Following the recent string of crypto bankruptcies, over a million individuals are calling for access to their accounts, coins, and tokens.
Standing in their way is the answer to this question: What is property of a debtor’s estate, or more to the point, what is not property of the estate?
The other question that may matter just as much is what difference it makes.
Based on a filing in the FTX case on Nov. 21, it appeared there was only $1.2 billion of cash available against an unknown amount of claims held by over a million potential creditors, the top 50 of whom are owed, according to FTX’s filings, over $3.1 billion. More assets may be uncovered.
What it Means
Property of the estate is one of the most fundamental concepts in US bankruptcy law. A debtor’s estate consists of “all legal or equitable interests of the debtor in property,” including tangible and intangible property, as of the beginning of the case “wherever located and by whomever held.”
And this includes all “proceeds, product, offspring, rents, or profits of or from property of the estate.”
For our purposes, there is one salient exception to the voracious appetite of the estate: property held by a debtor in some kind of trust. Whether the hollowed-out crypto estates hold an individual’s money, coins, or tokens in trust is perhaps the most important question in all the crypto bankruptcies, especially FTX.
Who Holds the Key
Let’s begin with a harsh reality check and a fundamental mantra of crypto. If your crypto is stored in a wallet with a private key that only you hold, no one can dispute that the crypto is yours. But lose the key and you lose the crypto. However, if your crypto is stored in a wallet on an exchange, and that exchange goes into bankruptcy, then what?
Generally, counsel in other crypto bankruptcies have taken the position that whatever is in the estate or can be recovered by the estate, and belongs to the estate in gross, not any particular creditor. So what does this really mean for FTX customers?
FTX.com’s terms of service provide that “you control the digital assets held in your account,” and that “title to your digital assets shall at all times remain with you and shall not transfer to FTX Trading.”
In addition, “none of the digital assets in your account are the property of, or shall or may be loaned to, FTX Trading.” The company “does not represent or treat digital assets in user’s accounts as belonging to FTX Trading.”
This certainly appears to create a legal “trust” relationship—“in which one person holds title to property, subject to an obligation to keep or use the property for the benefit of another.”
In this regard, FTX digital assets seem to resemble the assets held in a “custody” account at Celsius, a crypto asset-based finance platform that filed for bankruptcy on July 13, which Celsius has acknowledged is customer property and not property of its estate.
However, Celsius’s position may now be in question based on an interim report issued by the examiner appointed in Celsius’s bankruptcy case.
The Nov. 19 report revealed that there were insufficient accounting and operational controls or technical infrastructure in the custody accounts and that “as a result, customers now face uncertainty regarding which assets, if any, belonged to them as of the bankruptcy filing.”
It may not be enough to have agreements that create relationships that should be inviolate, because the actions taken by the holders of a customer’s crypto in violation of those agreements may still leave those customers unprotected.
Another issue that need to be resolved relates to venue—where the case will take place, and to choice of law—what law will govern the legal questions.
FTX was incorporated in Antigua and Barbuda, headquartered in the Bahamas, and did business globally. Though 100-plus FTX cases were filed in the bankruptcy court in Delaware, a case has also started in the Bahamas. This has caused a jurisdictional fight.
Cases decided under the US bankruptcy code make clear that property subject to a trust is excluded from property of a debtor’s estate.
But whether a trust relationship has actually been created is a matter of “state law,” meaning that the bankruptcy court, which is a federal court, will look to the law of the relevant state or country to interpret the provisions of the contract.
In this case, the provisions are the TOS—that the parties entered into as well as the validity and effect of that contract.
The terms of service of FTX state that disputes are to be determined “in accordance with English law.” What exactly that means, is not completely clear.
Now, assuming these are trust funds, does it matter? Maybe. Unless all the press is wrong, which it might be, billions of dollars are just gone. Whether someone will be held criminally liable is to be determined by folks with badges and .gov in their email addresses, not bankruptcy lawyers or the new CEO of FTX.
What happens to whatever money is left in FTX or can be recovered by the estate for creditors? Whose money is it? Everyone’s?
In which case, the normal bankruptcy process would make a pro rata distribution to creditors in accordance with the priority of payment scheme in the bankruptcy code.
Or, are any of the assets remaining considered trust assets? Meaning, do they belong to specific parties individually and not to all parties collectively?
Bottom line—it is way too soon to tell.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Jason Gottlieb is chair of the White Collar, Regulatory Enforcement & Digital Assets Practice at Morrison Cohen.
Joseph T. Moldovan is chair of the Business Solutions, Restructuring & Governance Practice at Morrison Cohen.