Expert Views: Celsius Court Rules Customers Relinquished Ownership of Crypto in Earn Accounts
Editor’s Note: Below is the latest in Reorg’s Expert Views series: an article written by Timothy Karcher, Vincent Indelicato and Daniel Desatnik of Proskauer Rose LLP. Request trial access of Reorg’s coverage of Celsius’ bankruptcy.
In resolving a “gating issue” in Celsius’ chapter 11 cases, the United States Bankruptcy Court for the Southern District of New York determined that Celsius, and not the customers/account holders, owns the cryptocurrency assets deposited in Earn accounts.
Rather than owning their deposited crypto, Earn account customers are left with an unsecured claim in Celsius’ chapter 11 cases, fixed as of the petition date.
When customers flocked to Celsius to deposit their cryptocurrencies in “Earn accounts” in exchange for attractive interest rates, many of them believed they would continue to own their crypto and be able to withdraw it at any time. After Celsius filed for chapter 11 bankruptcy and revealed a $1.2 billion hole in its balance sheet, these customers braced themselves for the possibility that some of the crypto in these Earn accounts, estimated at approximately $4.2 billion, might not be recoverable.
Contract Law Issue
The bankruptcy court’s ruling dealt a major blow to the 600,000 Earn account customers who had hoped for the swift return of at least a portion of their cryptocurrency from Celsius’ bankrupt estate. In light of the decision, the distribution of cryptocurrency to these Earn account customers does not seem likely anytime soon. Having learned that the cryptocurrency is property of the debtors’ estates, the 600,000 Earn account customers must now wait for distributions under a chapter 11 plan before they see any recovery on account of their claims.
Profound Impact on Celsius Customers
The Bankruptcy Court’s decision is likely to have a profound impact on many aspects of Celsius’ chapter 11 cases, and, while not binding precedent for other cryptocurrency exchange bankruptcies, the holding might influence the outcome of other cryptocurrency cases, or at least the strategy.
While the full measure of the fallout has yet to be determined, here are just a few initial observations. First, the size of each Earn account holders’ unsecured claim has ballooned exponentially from what they likely believed their exposure to be. Many of these customers believed they would get much of their crypto back and then have a small unsecured claim for what was unrecoverable. However, in light of the court’s decision, they now have an unsecured claim for their entire deposit.
Second, the path to recovery for Earn account holders has seemingly become much longer and uncertain. Rather than getting some portion of their deposit back and waiting for a return on the deficiency, the Earn account holders will have to wait for distributions under a confirmed chapter 11 plan, and that could take a long time.
Third, the ruling may have complex tax implications for the Earn account holders if, as stated in the court’s decision, account holders transferred ownership of their crypto to Celsius on each of the dates the crypto was deposited in an Earn account. One area of focus might be the value of Celsius’ promise to the customer, especially when it turned out that that Celsius ultimately was not in a position to fulfill its obligation. Further, customers who lost their crypto will likely have to wait until the end of the case to know the magnitude of their loss.
Perhaps most crushing to the Earn account hopefuls is that they now must face the reality that, for them, these cases are a liquidation, where the seller – Celsius – will play the dual role of villain and auctioneer of the assets the customers thought they owned.
Impact on the Crypto Industry and Crypto-Related Bankruptcy Cases
The impact of the Celsius decision on the question of whether crypto is property of the bankruptcy estate in other crypto bankruptcy cases may be limited. Ownership of deposited crypto will likely be governed by the specific language of the applicable terms of service and the circumstances under which customers may or may not have become bound to the terms, rather than any unique feature of crypto assets.
Where the decision may have a greater impact is on how crypto exchanges communicate their terms of service to customers going forward, and what customers might demand to see from these crypto exchanges before depositing their digital assets with them.
While the issue of crypto ownership was treated as a “gating issue” in the eyes of the court, Earn account customers are likely left to wonder whether this all-or-nothing dispute, impacting more than $4.2 billion in claims, needed to be resolved at this point in the proceedings or whether it could have been resolved at a later date. However, both the debtors and the unsecured creditors committee supported the application at this time because the debtors wanted authority to sell $18 million of stablecoins to fund administration of the chapter 11 cases. As the amount realized through the sale is only sufficient to provide one additional month of liquidity, Earn account holders will likely wonder whether the debtors, working with the UCC, could have found another way to address the debtors’ liquidity needs while allowing the ownership to be resolved through a global compromise in furtherance of a chapter 11 plan. In any event, once the ownership issue was put squarely before the court, it is hard to see how the outcome of the decision could have been any different.
The Celsius decision highlights the tension between creditors seeking to increase the size of the bankruptcy estate to fund distributions and customers seeking the return of crypto they believe is their property. It remains to be seen whether a critical mass of the Earn account holders can find an organized way to successfully counter the negative effects of this decision, either in the claims resolution process or otherwise. Moreover, the decision may also affect how other crypto cases proceed. In the future, debtors and committees may consider whether there is sufficient ambiguity about the ownership to form the basis of a global settlement incorporated into a chapter 11 plan.
Reorg is covering crypto bankruptcies including Voyager, Celsius, FTX and BlockFi. Read a summary here.