Bitcoin as a “Commodity” and the Resulting Impact on Bankruptcy Proceedings

A recent federal district court ruling here in the United States (in a different proceeding) took a similar position. On September 26, 2018, the U.S. District Court for the District of Massachusetts ruled in Commodity Futures Trading Commission v. My Big Coin Pay, Inc., No. 18-10077-RWZ, 2018 WL 4621727 (D. Mass. Sept. 26, 2018), that Bitcoin and other cryptocurrencies are “commodities” as defined by the U.S. Commodity Exchange Act (CEA), 7 U.S.C. ch. 1. That ruling is significant because the value of cryptocurrencies, as commodities, would be determined at the time of recovery, rather than on the date a bankruptcy petitioner initiated bankruptcy proceedings. 

The question remains whether bankruptcy courts in the United States will follow suit and take a flexible approach to claims valuation and distributions when it comes to cryptocurrency, given the unprecedented volatility of this particular asset.

A Brief History of MtGox

MtGox was created by a U.S. programmer, Jed McCaleb, in 2010. At that time, the price of Bitcoin was about $0.08. As of 2013, MtGox was the single largest Bitcoin exchange in the world, managing over 70 percent of all Bitcoin transactions across the globe. Bitcoin’s value experienced an astronomical increase, selling at $1,200 per coin. In February 2014, it was discovered that as early as 2011, hackers began raiding MtGox and ultimately stole 744,408 Bitcoins belonging to the exchange’s customers, as well as an additional 100,000 Bitcoins belonging to the company itself.

On February 28, 2014, MtGox filed for bankruptcy protection in Japan, as well as a petition under Chapter 15 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas. Subsequently, in March 2014, MtGox reported that it had rediscovered 200,000 Bitcoins.

In April 2014, MtGox petitioned the Tokyo District Court for liquidation, which provides for the winding-up of the debtor’s estate. In other words, all of MtGox’s assets, including the Bitcoin it possessed, would be sold, converted to cash, and distributed to creditors. Notably, distributions would be based on the value of customer claims as of the date MtGox filed for bankruptcy relief.

To drum up cash to make distributions to creditors, the bankruptcy trustee began to sell off large chunks of MtGox’s Bitcoin, selling $400 million in Bitcoin and BCH from December 2017 through February 2018. During that time period, Bitcoin’s price fluctuated, clocking in at $10,000 to $19,000 per Bitcoin in the month of December 2017 alone. Experts criticized the MtGox trustee for having a hand in Bitcoin’s price volatility by unloading such huge quantities of Bitcoin onto what was (and still is) a nascent market.

After repeated petitions by creditors, in June 2018, the Tokyo District Court suspended the bankruptcy proceedings and approved the commencement of civil rehabilitation. The key difference between the two proceedings—at least for creditors—is that the trustee gained the ability as part of the rehabilitation process to make distributions in Bitcoin or BCH, instead of paying out claims in cash based on the cryptocurrency’s valuation as of the date of the MtGox bankruptcy. This would have a profound impact on creditor recoveries. The trustee explained the process as follows:

In bankruptcy proceedings, non-monetary claims are converted into monetary claims based on the valuation as at the time of the commencement of bankruptcy proceedings. In contrast, in civil rehabilitation proceedings, non-monetary claims are not converted into monetary claims at the time of commencement of the civil rehabilitation proceedings. Therefore, in the civil rehabilitation proceedings in this matter, claims seeking a refund of bitcoins (“Bitcoin Claims”) will also not be converted into monetary claims after the commencement of the civil rehabilitation proceedings.

MtGox Civil Rehabilitation Trustee, Announcement of Commencement of Civil Rehabilitation Proceedings, Answers to Frequently Asked Questions (June 22, 2018), Q&A A1(2).

Valuation of Claims for Cryptocurrency in Bankruptcy

Typically, the value of an unsecured claim in bankruptcy is readily available—the amount reflected on an invoice or purchase order, loan documents, or lease. These documents paper the parties’ mutual understanding of the value of whatever goods or services are traded. In the context of securities, a customer’s unsecured claim would be valued on the date of the financial institution’s bankruptcy filing, with the amount denominated in the prevailing (fiat) currency.

The MtGox bankruptcy unveiled the conundrum created by the uncertainty regarding cryptocurrency: Is it a currency? Or is it a commodity? Or some hybrid? If it truly is a currency, one would argue that any claim arising should first be “translated” into the prevailing fiat currency (e.g., yen or U.S. dollars) and then paid out in accordance with the value as of the petition date. This was the approach originally undertaken by the MtGox trustee while the case was still in bankruptcy.

Thus far, only one bankruptcy court decision in the United States has dealt with whether Bitcoin is a currency or commodity. In In re Hashfast Technologies LLC, No. 14-30725, 2016 WL 8460756 (Bankr. N.D. Cal. Feb. 5, 2016), the defendant (the transferee of an allegedly fraudulent transfer of Bitcoins by the debtor) asserted that to the extent he was held liable, he should be required to return no more than the value of the Bitcoins (as opposed to the Bitcoins themselves) on the date of transfer. In contrast, the plaintiff trustee argued that Bitcoins are more like commodities, thus the bankruptcy court should order the return of the Bitcoins themselves or their value at the time of recovery. Central to the dispute was the fact that the value of Bitcoin had increased by 400 percent since the date of transfer. Ultimately, the bankruptcy court made no decision regarding the currency-or-commodity dispute, concluding that Bitcoin are not U.S. dollars. The court deferred making a decision as to whether the Bitcoin would be returned and, if not, what the valuation date would be for purposes of its liquidation (if and when the trustee prevailed in his count for avoidance).

The debate may now be over. On September 26, 2018, the U.S. District Court for the District of Massachusetts ruled in Commodity Futures Trading Commission v. My Big Coin Pay, Inc., 2018 WL 4621727, that Bitcoin did meet the definition of a “commodity” under the CEA. In My Big Coin Pay, the U.S. Commodity Futures Trading Commission (CFTC) brought an action alleging a fraudulent virtual currency scheme by the defendants in violation of the CEA. According to the complaint, the defendants induced customers to buy virtual currency by making untrue and misleading statements, including that the defendants’ currency was “backed by gold,” would be accepted anywhere Mastercard was accepted, and was being “actively traded” on several currency exchanges. The defendants filed a motion to dismiss on the basis that virtual currency did not constitute a “commodity” under the CEA. The court considered case law related to the treatment of natural gas as analogous to virtual currency. Reasoning that, as with natural gas, there is futures trading in virtual currencies (like Bitcoin), the court held that virtual currencies are commodities under the CEA, and it denied the defendants’ motion to dismiss. Id. at *4–5.

Accordingly, in theory, Bitcoin and other cryptocurrencies should be treated like gold or oil. The “crypto as commodity” ruling could have enormous implications on valuation in the bankruptcy context. The return of Bitcoin or any other cryptocurrency (i.e., transfer avoidance, recoupment, or claims distribution) likely will be favored in lieu of a contested and expensive valuation battle. However, if the mere return of Bitcoin is not feasible (for example, if they are stolen as in the case of MtGox), the protocol for valuation becomes critical.

In the context of a fraudulent transfer (or other award of damages to a plaintiff trustee or debtor in possession), if the transferred property is not returned, the court can award its value, which is “measured at the time of recovery where the property naturally increases in value.” Heller Ehrman LLP v. Jones Day (In re Heller Ehrman), No. 10-3221DM, 2014 WL 323068, at *8 (Bankr. N.D. Cal. Jan. 29, 2014) (citing USAA Fed. Sav. Bank v. Thack (In re Taylor), 599 F.3d 880, 890 (9th Cir. 2010)). In the context of the U.S. Bankruptcy Code, 11 U.S.C. § 101 et seq.—which at section 503(b)(9) governs the valuation of goods provided to a debtor in the 20 days preceding the petition date—a commodity is valued “based on the price at which it could be purchased during the relevant period on the commodity market.” In re Pilgrim’s Pride Corp., 421 B.R. 231, 243–44 (Bankr. N.D. Tex. 2009). Trustees and debtors may argue that the “increase in value” should be retained by the estate, for the benefit of other creditors (i.e., holders of claims for commodities that have decreased in value).

The valuation of commodities has played a large role also in assessing the feasibility of Chapter 11 reorganization plans. For example, in In re Sabine Oil & Gas Corp., 555 B.R. 180 (Bankr. S.D.N.Y. 2016), the bankruptcy court confirmed a Chapter 11 plan despite a heated battle over the amount of proposed adequate protection payments to the debtors’ lenders. (Motion to certify appeal denied, No. 16-CV-2561 (JGK), 2016 WL 6238616 (S.D.N.Y. Oct. 25, 2016); appeal dismissed as moot, No. 16 CIV. 6054 (LAP), 2017 WL 477780 (S.D.N.Y. Feb. 3, 2017).) In Sabine, the debtors’ proposed adequate protection payments were based on the historical value of the lenders’ collateral, which consisted of oil and gas (i.e., the lower the value, the higher the adequate protection payments). The creditors’ committee claimed that the adequate protection payment amounts should be based on the most recent valuation of oil and gas. The court noted that there is an “inherent tension involved in performing valuation analysis using data that is subject to constant change” and observed that “[r]esolving this tension is specially challenging in the context of a commodity industry . . . in which pricing is subject to significant volatility, seasonality, and other factors that increase the dynamism of pricing information.” Sabine, 555 B.R. at 272. Although the most current information was “most pertinent,” the court cautioned that its valuation also should take into consideration the “practical reality” of the delays within the Chapter 11 process and that “the concern that what may be a temporary shift in commodity prices could lead to a determination of value that is inequitable to one or more parties.” Id. The court ultimately sided with the debtors’ valuation based on historical prices, in lieu of looking exclusively to more recent pricing information. Id.

Conclusion

Given the volatility of cryptocurrency, with the recent clarifications coming out of the courts regarding the “currency or commodity” debate, bankruptcy courts may employ greater discretion regarding how to treat the valuation of Bitcoin and other cryptocurrencies in a variety of contexts throughout the duration of a bankruptcy proceeding. Indeed, the more protracted a bankruptcy proceeding is, the greater the likelihood that the valuation of cryptocurrency—whether as collateral, damages, or claim distribution—will become a pivot point in such a proceeding.
 

Joanne Molinaro is a partner and Susan Poll Klaessy is a senior counsel with Foley & Lardner LLP in Chicago, Illinois.

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