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Chimeras: what happens when novel intangible assets meet ancient, abstract legal frameworks in insolvency

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November 15, 2022 – Due to the turbulent past few days surrounding cryptocurrency exchanges, the nature and status of crypto-assets are being scrutinized under numerous legal regimes, including those in the United States, England and Wales (E&W). may be tested on .

The rapid growth and complexity of crypto-assets, coupled with the lack of legal guidance, has led to a level of uncertainty regarding the core legal rights of crypto-asset owners. Opponents are publicly debated as regulators deal with the first wave of bankrupt crypto companies. This article addresses some of the key bankruptcy-related questions in the United States, England, and Wales.

How do you establish ownership of crypto assets?

Position in the United States

• As a general matter, most experts argue that ownership of crypto assets derives from knowledge or control of the associated private keys, providing additional conveniences for custodial arrangements.

• The Uniform Law Commission recently proposed a new section of the Uniform Commercial Code governing how parties can transfer crypto assets and acquire security interests, leaving much room for other laws to create property rights. It is worth noting that

Position at E&W

• In 2019, the UK Jurisdiction Task Force concluded that ownership of crypto-assets is generally attributed to the person who has acquired knowledge and control of the private key according to the rules of a particular crypto-asset system (e.g. crypto Asset ownership varies according to the rules of the specific crypto asset system). A person who holds multiple private keys or keys on behalf of another person). This is endorsed by the Legal Commission Advisory Committee, which suggests that ‘control’ rather than ‘ownership’ is the most suitable concept to apply to crypto-assets (although control does not necessarily mean legal ownership). Note that it does not necessarily imply rights (i.e. custody arrangements).

• The ability to access keys and manage crypto assets is one of the key challenges for Insolvency Practitioners (IPs) appointed to deal with insolvent companies holding crypto assets.

Do crypto assets form part of a bankruptcy estate?

Position in the United States

• All of the debtor’s property at the time of opening of bankruptcy proceedings becomes immovable property.

• Recently, Voyager and Celsius, cryptocurrency platforms that accept cryptocurrency customer deposits for investment or exchange, filed bankruptcy proceedings in the Southern District of New York Bankruptcy Court. In each of these cases there has been significant debate over who “owns” the digital assets. Bankrupt platforms or customers? How assets are held and uses applied to specific platforms Depending on the terms, existing law may establish either a custody relationship in which the “customer” retains ownership or a debtor/creditor relationship in which the customer transfers ownership. Submit to the Platform and hold only claims for withdrawal or redemption of assets.

• In both cases, the estate claimed that much of the customer’s crypto assets it owned constituted non-refundable estate assets.

• In recent non-U.S. cases, where customers are entitled to physical distributions, receipt of distributions may be reduced or significantly delayed due to a variety of factors, including: is shown.

• Quality of estate records and/or whether the debtor owns all client assets.

• Whether you have enough funds to manage your crypto assets.When

• Ownership Disputes.

Position at E&W

• If held directly, crypto assets form part of the bankruptcy estate.

• This general position is complicated when crypto assets are held on crypto exchanges. Such crypto-assets may, for example, be held on behalf of the customer as follows:

• Explicit trust created through the exchange’s terms of service.Also

For example, if the crypto-asset was legally owned by an exchange, but the exchange indicates that it must own the asset on behalf of the customer (i.e. the customer retains the beneficial interest) ), constructive trust.

• In general, unless an explicit trust relationship between the exchange and its customers is demonstrated, IPs designated in connection with that exchange may face difficult legal issues, some of which May lead to litigation (see Lehman, MF Global, etc.). .

• It is also unclear whether crypto assets held by exchanges on behalf of beneficial creditors in bankruptcy will be classified as customer assets or segregated assets. This distinction can lead to significantly different outcomes for customers and should be considered on a case-by-case basis.

• Separately, if a cryptocurrency exchange or platform enters bankruptcy proceedings, an important consideration is whether the virtual assets are property of bankruptcy property under r.1.2 Bankruptcy (E&W) Regulations 2016; That is, whether the customer is an unsecured creditor or the crypto assets are held on the basis of the customer’s trust.

Other significant bankruptcy issues

Position in the United States

Return of physical crypto

• A major consideration is whether customers eligible for distributions from bankruptcy estates should receive such distributions in cash or in crypto assets themselves.

• If the customer has general unsecured claims only, the obligor has no obligation to return the crypto assets.

• In Voyager and Celsius, the estate expresses its preference to satisfy the customer’s claim at least partially in kind, even if the distribution represents the estate’s payment to creditors rather than the return of the customer’s property. did. This approach has the inherent advantage of avoiding the risk of influencing market prices through liquidation or converting crypto assets into fiat at market lows, which has been welcomed by customers so far. .

• However, those who allege that the distribution of crypto assets with a value in excess of the amount claimed by the recipient as of the date of filing violates US bankruptcy law, which requires the amount claimed in US dollars as of the date of filing. There is also

Are Virtual Currencies “Currencies” Under Bankruptcy Law?

US bankruptcy law contains onerous protections for financial deposits and investments owned by the debtor in bankruptcy. The U.S. Trustees recognize that this “may or may not be the case” for crypto assets. Given the code’s stringent requirements, treating cryptocurrencies as currencies may effectively require debtors to liquidate their crypto positions immediately upon submission.

Position at E&W

Distribution of crypto-assets and crypto-asset earnings

• Once IPs gain sufficient control over crypto assets, a key question will be whether approved claims derived from holding crypto assets should be paid in crypto or converted to fiat before distribution. That’s what it means. UK bankruptcy law does not provide a concrete answer to this question as cryptocurrencies are not currently legal tender. In the Cayman Islands, Liquidators of Three Arrows Capital were allowed to convert their crypto assets into USD, USD Coin, or Tether (which is pegged to USD).

• Realization and/or distribution of crypto assets (or the fiat currency proceeds from their sale) can be costly, complex and time consuming.

• Determining the appropriate value of claims based on crypto-assets is an important consideration for IPs, especially when that crypto-asset class is subject to significant price volatility.

Do crypto assets constitute financial collateral and do certain crypto businesses/transactions benefit from the UK Safe Harbor Regulations?

• In the context of security acquisition/enforcement, a key issue is whether crypto-assets fall within the scope of the Financial Collateral Act, and the transaction will benefit from the repeal of certain statutory procedures and amendments to the provisions of the Bankruptcy Act. (e.g. carve-outs of profit enforcement, changes to void and foreclosure rules, etc.). This is currently untested, so its legal status is unknown.

• Cryptocurrency businesses and transactions will benefit from the legal certainty of the UK’s Safe Harbor and Settlement Finality Rules, which protect the foundations of financial markets by not applying certain insolvency law provisions. It is also unclear whether it is possible.

Opinions expressed are those of the author. They do not reflect Reuters News’ commitment to integrity, independence and freedom from bias under its Trust Principles. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Sara Coelho is a partner at Shearman & Sterling in New York.

Alexander Wood is a partner of London-based Shearman & Sterling.

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