In Defense of Chapter 11 for Mass Torts
by | posted in: Bankruptcy, Chapter 11, Mass Torts, Texas Two-Step, Third-Party Releases, Valuation | 0

By Anthony J. Casey and Joshua Macey (University of Chicago Law School)

Anthony J. Casey
Joshua Macey

Recent high-profile bankruptcies involve the use of Chapter 11 proceedings to resolve mass tort claims. In these cases, debtors have employed controversial maneuvers to facilitate global resolution and to minimize operational disruptions that can result from bankruptcy filings. Most notorious among these maneuvers are the third-party release (a key feature in every mass tort bankruptcy) and the two-step bankruptcy (a recent innovation in asbestos cases, also known as the “Texas” two-step).

While most bankruptcy courts have blessed the use of Chapter 11 to resolve mass torts claims, scholars, policymakers, and media commentators have argued that bankruptcy proceedings provide an improper forum for resolving these cases. Critics have taken special aim at the use of the third-party release and the two-step bankruptcy.

In an Essay forthcoming in the Chicago Law Review, we argue that Chapter 11 proceedings provide an appropriate and often superior forum in which to resolve mass tort claims. We further argue that legal innovations such as the two-step bankruptcy and the third-party release can reduce bankruptcy costs and preserve value for all claimants. As a result, these maneuvers and others like them should be welcomed as long as courts are attentive to the potential for opportunistic abuse.

Bankruptcy law resolves the collective action problem that arises when creditors pursue their claims in a variety of separate proceedings. When creditors worry they will not recover the full value of their debt, they race to the courthouse—or courthouses—to collect what they are owed. The result is the destruction of value and potential dismemberment of viable firms. This leaves all claimants and stakeholders worse off. The Bankruptcy Code’s core provisions—the automatic stay, priority rules, prohibitions on fraudulent transfers, preference rules, and treatment of unpaid claims—are all designed to address these problems. This point has never been controversial.

Mass tort cases present this exact collective action problem. When a firm is unable to pay all its tort claims, claimants who file early, or who find themselves before a sympathetic jury, or whose injuries happen to manifest quickly, may receive a large payout. Late claimants risk being left with nothing if the firm’s resources are depleted. And the costs of a decentralized, lengthy resolution of mass torts claims can be large and value destructive for all stakeholders.

Chapter 11 proceedings can mitigate these problems and provide an appropriate and often superior forum in which to resolve mass tort claims. Despite the rhetoric surrounding recent cases, the bankruptcy community has recognized the resolution of mass tort claims as a widely accepted core function of bankruptcy courts for decades. And for good reason: Chapter 11 provides tools for dealing with holdouts and future claimants that are unavailable in conventional class actions or multidistrict litigation proceedings.

Moreover, bankruptcy tools that facilitate efficient, lower-cost resolution should be welcomed. The two-step bankruptcy and the third-party release are such tools, as long as courts guard against opportunistic abuse. Properly used, the third-party release prevents holdout behavior and incentivizes perpetrators of corporate misconduct to disclose their role in the company and to contribute assets to the bankruptcy estate. Similarly, the two-step bankruptcy allows a firm to quarantine mass tort liabilities from operations facilitating resolution in a single, streamlined bankruptcy proceeding without involving all nontort counterparties. These maneuvers thus further the Code’s purpose by providing a single forum in which to efficiently and fully resolve the firm’s mass tort liabilities.

Of course, debtors and managers can abuse the third-party release and the two-step bankruptcy. But given their potential to benefit all claimants, these tools should not be altogether prohibited. Instead, because the potential for abuse is identifiable, targeted procedures and reforms can mitigate it.

For example, courts should ensure bankruptcy proceedings do in fact mitigate collective action problems and do make tort claimants as a class worse off. Courts should be aggressive in demanding disclosures from the released parties, in requiring strong proof about the value of assets and liabilities, and in policing fraudulent transfers.

Perhaps a trickier issue is that unequal bargaining dynamics and information asymmetries may allow managers to use the reorganization process to take advantage of tort claimants. With full control of the bankruptcy proceeding, managers can pressure tort claimants with take-it-or-leave-it offers. They may also have private information about asset and claim values. Though these are serious concerns, we think that they, too, are best addressed through reforms to the bankruptcy process. To that end, we consider a menu of reforms that would inhibit insiders from taking advantage of their superior informational position.

Click here to read the full article.

And Another Lender Blocking Provision Bites the Dust, Texas Bankruptcy Court Rules
by | posted in: Bankruptcy, Chapter 11, Jurisprudence, Secured Lenders | 0

By Adam C. Rogoff and Ashland J. Bernard (Kramer Levin)

Adam C. Rogoff
Ashland J. Bernard

One feature commonly seen in commercial lending transactions is a waiver of the borrower’s authority to file for bankruptcy without the consent of the lender. While such “blocking” provisions are generally upheld where the equity interest holders are the parties with such rights, they are generally unenforceable as a matter of public policy when such protection is given to a creditor with no meaningful ownership interest in the corporate debtor.

In a recent decision issued in In re Roberson Cartridge Co., LLC, Case No. 22-20192 (RLJ), 2023 Bankr. LEXIS 588 (Bankr. N.D. Tex. March 7, 2023), the Bankruptcy Court for the Northern District of Texas denied a secured creditor’s motion to dismiss the corporate debtor’s Chapter 7 case on the grounds that the petition was filed without the requisite corporate authority. In doing so, the bankruptcy court held void as against public policy a blocking provision in the company’s governing documents, which purported to give the creditor — which held convertible debt of the debtor — the exclusive right to consent to the debtor’s bankruptcy filing. Through an analysis of the company’s governing documents under applicable provisions of the Texas Business Organizations Code, the bankruptcy court concluded that a pledge of equity by the debtor-LLC’s member did not divest the LLC’s manager from corporate authority to file for bankruptcy. Nor was the consent right enforceable with respect to convertible debt where, prior to the bankruptcy filing, the creditor had not exercised its right to convert the debt to equity (and therefore was only a creditor on the petition date). This ruling of a bankruptcy court in the Fifth Circuit joins the growing body of case law from other circuits that holds such bankruptcy-restrictive contractual provisions void as a matter of public policy.

Click here to read the full article.

Bankruptcy Overload
by | posted in: Bankruptcy, Bankruptcy Reform, Chapter 11, Mass Torts, Reorganization, Third-Party Releases | 0

By Laura Coordes (Arizona State University Sandra Day O’Connor College of Law)

Laura Coordes

Over the past few years, a growing number of scholars have sought to diagnose what is wrong with the U.S. bankruptcy system. Congress has held hearings in search of an answer. And many answers have emerged, ranging from lack of balance to outright lawlessness. In my article, Bankruptcy Overload, I contend that these problems are part of a larger issue: the bankruptcy system is overloaded. Those who use it, whether debtors or non-debtors, frequently seek to extract more out of a bankruptcy than the process can, practically and legally, provide.

We have always asked the bankruptcy system to do a lot—indeed, the system’s flexibility and adaptability to new challenges and situations are often described as features rather than bugs. As our current system approaches its 45th birthday, however, it has become increasingly clear that users of the bankruptcy system are putting enormous pressure on it to do more, to resolve more issues, and to satisfy the needs and wants of a growing number of players. In the face of this increasing pressure, the system is beginning to buckle—and this buckling results in many of the problems scholars have identified with modern bankruptcy practice.

The goals and boundaries of bankruptcy law have always been subject to debate, making the system particularly susceptible to taking on more than it can bear. Over the years, many have embraced the resulting uncertainty of the limitations of bankruptcy as a necessary byproduct of bankruptcy’s built-in flexibility. However, even a system with significant capacity can be overloaded, and this Article’s core claim is that the bankruptcy system has reached that point.

This Article defines and explains the concept of bankruptcy overload, illustrating that many of the problems currently plaguing the bankruptcy system derive from overloading it. In addition, although overloading the system may create problems in individual cases, this Article shows that bankruptcy overload is systemically harmful, and that failure to recognize and address it will undermine the system’s long-term utility. Those seeking changes to bankruptcy law must be aware of the system’s capacity constraints. In addition to defining bankruptcy overload and identifying its harms, the Article illuminates ways to address many of the issues present in bankruptcy today while being cognizant of the effect of changes to bankruptcy law on the system as a whole.

The full article is available here.

Sears Holding: A Case Study in Valuing Collateral in Chapter 11
by | posted in: 363 Sale, Chapter 11, Reorganization, Valuation | 0

By Mark G. Douglas and Oliver S. Zeltner (Jones Day)

Mark G. Douglas
Oliver S. Zeltner

Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) are valued determines a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cramdown” plan can be confirmed despite the objections of dissenting creditors. Depending on the context, bankruptcy courts rely on numerous different standards to value estate assets, including book, retail, wholesale, liquidation, forced-sale, going-concern, and reorganization value.

The U.S. Court of Appeals for the Second Circuit recently examined collateral valuation in a chapter 11 case for the purpose of determining whether junior secured creditors were entitled to “super-priority” administrative claims to compensate them for alleged diminution in the value of their collateral after the petition date and before the bankruptcy court approved a sale of the debtors’ business as a going concern. In ESL Investments, Inc. v. Sears Holdings Corp. (In re Sears Holdings Corp.), 51 F.4th 53 (2d Cir. 2022), cert. denied sub nom. Cyrus Capital Partners, L.P. v. Sears Holdings Corp., No. 22-765 (U.S. Mar. 20, 2023), the Second Circuit held that, given the uncertainty surrounding the retail debtors’ fate at the time they filed for bankruptcy, the bankruptcy court did not err in valuing inventory collateral at its “net orderly liquidation value,” rather than book value, going-out-of-business sale value, or forced liquidation value. The Second Circuit also found no fault with the bankruptcy court’s decision to value non-borrowing base inventory at zero and to ascribe full face value to undrawn letters of credit where, among other things, the junior lenders failed to meet their evidentiary burden of suggesting a reasonable alternative.

There are several key takeaways from the Second Circuit’s ruling in Sears Holding.

First, valuation in bankruptcy is a fact-specific inquiry, and the selection of an appropriate valuation method, guided by section 506(a) of the Bankruptcy Code, is committed to the sound discretion of the Bankruptcy Court.

Second, Sears Holding is a testament to the consequences of failing to satisfy evidentiary burdens. The Second Circuit found no error in the bankruptcy court’s decision to ascribe no value to certain inventory and to discount to zero the full face value of undrawn letters of credit because the junior lenders had the burden of proposing a reasonable alternative but repeatedly failed to do so.

Third, the Second Circuit reaffirmed in Sears Holding that applicable U.S. Supreme Court precedent regarding valuation in a chapter 13 case also applies in chapter 11, requiring the bankruptcy court to be guided in its valuation by the use or disposition likely for the subject collateral, rather than some hypothetical use or disposition.

The Supreme Court denied the junior lenders’ petition for review of the Second Circuit’s decision on March 20, 2023.

Click here to read the full article.

Bankruptcy Amnesia
by | posted in: Bankruptcy, Bankruptcy Reform, Chapter 11, Legislation, Mass Torts, Statutory Interpretation, Third-Party Releases | 0

By Jonathan Lipson (Temple University Beasley School of Law)

Jonathan Lipson

[Editor’s Note: The author represented, on a pro bono basis, an individual claimant in the bankruptcy of Purdue Pharma.]

In late 2022, counsel for opioid-maker Purdue Pharma posted an essay on the Harvard Bankruptcy Roundtable (HBRT), “Please Don’t Forget the Victims: Mass Torts, Third Party Releases and the U.S. Bankruptcy Code” (“Forget”). Forget largely restated arguments they made to the Second Circuit Court of Appeals in their bid to reinstate controversial nonconsensual nondebtor “releases” (NDRs) of collateral civil liability arising from the OxyContin-maker’s confessed drug-marketing crimes. HBRT asked me to respond to Forget because I was pro bono counsel to one of those they would have us remember: Peter Jackson, whose daughter Emily died after taking a single OxyContin in 2006.

While the sentiment to “remember the victims” is laudable, the substance of Forget renders its title a cruel irony. Forget says almost nothing about the victims of a public health crisis that has taken over half a million lives and in which Purdue Pharma, and its wealthy and secretive owners, the Sacklers, apparently played a singular role. Instead, Forget would honor survivors of this crisis through the use of legally dubious NDRs.

Forget conspicuously omits or distorts problems in the Purdue Pharma case and precedent on which its NDRs would rest. It ignores the fact that nondebtor “releases” and “settlements” are contractual in nature, and cannot be forced onto the unwilling; that over 80% of creditors cast no vote on Purdue Pharma’s plan, so there was hardly “overwhelming” support for it; and that the precedent on which they rely—historic mass tort and Supreme Court cases—are readily distinguishable from Purdue Pharma.

Forget would have us forget just how problematic Purdue Pharma—and its quest to insulate the Sackler family—has been, thereby seeking to induce a kind of “bankruptcy amnesia.”

The full article is available here.

[Crypto-Bankruptcy Series] Concluding Thoughts on the Series
by | posted in: Bankruptcy, Chapter 11, Crypto-Bankruptcy Series, Cryptocurrency, International and Comparative | 0

By Xiao Ma (Harvard Law School)

Xiao Ma

Note: This post is the concluding post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:

1. The FTX Bankruptcy: First Week Motions, Jurisdictional Squabbling, and Other Unusual Developments, by Megan McDermott

2. Quantifying Cryptocurrency Claims in Bankruptcy: Does the Dollar Still Reign Supreme?, by Ingrid Bagby, Michele Maman, Anthony Greene, and Marc Veilleux

3. The Public and the Private of the FTX Bankruptcy, by Diane Lourdes Dick and Christopher K. Odinet

4. Staking, Yield Farming, Liquidity Mining, Crypto Lending – What are the Customer’s Risks?, by Matthias Lehmann et al. (University of Vienna)

5. The Treatment of Cryptocurrency Assets in Bankruptcy, by Steven O. Weise, Wai L. Choy, and Vincent Indelicato

6. FTX Bankruptcy – A Failure of Centralized Governance in the Name of Decentralized Cryptocurrencies, by Vivian Fang

7. Roundup: Celsius Network LLC, by Jessica Graham

8. The Implications of CeFi and DeFi in Bankruptcy: A Hot Take on Celsius, by Kelvin FK Low and Timothy Chan

9. Crypto Volatility and The Pine Gate Problem, by Anthony Casey, Brook Gotberg, and Joshua Macey

This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.

Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.

***

There is a new category of bankruptcies: crypto-bankruptcies. Although difficult to pinpoint the exact beginning of the recent wave of crypto winter (the common belief is that it can be traced back to the collapse of Terra/Luna in May 2022.) Since then, several crypto companies – such as Voyager, Celsius, FTX, BlockFi, and Genesis – have landed in U.S. bankruptcy courts. This trend has prompted our Roundtable to devote a special series to exploring these new developments. I appreciate the opportunity to have managed this series and enjoyed working with authors who contributed thought-provoking posts. While the crypto-bankruptcies will continue to unfold, we are concluding our series for now to feature other content on our forum. We hope that the series has provided some initial food for thought, and that discussions will extend beyond this series as we, the community of bankruptcy academics and practitioners, continue to learn and forge new thinking together about these novel crypto-bankruptcies. 

I would like to take this opportunity to add some concluding thoughts. First, the jurisdictional squabbling present in FTX’s bankruptcy, as highlighted by Megan McDermott, may signify a broader trend that the U.S. bankruptcy courts could become the leading venue in resolving crypto-related insolvencies. Cryptocurrencies are perhaps uniquely international, with no clear need for insolvency proceedings to take place in any particular jurisdiction. Indeed, other jurisdictions (most notably Singapore and London) have recently tried to increase their attractiveness as the home of major cross-border insolvencies, and cryptocurrency companies may have been a major test case for these efforts. Nevertheless, this wave of crypto-bankruptcies has taken place in the United States.

This new set of crypto-bankruptcy cases will put the efficacy and efficiency of Chapter 11 to the test. Crypto investors worldwide are closely monitoring the processes and carefully studying the rulings of U.S. bankruptcy judges (such as the critical Celsius opinion briefed by Jessica Graham). These opinions may have broad implications and global reach for the whole crypto industry. The ongoing crypto-bankruptcy proceedings also provide great insights into the business activities, financial condition, and commercial realities of major players in this fast-evolving industry. For example, the 600+-page Celsius examiner’s report not only detailed how Celsius struggled to generate enough yield to support its high reward rates and made terrible investment and asset deployment decisions, but also brought  public attention to its governance deficiencies and problematic representations made to the public. Diane Dick and Christopher Odinet reminded us of the need to investigate the causes of debtors’ failures and to craft appropriate laws and regulations safeguarding substantial public interests. On the other hand, they also highlight the dilemma of whether the limited resources of bankruptcy estates can support the type of independent management and fact-finding that might be essential to addressing the public concerns of crypto-bankruptcies, but which are not typically central to the chapter 11 model. 

Second, in reflecting on the cause of FTX’s massive failure, Vivian Fang noted how distressed companies’ financial positions have been inflated with illiquid assets and obscure instruments throughout corporate history. In FTX’s case, the related party transactions that are secured by FTTs, its own token, remind us of the SPVs of Enron that were solely financed by its own stock, and how a drop in the value of this stock led to Enron’s collapse. Investigations of fraudulent transactions and preferential payments are likely to be themes shared by the highly interconnected crypto-bankruptcies. Note that one essential (and as-yet-unanswered) issue that will greatly impact how these cases proceed is how to effectuate transaction avoidance law and enforce the clawback of payments that take place on the blockchain via nodes of anonymity. 

Another major theme, as predicted and discussed by Matthias Lehmann, Kelvin Low and Timothy Chan, and Diane Dick and Christopher Odinet, is how to characterize the crypto assets that the customers stake on the troubled crypto platforms. Steven Weise, Wai Choy and Vincent Indelicato’s memo analyzed the legal framework under which the crypto assets that are custodially held by a platform should be treated as customers’ assets, not the property of the bankruptcy estate. Whether such a custodial relationship exists would be a separate question, as many customer agreements provide otherwise (e.g., terms governing Celsius customers’ earn accounts were central to the opinion in that case). Crypto exchanges commonly comingle and rehypothecate crypto assets, making it even harder for customers to withdraw their staked cryptos during a chapter 11 case. This, in turn, makes the industry more susceptible to contagion (and such contagion has reached traditional banking where institutions have substantial ties to crypto, e.g., Silvergate Capital) as downward pressure on the value of crypto assets could quickly spread among a network of lenders and borrowers whose financial activities are linked to an identical set of collateral. The ongoing crypto-bankruptcy proceedings also revealed much interconnectedness among these distressed debtors through crypto-collateralized loans and cross-crypto-holdings.

In these evolving crypto-bankruptcies, judges are likely to set parameters around various substantive issues related to the valuation and recovery of crypto assets. Ingrid Bagby, Michele Maman, Anthony Greene, and Marc Veilleux considered the popular request for “payment-in-kind” distribution as prices of crypto assets are incredibly volatile and concluded that the USD continues to reign for now. The fluctuation of crypto assets’ value raises other concerns, such as the Pine Gate problem, as Anthony Casey, Brook Gotberg, and Joshua Macey noted. With the petition date serving as the artificial moment of reckoning, debtors in crypto-bankruptcies may effectively force customers into a bottom-of-market sale to finance the Chapter 11 process, and the liquidity generated may be redistributed to other creditors or managers. Relatedly, Kelvin Low and Timothy Chan discussed the fungible nature of crypto assets and how they do not have any inherent utility except for the ability to (potentially) make a profit upon alienation. 

This line of reasoning, in turn, gets to the heart of the heavily debated question of the nature of cryptocurrencies. Since the beginning of crypto-bankruptcies, a lingering question of mine has been – if these crypto exchanges and debtors’ business models bear significant similarities to banks, stock brokers, or commodity brokers, should they be excluded from filing under Chapter 11 in the first place pursuant to 11 U.S.C. § 109? Before Judge Wiles approved the Voyager-Binance deal, regulators raised objections stating that Voyager may be involved in unregistered offers and sales of securities, as well as illegal operations of virtual currency businesses without licenses. Once these crypto debtors’ business endeavors are better defined through the magnifying glass of bankruptcy proceedings and the governmental agencies settle on the regulatory framework for the crypto industry, future crypto debtors may not necessarily be eligible to seek chapter 11 remedies but will have to resort to chapter 7 liquidation or other proceedings that are specifically tailored to financial institutions. 

It is fascinating that U.S. bankruptcy courts, in addition to resolving mass torts, are now facing new challenges in navigating the ambiguities and uncertainties of U.S. crypto regulations. As they make rulings and decisions, these courts are essentially shaping the law for the entire crypto world, which was founded on the ideal of transcending centralized governance. While some jurisdictions, such as Singapore, have a manifested ambition to become a crypto hub, others, like China, have shown great animosity toward the industry. In contrast, the European Commission has recently launched a blockchain regulatory sandbox, which aims to facilitate dialogues between developers and regulators. Nonetheless, I find no dialogue more informative and soul-searching than the evolving crypto-bankruptcy cases happening here in the U.S. All eyes are on these cases, and questions are hammering at the doors of courthouses.

[Crypto-Bankruptcy Series] Crypto Volatility and The Pine Gate Problem
by | posted in: Bankruptcy Reform, Chapter 11, Collateral Stripping, Crypto-Bankruptcy Series, Cryptocurrency, Valuation | 0

By Anthony Casey (University of Chicago), Brook Gotberg (Brigham Young University), and Joshua Macey (University of Chicago)

Anthony Casey
Brook Gotberg
Joshua Macey

Note: This post is the ninth post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:

1. The FTX Bankruptcy: First Week Motions, Jurisdictional Squabbling, and Other Unusual Developments, by Megan McDermott

2. Quantifying Cryptocurrency Claims in Bankruptcy: Does the Dollar Still Reign Supreme?, by Ingrid Bagby, Michele Maman, Anthony Greene, and Marc Veilleux

3. The Public and the Private of the FTX Bankruptcy, by Diane Lourdes Dick and Christopher K. Odinet

4. Staking, Yield Farming, Liquidity Mining, Crypto Lending – What are the Customer’s Risks?, by Matthias Lehmann et al. (University of Vienna)

5. The Treatment of Cryptocurrency Assets in Bankruptcy, by Steven O. Weise, Wai L. Choy, and Vincent Indelicato

6. FTX Bankruptcy – A Failure of Centralized Governance in the Name of Decentralized Cryptocurrencies, by Vivian Fang

7. Roundup: Celsius Network LLC, by Jessica Graham

8. The Implications of CeFi and DeFi in Bankruptcy: A Hot Take on Celsius, by Kelvin FK Low and Timothy Chan

This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.

Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.

***

When a crypto exchange such as FTX files for bankruptcy, crypto assets will often be treated as property of the estate and not as property of the individual or business that deposited coins with the exchange. Scholars have focused on the financial stability and consumer protection issues that arise as a result of this treatment.

In our opinion, there is an additional reason to treat crypto depositors as owners, not as creditors, of crypto assets, and to exempt holders of crypto assets from ordinary bankruptcy procedures such as the automatic stay. With some exceptions such as stablecoins, crypto assets are highly volatile. Claims against a crypto exchange, including claims submitted by customers who traded crypto assets on the exchange, are valued at the filing date. The failure of a crypto exchange is likely to occur when the crypto asset’s value has declined significantly. The fact that claims are valued at the filing date could lead to strategic bankruptcy petitions that redistribute value away from junior claimants. And even if crypto exchanges do not file with this purpose in mind, bankruptcy, by creating an artificial moment of reckoning, is likely to redistribute value from customers of a crypto exchange to the exchange’s other creditors or managers.

This is an extreme version of a familiar problem, which is that bankruptcy, by forcing a moment of reckoning, causes claimants who have invested in volatile assets to lose the option value of those investments. Imagine a company that has an asset that could appreciate significantly in the future but currently holds little value. If the firm files for bankruptcy, creditor claims are based on the value of the asset at the time the firm files for bankruptcy. If there is reason to think that the asset’s value will increase in the future, a bankruptcy filing allows the debtor to pay the relatively little and then benefit when the asset’s value goes up. That, in our opinion, offers another reason to think that customers of crypto exchanges should not be treated as unsecured creditors.

Click here to read the full article.

[Crypto-Bankruptcy Series] Roundup: Celsius Network LLC
by | posted in: Bankruptcy, Chapter 11, Crypto-Bankruptcy Series, Cryptocurrency, Priority | 0

By Jessica R. Graham (Harvard Law School)

Jessica R. Graham

Note: This post is the seventh post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:

1. The FTX Bankruptcy: First Week Motions, Jurisdictional Squabbling, and Other Unusual Developments, by Megan McDermott

2. Quantifying Cryptocurrency Claims in Bankruptcy: Does the Dollar Still Reign Supreme?, by Ingrid Bagby, Michele Maman, Anthony Greene, and Marc Veilleux

3. The Public and the Private of the FTX Bankruptcy, by Diane Lourdes Dick and Christopher K. Odinet

4. Staking, Yield Farming, Liquidity Mining, Crypto Lending – What are the Customer’s Risks?, by Matthias Lehmann et al. (University of Vienna)

5. The Treatment of Cryptocurrency Assets in Bankruptcy, by Steven O. Weise, Wai L. Choy, and Vincent Indelicato

6. FTX Bankruptcy – A Failure of Centralized Governance in the Name of Decentralized Cryptocurrencies, by Vivian Fang

This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.

Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.

***

On January 4th, 2023, the U.S. Bankruptcy Court for the Southern District of New York issued its opinion regarding digital assets held by Celsius Network LLC (“the Debtor”). In a decision that arguably could have lasting implications for crypto bankruptcies and the crypto industry more generally, the Court held that the assets deposited with Celsius in one of its programs, the “Earn” rewards program, had been relinquished to the Debtor and thus are to be considered assets of the Debtor’s bankruptcy estate. For customers with assets in the Debtor’s “Earn” program, this decision means that they will not be entitled to an immediate return of their invested assets. Instead, “Earn” customers will be treated as general unsecured creditors and receive payment at the end of the Debtor’s bankruptcy.  Such payments will be made only after payment to any other priority creditors, and “Earn” customers will receive payments proportionate to the amount of their investments out of whatever money may be left at the end of the bankruptcy.

The Debtor offered three types of accounts: (1) “Earn”; (2) “Custody”; and (3) “Borrow”. This holding only applies to the “Earn” accounts because of the nature of the accounts. Assets deposited through the “Earn” program were comingled across consumers, and the Debtor had the right to invest these assets or use them for other purposes. In registering for one of these accounts, the Terms of Use dictated that customers were transferring ownership of assets deposited in the account to the Debtor, “in every sense and for all purposes.” Thus, the Court reasoned, these assets must be considered the property of the estate.  In interpreting the Terms of Use as an enforceable contract, the Court rejected the claim that these agreements were merely clickwrap. The Court also rejected the claim that the terms of use were ambiguous, stating that nothing in the agreement suggested customers would retain a lien on the assets they deposited. The Court did, however, leave the door open for customers to challenge the possession of their specific assets with individual defenses—the Court only articulated an assumption that the assets were the estate’s property.

The overarching theme is the importance of digital asset holders to carefully read the terms of use when opening accounts. Assets held in the other two types of accounts—“Custody” and “Borrow”—will need to be addressed in separate litigation, as they are governed by different customer agreements and management standards.

Several law firms have taken note of this decision, providing takeaways and analyses of impact. Sidley stresses the importance of carefully reading (for investors) or drafting (for market participants) the terms of use agreements and their related marketing materials. Morrison Foerster emphasizes the special nature of the decision, reasoning that it is unlikely to be determinative for other crypto cases because of the reliance on specific terms of use. Husch Blackwell highlights the importance of the Court’s imminent decisions regarding the other types of accounts, noting that the implications of those decisions could alter the landscape of crypto in the future.

[Crypto-Bankruptcy Series] The Treatment of Cryptocurrency Assets in Bankruptcy
by | posted in: Bankruptcy, Chapter 11, Crypto-Bankruptcy Series, Cryptocurrency, Priority, Statutory Interpretation | 0

By Steven O. Weise, Wai L. Choy, and Vincent Indelicato (Proskauer Rose LLP)

Steven O. Weise
Wai L. Choy
Vincent Indelicato

Note: This post is the fifth post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:

1. The FTX Bankruptcy: First Week Motions, Jurisdictional Squabbling, and Other Unusual Developments, by Megan McDermott

2. Quantifying Cryptocurrency Claims in Bankruptcy: Does the Dollar Still Reign Supreme?, by Ingrid Bagby, Michele Maman, Anthony Greene, and Marc Veilleux

3. The Public and the Private of the FTX Bankruptcy, by Diane Lourdes Dick and Christopher K. Odinet

4. Staking, Yield Farming, Liquidity Mining, Crypto Lending – What are the Customer’s Risks?, by Matthias Lehmann et al. (University of Vienna)

This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.

Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.

***

The cryptocurrency market has experienced significant liquidity events, accelerating an industrywide sell-off and leaving the value of cryptocurrencies at historic lows—what many call a “crypto winter.” The idea that participants in the cryptocurrency industry, namely exchanges that operate platforms that allow users to transact in cryptocurrency, may resort to chapter 11 bankruptcy has created questions as to how such assets would be handled during a bankruptcy.

In “The Treatment of Cryptocurrency Assets in Bankruptcy,” Proskauer partners Steven O. Weise, Wai Choy, and Vincent Indelicato explore the question of whether crypto assets deposited by customers in a cryptocurrency exchange may be considered property of the bankruptcy estate and therefore not recoverable by the customer.  While some commentators have suggested that crypto assets might be considered property of the bankruptcy estate, existing common law, current 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 customers and, hence, not subject to dilution by general unsecured claim holders.  However, the analysis of when a custodial relationship exists will depend on the agreements and other facts of a particular relationship.

Click here to read the full article.

[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] Postscript and Analysis of Third Circuit Dismissal of LTL Management’s Bankruptcy
by | posted in: Bankruptcy Reform, Chapter 11, Corporate Governance, fraudulent transfer, Jurisprudence, Mass Torts, Texas Two-Step and the Future of Mass Tort Bankruptcy Series, Third-Party Releases | 0

Editor’s Note: On November 1, 2022, the BRT concluded our eight-part series on the Texas Two-Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies (see below for the full list of posts in the series).  On January 30, 2023, the Third Circuit released its opinion dismissing the bankruptcy filing of LTL Management, raising a host of new questions for mass tort bankruptcies.  In response, the BRT invited contributors to the prior series, as well as some new voices, to analyze the decision and what it might mean for the future of mass tort bankruptcies.

We will resume our series on crypto bankruptcies next week!

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William Organek

In “The Dismissal of LTL and What Lies Ahead for Mass Tort Bankruptcy,” William Organek (Harvard Law School) summarizes the Third Circuit’s opinion dismissing LTL’s bankruptcy filing.  The post then describes key takeaways from the opinion, suggesting how this might impact future mass tort bankruptcy filings, LTL’s tort creditors, and parent company Johnson & Johnson.  Finally, it examines questions raised by mass tort bankruptcies that the opinion does not answer, instead leaving them for future cases and debtors.

The full post can be read here.

 

 

 

Hon. Judith K. Fitzgerald (ret.)

In “Over-Thinking Ramifications of the Dismissal of LTL Management LLC’s Bankruptcy,” Hon. Judith K. Fitzgerald (ret.) (University of Pittsburgh School of Law and Tucker Arensberg, P.C.) explains how the Third Circuit’s opinion merely applies existing Third Circuit precedent to a single debtor to reach a fact-specific conclusion about the appropriateness of bankruptcy for LTL Management LLC.  In doing so, the post argues against concerns that the opinion will make it more difficult for companies facing imminent financial distress to use bankruptcy to resolve their liabilities, even in the mass tort context.

The full post can be read here.

Note: Judge Fitzgerald is a consultant for counsel for certain parties in the LTL bankruptcy, and the opinions expressed herein are solely her own.

 

 

Adam J. Levitin

In “The Implications of LTL’s Per-Debtor Analysis,” Adam J. Levitin (Georgetown University Law Center and Gordian Crypto Advisors LLC) describes how the LTL decision interacts with the standard entity separateness explanation for much of corporate law.  If courts read the opinion strictly to require a debtor-by-debtor analysis of insolvency, this could have major implications for joint administration, venue, and other issues central to bankruptcy administration that stretch far beyond the mass tort context.

The full post can be read here.

Note: Adam Levitin is a consultant for counsel for certain parties in the LTL bankruptcy, and the opinions expressed herein are solely his own.

 

 

Edward J. Janger
John A. E. Pottow

In “Waltz Across Texas: The Texas Three-Step,” Edward J. Janger (Brooklyn Law School) and John A. E. Pottow (University of Michigan Law School) explore how the seemingly limited decision in the LTL bankruptcy cannot be divorced from wider questions about why bankruptcy is being used to resolve mass tort liability.  Focusing on the essential role that third-party releases play in mass tort bankruptcy filings, it suggests that we consider not only whether financial distress is required for good faith, but also what should be required of nondebtors seeking third-party releases and what justifies such extraordinary relief.

The full post can be read here.

 

 

Jonathan C. Lipson

In “The Third Circuit’s New One-Step: Good Faith as Purpose in LTL,” Jonathan C. Lipson (Temple University–Beasley School of Law) analyzes the LTL decision by examining how the court understands the concept of good faith.  Earlier decisions in the Third Circuit relied on a primarily contractualist, or rules-based approach to good faith–does a debtor face financial trouble or does it have a substantial number of creditors?  The LTL decision, however, endorses a more policy-oriented, or standards-based approach to good faith, asking whether the contemplated use of bankruptcy appropriately furthers the policy goals of chapter 11.  This could lead to a re-evaluation of whether bankruptcy should be used for resolving mass torts, and some of the tools used by bankruptcy courts to facilitate a deal among the debtor and its creditors.  This could have particular ramifications for other mass tort bankruptcies such as that of Purdue Pharma.

The full post can be read here.

 

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Earlier posts in the series:

  1. Introduction to LTL Management’s Bankruptcy, by Jin Lee and Amelia Ricketts (students at Harvard Law School)
  2. Vertical Forum Shopping in Bankruptcy, by Jonathan C. Lipson (Temple University-Beasley School of Law)
  3. Upending the Traditional Chapter 11 Bargain, by Jared A. Ellias (Harvard Law School)
  4. A Qualified Defense of Divisional Mergers, by Anthony Casey and Joshua Macey (University of Chicago Law School)
  5. Is the Texas Two-Step a Proper Chapter 11 Dance?, by David Skeel (University of Pennsylvania Carey Law School)
  6. The Texas Two-Step and Mandatory Non-Opt-Out Settlement Powers, by Ralph Brubaker (University of Illinois College of Law)
  7. The Texas Two-Step: The Code Says it’s a Transfer, by Mark Roe and William Organek (Harvard Law School)
  8. A Different Look at Sec. 548 and Concluding Thoughts, by Hon. Judith K. Fitzgerald (University of Pittsburgh School of Law and Tucker Arensberg, P.C.) and Adam J. Levitin (Georgetown University Law Center and Gordian Crypto Advisors LLC); and John A.E. Pottow (University of Michigan School of Law)
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