Are All Crypto Entities Eligible To File For Bankruptcy Under Chapter 11?

• Published date: 04 August 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Technology, Insolvency/Bankruptcy, Securities, Fin Tech
• Law Firm: Debevoise & Plimpton
• Author: Mr Jeff Robins, Alison M. Hashmall, Elie J. Worenklein, Michael C. Godbe, Ezra Newman, Lily D. Vo and Justice H. Walters

In light of recent volatility in crypto markets and news of several crypto entities filing for bankruptcy,¹ market participants are increasingly scrutinizing the credit of crypto intermediaries and considering whether there will be an influx of additional filings. In thinking through credit risk, one critical preliminary set of questions that market participants should ask is which bankruptcy regime is likely to apply to a crypto intermediary, what are crypto asset-holder rights likely to be under that regime, and what are creditor rights more broadly. For certain common types of crypto intermediaries, a regime other than the U.S. Bankruptcy Code (the "Code")² may be the most likely. For others, while the crypto entity may qualify to be a debtor under the Code, chapter 11 restructuring may not be available and a chapter 7 liquidation may be the only option. As will be discussed in more detail below, this can be a fact-specific analysis that may depend on the nature of the entity's crypto activities and the legal characterization of the relevant crypto assets. The classification of the crypto entity will impact the applicable insolvency regime and the likely outcome for creditors and customers.

Section 109 of the Code enumerates the requirements for an entity to be eligible to be a debtor. Of particular interest to the crypto industry, section 109(b) lists entities that are not eligible to be a debtor, including a variety of domestic and foreign banking institutions.³ Thus, an entity whose crypto activities might be deemed to involve a type of banking that may fall within the exclusion in section 109(b) may not qualify as a debtor under the Code and may need to consider another insolvency regime.4 An example of another insolvency regime is the Office of the Comptroller of the Currency ("OCC") receivership regime, under 12 CFR part 51, for uninsured national banks, which may apply if a crypto entity is a trust bank charted by the OCC.

Moreover, even an entity that qualifies to be a debtor under the Code may not be eligible for a chapter 11 reorganization case. Section 109(d) of the Code provides that only certain entities may commence a chapter 11 reorganization and specifically excludes "stockbrokers" and "commodity brokers" as potential debtors for chapter 11 cases.⁵ Such entities are only eligible for liquidation proceedings under chapter 7.⁶ Thus, whether or not a crypto entity is considered a stockbroker or a commodity broker determines how it may proceed with a potential bankruptcy case. Sections 741 – 753 of the Code specifically govern the liquidation of stockbrokers, while sections 761 – 767 of the Code govern the liquidation of commodity brokers.

The Code defines the term "stockbroker" as a "person with respect to which there is a customer . . . and that is engaged in the business of effecting transactions in securities for the account of...