Why crypto firms opt for Chapter 11 bankruptcy under the U.S. Bankruptcy Code

Following the collapse of the Terra ecosystem, the crypto market was swept by a wave of bankruptcies. Celsius Network, Three Arrows Capital, Voyager Digital, FTX and a number of other major players declared insolvency.

Many of these companies are pursuing the relevant process in the United States, where filing under Chapter 11 of the US Bankruptcy Code allows them to reorganize the business and repay debts to creditors.

Exclusively for ForkLog, GMT Legal lawyers spoke about the advantages and disadvantages of the approach above, how it differs from alternative models, and potential problems crypto companies may face within this process.

What is Chapter 11 bankruptcy?

In the United States, the bankruptcy framework allows an applicant to restructure the business, discharge debts and even “extend the life” of a troubled company.

Chapter 11 is often described as a reorganisational process, since the debtor typically continues to run the business, retains the powers and duties of a fiduciary, and may continue operating.

Generally, the same people continue to control the business. However, in special cases (for example, involving fraud or gross incompetence) a court-appointed fiduciary may intervene to perform these duties for the duration of the proceedings.

To successfully navigate the procedure, the company must prepare a reorganisation plan. Creditors may vote on the plan. If it receives the required votes and meets statutory requirements, a court will approve it.

Pros and cons of the procedure for the debtor and creditors

GMT Legal lawyers cite the advantages of Chapter 11 as preserving control over the company and the ability to continue conducting business. This can enable a more complete recovery for interested parties.

“Once the proceedings begin, the company gains protection from creditors, meaning attempts to recover debts are suspended, which can also be a significant plus,” said a firm representative.

Among the drawbacks are lengthy timelines—sometimes spanning several years—and high costs. They noted that the process is among the most expensive types of bankruptcy, in part due to court costs for lawyers.

Can a court dismiss or terminate a Chapter 11 case?

GMT Legal noted that a court may dismiss a Chapter 11 case for a number of reasons. For example:

• non-compliance with court orders or the US Bankruptcy Code;
• insufficient protection of creditors’ interests;
• inability of the debtor to effect a successful reorganization;
• proper grounds asserted by the debtor or a majority of creditors;
• adverse events occurring during the bankruptcy process, such as a deterioration in the debtor’s financial condition.

Lawyers emphasised that a court may dismiss the case only for good cause and after providing notice and an opportunity for a hearing to all interested parties.

Specifics of Chapter 11 bankruptcy for crypto firms

As noted above, to successfully navigate the process the debtor must provide a reorganization plan, which includes the value of its assets and liabilities.

With crypto firms, difficulties may arise because assets on their balance sheets are hard to identify and value.

“Volatility of tokens on the market can be very high, so the overall value of the company’s crypto assets can change significantly, complicating the process. Moreover, in some cases these assets are difficult to identify since the company may hold many custodial and non-custodial wallets. If some wallets are accessible only to certain people or are not reflected in accounting records, accessing the assets stored on them can be problematic,” GMT Legal explained.

Lawyers also noted that problems may arise at the asset-liquidation stage. The debtor may try to sell the entire company position in low-liquidity tokens on the market, triggering a sharp drop in their value. Ultimately, they would receive less than initially anticipated.

What are the alternatives?

Experts say the most popular alternatives to the discussed procedure are filing under Chapter 7 of the US Bankruptcy Code, as well as selling assets outside of bankruptcy and restructuring debt.

“However, for large companies with substantial debt and a desire to continue operating, the Chapter 11 option is usually the most optimal. Moreover, such bankruptcy offers advantages not only to the debtor but also to creditors — if the reorganization plan is successfully executed, creditors receive a much larger share of funds than under Chapter 7 or other methods,” GMT Legal explained.

Thus, the Chapter 11 bankruptcy procedure involves liquidating the business with debt repayment under Chapter 7. Lawyers emphasised that in this case the company ceases its activities, and creditors receive only a small portion of the due payments.