of the largest U.S. Banks bid on SVB at the initial auction, there was at least one offer which was declined by the FDIC. The WSJ is also reporting that regulators are planning to hold another auction of SVB’s assets. We also anticipate an auction of Signature’s assets. The timing of these auctions remains unclear.

In the event that either or both of these auctions produce buyers of the Bridge Banks’ respective assets in bulk, those buyers will become the lenders under the failed banks’ loans. In that case, the applicable successor lender will advise its new borrowers of their new bank contacts and provide relevant loan administration information including loan payment procedures.

If either or both of the auctions fail to produce a buyer for all of the bank’s assets, a bank’s loan portfolio may be split up and sold piecemeal. In this event it may take longer before borrowers know the identity of their new lender. If some or all of the loans are not purchased, they will continue to be administered by the respective Bridge Banks or the FDIC. As noted above, the intent of the FDIC is to continue to operate the Bridge Banks pending substantial completion of the sale process.

Borrowing Under an SVB or Signature Line of Credit

In general, when the FDIC is appointed receiver, it immediately begins analyzing loans that require special attention, such as unfunded and partially funded lines of credit, and construction and development loans. Typically speaking, the role of receiver generally precludes the FDIC from continuing the lending operations of a failed bank; however, the FDIC will consider advancing funds if it determines an advance is in the best interest of the receivership, such as to protect or enhance collateral, or to ensure maximum recovery to the receivership. See A Borrowers Guide to an FDIC Insured Bank Failure.

When the FDIC is operating as receiver, its general procedures provide that if a borrower submits a request for additional funding, the FDIC will conduct a thorough analysis to determine the best course of action for the receivership. The FDIC uses information contained in the failed bank’s loan files to the extent available and considered reliable. Because the files of failed banks are often incomplete or poorly documented, the FDIC may require additional financial information to perform its analysis and make decisions.

In the current circumstances, with the Bridge Banks operating under the systemic risk exception, these general FDIC rules appear to have been relaxed, at least for the time being and our clients are reporting that borrowing (and deposit) operations are generally functioning in the ordinary course. We have not yet heard from any clients that additional information has been required in connection with advances from the Bridge Banks.

SVB Contact Information

The FDIC is currently directing SVB borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at SVB. SVB also has a call center at 800-774-7390 open from 5:00 AM to 5:30 PM (Pacific) with representatives that can assist borrowers.

Signature Contact Information

The FDIC is currently directing Signature borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at Signature Bank. Signature Bank also has a 24-hour call center at 866-744-5463 with representatives that can assist borrowers.

On Monday, March 13, our clients had mixed results contacting their existing bank relationship managers and drawing on lines of credit. Some clients requested online draws but have not been successful as a result of system malfunctions (and we heard the same reports with respect to some attempts to access and move deposits). On the other hand, we heard reports from our clients that automatic draws and account sweeps have continued to function (and many borrowers successfully accessed their accounts). Today (March 14), clients appear to be having more success in accessing their lines of credit. We will continue to gather information about borrowers’ ability to access their lines as it becomes available.

Loan Payoff/Lien Release Information

Many clients have inquired about the mechanics for arranging a loan payoff/refinancing of their SVB loan or Signature loan. In the event that the loan is sold, the borrower can coordinate payoff with the new lender that purchased the loan. In the meantime, borrowers should reach out to their relationship managers or otherwise contact the bank using the means provided above to arrange any payoff and/or lien release. Further information regarding lien releases may also be found on the FDIC lien release website. In the event that borrowers’ loans are not sold quickly by the FDIC to a new lender, we expect that those borrowers will be strongly encouraged by the FDIC to arrange for a refinancing. See A Borrowers Guide to an FDIC Insured Bank Failure.

Continue Performing Obligations under Loan Documents

Notwithstanding the failures of SVB and Signature, their borrowers should continue to abide by their loan documents, including submitting payments as required by their loan documents at the same addresses and complying with all other covenants and agreements. Borrowers will be advised by the FDIC, the Bridge Banks or a subsequent purchaser of their loan if there are any updates to payment mechanics or bank contact information.

Article By Timothy John Carter, Jonathan C. Hayden, Trevor Hoffmann, Muryum Khalid, Kevin Renna, Douglas B. Rosner, Andrew Rothstein, Jesse Rubinstein, and Jesse Scott of Goulston & Storrs.

Click here for more financial legal news from the National Law Review.

2023 Goulston & Storrs PC.

Silicon Valley Bank Fails After Run on Deposits

“The Federal Deposit Insurance Corporation took control of the bank’s assets on Friday. The failure raised concerns that other banks could face problems, too.”

Read the New York Times article (Free Subscription Required)

In light of the news this morning that Silicon Valley Bank (SVB) has been closed by the California Department of Financial Protection, which appointed the Federal Deposit Insurance Corporation as SVB’s receiver, it’s fair to ask if this is the beginning of a trend among regional banks or an isolated incident. SVB, while unique in the banking industry, since it would lend against illiquid (pre-IPO) securities, mainly issued by ventured-backed companies, faced challenges in a rising interest rate environment that are not unique and which, many similarly situated regional banks, are still facing.

As the Federal Reserve considers whether to raise interest rates by 0.25% or 0.5%, in order to combat inflation, a key factor in their analysis will be the impact these interest rate hikes have on regional banks and their portfolios. Regional banks, unlike their Fortune 100, multi-national counterparts, derive their value from vast portfolios of bonds, which are very sensitive to interest rate hikes (as interest rates rise, the value of these bonds fall). For instance, the S&P Regional Banks Select Industry Index is down 3.69% today, 19.92% month-to-date, and 13.02% year-to-date.

Therefore, in the coming days, it will be crucial to watch both the Federal Reserve’s Federal Open Market Committee meeting on March 21-22 and whether SVB’s collapse signals a contagion among the regional bank sector. SVB’s closure is the biggest bank collapse since the financial crisis and many start-up/early-stage companies will be very interested to see if it is the last or the first of many.

© 2023 ArentFox Schiff LLP

Who Owns the Crypto, the Customer or the Debtor?

Whose crytpo is it? With the multiple cryptocurrency companies that have recently filed for bankruptcy (FTX, Voyager Digital, BlockFi), and more likely on the way, that simple sounding question is taking on huge significance. Last week, the Bankruptcy Court for the Southern District of New York (Chief Judge Martin Glenn) attempted to answer that question in the Celsius Network LLC bankruptcy case.

The Facts of the Case

Celsius and its affiliated debtors (collectively, “Debtors”) ran a cryptocurrency finance platform. Faced with extreme turbulence in the cryptocurrency markets, the Debtors filed Chapter 11 petitions on July 13, 2022. As part of their regular business, the Debtors had allowed customers to both deposit cryptocurrency digital assets on their platform and earn a percentage yield, as well as take out loans by pledging their cryptocurrencies as security. One specific program offered by the Debtors was the “Earn” program, under which customers could transfer certain cryptocurrencies to the Debtors and earn “rewards” in the form of payment of in-kind interest or tokens. On the petition date, the Earn program accounts (the “Earn Accounts”) held cryptocurrency assets with a market value of approximately $4.2 billion. Included within the Earn Accounts were stablecoins valued at approximately $23 million in September 2022. A stablecoin is a type of cryptocurrency designed to be tied or pegged to another currency, commodity or financial instrument.

Recognizing their emerging need for liquidity, on November 11, 2022, the Debtors filed a motion seeking entry of an order (a) establishing a rebuttable presumption that the Debtors owned the assets in the Earn Accounts and (b) permitting the sale of the stablecoins held in the Earn Accounts under either section 363(c)(1) (sale in the ordinary course of business) or section 363(b)(1) (sale outside the ordinary course of business) of the Bankruptcy Code. The motion generated opposition from the U.S. Trustee, various States and State securities regulators and multiple creditors and creditor groups. The Official Committee of Unsecured Creditors objected to the sale of the stablecoins under section 363(c)(1) but argued that the sale should be approved under section 363(b)(1) because the Debtors had shown a good business reason for the sale (namely to pay ongoing administrative expenses of the bankruptcy cases). On January 4, 2023, the court issued its forty-five (45) page memorandum opinion granting the Debtors’ motion.

The Court’s Decision

Although the ownership issue may appear complex given the nature of the assets (i.e., cryptocurrency), the bankruptcy court framed the issue into relatively straightforward state law questions of contract formation and interpretation. The court first analyzed whether there was a valid contract governing the parties’ rights to the cryptocurrency assets in the Earn Accounts. Under governing New York law, a valid, enforceable contract requires an offer and acceptance (i.e., mutual assent), consideration and an intent to be bound. The court found that all three elements were satisfied. The Debtors required that all customers agree to and accept “Terms of Use.” The Terms of Use was set up as a “clickwrap” agreement that required customers to agree to the terms and prevented the customers from advancing to the next page and completing their sign up unless they agreed to the Terms of Use. Under New York law, “clickwrap” agreements are sufficient to constitute mutual assent. The court also found that consideration was given by way of allowing the customers to earn a financing fee (i.e., the rewards in the form of payment of in-kind interest or tokens). Finally, the court noted that no party had presented evidence that either the Debtors or the customers lacked intent to be bound by the contract terms. Accordingly, the court held that the Terms of Use constituted a valid contract, subject to the rights of customers to put forth individual contract formation defenses in the future, including claims of fraudulent inducement based on representations allegedly made by the Debtors’ former CEO, Alex Mashinsky.

Having found a valid contract to presumptively exist, the court turned its attention to what the Terms of Use provided in terms of transfer of ownership. In operative part, the Terms of Use provided:

In consideration for the Rewards payable to you on the Eligible Digital Assets using the Earn Service … and the use of our Services, you grant Celsius … all right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere, and to pledge, re-pledge, hypothecate, rehypothecate, sell, lend or otherwise transfer or use any amount of such Digital Assets, separately or together with other property, with all the attendant rights of ownership, and for any period of time, and without retaining in Celsius’ possession and/or control a like amount of Digital Assets or any other monies or assets, and use or invest such Digital Assets in Celsius’ full discretion. You acknowledge that with respect Digital Assets used by Celsius pursuant to this paragraph:

  1. You will not be able to exercise rights of ownership;
  2. Celsius may receive compensation in connection with lender or otherwise using Digital Assets in its business to which you have no claim or entitlement; and
  3. In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws.

Based on this language, the court held that the Terms of Use unambiguously transferred ownership of the assets in the Earn Accounts to the Debtors. Central to the court’s decision was that under the Terms of Use customers had granted the Debtors “all right and title to such Digital Assets, including ownership rights.” Based on this language, the court found that title and ownership of the cryptocurrency held in the Earn Accounts was “unequivocally transferred to the Debtors and became property of the Estate on the Petition Date.”

Finally, the court found that the Debtors had shown that they needed to generate liquidity to fund the bankruptcy cases, and that additional liquidity would be needed early this year. Accordingly, the court held that the Debtors had shown sufficient cause to permit the sale of the stablecoins outside of the ordinary course of business in accordance with section 363(b)(1).

Implications

Given the turbulent nature of the cryptocurrency market and the likelihood of further cryptocurrency bankruptcy filings, the court’s ruling is sure to have significant implications. First, unless it is reversed on appeal, the opinion means that the Debtors’ Earn program customers do not own the funds in their digital accounts and will instead be relegated to the status of unsecured creditors with a highly uncertain recovery. Second, the opinion underscores the Wild West nature of crypto and the fact that unlike deposits at a federally insured financial institution, deposits at cryptocurrency exchanges are not similarly insured and may be at risk. Third, customers or account holders in other cryptocurrency exchanges or businesses should carefully review the applicable terms of use to determine if those terms transferred ownership of their digital assets to their cryptocurrency counterparty. It is likely a fair assumption that such other terms of use transferred ownership in the same way that the Celsius Terms of Use did, in which case customers must remain vigilant of the financial health of their cryptocurrency counterparty. Finally, all parties engaging in on-line business transactions, including those outside of cryptocurrency, are on notice that clickwrap agreements commonly found in such transactions are, at least under New York law, enforceable. In short, those agreements mean something, and the fact that a party did not read the terms before agreeing to them through a “click” is likely not going to be a viable defense to the enforcement of those terms.

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Tom Brady, Larry David, and Others Named Defendants in Class Action Suit Filed Against FTX

Four days after FTX, once the world’s third-largest crypto exchange, filed for voluntary Chapter 11 bankruptcy, former FTX investors filed a class action against 11 athletes and celebrities who promoted FTX in advertisements and on social media, including NFL quarterback Tom Brady and comedian Larry David.

The lawsuit, which also names FTX’s co-founder and former chief executive Sam Bankman-Fried as a defendant, seeks $11 billion in damage.

Background

The FTX bankruptcy filing covers about 130 FTX Group companies, including FTX.com, FTX’s US operations, and Bankman-Fried’s cryptocurrency trading firm, Alameda Research. According to published reports, Bankman-Fried had covertly used funds from FTX customers to make risky bets for Alameda Research – a hedge fund he also ran – and had commingled funds between the two entities.

Allegations Against FTX Celebrity Endorsers

The class action was brought on behalf of US investors who hold FTX yield-bearing accounts funded with crypto assets. The plaintiff and class-action members alleged that FTX lured them to its yield-bearing accounts and transferred investor funds to related entities to maintain the appearance of liquidity.

While an investor class action following bankruptcy is not necessarily surprising, the fact that the complaint named various celebrity endorsers and spokespeople as defendants is fairly unusual. Among them, Larry David starred in an advertisement for FTX that aired during the 2022 Super Bowl. The ad featured David being a skeptic on inventions such as the wheel, the fork, the toilet, democracy, the light bulb, the dishwasher, the Sony Walkman, and, finally, FTX, and cautioned viewers, “Don’t be like Larry.” Other conduct cited by the complaint includes:

  • Tom Brady and Gisele Bundchen: according to the complaint, Brady and Bundchen served as brand ambassadors for FTX, took equity stakes in FTX Trading Ltd., and appeared in an advertisement showing them telling acquaintances to join the FTX platform.

  • Kevin O’Leary: served as brand ambassador and FTX shareholder and made several public statements, including on Twitter, “designed to induce consumers to invest in” FTX’s yield-bearing accounts.

  • Naomi Osaka: the tennis star served as a brand ambassador for FTX in exchange for an equity stake and payments in an unspecified amount of cryptocurrency, appeared in advertisements, and promoted FTX to her Twitter followers.

The plaintiff and class members claimed that those FTX promoters engaged in a conspiracy to defraud investors and violated Florida state laws prohibiting unfair business practices. Specifically, in their civil conspiracy claim, the plaintiff and class members alleged that “the FTX Entities and Defendants made numerous misrepresentations and omissions to Plaintiff and Class Members about the Deceptive FTX Platform in order to induce confidence and to drive consumers to invest in what was ultimately a Ponzi scheme, misleading customers and prospective customers with the false impression that any cryptocurrency assets held on the deceptive FTX Platform were safe and were not being invested in unregistered securities.” [1]

Celebrities Under Scrutiny in Crypto Industry

The US Securities and Exchange Commission (SEC) has gone after celebrities for deceptively touting cryptocurrencies since 2017. In November 2017, SEC Chair Gary Gensler warned celebrities that federal securities laws require people who tout a certain stock or crypto security to disclose the amount, the source, and the nature of those payments they received.[2]

In October 2022, the SEC found that Kim Kardashian violated the anti-touting provision of the federal securities laws by plugging on social media a crypto asset security offered and sold by EthereumMax (EMAX) without disclosing the payment she received for the promotion.[3] Kardashian later settled with the SEC, paid $1.26 million in penalties, disgorgement, and interest, and cooperated with the Commission’s ongoing investigation.[4] “Ms. Kardashian’s case also serves as a reminder to celebrities and others that the law requires them to disclose to the public when and how much they are paid to promote investing in securities,” Gensler added.[5]

Investors have also gone after celebrities for deceptively touting cryptocurrencies. In January 2022, a group of investors filed a lawsuit against Kim Kardashian, along with boxer Mayweather and former basketball star Paul Pierce, for losses they suffered after the celebrities promoted EMAX.

Implications

This case offers a stark warning to celebrities and non-crypto companies that might be considering serving as brand ambassadors or paid influencers for crypto companies, or engaging in sponsorships. Any individual or organization considering entering into a co-promotion or sponsorship agreement with a company in the crypto industry should ensure adequate due diligence has been conducted on the potential partner and carefully scrutinize crypto and NFT offerings for potential liability or exposure under US securities laws. Notably, the US Federal Trade Commission is also carefully scrutinizing the use of influencers and endorsements in commercial marketing and imposes its own disclosure obligations.

© 2022 ArentFox Schiff LLP

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FOOTNOTES

[1] See Complaint, Count Three.

[2] See SEC Statement Urging Caution Around Celebrity Backed ICOs, available at SEC.gov | SEC Statement Urging Caution Around Celebrity Backed ICOs.

[3] See SEC Charges Kim Kardashian for Unlawfully Touting Crypto Security, available at SEC.gov | SEC Charges Kim Kardashian for Unlawfully Touting Crypto Security.

[4] Id.

[5] Id.

Quantifying Cryptocurrency Claims in Bankruptcy: Does the Dollar Still Reign Supreme?

In the past six months, four major players in the crypto space have filed for chapter 11 bankruptcy protection: Celsius Network, Voyager Digital, FTX, and BlockFi, and more may be forthcoming.  Together, the debtors in these four bankruptcy cases are beholden to hundreds of thousands of creditors.  The bulk of the claims in these cases are customer claims related to cryptocurrency held on the debtors’ respective platforms.  These customer claimants deposited or “stored” fiat currency and cryptocurrencies on the debtors’ platforms.  Some of these funds allegedly were commingled or rehypothecated, leaving customer accounts severely underfunded when liquidity crunches arose at the various entities.  The total amount of such claims is estimated to be in the billions — that is, if these claims ultimately are measured in United States Dollars (“USD”).

Crypto-watchers and bankruptcy lawyers alike have speculated how customer claims based on digital assets such as cryptocurrencies should be valued and measured under bankruptcy law.  Given the volatility of cryptocurrency prices, this determination may have a significant effect on recoveries, as well as the viability of the “payment-in-kind” distribution mechanics proposed in Voyager, Celsius, and BlockFi.  A number of creditors appearing pro se in these proceedings have expressed a desire to keep their mix of cryptocurrencies through these proposed “in-kind” distributions.

However, a crypto-centric approach to valuing claims and making distributions raises a number of issues for consideration.  For example, measuring customer claims in cryptocurrency and making “in-kind” distributions of these assets could lead to creditors within the same class receiving recoveries of disparate USD value as the result of the fluctuation in cryptocurrency prices. Moreover, as has been discussed in the Celsius proceedings, the administrative burden associated with maintaining, accounting for, and distributing a wide variety of cryptocurrencies as part of a recovery scheme would likely prove complex.  Equity holders also might challenge the confirmability of a plan where valuations and recoveries are based on cryptocurrency rather than USD, as a dramatic rise in cryptocurrency values could return some value to equity.

Like most issues at the intersection of insolvency and cryptocurrency, there is little precedent to guide creditors through the uncertainties, but a recent dispute in the Celsius bankruptcy proceedings as to whether a debtor is required to schedule claims in USD, or whether cryptocurrency claims can be scheduled “in-kind,” may serve as a preview of things to come.

I.          General Background

Celsius Network (“Celsius” and, together with its affiliated debtors and debtors in possession, the “Debtors”), self-described as one of the “largest and most sophisticated” cryptocurrency-based finance platforms and lenders that claimed over 1.7 million users worldwide,1 filed petitions under Chapter 11 of the Bankruptcy Code on July 13, 2022.2  On October 5, 2022, the Debtors filed their schedules of assets and liabilities (“Schedules”).  Each Debtor’s schedule of unsecured creditors’ claims (Schedule E/F) lists the claims of the Debtors’ customers by the number of various forms of cryptocurrency coins and account types, rather than in USD.3

On October 25, 2022, a group of beneficial holders, investment advisors, and managers of beneficial holders (collectively, the “Series B Preferred Holders”) of the Series B Preferred Shares issued by debtor Celsius Network Limited filed a motion seeking entry of an order directing the Debtors to amend their Schedules to reflect customer claims valued in USD, in addition to cryptocurrency coin counts.4

II.         Arguments

a.         Series B Preferred Holders

Broadly, pursuant to Bankruptcy Rule 1009(a),5 the Series B Preferred Holders sought to have the Debtors amend their Schedule E/F to “dollarize” creditors’ claims, i.e., value customer claims in their dollar value as of the petition date.  As filed, the Series B Preferred Holders asserted that the Debtors’ schedules were “improper, misleading, and fail[ed] to comply” with the Bankruptcy Rules “because they schedule[d] customer claims in cryptocurrency coin counts, rather than in lawful currency of the United States as of the Petition Date.”6  The Series B Preferred Holders asserted that such amended schedules are essential to the Debtors’ ability to structure, solicit, and confirm a plan of reorganization under the requirements of Section 1129, including whether “(i) claims are impaired or unimpaired, (ii) holders of similarly situated claims are receiving the same treatment, and (iii) the plan meets the requirements of the ‘absolute priority rule.’”7  In support of their arguments that USD valuation of a customer’s claim should be required, the Series B Preferred Holders relied on provisions of the Bankruptcy Rules, Bankruptcy Code, and Official Forms.  The Series B Preferred Holders stressed that the motion “takes no position regarding the form of distribution customers” should receive under the Debtors’ plan, but rather that the Debtors must “add the [USD] amount of each customer claim in Schedules E/F to the cryptocurrency coin counts.”8

The Series B Preferred Holders also asserted that the requirement to denominate claims in USD is consistent with Section 502(b) of the Bankruptcy Code, which provides that when a debtor or party-in-interest objects to a claim, the court determines the amount of the claim in USD as of the debtor’s petition date.

b.         Debtors’ Response

The Debtors had previously indicated that they were not seeking to dollarize its customers’ claims; rather, the Debtors represented that they intend to return cryptocurrency assets to its customers “in kind.”9  The Debtors stated that they interpreted Bankruptcy Rule 9009(a)(1)-(2) and General Order M-386, dated November 24, 2009 (the “General Order M-386”) to allow the Debtors to remove the dollar symbol when scheduling claims regarding cryptocurrency coin counts.10  This approach, the Debtors argue, lessens confusion for its customer case and decreases administrative expense for the estate.11

Further, the Debtors argued that the Series B Preferred Holders’ reliance on Section 502(b) was misplaced because the application of such section is inapplicable at this stage of the proceedings where no claims objection has taken place.12

The Committee of Unsecured Creditors (“UCC”) agreed with the Debtors’ approach, stating that it “makes sense” for account holders to validate their scheduled claims by cryptocurrency type and that it wished to be consulted on the petition date prices used by the Debtors if they filed an amendment to the schedules.13

III.        Analysis

a.         Bankruptcy Code & Rules & Forms

Bankruptcy Rule 1007(b)(1) requires that a debtor’s schedules of assets and liabilities must be “prepared as prescribed by the appropriate Official Forms.”14  The relevant official form that a debtor must use to prepare its schedule of assets and liabilities is Official Form 206, which contains a USD symbol to denote the amount of liabilities that a debtor must list.15  Specifically, Official Form 206 provides:

As seen above, Official Form 206 does “hardwire” a dollar sign (“$”) into the boxes provided for claim amounts.  Bankruptcy Rule 9009 states that the official forms are to “be used without alteration, except as otherwise provided in the rules, [or] in a particular Official Form.”16  Bankruptcy Rule 9009 permits “certain minor changes not affecting wording or the order of presenting information,” including “expand[ing] the prescribed areas for responses in order to permit complete responses” and “delet[ing] space not needed for responses.”17  Lastly, General Order M-386 permits “such revisions as are necessary under the circumstances of the individual case or cases.”18 The introduction to General Order M-386 states that standard forms were adopted to “expedite court review and entry of such orders” and that courts will expect use of the standard forms “with only such revisions as are necessary under the circumstances of the individual case or cases.”19

b.         Section 502(b)

Bankruptcy Code Section 502(b) provides that if there is an objection to a claim, the court “shall determine the amount of such claim in lawful currency of the United States as of the [petition] date . . . .”20  This “prevents the value of a claim from fluctuating by setting the claim as of the petition date and converting it to the United States dollars.”21  Acknowledging the “novel phenomenon” of dollarizing claims in cryptocurrency, the Series B Preferred Holders analogize this to cases where courts have required claims asserted in or based on in foreign currency or amounts of gold should be valued in USD.  However, these cases were decided in the context of a claims objection. The Celsius Debtors argued that these cases have limited utility in the context of a motion for an order directing the Debtors to amend their schedules pursuant to Bankruptcy Rule 1009(a).22

IV.        The Court’s Order

Ahead of the hearing regarding the motion for an order directing the Debtors to amend their schedules, the Debtors and the Series B Preferred Holders were able to consensually resolve the motion and filed a revised proposed order prior to the hearing on the motions on November 15.23  The Debtors agreed to amend their schedules by filing a conversion table within three days of the entry of the order, in consultation with the UCC and Series B Preferred Holders, that reflects the Debtors’ view of the rate of conversion of all cryptocurrencies listed in the Debtors’ schedules to USD as of the petition date.  The idea is that the conversion table could be used by customers as a reference for calculating the USD value of their claim, to the extent needed for filing a proof of claim.  The conversion table is not binding – the order preserves the rights of all parties to contest the conversion rates and does not require a party-in-interest to file an objection that is not stated in USD “solely on the basis that such claims should be reflected in [USD].”24  The order also requires the Debtors to file updated schedules “dollarizing” its account holders’ cryptocurrency holdings to the extent required by any future court order or judicial determination.

On November 17, 2022, the court entered the revised proposed order.25

V.         Cash Is Still King?

Other bankruptcy courts have taken similar approaches as the Celsius court in this issue.  An earlier cryptocurrency case, In re Cred Inc., the debtors did not schedule cryptocurrency claims in USD, but included a conversion table in their filed schedules, which set forth a conversion rate to USD as of the petition date.26  Debtors in other cases, such as Voyager Digital, scheduled the amounts of their customer claims as “undetermined” and listed them in Schedule F in cryptocurrency.27  BlockFi, which filed for bankruptcy on November 28, 2022, already has filed a proposed plan that would distribute its cryptocurrencies to its customers in–kind in exchange for their claims against the BlockFi debtors.28  To date, neither BlockFi nor FTX have filed their schedules, and it remains to be seen whether they will follow the pattern established in Celsius and Voyager.

For creditors and equity holders, whether claims are measured in USD or the applicable cryptocurrency is only the beginning of what will likely be a long and contentious road to recovery.  It remains to be seen whether any of these debtors will be able to confirm a viable restructuring plan that relies on any sort of “in-kind” distribution of cryptocurrencies.  Further issues are likely to arise in the claims resolution process even further down the road as claimants and liquidation trustees (or plan administrators) wrestle with how to value claims based on such a volatile asset, subject to ever-increasing regulatory scrutiny.  However, for the time being, the bankruptcy process continues to run on USD.

FOOTNOTES

1 Declaration of Alex Mashinsky, CEO of the Debtors ¶¶ 1, 9, 20, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 23].

2 Id. at ¶ 131.

3 Debtors’ Schedules of Assets and Liabilities and Statements of Financial Affairs, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 974]; see also Schedule E/F, Case No. 22-10967 [Docket No. 5]; Case No. 22-10970 [Docket No. 5]; Case No. 22-10968 [Docket No. 5]; Case No. 22-10965 [Docket No. 6]; Case No. 22-10966 [Docket No. 7]; Case No. 22-10964 [Docket No. 974]; Case No. 22-10969 [Docket No. 5]; Case No. 22- 10971 [Docket No. 5].

4 Series B Preferred Holders Motion to Direct Debtors to Amend Schedules, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1183].

5 “On motion of a party in interest, after notice and a hearing, the court may order any . . . schedule . . . to be amended and the clerk shall give notice of the amendment to entities designated by the court.” Fed. R. Bankr. P. 1009(a).

6 Series B Preferred Holders Motion to Direct Debtors to Amend Schedules ¶ 1.

7 Id. ¶ 3 (citing 11 U.S.C. §§ 1123(a)(2)-(4), 1129(a)(1), 1129(b)).

8 Series B Preferred Holders’ Reply ¶ 10, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1334].

9 See 8/16/22 Hr’g Tr. at 35:5-7 (“The company is not seeking to dollarize claims on the petition date and give people back a recovery in fiat.”); id. at 42:11-16 (“[The UCC is] pleased that the company is not focused on dollarization of claims . . . an in-kind recovery is absolutely critical.”).

10 General Order M-386 is a resolution of the Board of Judges for the Southern District of New York, which provides for “a standard form for orders to establish deadlines for the filing of proofs of claim . . . in chapter 11 cases” to “thereby expedite court review and entry of such orders.”

11 Debtors’ Objection to Series B Preferred Holders’ Motion ¶ 9, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1304].

12 Id. ¶ 12 (citing In re Mohr, 425 B.R. 457, 464 (Bankr. S.D. Ohio)).

13 Id. at 42:12-16 (“We are pleased to hear that the company is not focused on dollarization of claims . . . receiving an in-kind recover is 16 absolutely critical.”); UCC Statement and Reservation of Rights ¶ 6, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1303].

14 Fed. R. Bankr. P. 1007(b)(1).

15 See Official Form 206, Part 2, Line 4 (using the USD sign into Form 206 for scheduling the debtor’s liabilities).

16 Fed. R. Bankr. P. 9009(a).

17 Id.

18 General Order M-386 ¶ 9.

19 General Order M-386 ¶ 2 (unnumbered, preliminary statement).

20 11 U.S.C. § 502(b).

21 In re Aaura, Inc., No. 06 B 01853, 2006 WL 2568048, at *4, n.5 (Bankr. N.D. Ill. Sept. 1, 2006).

22 In re USGen New Eng., Inc., 429 B.R. 437, 492 (Bankr. D. Md. 2010) (using the exchange rate in effect on the petition date, in the context of a claims objection, to convert the claim to USD), aff’d sub nom. TransCanada Pipelines Ltd. v. USGen New Eng., Inc., 458 B.R. 195 (D. Md. 2011); Aaura, 2006 WL 2568048, at *5 (“Section 502(b) converts Aaura’s obligation to repay the obligation in gold into a claim against the estate in dollars, but it makes this transformation only as of the petition date, not retroactive to the date on which Aaura first became liable.”); Matter of Axona Intern. Credit & Com. Ltd., 88 B.R. 597, 608 n.19 (Bankr. S.D.N.Y. 1988) (noting Section 502(b) refers to the petition date as “the appropriate date for conversion of foreign currency claims”), aff’d sub nom. In re Axona Intern. Credit & Com. Ltd., 115 B.R. 442 (S.D.N.Y. 1990); ABC Dev. Learning Ctrs. (USA), Inc. v. RCS Capital Dev., LLC (In re RCS Capital Dev., LLC), No. AZ-12-1381-JuTaAh, 2013 Bankr. LEXIS 4666, at *38-39 (B.A.P. 9th Cir. July 16, 2013) (same).

23 Notice of Proposed Order, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1342].

24 Id. at ¶¶ 7, 8.

25 Order Pursuant to Bankruptcy Rule 1099 Directing the Debtors to Amend Their Schedules in Certain Circumstances, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. 2022) [ECF No. 1387].

26 Schedules at 12, In re Cred Inc., Case No. 20-128336 (JTD) (Bankr. D. Del. 2021) [ECF No. 443].

27 Schedules, In re Voyager Digital Holdings, Inc., Case No. 22-10943 (MEW) (Bankr. S.D.N.Y. Aug. 18, 2022) [ECF No. 311].

28 Joint Plan of Reorganization § IV.B.1.a, In re BlockFi Inc., Case No. 19361 (MBK) (Bankr. D.N.J. 2022) [ECF No. 22].

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