In a matter of first impression relating to an important bankruptcy claims administration issue, Judge Sean H. Lane of the United States Bankruptcy Court for the Southern District of New York, recently denied the ability of a court appointed claims agent to sell and profit from providing direct access to publicly available claims register information. The unsuccessful purchaser of such information was XClaim Inc. (“Xclaim”), a relatively new venture that is seeking to develop a web-based claims trading platform. Pursuant to an “access agreement” with the claims agent (which Judge ordered to be disclosed to the public), Xclaim sought exclusive access to creditor data in a digital format that is compatible with Xclaim’s platform – presumably to immediately utilize such data to solicit creditors and drive them to their claims trading website. In exchange for providing direct access and related services, the claims agent would have received a processing fee equal to 10% of the commission collected for each transferred claim.

The issue of claims agents entering into these access agreements with Xclaim was first revealed in the Pareteum case, where Judge Lisa G. Beckerman inquired whether that claims agent had a contractual relationship with Xclaim and questioned the legitimacy of such an arrangement.  The issue was then raised again in the Voyager and Celsius bankruptcy cases, but those claims agents agreed to carve out the access arrangement with Xclaim and therefore avoided the issue altogether.  While Judge Lane passed no judgement on the morality of such a venture, he found that the arrangement specifically violated numerous section of Federal law including 28 U.S.C. § 156(c), 28 U.S.C. § 1930(e) and SDNY Bankr. Local Rule 5075-1.  Those rules and regulations govern the ability of a claims agent to act as the Clerk of the Court in providing non-exclusive access to the public claims register as well as proscribing and limiting the fees that may be charged for performing these quasi-Clerk services.  Judge Lane found that Xclaim’s fee arrangement could not be reconciled with the applicable rules and regulations including the proscribed fees that may be charged.  

Judge Lane’s ruling can be found in the record of the hearing held on July 20, 2022 in the In re Madison Square Boys & Girls Club, Inc. bankruptcy proceeding, Case No. 22-10910-shl.

The first week of July has brought with it a flurry of activity in the digital asset markets – but not the type of activity that investors in the space likely hoped for.

On June 27th, Three Arrows Capital, Ltd. (“3AC”) commenced a liquidation proceeding in the British Virgin Islands, followed on July 1st by a Chapter 15 case in the Southern District of New York. Chapter 15 generally provides for recognition by a US court of an insolvency proceeding in a non-US jurisdiction. The company, a proprietary trading fund, is now under the control of joint liquidators tasked with stabilizing the estate, preserving and winding up its assets, investigating claims and pursuing causes of action under the laws of BVI. Should the BVI proceeding be recognized as a “foreign main proceeding,” the case will provide the liquidators some stability through the enforcement of the automatic stay over the firm’s US assets, preserving the status quo.

On the heels of 3AC’s filing, on July 5th, Voyager Digital Holdings, Inc. and certain affiliates (“Voyager”) commenced Chapter 11 cases in the Southern District of New York. Voyager operates a brokerage that allowed customers to trade digital assets, earning “rewards” on their investments, and also offered custodial services. It estimated both its assets and liabilities as between $1-10 billion. Similar to Celsius Network (discussed here), Voyager operated with little regulation and made loans and investments in other platforms in order to generate yield. One of its largest loans was to 3AC – a loan of 15,250 BTC and $350 million USDC (the “3AC Loan”). On July 1st, facing a “run on the bank,” Voyager restricted further withdrawals by its customers as Celsius Network had done weeks earlier.

Unlike 3AC’s filing, however, Voyager did so with a plan in hand, filing its proposed plan of reorganization shortly after filing its case. Generally, the plan provides that customers will receive (a) digital assets purchased by, or on behalf of customers and held by the company on the petition date (although it is unclear which or how many coins will be available for distribution), (b) stock in the reorganized Voyager, (c) existing tokens that had been issued by Voyager, and (d) recovery, if any, on account of the 3AC Loan (with the appointment of a litigation agent to pursue recovery). The plan allows some flexibility to exchange stock for coins. According to the plan, 100% of the new stock of a reorganized Voyager, subject to dilution for management, will be distributed to the customers. The company says that it will continue to market the business to third-party investors during the bankruptcy case with the hope of increasing value to its creditors.

Voyager’s bankruptcy case will raise issues of first impression. For example, the plan does not appear to distinguish between the claims of those customers with digital assets earning “rewards” on the trading platform from those with assets purportedly maintained in custodial accounts. As discussed here, there may be arguments that assets held in custodial accounts are not properly property of the estate. The plan also treats the claims of account holders separately from those of general unsecured creditors who are entitled to a share of the “Claims Allocation Pool,” a term left undefined in the filed plan. The plan also treats customers differently than it does a claim on account of an unsecured loan from Alameda Ventures Ltd. (which is proposed to receive no recovery). As can be expected, the first plan of reorganization in a Chapter 11 of a cryptocurrency platform incorporates standard existing legal frameworks to address creditor recovery and rehabilitation of the estate, such as conversion to equity and use of litigation trusts. It will be interesting to see how these frameworks perform in the digital assets space. Other issues may arise if there continues to be volatility in the value of digital assets (if, for example, BTC is at $20,000 when the plan is solicited but later increases dramatically in value before voting or confirmation).

Given the unsettled markets, other cryptocurrency funds, platforms and exchanges may follow the paths of 3AC and Voyager in the near future. It will also be informative to track the comparative path of Voyager vs. Celsius Network, which as of July 7th, has not filed for bankruptcy. Novel issues will arise and important lessons will be learned from these and other cases and we will continue to follow them closely as they develop.

Celsius Networks (“Celsius”) became the latest cryptocurrency platform to raise market temperatures by halting all withdrawals, swaps and transfers from and between its customers’ accounts on June 12, 2022. Celsius touted a next wave of “unbanking,” operating a lending platform allowing the holders of digital assets the opportunity to earn a significantly high returns on those assets.  Due, in part, to the lack of regulation, Celsius, and other firms like it, retain wide discretion to use of their customers’ assets and, among other things lend those assets to other platforms at higher rates, enter into complex swap and option transactions that bet on price movements, enter into repo or other lending arrangement to increase yield, or invest in other cryptocurrency projects, all without regulatory constraint. Indeed, it was this broad discretion that led, in part, to the downfall of a similarly situated platform, Cred, Inc., and its ultimate bankruptcy discussed here on Crypto Digest.

Given the recent media coverage and growing concerns among investors over the risks associated with a bankruptcy filing of a cryptocurrency exchange, it feels timely to highlight some issues that arose in the Chapter 11 cases of Cred Inc. and certain of its affiliates (collectively, “Cred”) also discussed on Crypto Digest.

Unitranche financing began as a middle-market product, tracing its origins to the days of recovery from the global credit crisis. The credit markets re-opened with an explosion of available capital from traditional lenders, business development companies and other direct lenders. With an increasing supply of capital, leverage shifted to borrowers and private equity, allowing them to better dictate the terms and conditions of their loan facilities. With the greater prevalence of so-called “covenant-lite” loans, also came the exponential growth of the unitranche market. What began as a financing structure most often used for loans of less than $50 million, unitranche loans are now regularly used for financings exceeding $1 billion, and in 2021, up to $3 billion.  A unitranche facility combines the benefits of multi-tranche debt regularly found in the syndicated lending markets (i.e., the ability to raise funds from lenders with different risk profiles and return expectations), with those of speed and certainty that are a hallmark of the private lending community. In its simplest form, unitranche facilities are structured using a single-tier, combing the senior and junior components of syndicated loans into one loan. Whereas a syndicated loan may require distinct grants of senior and junior liens on collateral to multiple lending groups, a unitranche uses a single lien to secure the entire facility. The benefits to the borrower are obvious: it is faced with a single term loan: one set of principal and interest payments, a single package of covenants to monitor, and a uniform list of defaults to avoid. Layering on the advantage of a single agent, a unitranche facility greatly streamlines loan administration from the borrower’s perspective.

Late last week, the District Court for the Southern District of New York provided a reminder of the importance of precise drafting. In Transform Holdco LLC v. Sears Holdings Corp. et. al., CV-05782, Doc. 20, the contractual question at issue related to the purchase of substantially all of the assets (and assumption of certain of the liabilities) of Sears and its domestic and foreign subsidiaries by Transform Holdco LLC (“Transform”) in Sears’ bankruptcy case. Typical of a sale under Section 363 of the Bankruptcy Code, Transform’s purchase was largely structured as an asset sale, allowing it to acquire those assets “free and clear” of liens and encumbrances. Also typical, certain assets were excluded from the sale, including cash and cash equivalents of the US and foreign entities, defined in the purchase agreement as “Excluded Assets.” Following execution of the agreement, the parties entered into an amendment which allowed Transform some flexibility regarding its purchase of the assets of Sears’ foreign subsidiaries. Because the transfer of the foreign assets might be problematic, Transform was granted an option to instead acquire the equity of those subsidiaries. The amendment provided that, if Transform “determines (in its sole discretion)… that it is necessary or desirable to acquire all of the equity interests in any Foreign Subsidiary in lieu of the acquisition of assets and assumption of liabilities…, then the [s]ellers shall use reasonable best efforts to transfer such equity interests, which equity interests shall be deemed to be Acquired Foreign Assets.” (emphasis added). The agreements were governed by Delaware law.

Continue Reading Contractual Ambiguity (or Not) Tested in Sears

The financing of commercial litigation has grown enormously since it first appeared on the scene in the US, about 15 years ago.  While still small relative to the overall US financial market, it is estimated that more than $11 billion has been invested in litigation finance in the US last year alone.  In essence, lenders (often referred to as “funders”) provide commercial claimants and contingency law firms with the capital needed to prosecute legal claims which the funders believe have a strong likelihood of success.  Funders receive a return based upon, and typically conditioned upon, a successful conclusion of the litigation.  The use of litigation funding by bankruptcy practitioners is a growing phenomenon and one that we see as an increasingly important element in how bankruptcy-related litigation is managed.

Continue Reading The Use of Litigation Funding in Bankruptcy

Backstop commitments have become commonplace in large corporate bankruptcy cases – they provide certainty to the debtor that it will have the funds needed to satisfy its obligations to creditors under its plan of reorganization and that it will have liquidity to operate post-bankruptcy as the reorganized entity. Backstop commitments are also a way for certain creditors to generate some additional return in the form of commitment fees and expense reimbursements in exchange for their agreement to backstop all or a material portion of a proposed rights offering or other financing arrangement. Typically, the opportunity to participate as a backstop provider is not offered to all creditors in a class but is rather limited to those having large claims – often members of an ad hoc group that have the leverage to negotiate for such treatment, and most importantly, the financial wherewithal to perform.  For that reason, the fees associated with backstop commitments are sometimes controversial, criticized by those not participating as an unnecessary expense paid by a debtor to a preferred group of creditors in exchange for their support and/or violative of Section 1124(a)(4) of the Bankruptcy Code which requires generally that similarly situated creditors receives the same treatment.

Continue Reading Backstops Survive Another Challenge

Considerations of “environmental, social and governance” (or ESG) criteria with respect to a company’s management and operations continue to take on greater importance in lenders’ and investors’ credit and investment decisions.  How a borrower or a target company measures up to these ever-developing ESG standards will impact its cost of capital and value to potential investors and acquirors. While it remains difficult to predict how the perception of a company’s ESG performance (or even its rating) may impact its capital-raising efforts or its likelihood of success or failure, a number of trends seem inevitable.

Continue Reading Trends in ESG for Members of the Restructuring Community

Foreign companies seeking to protect their overseas assets from their creditors have often turned to the United States for immediate relief under Chapter 11 of the Bankruptcy Code.  Establishing jurisdiction in the US for purposes of a bankruptcy filing has proved easy – the establishment of a nominal professional fees retainer with a local law firm on the eve of a bankruptcy filing will suffice.  Upon such a filing, the automatic stay under Section 362 of the Bankruptcy Code goes into global effect, shielding a foreign debtor’s assets, wherever they may be located, from creditors’ recovery actions and litigation. At times, that relief may be short-lived. An aggrieved creditor may challenge a bankruptcy filing as having been made in “bad faith”, seeking to dismiss a pending bankruptcy proceeding that it believes was designed for the sole purpose of frustrating the exercise of its creditor rights and remedies and for which US jurisdiction was manufactured.

Continue Reading Foreign Debtors and Chapter 11 – Seeking Relief from Turbulent Skies