[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.

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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.

What Small Businesses Need Most Is A Little More Time
by | posted in: Bankruptcy, Bankruptcy Reform, Bankruptcy Roundtable Updates | 0

By Brook Gotberg (University of Missouri Law School; Chair, Small Business Committee of the Bankruptcy & COVID-19 Working Group)

Brook Gotberg

In the wake of the national shutdown of most commercial activity in response to the COVID-19 pandemic, many small businesses are struggling with financial disruption, restrictions on reopening, and uncertainty regarding future business prospects.  Small businesses make up the vast majority of private firms in the United States, and provide nearly two-thirds of all new jobs.  These businesses have been the most visible economic casualties of the global pandemic, with many already closing for good, and many others reevaluating their prospects.  Certain industries, particularly dining and entertainment, have been particularly hard-hit, and could face large-scale obliteration.

A group of interdisciplinary scholars, the Small Business Committee of the Bankruptcy & COVID-19 Working Group, has been meeting regularly since March to discuss policy proposals for bankruptcy that would best protect viable small businesses from unnecessary death.  Although bankruptcy serves as a method to discharge debt, it also operates to stop collection efforts, which may be essential even for companies with little to no debt.  We fear that many formerly profitable small businesses will unnecessarily fail in the face of the current constraints on bankruptcy protection – constraints which assume a functioning economy, not the current reality.  Moreover, a mass filing of bankruptcies could overwhelm the bankruptcy system itself, particularly in light of the accelerated time frames currently designated for small businesses under the Bankruptcy Code.

We therefore recommend that the Code be temporarily adjusted to put a six-month freeze on most typical deadlines, affording debtors additional time to propose a plan of reorganization.  Furthermore, we recommend that debtors be allowed an amortized schedule to repay past-due rent.

Our reasoning for this proposal is simple.  While bankruptcy law in normal times can distinguish viable companies from non-viable companies and recommend reorganization or liquidation accordingly, these are not normal times.  Baseline assumptions for the value of businesses depend on revenues, which are now artificially constrained.  Creditors, trustees, and judges cannot make informed decisions on the viability of a given enterprise based on the recent past, and that uncertainty is unlikely to be resolved in the near future.  It is therefore essential to allow bankrupt firms more time to take advantage of the automatic stay while reassessing options for reorganization.

Furthermore, the hit to revenues will likely create debt overhang for otherwise profitable businesses that could prove impossible to overcome in the short run. This is particularly true for rental obligations.  For many small businesses, past-due rent is likely to be the primary obligation, but the law does not permit debtors to repay past-due rent over time, as is permitted for other forms of debt.  Current bankruptcy rules require a debtor to commit to its outstanding rental agreements within 60 days of filing, and then to repay all past-due rental obligations “promptly” (see 11 U.S.C. § 365(b) and (d)(4)(A)).  Our policy recommendation would permit small business debtors to repay rental obligations over the life of the plan – three to five years, under the Small Business Reorganization Act (SBRA).

Similarly, we also recommend that interest accumulated on oversecured collateral after the date of the national emergency proclamation, March 13, 2020, be disallowed in an effort to preserve the respective positions of all creditors.

Recognizing the burden placed on landlords and secured creditors by these recommendations, our proposed changes to deadlines do not interfere with swift cash collateral motions and motions to obtain alternative financing.  We also recommend that, although most motions to lift the stay would not be permitted, creditors should be allowed to lift the stay in circumstances where it can be shown that the debtor is wasting or spoiling the collateral.

A simultaneous permanent closure of small businesses would be catastrophic for the American economy, as hinted at by the surge in unemployment that followed the temporary closures.  Beyond the loss of jobs, closure of businesses would mean fewer services offered within the community, and closed storefronts would likely invite blight, particularly in already vulnerable communities.  This could erase years of hard-won economic and social progress.

The goal of the Bankruptcy & COVID-19 Working Group is to make workable policy recommendations that will have a meaningful impact in mitigating the harm caused by COVID-19 to the American economy.  The group continues to meet, gather data, and review additional policy recommendations.  The goal is to minimize the long-term damage caused by the global pandemic by exploring how bankruptcy policy can do the most good.

The full letter can be found here.

Optimal Deterrence and the Preference Gap
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Preference | 0

By Brook Gotberg (University of Missouri School of Law)

It is generally understood that the way to discourage particular behavior in individuals is to punish that behavior, on the theory that rational individuals seek to avoid punishment. Laws aimed at deterring behavior operate on the assumption that increasing the likelihood of punishment, the severity of punishment, or both, will decrease the behavior. The success of these laws is also evaluated by how much the targeted behavior decreases. The law of preferential transfers, which effectively punishes creditors who have been paid prior to the bankruptcy has been defended on the grounds that it deters a race to collect from a struggling debtor. However, deterrence theory suggests that the low likelihood of punishment and the cap on punishment associated with preference law make it a very poor deterrence. Further, statements pulled from interviews with affected creditors, debtors, and attorneys demonstrate that in practice, preference law does little or nothing to deter targeted behavior, and in the process imposes significant costs. The weaknesses of preference law call for its significant revision to place a greater focus on specific categories of creditors to be punished on account of their pre-bankruptcy activities.

The full article is available here.

 

Conflicting Preferences: Avoiding Proceedings in Bankruptcy Liquidation and Reorganization
by | posted in: Avoidance | 0

By Brook Gotberg, J. Reuben Clark Law School, Brigham Young University

GotbergThe law of preferential transfers permits the trustee of a bankruptcy estate to avoid transfers made by the debtor to a creditor on account of a prior debt in the 90 days leading up to the bankruptcy proceeding.  The standard for avoiding these preferential transfers is one of strict liability, on the rationale that preference actions exist to ensure that all general creditors of the bankruptcy estate recover the same proportional amount, regardless of the debtor’s intent to favor any one creditor or the creditor’s intent to be so favored.  But preference law also permits certain exceptions to strict preference liability and gives the estate trustee discretion in pursuing preference actions. This undermines the policy of equal distribution by permitting some creditors to fare better than others in the bankruptcy distribution.  However, these practices are arguably necessary to promote the conflicting bankruptcy policies that seek to maximize the value of the estate for the benefit of creditors and also encourage the survival of struggling businesses.

As a result, the law of preferences is internally inconsistent and controversial, attempting unsuccessfully to serve multiple policy masters simultaneously.  Much of the analysis on preferences up to now has proposed amending preference law generally in an attempt to satisfy these often conflicting demands.  This article recommends a more dramatic approach; returning preference law to a mechanism of equal distribution in liquidation proceedings (Chapter 7) by eliminating true exceptions to the rule, and doing away with preference law in the context of bankruptcy reorganization (Chapter 11).

For the full article see here.

Next week we will be featuring another article on this topic, Professor Daniel J. Bussel’s The Problem with Preferences.