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FTX Looks at Years of Lawsuits to Recover Billions From Customers

Nov. 18, 2022, 6:11 PM

FTX’s bankruptcy opens the door to creditors’ likely lawsuits looking to claw back billions of dollars in assets that customers and insiders withdrew before the crypto company’s abrupt Chapter 11 filing.

As the company’s advisers scramble to get a handle on its finances, they’ll have a slate of bankruptcy tools available that will allow them to try to wrangle funds back into the FTX empire to try to pay all creditors, though the efforts will likely take years.

Debtors can try to claw back funds that were transferred out of the company in the days and months before the bankruptcy occurred—including billions of dollars of withdrawals customers made in the days leading up to the bankruptcy filing. FTX co-founder, Sam Bankman-Fried, said the platform saw roughly $5 billion of withdrawals on Nov. 6, just five days before its Chapter 11 filing.

Recovering eve-of-bankruptcy payments to creditors, known as preferences, could be critical to FTX’s ability pay off debts to the wider creditor body. Additionally, FTX could try to claw back its payments without court permission after the bankruptcy filing. The company can also go after transfers of assets and property designed to defraud creditors or made without receiving adequate value in return, known as fraudulent transfers.

Recovery efforts won’t be easy. The company’s financial controls have failed, and the existing financial information isn’t trustworthy, according to FTX’s new CEO, John J. Ray III. Nonetheless, Ray has said in court filings that among his goals are to maximize value for FTX stakeholders and investigate claims against FTX’s co-founders, including Bankman-Fried.

“Bankruptcy court is a fishbowl. Every decision FTX made in recent weeks will be highly scrutinized by a litany of players—committees, potentially an examiner or a trustee, other investors—with a range of tools at their disposal,” said Daniel Shamah, a partner at law firm O’Melveny & Myers. “Expect this to be a long, expensive process that will take years to play out.”

Preferences

Customers who pulled their digital assets from FTX in the days leading up to the bankruptcy could face demands that the paid amount be returned if a judge determines the withdrawals were not within the “ordinary course of business.” The customers forced to return payments they took out in 90 days before the bankruptcy would hold unsecured claims against the estate for those amounts.

"[T]here’s a possibility of preference actions being brought against everyone who withdrew funds from the exchange in the lead up to the bankruptcy,” said Adam Levitin, a law professor at Georgetown University.

But there are potential complications to preference actions because securities or commodities transaction “safe harbors” could apply, Levitin said. An existing bankruptcy safe harbor allows assets like commodities and securities to continue to be traded on an exchange without risk of clawback.

Recipients of alleged preferences might also claim that they only took their own property and weren’t paid by the company as creditors.

The $5 billion of reported withdrawals by customers on the eve of the bankruptcy filing indicates a serious risk of preferential and fraudulent transfer actions against customers, said Joseph Cioffi, a partner at Davis+Gilbert.

“Customers would likely have defenses based on their expectations and also lack of knowledge of FTX’s scheme,” Cioffi said.

Post-Bankruptcy Transfers

FTX counsel in court papers said that they have “credible evidence” that the Bahamian government “is responsible for directing unauthorized access to the Debtors’ systems for the purpose of obtaining” FTX’s digital assets” after the Chapter 11 filings was made.

If Ray is correct, any transfers of those assets could be the target of clawback efforts. Companies in bankruptcy operate under the strict oversight of the bankruptcy court, and are monitored by the Justice Department’s watchdog, the US Trustee.

A debtor in bankruptcy can’t make transfers that are beyond the ordinary course of its business without permission from the court.

There’s been at least $372 million of “unauthorized transfers” on the bankruptcy filing date, Ray said in court filings.

Fraudulent Transfers

It will likely take FTX’s new executives time to determine how much property was transferred by the company that wasn’t for reasonably equivalent value.

FTX corporate funds have been used to buy homes and and other personal items for its employees and advisers, without documentation of those transactions as loans, according to Ray. Some real estate has been recorded in the names of those employees and advisers, according to court filings.

If owners or executives of FTX used the company’s funds as their own private piggy bank, those transfers can also be recovered as fraudulent transfers.

Even charitable or political donations made by FTX in the past two years could possibly be clawed back, Levitin noted. Unusual payments to insiders will get particular scrutiny, he said.

To contact the reporter on this story: James Nani in New York at jnani@bloombergindustry.com; Daniel Gill in Washington at dgill@bloomberglaw.com

To contact the editors responsible for this story: Maria Chutchian at mchutchian@bloombergindustry.com; Roger Yu at ryu@bloomberglaw.com