An insolvency attorney told Cointelegraph that clawback provisions could force businesses and investors to return billions of dollars paid in the months leading up to the crypto exchange’s collapse. This means that the contagious spread of the FTX Group collapse may not be finished yet.
In a nutshell, a “clawback” is money paid out that must be returned due to special circumstances or events, such as when an insolvent business must recover funds paid within 90 days of filing for Chapter 11 bankruptcy. The 90-day period is extended to one year if the creditor is an insider.
Consequently, creditors may seek a clawback on FTX’s transfers to third parties, such as the $2.1 billion that Binance paid FTX when it exited its Series A investment in FTX. In an interview with CNBC, Binance CEO Changpeng “CZ” Zhao dismissed concerns regarding the return of the funds, stating that Binance’s lawyers should handle it.
According to bankruptcy attorney Mark Pfeiffer, who is a member of the Blockchain and Crypto Assets Practice group at law firm Buchanan Ingersoll & Rooney, the bankruptcy court could require the return of the crypto assets or money equivalent to the value of the crypto transferred in the event of a clawback to recover funds for creditors.
Pfeiffer made the following observation: “If the court decides to require the defendant to pay the value, it is not clear whether the amount will be the value at.” Consequently, the court would have to consider the date of the transfer, the filing of a bankruptcy or lawsuit, or the entry of a judgment when determining the assets’ value. The insolvency attorney stated:
“Customers who liquidate the crypto as cash run the risk that they will have to return crypto, which exposes them to the risk that the value of the crypto will increase. Customers who hold the crypto, run the risk the court will require them to return cash even though the crypto they are holding might not be liquidated for the amount of the judgment. In other words, no matter what they do, they run the risk of compounding their problems if they guess wrong.”
Silvergate Bank is one of many businesses that may be required to return funds as the bankruptcy process progresses. Cointelegraph reported that FTX customers filed a lawsuit in December claiming that the bank helped the now-defunct cryptocurrency exchange commit fraud by making improper transfers of funds.
Pfeiffer told Cointelegraph that there are three main types of clawback. Under Section 547 of the Bankruptcy Code, a debtor or a trustee can avoid transferring property to a creditor within 90 days of filing for bankruptcy while the debtor or trustee was insolvent.
A preference claim can be countered in a number of ways. If the transfer was made in the normal course of business, this is the most common scenario. However, the question of whether a de facto “run on the bank” would fall under normal circumstances remains,” Pfeiffer stated.
A fraudulent transfer of property made while the debtor was insolvent with the actual intention of defrauding creditors is the second type, as defined by Section 548 of the Bankruptcy Code. Pfeiffer pointed out:
“Although there may be fraud involved in the FTX case, it may not be made with the intent to defraud creditors. The intent might not have anything to do with creditors. It may be that the intent was to solely enrich the principals.”
The final type of fraudulent transfer, as defined by Section 548, is a transfer of property that occurred while the debtor was insolvent and for which the debtor received less than reasonably equivalent value.
While the bankruptcy of FTX may not differ significantly from other bankruptcy cases involving fraud and mismanagement, it may serve as an example for how bankruptcy courts deal with crypto assets.
Similar questions are likely to arise, despite the fact that regulators and other courts may not adhere to the rules of bankruptcy courts. Is it a commodity, a security, a currency, or another type? Pfeiffer stated, “This issue will also appear outside of bankruptcy, as it does in securities regulation and general litigation outside of bankruptcy.”