Category: finance

The Future of Stablecoins, Crypto Staking and Custody of Digital Assets

In the wake of the collapse of cryptocurrency exchange firm FTX, the Securities and Exchange Commission (SEC) has ratcheted up its oversight and enforcement of crypto firms engaged in activities ranging from crypto staking to custody of digital assets. This is due in part to concerns that the historically free-wheeling and largely unregulated crypto marketplace may adversely impact U.S. investors and contaminate traditional financial systems. The arguments that cryptocurrencies and digital assets should not be viewed as securities under federal laws largely fall on deaf ears at the SEC. Meanwhile, the state of the crypto economy in the United States remains in flux as the SEC, other regulators and politicians alike attempt to balance competing interests of innovation and investment in a relatively novel and untested asset class.

Is Crypto Staking Dead?

First, what is crypto staking? By way of background, it’s necessary to understand a bit about blockchain technology, which serves as the underpinning for all cryptocurrency and digital asset transactions. One of the perceived benefits of such transactions is that they are decentralized and “peer-to-peer” – meaning that Person A can transact directly with Person B without the need for a financial intermediary to approve the transaction.

However, in the absence of a central authority to validate a transaction, blockchain requires other verification processes or consensus mechanisms such as “proof of work” (which in the case of Bitcoin mining ensures that transactions are valid and added to the Bitcoin blockchain correctly) or “proof of stake” (a network of “validators” who contribute or “stake” their own crypto in exchange for a chance to validate a new transaction, update the blockchain and earn a reward). Proof of work has come under fire by environmental activists for the enormous amounts of computer power and energy required to solve complex mathematical or cryptographic puzzles to validate a transaction before it can be recorded on the blockchain. In contrast, proof of stake is analogous to a shareholder voting their shares of stock to approve a corporate transaction.

Second, why has crypto staking caught the attention of the SEC? Many crypto firms and exchanges offer “staking as a service” (SaaS) whereby investors can stake (or lend) their digital assets in exchange for lucrative returns. This practice is akin to a person depositing cash in a bank account in exchange for interest payments – minus FDIC insurance backing of all such bank deposits to protect investors.

Recently, on February 9, 2023, the SEC charged two crypto firms, commonly known as “Kraken,” for violating federal securities laws by offering a lucrative crypto asset SaaS program. Pursuant to this program, investors could stake their digital assets with Kraken in exchange for annual investment returns of up to 21 percent. According to the SEC, this program constituted the unregistered sale of securities in violation of federal securities laws. Moreover, the SEC claims that Kraken failed to adequately disclose the risks associated with its staking program. According to the SEC’s Enforcement Division director:

“Kraken not only offered investors outsized returns untethered to any economic realities but also retained the right to pay them no returns at all. All the while, it provided them zero insight into, among other things, its financial condition and whether it even had the means of paying the marketed returns in the first place.”1

Without admitting or denying the SEC’s allegations, Kraken has agreed to pay a $30 million civil penalty and will no longer offer crypto staking services to U.S. investors. Meanwhile, other crypto firms that offer similar programs, such as Binance and Coinbase, are waiting for the other shoe to drop – including the possibility that the SEC will ban all crypto staking programs for U.S. retail investors. Separate and apart from potentially extinguishing a lucrative revenue stream for crypto firms and investors alike, it may have broader consequences for proof of stake consensus mechanisms commonly used to validate blockchain transactions.

NY DFS Targets Stablecoins

In the world of cryptocurrency, stablecoins are typically considered the most secure and least volatile because they are often pegged 1:1 to some designated fiat (government-backed) currency such as U.S. dollars. In particular, all stablecoins issued by entities regulated by the New York Department of Financial Services (NY DFS) are required to be fully backed 1:1 by cash or cash equivalents. However, on February 13, 2023, NY DFS unexpectedly issued a consumer alert stating that it had ordered Paxos Trust Company (Paxos) to stop minting and issuing a stablecoin known as “BUSD.” BUSD is reportedly the third largest stablecoin by market cap and pegged to the U.S. dollar.

The reasoning behind the NY DFS order remains unclear from the alert, which merely states that “DFS has ordered Paxos to cease minting Paxos-issued BUSD as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance in regard to Paxos-issued BUSD.”2 The same day, Paxos confirmed that it would stop issuing BUSD. However, in an effort to assuage investors, Paxos stated “All BUSD tokens issued by Paxos Trust have and always will be backed 1:1 with U.S. dollar–denominated reserves, fully segregated and held in bankruptcy remote accounts.”3

Separately, the SEC reportedly issued a Wells Notice to Paxos on February 12, 2023, indicating that it intended to commence an enforcement action against the company for violating securities laws in connection with the sale of BUSD, which the SEC characterized as unregistered securities. Paxos, meanwhile, categorically denies that BUSD constitute securities, but nonetheless has agreed to stop issuing these tokens in light of the NY DFS order.

It remains to be seen whether the regulatory activity targeting BUSD is the beginning of a broader crackdown on stablecoins amid concerns that, contrary to popular belief, such coins may not be backed by adequate cash reserves.

Custody of Crypto Assets

On February 15, 2023, the SEC proposed changes to the existing “custody rule” under the Investment Advisers Act of 1940. As noted by SEC Chair Gary Gensler, the custody rule was designed to “help ensure that [investment] advisers don’t inappropriately use, lose, or abuse investors’ assets.”4 The proposed changes to the rule (referred to as the “safeguarding rule”) would require investment advisers to maintain client assets – specifically including crypto assets – in qualified custodial accounts. As the SEC observed, “[although] crypto assets are a relatively recent and emerging type of asset, this is not the first time custodians have had to adapt their practices to safeguard different types of assets.”5

A qualified custodian generally is a federal or state-chartered bank or savings association, certain trust companies, a registered broker-dealer, a registered futures commission merchant or certain foreign financial institutions.6 However, as noted by the SEC, many crypto assets trade on platforms that are not qualified custodians. Accordingly, “this practice would generally result in an adviser with custody of a crypto asset security being in violation of the current custody rule because custody of the crypto asset security would not be maintained by a qualified custodian from the time the crypto asset security was moved to the trading platform through the settlement of the trade.”7

Moreover, in a departure from existing practice, the proposed safeguarding rule would require an investment adviser to enter into a written agreement with the qualified custodian. This custodial agreement would set forth certain minimum protections for the safeguarding of customer assets, including crypto assets, such as:

  • Implementing appropriate measures to safeguard an advisory client’s assets8
  • Indemnifying an advisory client when its negligence, recklessness or willful misconduct results in that client’s loss9
  • Segregating an advisory client’s assets from its proprietary assets10
  • Keeping certain records relating to an advisory client’s assets
  • Providing an advisory client with periodic custodial account statements11
  • Evaluating the effectiveness of its internal controls related to its custodial practices.12

The new proposed, cumbersome requirements for custodians of crypto assets appear to be a direct consequence of the collapse of FTX, which resulted in the inexplicable “disappearance” of billions of dollars of customer funds. By tightening the screws on custodians and investment advisers, the SEC is seeking to protect the everyday retail investor by leveling the playing field in the complex and often murky world of crypto. However, it still remains to be seen whether, and to what extent, the proposed safeguarding rule will emerge after the public comment period, which will remain open for 60 days following publication of the proposal in the Federal Register.

1 SEC Press Release 2023-25 (Feb. 9, 2023).

2 NY DFS Consumer Alert (Feb. 13, 2023) found at https://www.dfs.ny.gov/consumers/alerts/Paxos_and_Binance.

3 Paxos Press Release (Feb. 13, 2023) found at https://paxos.com/2023/02/13/paxos-will-halt-minting-new-busd-tokens/.

4 SEC Press Release 2023-30 (Feb. 15, 2023).

5 SEC Proposed Rule, p. 79.

6 SEC Fact Sheet: Proposed Safeguarding Rule.

7 SEC Proposed Rule, p. 68.

8 For instance, per the SEC, this could require storing crypto assets in a “cold wallet.”

9 Per the SEC, “the proposed indemnification requirement would likely operate as a substantial expansion in the protections provided by qualified custodians to advisory clients, in particular because it would result in some custodians holding advisory client assets subject to a simple negligence standard rather than a gross negligence standard.” See SEC Proposed Rule, p. 89.

10 Per the SEC, this requirement is intended to “ensure that client assets are at all times readily identifiable as client property and remain available to the client even if the qualified custodian becomes financially insolvent or if the financial institution’s creditors assert a lien against the qualified custodian’s proprietary assets (or liabilities).” See SEC Proposed Rule, p. 92.

11 Per the SEC, “[in] a change from the current custody rule, the qualified custodian would also now be required to send account statements, at least quarterly, to the investment adviser, which would allow the adviser to more easily perform account reconciliations.” See SEC Proposed Rule, p. 98.

12 Per the SEC, the proposed rule would require that the “qualified custodian, at least annually, will obtain, and provide to the investment adviser a written internal control report that includes an opinion of an independent public accountant as to whether controls have been placed in operation as of a specific date, are suitably designed, and are operating effectively to meet control objectives relating to custodial services (including the safeguarding of the client assets held by that qualified custodian during the year).” See SEC Proposed Rule, p. 101.

Article By Anjali C. Das of Wilson Elser Moskowitz Edelman & Dicker LLP

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

© 2023 Wilson Elser

Australia: ASIC Reveals 2023 Enforcement Priorities

The Australian Securities and Investments Commission (ASIC) has revealed its key enforcement priorities for 2023. This year, ASIC has signalled an expanded focus on enforcement activity targeting:

  • sustainable finance practices and disclosure of climate risks;
  • financial scams;
  • cyber and operational resilience; and
  • investor harms involving crypto-assets.

In its release, ASIC has emphasised that the regulator’s prioritisation of monitoring in these areas intends to “address misconduct, market integrity threats and consumer harms in sectors including financial services, retail and crypto-assets.”

The warning coincides with this month’s release of ASIC’s enforcement and regulatory report that highlights the major uptick in enforcement and regulatory actions taken by ASIC during the last half of 2022, including:

  • 173 criminal charges being laid and $76.3 million in civil penalties imposed;
  • heightened action against money laundering risks;
  • the issuance of 22 design and distribution obligations (DDO) stop orders to prevent consumers and investors being targeted by products inappropriate to their objectives, financial situation and needs; and
  • the regulator’s first action for greenwashing and consequential issuance of infringement notices for misleading sustainability-related statements.

Another priority of ASIC for the coming year is to increase its transparency to industry and streamline its interactions with the entities it regulates. For the first time, ASIC has released a regulatory developments timetable setting out projected timeframes for ASIC regulatory work, such as the publication of draft or final guidance, and the anticipated making of a legislative instrument. ASIC’s release of these key enforcement priorities and regulatory developments timetable gives us a clear indication of ASIC’s intention to continue its heightened level of surveillance and enforcement action into 2023.

Article By Matthew J. Watts and Rebecca Mangos of K&L Gates

For more securities legal news, click here to visit the National Law Review.

Copyright 2023 K & L Gates

Breaking News – Hermès Makes History With First NFT Trademark Trial Victory

A New York City jury just returned a verdict in favor of Hermès in a historic dispute between the luxury fashion house and digital artist Mason Rothschild over Hermès’ alleged trademark rights relating to Hermès’ famous Birkin handbag. The jury awarded Hermès $133,000 in total damages for trademark infringement, dilution, and cybersquatting.

The jury finding that the First Amendment did not shield Rothschild from liability in connection with his MetaBirkins NFTs project is significant, particularly as this matter involved the first trial by jury to consider the interplay of free speech and trademark protection in the context of NFTs. This decision, which may be appealed, provides guidance for artists, brands, and others seeking ingress into metaverse, including to what extent “real world” intellectual property rights apply to and may be enforced in virtual worlds.

Haute-ly Contested NFTs

Throughout the dispute over this past year, the parties have contested each other’s characterization of the MetaBirkins NFTs. To Hermès, the MetaBirkins NFTs are merely the instruments of a “digital speculator” looking to exploit one of its most exclusive assets via NFTs. In contrast, Rothschild argues that the MetaBirkins NFTs project, a series of 100 NFT images that depict a range of reimagined Hermès Birkin bags featuring a variety of colorful fur, is digital art and a commentary on the famed BIRKIN bag, consumerism, and animal cruelty within the fashion industry. As a result, he argues that the MetaBirkins NFTs are artistic works that should be shielded from liability under the free speech principles of the First Amendment of the Constitution. The nine-member jury disagreed, finding that the MetaBirkins NFTs were more like commodities that are subject to trademark and other laws, rather than artwork. A factor that may have influenced the jury’s decision was evidence suggesting that Rothschild may have seen the MetaBirkins NFTs as a “cash cow.” This may have cast doubt on the authenticity of his characterization of the MetaBirkins NFTs as an art project.

The Test is Yet to Come

Although the jury found the MetaBirkins NFTs to be infringing, the final disposition of this dispute remains pending with the possibility of appeal. Given the importance of the issues at stake, the outcome of this case is bound to be subject to debate regardless of any appeal.

Moreover, while no NFT-specific legal test appears to have emerged from this case and the legal landscape for IP in the Metaverse (and beyond) continues to lack clear guidance, this case has nonetheless provided insight on how courts (and juries) may view the interplay of IP and NFTs. The ultimate outcome of this landmark case is likely to form the basis of the emerging law involving IP rights and NFTs.

© 2023 ArentFox Schiff LLP
For more Intellectual Property Legal News, click here to visit the National Law Review

Multi-Club Ownership – For the Good of the Game?

Alongside the rise of investment from sovereign wealth and private equity funds, sport has also seen an increase in multi-club/franchise ownership groups. These groups, often spanning across different sports, leagues, countries, and continents, allow investors to diversify their portfolios and spread their risks.

However, in football, the rise of the Multi-Club Ownership (MCOs) model poses a challenge for how the sport is governed and has implications on current and future financial regulation. MCOs acquire multiple football clubs, building a network of related teams in the process. This, consequentially, has a knock-on effect on player transfers, commercial opportunities, and the overall competitive balance of football across the globe.

In this article, we discuss the benefits of MCOs for both clubs and owners, the potential competitive advantages clubs can gain through MCOs, and whether the existing financial regulations are fit for purpose given the increasing number of MCOs within the sport.

Governance

One of the key benefits for clubs under an MCO structure is the ability to leverage centralized governance infrastructure and apply lessons learned from across the group. By centralizing key departments at the portfolio level, and incentivizing knowledge sharing within the group, MCOs can apply synergies and implement best practices with each new acquisition, leading to a more effective and efficient operation. Additionally, the centralized governance structure within an MCO brings with it opportunities for financial benefits in the form of cost savings and potentially increased revenues.

Sponsorships and Commercial Deals

Operating under an MCO allows clubs to benefit from sponsorships and other commercial deals negotiated at the group level, while also increasing individual brand awareness for each respective club. For example, an MCO could negotiate a group sponsorship agreement with a kit manufacturer or shirt sponsor covering a number of teams within the group, including the flagship club.

Agreements of this kind would be beneficial for all parties involved. The sponsor increases its own profile by being associated with the flagship club, while also getting instant access to a variety of markets through the other clubs in the agreement. At the group level, the homogeneity created by having clubs within the group playing in similar kits creates a stronger brand identity, whilst also boosting the brand profile for the smaller clubs by further associating them with the flagship club. Additionally, a group agreement would allow the MCO to secure a competitive rate that may have been unattainable for a solitary club.

Player Scouting, Acquisition, and Development

The other major financial benefit for clubs in an MCO structure relates to how players are scouted, acquired, and developed. A common feature of MCOs is the application of a uniform strategy, across all portfolio clubs, set at a group level by a Sporting/Technical Director. When trickled down to each club, this results in a global scouting network, acquiring local talent with the group’s playing style in mind. These players will then be brought into an academy, through which they will be developed to play in the MCO’s preferred playing style.

While this does not represent an immediate cost saving, this network of local scouting and academies at the club level can lead to a significant competitive and financial advantage as players move within the group from smaller clubs to the flagship club. By transferring or loaning players “in-house”, MCOs can ensure that a player’s development is not hampered by being played in an unfavorable position, or by being asked to perform a different role, protecting their value.

Additionally, by acquiring players from within the group, clubs save both time and money on scouting, as players are already a known quantity within the network. Furthermore, the receiving club acquires a player tailor-made to their playing style, reducing the time required to bed them in.

“In-house” Transfer Agreements

As exemplified by the transfer of Hassane Kamara between Pozzo family-owned clubs Watford and Udinese, “in-house” transfers can be leveraged to alleviate financial constraints for clubs within the group. Kamara, initially purchased by Watford in January 2022 for £4m, and who went on to be Watford’s player of the season, was subsequently sold to Udinese in August 2022 for £16m.

However, Kamara was then loaned straight back to Watford for the 2022/23 season. Although prima facie, this transfer does not benefit Udinese, it allowed Watford to recognize an £8m profit on Kamara while retaining his services, and strengthening their cash flow at a time when they were negotiating contracts with other star players. While “in-house” transfers of this kind raise questions regarding their fitness and propriety, they also have implications on competitive balance.

Parent Feeder

The most recognizable transfer strategy within MCOs is the feeder club model. This can be mutually beneficial to both clubs, with the best-performing players transferring to the “parent” clubs” and the “feeder” club receiving transfer income, as well as occasional loan transfers of youth team players to develop while remaining in the MCO structure.

Such a relationship can be seen between Red Bull owned, RB Leipzig (RBL) and FC Red Bull Salzburg (FCS). Since 2015, twelve players have transferred directly from FCS to RBL, with transfer fees totaling £119.75m. Eight of these players, bought for a total of £73.85m have subsequently been sold for a total of £117.50m, generating £43.65 profit RBL. The cumulative market value of the four players still playing for RBL has risen by £26.32m since their relevant transfers. For perspective, there have only been four transfers from RBL to FCS in the same period. [i]

Competition Integrity

Although centralized governance structures provide a wealth of benefits to clubs and owners within MCOs, there is a regulation to limit the effects of centralized governance on the integrity of competition.

UEFA’s regulations on common ownership prohibit teams from competing in the same competition where a single person or entity has a de facto control over both clubs. For clubs under common ownership to compete in the same competition, they must demonstrate that there are disparities within the clubs’ corporate matters, financing, personnel, and sponsorship arrangements.

On only one occasion since 2002 has UEFA’s rule on common ownership been considered. RBL and FCS both qualified for the 2017/18 Champions League and had to make significant structural changes in order for both teams to be admitted to that season’s edition. Therefore, as long as MCOs are willing to sacrifice centralized operations to an extent satisfactory to UEFA regulations, mutual competition is allowed. However, while many smaller clubs within more centralized MCO structures may not have short-term goals of European Football, UEFA regulations do raise questions over the investor’s long-term footballing ambitions for those clubs.

Financial Sustainability Regulations

In addition to the on-field benefits, being part of an MCO also provides opportunities for clubs to improve their financial position, and potentially exploit loopholes in existing financial regulation. UEFA’s recently introduced Financial Sustainability Rules (FSR) are built upon three pillars: solvency, stability, and cost control. The new cost control regulation, known as the squad cost ratio, states that a club’s outlays on wages, agents’ fees, and amortization costs must be less than 70% of club revenues. [ii]

In a scenario where an MCO owned club requires to decrease their squad cost ratio, it is possible that group sponsorship agreements and in-house transfers could be used to achieve this. By selling players within an MCO, and then receiving those players back on loan, clubs will recognize a profit on the sale for the purposes of FSR and bring down their squad cost ratio.

When considering group sponsorship agreements in respect of FSR, it is also possible that the accounting treatment of this contract at the club level could be engineered to assist a club in complying with the squad cost ratio. The allocation of revenue from a group-level sponsorship to each of the clubs under the agreement is not required to be split evenly, which provides MCOs with an opportunity to funnel revenues from group sponsorships to their clubs complying with FSR. With no current guidance or regulation on how group sponsorships should be treated from an accounting perspective, group sponsorships are another tool that can be utilized to improve their squad cost ratio.

Fair Value Regulations

Although MCOs bring opportunities to improve squad cost ratios, the FSR regulations also require all transactions to be made at “fair value”. This means that financial arrangements for sponsorships and player transfers must be accounted for on an “arm’s length” basis. Where there are doubts amongst the Club Financial Control Body (CFCB) board, it can request an adjustment of the proceeds resulting from the transfer of a player, or the allocation of sponsorship monies.

However, there is currently no precedent or evidence to indicate how UEFA would view the accounting treatment for a club under a group sponsorship agreement or the transfer of players within MCOs. Furthermore, while there is a clear means to value a sponsorship agreement, this is considerably more difficult with regard to transfers, specifically the valuation of a player.

While age, injury record, marketability, and contract length, are all attributable factors, a player’s worth comes down to how much the selling club desires weighted against how much the buying club is willing to pay. An MCO structure circumvents this issue and allows for “in-house” transfers at an inflated value stipulated by the shared owner/s. Given the regulations, it is unlikely any club would want to pique the interests of the CFCB by hyper-inflating the value of a transfer, but whether MCOs will be deterred from increasing the value of in house transfers by smaller, nominal values remains to be seen.

The Future of MCOs

Recent trends have shown that the existence of MCOs will be sustained over the coming years. Sport has developed alongside the increasingly commercialized world, resulting in significant growth in investor interest across multiple clubs and sports. However, how the governance and regulation of MCOs evolves will define their development in the long term. Another factor that must be considered is whether investors will prefer multi-sport ownership (MSOs), which bring with them their own regulatory considerations, particularly in relation to conflicts of interest. Nonetheless, in the immediate future we expect continued investment in Football, the question is whether they remain satisfied with just one club, or one sport.

[i] All figures have been taken from https://www.transfermarkt.co.uk/

[ii] A full copy of UEFA’s new regulations can be found here

Kurun Bhandari (Director) and James Michaels (Associate) at Ankura authored this article.

For more entertainment, art, and sports legal news, click here to visit the National Law Review.

Copyright © 2023 Ankura Consulting Group, LLC. All rights reserved.

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.

For more Bankruptcy Legal News, click here to visit the National Law Review.

© Copyright 2023 Squire Patton Boggs (US) LLP

EU Foreign Subsidies Regulation Enters Into Force In 2023

On December 23, 2022, Regulation (EU) 2022/2560 of December 14, 2022 on foreign subsidies distorting the internal market (FSR) was published in the Official Journal of the European Union. The FSR introduces a new regulatory hurdle for M&A transactions in the European Union (EU), in addition to merger control and foreign direct investment screening. The FSR’s impact cannot be overstated as it introduces two mandatory pre-closing filing regimes and it gives the Commission wide-reaching ex officio investigative and intervention powers. Soon, the Commission will also launch a public consultation on a draft implementing regulation that should further detail and clarify a number of concepts and requirements of the FSR.

The bulk of the FSR will apply as of July 12, 2023. Importantly, the notification requirements for M&A transactions and public procurement procedures will apply as of October 12, 2023.

We highlight the key principles of the FSR below and provide guidance to start preparing for the application of the FSR. We refer to our On The Subject article ‘EU Foreign Subsidies Regulation to Impact EU and Cross-Border M&A Antitrust Review Starting in 2023’ of August 2, 2022 for a more detailed discussion of the then draft FSR. We also refer to our December 8, 2022 webinar on the FSR. Given the importance of the FSR, we will continue to report any future developments.

IN DEPTH

FSR in a Nutshell

The FSR tackles ‘foreign subsidies’ granted by non-EU governments to companies active in the EU and which ‘distort the internal market’.

  • First, a ‘foreign subsidy’ will be considered to exist where a direct or indirect financial contribution from a non-EU country or an entity whose actions can be attributed to a non-EU country (public entities or private entities) confers a benefit on an undertaking engaging in an economic activity in the EU internal market, and where that benefit is not generally available under normal market conditions but is, instead, limited, in law or in fact, to assisting one or more undertakings or industries. A ‘financial contribution’ covers a broad spectrum and encompasses, amongst others, positive benefits such as the transfer of funds or liabilities, the foregoing of revenue otherwise due (e.g., tax breaks, the grant of exclusive rights below market conditions, or the provision or purchase of goods or services).

  • Second, a ‘distortion in the internal market’ will be considered to exist in case of a foreign subsidy which is liable to improve the competitive position of an undertaking and which actually or potentially negatively affects competition in the EU internal market. The Regulation provides some guidance on when a foreign subsidy typically would not be a cause for concern:
    – A subsidy that does not exceed EUR 200,000 per third country over any consecutive period of three years is considered de minimis and therefore not distortive;
    – A foreign subsidy that does not exceed EUR 4 million per undertaking over any consecutive period of three years is unlikely to cause distortions; and
    – A foreign subsidy aimed at making good/recovering from the damage caused by natural disasters or exceptional occurrences may be considered not to be distortive.

The FSR looks at ‘undertakings’, as is the case for merger control. Therefore, the Commission will not look merely at the legal entity concerned, but at the entire corporate group to which the entity belongs in order to calculate the total amount of foreign financial contributions granted to the undertaking. Even companies headquartered in the EU that have entities outside of the EU that have received foreign financial contributions are covered by the FSR.

The FSR introduces three tools for the European Commission (Commission): (i) a notification requirement for certain M&A transactions, (ii) a notification requirement for certain public procurement procedures (PPP) and (iii) investigations on a case by case basis.

Notification Requirement for Certain M&A Transactions

M&A transactions (or “concentrations”) involving a buyer and/or a target that has received a foreign financial contribution shall be notifiable if they meet the following cumulative conditions:

  • At least one of the merging undertakings, the acquired undertaking (target, not buyer) or the joint venture is established in the EU and has an EU turnover of at least EUR 500 million, AND

  • The combined aggregate financial contributions provided to the undertakings concerned in the three financial years (combined) prior to notification amounts to more than EUR 50 million.

M&A transactions that meet these criteria will need to be notified and approved by the Commission prior to implementation. During its review, the Commission will determine whether the foreign financial contributions received constitute foreign subsidies in the sense of the FSR and whether these foreign subsidies actually or potentially distort or negatively affect competition in the EU internal market. The Commission likely will consider certain indicators including the amount and nature of the foreign subsidy, the purpose and conditions attached to the foreign subsidy as well as its use in the EU internal market. For example, in a case of an acquisition, if a foreign subsidy covers a substantial part of the purchase price of the target, the Commission may consider it likely to be distortive.

Notification Requirement for Certain Public Procurement Procedures

A notifiable foreign financial contribution in the context of PPP shall be deemed to arise where the following cumulative conditions are met:

  • The estimated value of the public procurement or framework agreement net of VAT amounts to at least EUR 250 million, AND

  • The economic operator was granted aggregate foreign financial contributions in the three financial years prior to notification of at least EUR 4 million from a non-EU country.

Where the procurement is divided into lots, the value of the lot or the aggregate value of all lots for which the undertaking bids for must, in addition to the two criteria set out above, also amount to at least EUR 125 million.

Through this procedure, the Commission will ensure that companies that have received non-EU country subsidies do not submit unduly advantageous bids in public procurement procedures.

During the Commission’s review, all procedural steps may continue except for the award of the contract.

Even if the thresholds are not met, the Regulation requires undertakings to provide to the contracting authority in a declaration attached to the tender a list of all foreign financial contributions received in the last three financial years and to confirm that these are not notifiable, which the contracting authority will subsequently send to the Commission.

Investigations on a Case-by-case Basis

The Commission may on its own initiative investigate potentially distortive foreign subsidies (e.g. following a complaint). These investigations are not limited to M&A transactions or PPP. However, on the basis of this power, the Commission may investigate M&A transactions and awarded contracts under PPP which do not fall within the scope of the notification requirements set out above.

If the Commission carries out an ex-officio review, its analysis will be structured in two phases: a preliminary examination and an in-depth investigation. Although these phases have no time limits, the Commission will endeavor to take a decision within 18 months of the start of the in-depth investigation.

HOW TO PREPARE FOR THE APPLICATION OF THE FSR

Application of the FSR – Timetable

As mentioned above, the FSR will apply as of July 12, 2023. The FSR shall apply to foreign subsidies granted in the five years prior to July 12, 2023 where such foreign subsidies create effects at present, i.e., they distort the internal market after July 12, 2023. By way of derogation, the FSR shall apply to foreign financial contributions granted in the 3 years prior to July 12, 2023 where such foreign financial contributions were granted to an undertaking notifying a concentration or notifying a PPP pursuant to the FSR.

The FSR shall not apply to concentrations for which the agreement was signed before July 12, 2023. The FSR shall also not apply to public procurement contracts that have been awarded or procedures initiated before July 12, 2023.

In general, the FSR shall apply from July 12, 2023 while the notification obligations for M&A transactions and PPP shall only apply from October 12, 2023. However, it is advisable to start preparing immediately for the application of the FSR, given the substantial scope of the regulation.

Actions to Take Now

Businesses which conduct activities in the EU, should put in place a system to monitor and quantify foreign financial contributions received since at least July 2020 – to cover the three-year review – and, preferably, July 2018. In particular, attention should be paid to positive benefits and reliefs from certain costs normally due by the company. External counsel can assist in determining whether these foreign financial contributions constitute a ‘foreign subsidy’.

As soon as a company decides to engage in an M&A or PPP in the EU, the company should map all relevant foreign financial contributions for the relevant time period to check whether the relevant notification thresholds are met. Subsequently companies must carefully consider whether any such financial contribution constitutes a foreign subsidy and, if so, whether such foreign subsidy may have a distortive effect. It is also advisable to determine whether there any positive effects relating to the subsidy that could be invoked. Companies should ensure that the preparation above is ably assisted by external counsel.

In particular with regard to M&A transactions, companies should carry out an FSR analysis in addition to merger control and foreign direct investment reviews. Even at the stage of due diligence, it would already be advisable to check whether the target has received any foreign financial contributions. If the transaction might eventually trigger a notification to the Commission, the M&A agreement should provide for Commission approval in the closing conditions. When acting as a bidder for a target that meets the EU turnover threshold, your bid will be much better viewed when accompanied with clear assurances that no FSR filing is required or, alternatively, that a filing may be required but that the foreign subsidies received are not distortive of competition.

© 2023 McDermott Will & Emery
For more Antitrust Legal News, click here to visit the National Law Review.

NFT Endorsed by Celebrities Prompts Class Action

Since the early days of the launch of the Bored Ape Yacht Club (BAYC) non-fungible tokens (NFTs), several celebrities have promoted the NFTs. On Dec. 8, 2022, plaintiffs Adonis Real and Adam Titcher brought a lawsuit against Yuga Labs, creators of the BAYC, alleging that Yuga Labs was involved in a scheme with the “highly connected” talent agent Greg Oseary, a number of well-known celebrities, and Moonpay USA LLC, a crypto tech company. According to the complaint:

  1. Yuga Labs partnered with Oseary to recruit celebrities to promote and solicit sales of BYAC;
  2. Celebrities promoted the BAYC on their various platforms;
  3. Oseary used MoonPay to secretly pay the celebrities; and
  4. The celebrities failed to disclose the payments in their endorsements.

According to the complaint, as a result of the various and misleading celebrity promotions, trading volume for the BYAC NFTs exploded, prompting the defendants to launch the ApeCoin and form the ApeCoin decentralized autonomous organization (DAO). Investors who had purchased the ApeCoin allegedly lost a significant amount of money when the value of the coins decreased.

This case highlights the potential risks that may arise in connection with certain endorsements. In addition to the FTC, the SEC also has issued guidance on requirements in connection with promotional activities relating to securities, which may include digital assets, such as tokens or NFTs. Under SEC guidance, any paid promoter, celebrity or otherwise, of a security, including digital assets, must disclose the nature, scope and amount of compensation received in exchange for the promotion. This would include tv/radio advertisements and print, in addition to promotions on social media sites.

Article By Barbara A. Jones, William B. Mack, and India L. Sneed of Greenberg Traurig, LLP

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

©2022 Greenberg Traurig, LLP. All rights reserved.

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

For more Finance Legal News, click here to visit the National Law Review.

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.

Are Loans Securities?

We have been following a case that has been winding its way through New York federal courts for some time that players in the syndicated loan market have described as everything from “a potential game changer” to an “existential threat” to the syndicated loan market.

The case in question is Kirschner v. JPMorgan Chase Bank, N.A., which is before the United States Court of Appeals for the Second Circuit. In this case, the Court will consider an appeal of a 2020 decision by the United States District Court for the Southern District of New York which held that the syndicated term loan in question was not a security. Significantly, this ruling indicated that because syndicated term loans are not securities, they are therefore not subject to securities laws and regulations.

The consequence of a determination that syndicated loans are securities would be significant. It would mean, among other things, that the syndicated loan market would have to comply with various state and federal securities laws. This would significantly change the cost of these transactions as well as the means by which syndication and loan trading take place. The Loan Syndications and Trading Association (LSTA) filed an amicus brief in this case in May of this year, which we covered here. The LSTA argued in its brief, among other things, that beyond the increased cost, regulating syndicated loans as securities would fundamentally change other aspects of the syndicated loan market. Specifically, the LSTA pointed to the importance of a borrower’s ability to have veto rights and other control in determining which entities will hold its debt. The LSTA also noted the importance of quick access to funding on flexible terms specific to the borrower in question – something we know is at the heart of so many fund finance transactions – which would be greatly compromised within a securities regulatory regime. The LSTA brief also discusses potential negative impacts on the CLO market.

Those in favor of a change in regulation point to features such as nonbank lender participation in the market, the fact that the test to determine whether a loan is a security may be outdated, and the overall size of the syndicated loan market – at $1.4 trillion – which could be a risk to the larger global financial system potentially warranting more stringent regulation.

Most experts believe that the Second Circuit will not overturn the decision issued in the lower court, but the issue in question is significant enough that market players should keep an eye on this one. Oral arguments will take place early next year. We will continue to watch as this case develops and update you here.

Article By Leah Edelboim of Cadwalader, Wickersham & Taft LLP

For more securities and SEC legal news, click here to visit the National Law Review.

© Copyright 2022 Cadwalader, Wickersham & Taft LLP

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].

Article By Cadwalader, Wickersham & Taft LLP

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

© Copyright 2022 Cadwalader, Wickersham & Taft LLP