The Pacific Gas & Electric Co decision, from the US Court of Appeals for the Ninth Circuit, has strengthened the hands of creditor funds dealing with solvent but bankrupt debtors. Some attorneys see this decision as part of a trend in favour of the pre-petition contractual rights of creditors as some courts show their willingness to see to it that some of those rights survive the petition.
Separately, the Chapter 11 filings of Celsius Network and Voyager Digital look likely to force judges to address squarely a question critical to the development of the whole blockchain ecosystem. When one party, owning crypto assets, leaves them in the possession of another, is that more akin to a traditional custodial relationship or to a brokerage? Many creditors in Celsius and Voyager will be much better off if the answer turns out to be the former.
Corporate bankruptcy and restructuring law is in flux in the US, and private debt investors have a lot at stake on any number of hotly contested points as the forces in play move toward a new equilibrium. We focus here on two questions: how much interest should be paid post-petition, to creditors, by solvent debtors? And how are bankruptcy courts to understand cryptocurrencies, blockchain and assets built thereon?
As a general rule, unsecured creditors are not allowed to charge interest on their loans subsequent to the filing of a bankruptcy petition. The venerable “solvent debtor exception” to that rule holds that creditors are entitled to continued interest if the debtor in bankruptcy has a balance sheet in the black. More specifically, the doctrine may be invoked to require solvent debtors to pay post-petition interest that they owe to their unsecured creditors at the contract rate of interest rather than at the (reliably lower) federal judgment rate.
PG&E filed for Chapter 11 protection on 29 January 2019. It did so in response to lawsuits arising from the devastating wildfires in California. Sparks from the company’s equipment were widely blamed for starting many of the fires of the preceding two years, and the company believed bankruptcy court was the best way to apportion liability while continuing operations.
At the time of filing, PG&E’s assets surpassed liabilities by approximately $20 billion, making it the paradigm of a solvent debtor.
But its plan classified the claims of the ad hoc committee of trade claimants as general unsecured claims and offered the claimants payment of only 2.59 percent interest post-petition, the federal judgment rate. The plan also classified the creditors’ claims as “unimpaired”, so they had no power to vote against it. The ad hoc committed objected. The bankruptcy court, though, held that there is no solvent debtor rule under the Bankruptcy Code, and the unsecured creditors (regardless of impairment status) were entitled only to post-petition interest at the judgment rate. The district court affirmed that ruling, and the ad hoc committee appealed to the Ninth Circuit.
The appeals court said that bankruptcy courts must make a choice to “either compensate creditors in full, pursuant to the solvent-debtor exception, or designate them as impaired claimants entitled to the full scope of the [Bankruptcy] Code’s substantive and procedural protections”. In the former case the contractual rate should be at least the starting point, though it need not be the end point, of a bankruptcy court’s analysis.
Good news for debt holders
Shai Schmidt, a partner at law firm Glenn Agre Bergman & Fuentes who has practiced reorganisation law for years, mostly on the debtor’s side of the table, says that solvent debtors in Chapter 11 are rare, and they break down into two groups.
“Sometimes a company is forced into bankruptcy by emergency conditions – as by covid – but when the smoke clears, it becomes evident that the debtor has more assets than liabilities. Sometimes, on the other hand, a company enters Chapter 11 as a way of settling civil liabilities, especially tort liabilities. This was the case with PG&E and the wildfires’ liabilities it sought to resolve as part of its bankruptcy case in California.”
Attorneys questioned agree that there is and will continue to be forum shopping (choosing a favourable jurisdiction) by debtors (and by creditors interested in forcing an involuntary bankruptcy). PG&E is itself a Delaware-chartered corporation and, had it known it would be liable for the contractual interest in the Ninth Circuit, it might have filed in Delaware itself.
It is important to note that the Bankruptcy Court for the District of Delaware (in the Third Circuit) recently facing much the same problem, reached a different conclusion. The Delaware court maintained that there is no solvent debtor exception. There remains a patchwork of cases on the point across the country.
But some attorneys see the PG&E decision as part of a trend in favour of preserving pre-petition contractual rights. If so, this is more important for credit funds as a straw in the wind than as a rule for the few specific cases it directly affects.
Congress deliberates on crypto-world and bankruptcy
In July 2022 two important crypto businesses filed for Chapter 11 protection, Voyager Digital and Celsius Network.
Voyager Digital was a crypto broker. It had the misfortune of extending a large loan to Three Arrows Capital, a crypto fund. Three Arrows defaulted, and Voyager never recovered.
Celsius Network was a crypto lending company. It allowed users to deposit their digital assets into a “Celsius wallet”, and they could take out loans by pledging these assets as security. The Voyager and Celsius Chapter 11 filings have raised a number of unprecedented questions.
Emanuel Grillo, a partner at law firm Allen & Overy with a Chapter 11-oriented practice, summarised the issue this way: “If a bankrupt crypto entity is holding counterparties’ cryptocurrencies as a custodian, they should be able to secure their return. But if the client relationship is more akin to a traditional brokerage relationship, then you may not have a clue what will happen at the end of the day. Most of the underlying agreements are not particularly helpful.”
There is still broad expectation that a billionaire – possibly crypto entrepreneur Samuel Bankman-Fried – will swoop in and scoop up a lot of the insolvent entities and revive the sector. As Grillo says: “Somebody is going to have to start writing cheques to backstop this industry.”
In the meantime, lawmakers deliberate. There are two bills now before the Senate that might address some of the confusion about insolvent parties in the crypto world: the Lummis-Gillibrand bill and the Stabenow-Boozman bill. These take different approaches, although they may be little more than academic. It appears unlikely that discussions will yield a final measure ready for President Biden’s signature during what remains of this Congress.