FINANCIAL TECHNOLOGY: FTX’s Crypto Blizzard
Although it is not alone in its financial woes, the bankruptcy filing of cryptocurrency giant FTX Trading, Ltd., has probably gotten the most attention of the cryptocurrency firms that are in deep financial distress (“the Crypto Winter”).
This article discusses the basic structure of the Chapter 11 bankruptcy filing, as well as some interesting questions that will arise in the administration of this case. This article is not intended to be an exhaustive discussion of Chapter 11 bankruptcy, nor an exhaustive recitation of everything that is going to happen in this FTX proceeding. There are likely to be many twists and turns, in bankruptcy court as well as criminal court.
FTX was founded in 2019 by Sam Bankman-Fried, who earlier founded a firm called Alameda Research. FTX was described in its Forbes magazine profile as follows:
One of the largest crypto trading exchanges in the world, it handles some 11% of the $2.4 trillion in derivatives traded each month. (It) raised $1.5 billion in private funding last year (2022), jolting its valuation from $1.2 billion to $25 billion.
However, as its obligations grew, and the cryptocurrency market began to contract, contracted, Bankman-Fried continue to live a lavish lifestyle, and FTX continued to recruit celebrity evangelists. Unfortunately, it appeared to more and more observers that FTX was nothing more than a Ponzi scheme. Fortune, December 3, 2022; The Guardian, December 17, 2022.
On November 11, 2011, FTX filed for bankruptcy protection in Delaware. Meanwhile, Bahamian authorities sought to exercise jurisdiction on that island and in New York. The Bahamian and US authorities have now agreed to have the case heard in the Delaware District of the United States Bankruptcy Court. FTX Trading Ltd., Case No. 22-11068 (JTD)
Additionally, in December 2022, Mr. Bankman-Fried was arrested in Nassau by the Royal Bahamas Police Force, and charged with wire fraud, securities fraud, money laundering, and other crimes. He was released on a $250 MM bond, and extradited to the United States.
One commentator compared Bankman-Fried to Bernie Madoff. Financial Historian Diana Henriques, quoted in The Guardian, 12/17/2022.
In late February 2023, a superseding indictment in the US charged Bankman-Fried with bank fraud, operating an unlicensed money transmitter, modified campaign-finance law violations, and conspiracy to make unlawful political contributions. Coindesk, February 23, 2023.
FTX and its founder face significant legal jeopardy.
Now back to bankruptcy. A chapter 11 bankruptcy differs from a chapter 7 business liquidation, in the sense that the Chapter 11 debtor is not going out of business. It is reorganizing its debts. For example, the Los Angeles Dodgers General Motors, and Delta Airlines, all went through Chapter 11, to reorganize their debts.
The purpose of the chapter 11 bankruptcy is to allow the management of the debtor company to continue to manage and operate the company, pursuant to strict supervision by the United States Trustee. Quarterly reports are generated to show revenue and expenses. The goal is to maximize assets available for the plan of reorganization. The company, now known as a “debtor in possession,” is not allowed to waste, or misuse assets.
Eventually, the company will propose a plan of reorganization to its creditors, the largest of which organize themselves into a creditor’s committee. The creditors committee and the debtor in possession will haggle over the details of the plan, for example, to cut the debt by 20-, 30-, or 40%, or to stretch the debt out over an additional number of years, or some combination of both debt reduction and new repayment terms. Elizabeth Warren & Jay L. Westbrook, “The Success of Chapter 11: A Challenge to the Critics,” 107 Mich. Law Review 603 (2009).
If the parties cannot agree on a plan of reorganization, then the court has to decide whether it will force the debtor in possession and creditors to come up with another plan, or whether it will cram the debtor plan down the throat of the creditors (known as a “cram down hearing”).
Additionally, the Chapter 11 debtor-in-possession, with certain important exceptions, is entitled to the cancellation (“discharge”) of certain debts after the plan of reorganization is approved. 11 USC Sec. 1141(d)(1)
The Bankman-Fried criminal charges, however, throw in a different wrinkle: if for example FTX was operating as an alter ego of its founder, and not following all corporate formalities, some creditors may argue that FTX was a fraudulent enterprise, and is not entitled to bankruptcy relief. 11 USC Sec. 523(a)(2)(4) & (a)(4) [debts involving fraud not dischargeable]; 523(a)(6) [debts related to malicious conduct not dischargeable]; 11 USC Sec. 523 (c). Or, in the alternative, certain types of claims may be brought against the company, such as those dealing with fraud, which are not resolved as part of the plan of reorganization. The recent conviction of the Trump Organization on fraud charges in New York City provides an example of a prosecution that could result in a non-dischargeable debt, and could saddle FTX with significant fines and penalties.
In other words, the criminal charges against Bankman-Fried, and the eventual evidence showing the relationship between him and the company, may have a lot to do with what type of relief FTX eventually receives from the bankruptcy court, even assuming a very business friendly Delaware bankruptcy judge.
WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE!! PLEASE CONSULT AN ATTORNEY!!