A victims’ fund set up for creditors in the bankruptcy case of crypto lender Genesis could set a new precedent for future crypto bankruptcy cases, but that’s only if the fund is approved by the court.
Under standard Chapter 11 bankruptcy procedures, general unsecured creditors, such as Genesis customers, would only get paid what their digital asset claims are worth at the time of bankruptcy through a process known as dollarization. For example, since bitcoin was trading at $21,000 at the time Genesis filed for bankruptcy, that’s all they would receive for it, rather than the $50,800 it’s worth today.
However, the victims’ fund is a unique structure that could help general unsecured creditors, who the New York Attorney General’s (NYAG) office allege were harmed by Genesis, recover more of their losses in the bankruptcy proceedings. It forms part of a settlement agreement for a lawsuit brought by the NYAG, which alleged Genesis and several other entities defrauded investors. A hearing to approve the settlement will take place on Feb. 26.
The NYAG filed three separate general unsecured claims of $1.1 billion against three bankrupt Genesis entities last July. Under the proposed settlement agreement, rather than have the NYAG keep the funds from the claims, it will go into a victims’ fund. The fund will redistribute this over a billion dollar sum pro-rata to general unsecured creditors. The goal is to recover “the full and fair amounts” of creditors’ “actual losses.” Payment via the fund will only be made after all general unsecured creditors claims have been paid by the estate.
“The New York Attorney General is really showing dramatic support for crypto creditors who were defrauded,” said a Genesis general unsecured creditor, who asked to be referred to as BJ.
Unsecured creditors, such as BJ, are low on the totem pole for getting paid out in the bankruptcy process despite having lent cryptocurrency assets to the firm. Bankruptcy claims are paid in order of priority with secured claims being the highest priority, while equity security holders are the lowest. General unsecured creditors sit just above equity holders in terms of priority.
The structure of the deal is helpful because it ensures that if there’s money left over after the payment of claims, that money would go to the people who were defrauded, said Alan Rosenberg, a partner at law firm Markowitz, Ringel, Trusty & Hartog.
“It’s not uncommon to set up funds in bankruptcy cases for a class of creditors that have been harmed in the same way,” Rosenberg said. Prominent cases where victims’ funds have been set up include the bankruptcy case of Purdue Pharma, the maker of OxyContin, to settle thousands of lawsuits in relation to the harm done by opioids. The Boy Scouts of America, as part of its bankruptcy proceedings, also established a $2.4 million fund for those who were victims of sexual abuse.
Helping Creditors Who Have Been Harmed
Still, victims’ funds are not common in crypto bankruptcy cases despite the spate of recent bankruptcies that feature allegations of fraudulent behavior.
“It’s amazing because a government agency, [the NYAG], is actually recognizing the creditors,” BJ said. “People that loaned money like this, and who were victims of fraud, deserve to get paid back.”
Unsecured creditors in the majority of ongoing crypto bankruptcy cases — such as that of FTX — are set to have their claims paid through dollarization, which means they get paid the amount the digital assets are worth as of the bankruptcy petition date. This has frustrated those creditors who feel they were misled about how their assets would be used. Some creditors in the FTX bankruptcy have even sued the estate because the terms of service explicitly stated that the digital assets were their property and not that of FTX’s.
Genesis’s proposed reorganization plan aims to pay unsecured creditors the worth of their assets as of the distribution date of the funds, rather than via dollarization; however, Genesis’ parent company, DCG, has objected to this proposal.
Read more: DCG Records $210 Million in Q4 Revenue
The victims’ fund could act as a workaround for returning more funds to unsecured creditors even if claims are paid by dollarization. Unsecured creditors will first get their claim paid — as of the petition date — then once all unsecured creditors are paid, the victims’ fund, which contains the value of the NYAG’s claims, would be divvied out to unsecured creditors pro-rata.
However, this payment still very much depends on what assets the estate has for distribution, Rosenberg said. When Genesis filed for bankruptcy last year, the firm estimated both its assets and liabilities were in the range of between $1 billion to $10 billion. The firm also recently secured approval to sell Grayscale trust shares, which were valued around $1.6 billion at the time.
“If the assets are not there, they can’t possibly be paid in full,” Rosenberg said.
The Settlement’s Shaky Ground
Mark Salzberg, a partner at law firm Squire Patton Boggs, describes the settlement agreement as a “twist in the case” because DCG has already objected to creditor claims being valued based on distribution date in Genesis’s proposed Chapter 11 confirmation plan.
DCG’s lawyers believe the distribution should follow standard bankruptcy procedures of dollarization. They argue that unsecured creditors will get “in excess of what the bankruptcy code permits” and this will leave no extra value for equity holders if the confirmation plan is approved as is.
Under the settlement agreement, if approved, creditors will get more than what their claim is worth as of the petition date, due to the victims’ fund distribution. This would occur even if DCG’s objection to the confirmation plan is deemed valid by the court.
“You don’t see this very often,” Salzberg said. “It’s almost like a belt and suspenders approach. Two different vehicles, the plan or the settlement, gets you to the same result.”
In an objection to the settlement, DCG called the introduction of the agreement “a blatant and desperate attempt by the Debtors—in haste and with no apparent negotiation—to rig the outcome of the confirmation hearing.” A hearing for both the confirmation plan and the settlement are scheduled for the same day, Feb. 26.
“DCG objects to this subversive arrangement, put together last-minute and in secret, which seeks to redistribute all estate value to preferred creditors who would have already received the full value of their claims,” said DCG in a statement to Unchained.
Yesha Yadav, a professor of law at Vanderbilt University, said the settlement is “relatively precarious” because there are so many competing constituencies in this case. She expects the settlement approval process to be more drawn out than just a single hearing.
A Roadmap for Future Cases?
The settlement agreement is related to a sweeping lawsuit filed against Genesis entities, Genesis’s parent company Digital Currency Group (DCG) and the cryptocurrency exchange Gemini. The lawsuit alleged the firms had defrauded more than 230,000 investors of over $1 billion. A day after the settlement was announced, the NYAG increased the amount investors were defrauded of to $3 billion, and also named Genesis creditors as victims of fraud in the lawsuit.
Read more: NYAG Expands Fraud Lawsuit Against DCG to $3 Billion
The original complaint only included Gemini Earn creditors, who were customers who lent cryptocurrencies to Gemini for a lending program run in collaboration with Genesis.
If the settlement is approved by the court, it would resolve the NYAG’s action against Genesis, but not the other defendants, and would resolve any objections the agency has in relation to the confirmation of Genesis’s Chapter 11 restructuring plan.
On Xclaim, a marketplace for buying and selling bankruptcy claims, there’s optimism that Genesis’s bankruptcy case is nearing a resolution that’s favorable to creditors. Genesis claims were trading around 50 cents on the dollar in May last year, but are now seeing bids in the 70 cents to 80 cents on the dollar range, said Andrew Glantz, chief strategy officer at Xclaim. There are few sellers of claims at the price and many want to see higher bids, Glantz said.
If approved, experts expect the settlement agreement will provide a roadmap for other crypto bankruptcies where there have been allegations of fraud. Both Yadav and Rosenberg highlighted that this could be a suitable framework for cases that have large groups of creditors, such as crypto cases that have been very retail oriented.
“It would not surprise me at all that a victims’ fund, such as this, as has been proposed for Genesis, might become a more commonplace part of crypto bankruptcies going forward and any pending bankruptcies that are ongoing today,” Yadav said.
Gemini, Genesis and the New York Attorney General’s office did not respond to requests for comment for this story.
