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EMERGING ISSUES AT THE INTERSECTION OF DIGITAL ASSETS AND BANKRUPTCY LAW

EMERGING ISSUES AT THE INTERSECTION OF DIGITAL ASSETS AND BANKRUPTCY LAW

March 5, 2024 by Maylynn

March 5th, 2024 - Posted in Client Alert by Hunter Grasso

  1. Proposed Legislation Impacting Bankruptcy Proceedings

In July, Republican House Financial Services and House Agriculture Committee members introduced and approved the Financial Innovation and Technology for the 21st Century Act (the Act). The Act is intended to establish a regulatory framework for the digital asset market and provide clarity for market participants. Among other things, the Act attempts to create a framework for determining whether a particular digital asset should be classified as a commodity or a security and delineates the joint and respective regulatory powers of the CFTC and SEC.

The Act also provides protections for consumers in the event a digital commodity exchange files for bankruptcy. The Act provides that customer assets held by a digital commodity exchange are to be treated as “customer property” under section 761 of the Bankruptcy Code, which in conjunction with other sections of the Bankruptcy Code, would facilitate the prompt return of customer assets held by the bankrupt exchange. This provision seemingly addresses the issues that arose in the Celsius bankruptcy case, where substantial time and estate resources were dedicated to litigating whether certain customer funds were property of the estate and subject to distribution, or whether such customers were entitled to the prompt return of their funds.

On the other hand, the Act would impair the rights of digital commodity exchanges by limiting the available forms of bankruptcy relief. Specifically, the Act provides that a digital commodity exchange shall be considered a “futures commission merchant” for purposes of section 761 of the Bankruptcy Code. A “futures commission merchant” is also a “commodity broker”, as defined in section 101(6) of the Bankruptcy Code, and section 109(d) of the Code states that a “commodity broker” cannot be a Chapter 11 debtor. Meaning, the Act would effectively limit a digital commodity exchange to filing for Chapter 7 liquidation.

To the extent an exchange could not otherwise satisfy the “best interests of creditors test”, this provision is inconsequential. However, in instances where proceeding under Chapter 11 would theoretically result in greater distributions to creditors, this provision impairs the rights of debtors and creditors alike.

  1. Tokenization

The tokenization of real-world assets (RWAs) is gaining traction with finance and lending circles. Among other things, real property, cars, art, commodities, and financial instruments can be tokenized and put on-chain to be sold or pledged as collateral. The tokenization of RWAs globalizes access to liquidity and is more efficient and cost-effective than traditional lending, particularly for smaller players.

As tokenization becomes more common between lenders and borrowers, claims secured by tokenized assets will naturally arise more frequently in bankruptcy proceedings. Similarly, bankruptcy estates will inevitably include tokenized assets, and navigating the sale or liquidation of such assets will become a critical component of maximizing value for a bankruptcy estate and its creditors.

Even bankruptcy claims can be tokenized and sold or pledged as collateral. Doing so enables creditors to obtain immediate value for their claims instead of waiting for distributions from the bankruptcy estate.

For example, earlier this year, one of FTX’s creditors tokenized its $31,000 claim as a non-fungible token (NFT) on the Ethereum blockchain and later sold it to a third-party for around $12,000. The third-party subsequently pledged the tokenized claim as collateral for a short-term loan and received the funds immediately.

It remains to be seen whether tokenization will appeal to larger creditors, but either way, this transaction illustrates one of the many ways that tokenization will affect bankruptcy proceedings moving forward.

Click here to learn more about Bast Amron’s Bankruptcy practice. 

About Hunter Grasso

Hunter Grasso concentrates his practice in the areas of bankruptcy, insolvency, and commercial litigation. Prior to joining Bast Amron, Hunter practiced in the Miami office of a national firm and gained litigation experience representing developers and general contractors in complex commercial disputes. He also served as a Judicial Extern to the Honorable A. Jay Cristol, Chief Judge Emeritus U.S. Bankruptcy Court, Southern District of Florida, and as a Judicial Extern to the Honorable Laurel M. Isicoff, Chief Judge, U.S. Bankruptcy Court, Southern District of Florida. Click here to learn more.

 

 

  1. Proposed Legislation Impacting Bankruptcy Proceedings

In July, Republican House Financial Services and House Agriculture Committee members introduced and approved the Financial Innovation and Technology for the 21st Century Act (the Act). The Act is intended to establish a regulatory framework for the digital asset market and provide clarity for market participants. Among other things, the Act attempts to create a framework for determining whether a particular digital asset should be classified as a commodity or a security and delineates the joint and respective regulatory powers of the CFTC and SEC.

The Act also provides protections for consumers in the event a digital commodity exchange files for bankruptcy. The Act provides that customer assets held by a digital commodity exchange are to be treated as “customer property” under section 761 of the Bankruptcy Code, which in conjunction with other sections of the Bankruptcy Code, would facilitate the prompt return of customer assets held by the bankrupt exchange. This provision seemingly addresses the issues that arose in the Celsius bankruptcy case, where substantial time and estate resources were dedicated to litigating whether certain customer funds were property of the estate and subject to distribution, or whether such customers were entitled to the prompt return of their funds.

On the other hand, the Act would impair the rights of digital commodity exchanges by limiting the available forms of bankruptcy relief. Specifically, the Act provides that a digital commodity exchange shall be considered a “futures commission merchant” for purposes of section 761 of the Bankruptcy Code. A “futures commission merchant” is also a “commodity broker”, as defined in section 101(6) of the Bankruptcy Code, and section 109(d) of the Code states that a “commodity broker” cannot be a Chapter 11 debtor. Meaning, the Act would effectively limit a digital commodity exchange to filing for Chapter 7 liquidation.

To the extent an exchange could not otherwise satisfy the “best interests of creditors test”, this provision is inconsequential. However, in instances where proceeding under Chapter 11 would theoretically result in greater distributions to creditors, this provision impairs the rights of debtors and creditors alike.

  1. Tokenization

The tokenization of real-world assets (RWAs) is gaining traction with finance and lending circles. Among other things, real property, cars, art, commodities, and financial instruments can be tokenized and put on-chain to be sold or pledged as collateral. The tokenization of RWAs globalizes access to liquidity and is more efficient and cost-effective than traditional lending, particularly for smaller players.

As tokenization becomes more common between lenders and borrowers, claims secured by tokenized assets will naturally arise more frequently in bankruptcy proceedings. Similarly, bankruptcy estates will inevitably include tokenized assets, and navigating the sale or liquidation of such assets will become a critical component of maximizing value for a bankruptcy estate and its creditors.

Even bankruptcy claims can be tokenized and sold or pledged as collateral. Doing so enables creditors to obtain immediate value for their claims instead of waiting for distributions from the bankruptcy estate.

For example, earlier this year, one of FTX’s creditors tokenized its $31,000 claim as a non-fungible token (NFT) on the Ethereum blockchain and later sold it to a third-party for around $12,000. The third-party subsequently pledged the tokenized claim as collateral for a short-term loan and received the funds immediately.

It remains to be seen whether tokenization will appeal to larger creditors, but either way, this transaction illustrates one of the many ways that tokenization will affect bankruptcy proceedings moving forward.

Click here to learn more about Bast Amron’s Bankruptcy practice. 

About Hunter Grasso

Hunter Grasso concentrates his practice in the areas of bankruptcy, insolvency, and commercial litigation. Prior to joining Bast Amron, Hunter practiced in the Miami office of a national firm and gained litigation experience representing developers and general contractors in complex commercial disputes. He also served as a Judicial Extern to the Honorable A. Jay Cristol, Chief Judge Emeritus U.S. Bankruptcy Court, Southern District of Florida, and as a Judicial Extern to the Honorable Laurel M. Isicoff, Chief Judge, U.S. Bankruptcy Court, Southern District of Florida. Click here to learn more.

 

 

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Maylynn Menoud  | Marketing Director
T: (305) 379-7904 | D: (305) 357-4794
mmenoud@bastamron.com

BAST AMRON is a boutique law firm focused on business insolvency and litigation. Our insolvency practice emphasizes workouts, restructurings, liquidations, bankruptcy, and bankruptcy avoidance. We represent debtors, creditors, committees, trustees, and other fiduciaries in bankruptcies, receiverships, and assignments for the benefit of creditors. Our litigation practice is primarily plaintiff oriented. We know how to investigate, formulate and prosecute claims arising from business disputes. By combining our business insolvency knowledge with our extensive courtroom experience, we successfully guide our clients through all aspects and types of commercial litigation in state and federal courts across the country. Whether the issue is litigation or insolvency or both, we view our clients’ needs through a holistic lens to formulate and implement dynamic solutions to their most important challenges.

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