The collapse of FTX Group may not be the end of the contagious spread, as clawback provisions could force businesses and investors to return billions of dollars paid in months that led to the collapse of the crypto exchange, insolvency prosecutors told Cointelegraph.
In short, clawback refers to money paid out that is required to be returned due to special circumstances or events, such as a bankrupt company that must return paid funds in 90 days before filing for Chapter 11. If the creditor is an insider, the 90-day period is complete for one year.
As a result, creditors can seek clawbacks on transfers made by FTX to outside parties, including the $2.1 billion paid by FTX to Binance when Binance exited its Series A investment in FTX. Changpeng “CZ” Zhao, CEO of Binance, recently dismissed concerns about the refund in an interview with CNBC, saying Binance’s lawyers should handle it.
If there is a clawback to recover funds for creditors, the bankruptcy court can determine the return of crypto assets or money equal to the value of the crypto transferred, explains bankruptcy lawyer Mark Pfeiffer, who is a member of Blockchain and Crypto. Asset Practice Group at the law firm Buchanan Ingersoll & Rooney.
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“If the court decides to require the defendant to pay the price, it is not clear what amount will be the value”, noted Pfeiffer. As a result, the court must determine the value of the asset considering when the transfer occurs, or when the bankruptcy or lawsuit is filed, or when the judgment is entered. According to insolvency lawyers:
“Customers who liquidate crypto as cash have the same risk of having to return the crypto which exposes them to the risk that the value of the crypto will increase. Customers who hold crypto, open the risk that the court will require someone to return the cash even though the crypto held may be not liquidated for the penalty amount. In other words, whatever he does, he runs the risk of compounding the problem if he guesses wrong.”
Many other businesses need to raise money as bankruptcy proceedings continue, including the Silvergate bank. As reported by Cointelegraph, a lawsuit filed in December by FTX customers claims the bank helped the cryptocurrency exchange die in fraudulent activities through improper fund transfers.
There are three main types of clawbacks, Pfeiffer explained to Cointelegraph. First preference under section 547 of the Bankruptcy Code allows a debtor or trustee to avoid transferring property created to a creditor within 90 days prior to the bankruptcy in bankruptcy.
“There are several defenses to the claim of choice. The most common is that the transfer was made in the ordinary course of business. However, there is a question of whether the de facto “walk in the bank” would be in the ordinary course, ” notes Pfeiffer.
The second type, under section 548 of the Bankruptcy Code, is a fraudulent transfer of property made when the debtor is insolvent with the express purpose of defrauding creditors. Pfeiffer observed that:
“While there may have been fraud in the FTX case, it may not have been committed with the intent to defraud the creditors. The intent may have nothing to do with the creditors. The intent may be simply to increase the principals.”
Also under section 548, the last type of fraudulent transfer is a transfer of property made when the debtor is insolvent and the debtor receives less than equal value.
The FTX bankruptcy case may not be different from other bankruptcy cases involving fraud and mismanagement, but it may set a precedent for how crypto assets are handled in bankruptcy court.
When other regulators and courts don’t follow the bankruptcy court’s rules, the same question arises. “Is it a currency, a security, a commodity or something else? This issue will be seen outside of bankruptcy very much as in securities regulation and in public courts outside of bankruptcy,” Pfeiffer said.