Breaking Down the First-Ever Crypto Bankruptcy Ruling

Konstantina Katsimeni

The year 2023 began with the first-ever ruling in a bankruptcy case filed by the cryptocurrency lending company, Celsius Network. Celsius on January 4th, 2023, Judge Martin Glenn of the SDNY bankruptcy court held that certain digital assets in Celsius Network are property of the debtors’ bankruptcy estate, not the account holders.[1] The specific assets are the Celsius “Earn Accounts,” approximately 600,000 accounts with a total value of $4.2 billion on the petition date.[2] The Earn Accounts program allows customers to gain compounded interest on their crypto assets paid weekly if they store crypto on the Celsius wallet.[3] It allows Celsius to use its customers’ deposited assets as collateral primarily for their lending activities to institutional borrowers or any yield-generating activity.  The Earn Accounts were frozen in June and the account holders could not make any withdrawals on the Celsius platform, as announced by Celsius, due to “extreme marketing conditions.”[4] The specific accounts also contained stablecoins, estimated at $23 million in September 2022.[5]

The ruling suggests that those stored deposits in the Earn Accounts are property of the debtor’s estate, allowing Celsius Network to use them as authorized by the Bankruptcy Code. This can include selling them in order to recover funds. This leaves the account holders seeking recovery through bankruptcy proceedings, which means they will likely only recover part of their claims, if any. It also puts most Celsius customers, who held Earn Accounts, in lower priority in receiving back funds than those who held non-interest-bearing accounts, which is a different type of creditor. This makes their recovery almost certainly partial, if any, which prevents the future argument among similarly-situated creditors over who will be repaid entirely and who will not since everyone will receive an amount of the funds left proportionate to their initial investment. 

The debate in court came down to the estate’s property when the debtors motioned to sell $18 million worth of stablecoins from those accounts.[6] Celsius Network argued that the Earn Accounts were the estate’s property, not the account holders. Judge Glenn ruled that according to the terms of service, it was clear that the crypto lender owned customer deposits into the interest-bearing accounts.[7] Therefore, Earn Account holders are unsecured creditors waiting in line to be repaid. 

Judge Glenn’s decision followed two legal frameworks. The first one was the Bankruptcy Code, regarding the property of the estate, and the second was New York Contract Law, which determined the extent of the estate of debtors. 

The Bankruptcy Code under US Code, 11 USC §541 states that once a bankruptcy is filed, an estate is created with all the debtor’s interests in property with some exceptions.[8] Those interests and exceptions are specified in §541. This estate can, in turn, be sold by the debtor to fund the Chapter 11 plan or pay administrative expenses, including attorney fees. However, the Bankruptcy Code does not specify the extent of the debtor’s interest. Given the lack of precedent regarding the property of the estate in digital assets, Judge Glenn turned to New York Contract law and what is determined by the Terms of Use.[9] 

The basics of contract law state that for a contract to be enforceable, it must have certain elements, such as offer, acceptance, and consideration. The judge found that all three elements were satisfied and that the contract was valid.[10] However, since this is a clickwrap contract, the contract might not be enforceable because there were no negotiations between the offeror and offeree or because the signee might not have read all the fine print.[11] However, the judge found no issue with that as there is precedent of similar agreements being enforced by the courts, and there was no reason not to enforce them in this case.[12]

The opposing argument was made by the creditors that there had been contract modification through marketing and CEO Alex Mashinsky’s statements.[13] However, the argument fell through because extrinsic evidence is inadmissible under the parol evidence rule since the terms were sufficiently clear and unambiguous.[14]

There were also opposing arguments by the creditors for unconscionability, fraud, and breach of contract to void the contract, which the judge held did not address the property of estate debate.[15]

The verdict is good news for Celsius Network because, as owners of the accounts, they can start selling the stablecoins, which was the origin of the debate, and deal with the liquidity crisis they are currently facing. In addition, they can also use or sell the assets of the accounts in order to pay administrative fees, such as the attorney’s fees, since these are expenses that take priority under the Bankruptcy Code under Chapter 11.[16] 

However, the decision only applies to the Celsius Earn Accounts and should not be confused with the accounts held under “Custody” or other Celsius programs. For the customers of Celsius Earn Accounts, the verdict means they cannot withdraw their money directly from their Earn Accounts because they do not have any property interest in them according to the terms of use. Instead, they can try to retrieve their money under different proceedings, such as the reorganization plan. However, it is almost guaranteed that they will not recover the total amount of their deposits. 

This verdict acts as the first precedent in an adjudicated cryptocurrency case. It emphasizes the importance for all investors to read the terms of use and understand what they mean for their deposits. It will likely guide future bankruptcy cases, placing significant weight on the terms of use and binding the account holders to the contracts they sign. It indicates that the courts will apply contract law in determining the property of the estate of the bankrupt firms and how it should be treated. However, different contexts can grant transgression from the precedent. 

 

[1] Knauth Dietrich, U.S. Judge Says Celsius Network Owns Most Customer Crypto Deposits, Reuters, (Jan. 5, 2023), https://www.reuters.com/business/finance/us-judge-says-celsius-network-owns-most-customer-crypto-deposits-2023-01-05/.

[2] Wagner Casey, Not ‘Enough Value’ Left To Repay Celsius Customers, Blockworks, (Jan. 4, 2023), https://blockworks.co/news/not-enough-value-left-to-repay-celsius-customers.

[3] Melinek Jacquelyn, Bankruptcy Judge Rules Celsius Network Owns Users’ Interest-Bearing Crypto Accounts, Techcrunch (Jan. 4, 2023), https://techcrunch.com/2023/01/04/bankruptcy-judge-rules-celsius-network-owns-users-interest-bearing-crypto-accounts/.

[4] A Memo to the Celsius Community, Celsius, (June 12, 2022), https://celsiusnetwork.medium.com/a-memo-to-the-celsius-community-59532a06ecc6.

[5] Beganski André, Judge Rules Celsius Earn Account Funds Belong to Estate, Not Users, Yahoo Finance, (Jan. 4, 2023), https://finance.yahoo.com/news/judge-rules-celsius-earn-account-223805803.html.

[6] Benham T. & Rutenberg S., Court Rules that Earn Account Assets are Property of the Debtor: Celsius Bankruptcy Case: January 13, 2023, JDSupra, (Jan. 13, 2023), https://www.jdsupra.com/legalnews/court-rules-that-earn-account-assets-2933778/.

[7] Supra note 1.

[8] 11 USC § 541.

[9]  In re Celsius Network LLC, 22-10964 (MG), (Bankr. S.D.N.Y. Jan. 4, 2023) at 5.

[10] Id. at 24-28.

[11] Fuller Jeffrey, ANALYSIS: How Celsius Ruling Affects Customer Crypto in Ch. 11, Bloomberg Law, (Jan. 13, 2023), https://www.bloomberglaw.com/bloomberglawnews/bloomberg-law-analysis/XC8AFJE4000000?bna_news_filter=bloomberg-law-analysis#jcite.

[12] Supra note 9 at 26–27.

[13] Theresa Foudy & Andrew Kissner, Celsius Bankruptcy Court Holds Customer Deposits in “Earn Accounts” Are Estate Property, JDSupra, (Jan. 9, 2023), https://www.jdsupra.com/legalnews/celsius-bankruptcy-court-holds-customer-8920855/.

[14] Supra note 9 at 30.

[15] Supra note 9 at 23–24.

[16] 11 U.S. Code § 507.