The Restructuring Report

As society’s technology continues to grow more and more complex, bankruptcy attorneys find themselves on the front lines of an ever-evolving legal practice. One such emerging technology, cryptocurrency, has only just begun to become a new thorn in the sides of bankruptcy attorneys and requires their increased attention.

What is Cryptocurrency?

Cryptocurrency, a form of digital cash using cryptographical functions to conduct secure internet-based financial transactions, has recently grown in popularity in such forms as bitcoin. Now, with tech giants, such as Facebook, planning to launch their own versions of cryptocurrencies, bankruptcy attorneys will increasingly witness the emergence of new legal issues involving cryptocurrencies that necessitate their particular attention.

Issues Surrounding Cryptocurrency

As an initial matter, with cryptocurrencies growing in popularity and use amongst U.S. citizens, it is important for bankruptcy practitioners to generally understand what cryptocurrencies are and recognize that such holdings—even though virtual and ever changing in value—are considered assets of a debtor’s bankruptcy estate. When filing for bankruptcy, a debtor is therefore required to identify all of his or her cryptocurrency as assets on their bankruptcy schedules. See 11 U.S.C. §§ 521, 541.

Failure to disclose cryptocurrency on the bankruptcy schedules, regardless of their actual value as of the petition date and whether they are held in an investment account or some other vehicle, creates a risk of denial for a debtor’s discharge and consequent opportunity for a fresh start. For example, in In re Carmack, 2018 WL 5288912 (Bankr. D. Mass. Oct. 22, 2018), the bankruptcy court determined that the debtors would be denied a discharge under 11 U.S.C. § 727 after they failed to disclose a small investment account for bitcoin and online stock in which they had previously transferred money from their failing business and, as of the petition date, held approximately $500. While the amount itself did not necessarily require the court to deny the discharge, the court found that the debtors’ failure to disclose the bitcoin account showed, at the very least, a reckless disregard for the truth resulting in a denial of discharge.

While disclosing a debtor’s cryptocurrency holdings is necessary, the complexity of these assets and the process of trading them require extra vigilance on the part of bankruptcy counsel in order to determine what additional disclosures are needed as a bankruptcy case continues. For instance, in the bankruptcy case of Curtis James Jackson III (better known as 50 Cent), 50 Cent disclosed that he had received payment for an event via bitcoin, but that a third party had handled the transaction and immediately converted the bitcoin into U.S. dollars.

When disclosing a debtor’s cryptocurrency or account holding cryptocurrency, bankruptcy practitioners face the thorny issue of how exactly to value that cryptocurrency. Unfortunately, courts have provided little controlling guidance on precisely how a debtor should value cryptocurrencies like bitcoin. In one of the few cases in which this issue arose, the bankruptcy court for the Northern District of California reviewed how to value bitcoin in relation to a voided transfer under 11  U.S.C. § 550. HashFast Technologies v. Lowe (In re HashFast Technologies LLC), No. 14-30725-DM (Bankr. N.D. Cal. Feb. 22, 2016) (order on motion for partial summary judgment).

In that case, the Chapter 7 Trustee sought to have the bitcoin valued at its present value as a commodity, whereas the transferee argued that the bitcoin should be valued as currency with a value of the date of the transfer. The bankruptcy court ultimately chose not to determine whether bitcoin was a currency or commodity or exactly how to value the bitcoin, instead simply stating that the asset was distinct from U.S. dollars without any further clarification. Debtors and creditors alike are thus left with little guidance on just how cryptocurrencies like bitcoin should be valued in relation to bankruptcy issues.

Takeaways

As the use of cryptocurrencies becomes more mainstream, the above issues and others involving these assets will arise and eventually make their way into bankruptcy courts across the United States. It is therefore imperative for bankruptcy practitioners to obtain a general understanding of the ins and outs of cryptocurrencies and remain vigilant in monitoring recent court decisions in order to learn exactly how debtors and creditors should view and treat cryptocurrency in a bankruptcy case. Only then will bankruptcy attorneys be best able to prevent avoidable problems from arising for their clients.

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