The Other Side Of The Coin: Cryptocurrency Assets In Bankruptcy

• Published date: 18 July 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Technology, Insolvency/Bankruptcy, Securities, Fin Tech
• Law Firm: Proskauer Rose LLP
• Author: Mr Wai L. Choy, Vincent Indelicato, Timothy Q. Karcher, Steven Weise and Steve Ma

On July 5, 2022, cryptocurrency brokerage Voyager Digital filed for chapter 11 in the Southern District of New York Bankruptcy Court, citing a short-term "run on the bank" due to the "crypto winter" in the cryptocurrency industry generally and the default of a significant loan made to a third party as the reasons for its filing. At Voyager's first day hearing on July 8, 2022, the Bankruptcy Court asked the critical question of whether the crypto assets on Voyager's platform were property of the estate or its customers. Voyager asserted the crypto assets were assets of the estate pursuant to the terms of its customer agreements, but the question of ownership was more problematic in the context of a liquidation. In that context, Voyager's plan of reorganization proposes to resolve any mystery of ownership by delivering the reorganized company to its customers.

On July 13, 2022, cryptocurrency lender Celsius Network filed for chapter 11 in the Southern District of New York Bankruptcy Court. Celsius had frozen customer withdrawals on June 12, 2022 and, at the time of its chapter 11 filing, indicated that it would not be requesting court authority to allow customer withdrawals. Celsius noted in a press release that customer claims would be addressed through the chapter 11 process.

Voyager's and Celsius' chapter 11 bankruptcy filings highlight the question of whether crypto assets held by an exchange, or similar platform, may be considered property of a bankruptcy estate and, therefore, not recoverable by the customer, who would then likely be an unsecured claimholder of the debtor.

While some commentators have suggested that crypto assets might be considered property of the exchange's bankruptcy estate, existing common law, existing provisions of Uniform Commercial Code (UCC) Article 8, and proposed amendments to the UCC recognize that if the arrangement and relationship between the exchange and its customers is one that is characterized as "custodial," the crypto assets held by the exchange should remain property of the customer and, hence, not subject to dilution by general unsecured claimholders.

Custodial Assets in the Bankruptcy of the Custodian

The common law. When assets are held by a "custodian" for the benefit of the customers of the custodian, the assets are owned by the customer and would not form part of the debtor's bankruptcy estate. The United States Court of Appeals for the Seventh Circuit determined in In re Joliet-Will County Community Action Agency¹ that property held by the debtor as a custodian or other intermediary who then generally lacks beneficial ownership rights is not an asset of the bankruptcy estate.

The court then looked to see if the relationship between the debtor and those who transferred funds to the debtor was in fact "custodial." The court concluded the answer depends on "the terms under which the...