Pocket Full of Crypto Volatility: Stakeholders in Bankrupt Crypto Firms Need to Be Flexible, Agile and Educated | ArentFox Schiff

Valuation is a key element in bankruptcies. In general, a higher valuation of a bankrupt firm means greater creditor recoveries, and a higher valuation of pre-petition collateral means a smaller “adequate protection” package for senior secured lenders.

But the spate of recent crypto firm bankruptcies, coupled with the extreme volatility of cryptocurrency prices, has brought a new element to traditional valuation-based concerns: unexpected and drastic changes in valuations — of security packages and business values ​​— that occur early in bankruptcy. process. As a result, stakeholders in crypto-related bankruptcies must educate themselves about the preparedness, procedures and potential pitfalls should there be a need to change course.

The Core Scientific bankruptcy is the most prominent example of this trend. Largely due to the recent surge in cryptocurrency prices, the cryptocurrency miner, which filed for bankruptcy in December 2022, replaced its $75 million debtor-in-possession financing (so-called DIP financing) with a less expensive package and ended its restructuring. support agreement (RSA) with a ad hoc group of prepetition borrowers. Each pivot was full of potential pitfalls. The existing DIP had a built-in 15% termination fee and the RSA could only be terminated by the company pursuant to a “fiduciary out” provision. Now the parties are at loggerheads over valuation, as shareholders see the potential for a meaningful distribution and have formed an official equity committee.

By way of background, in November 2022, the price of Bitcoin fell to approximately $15,800 from over $64,000 a year earlier. The following month, Core Scientific filed for bankruptcy in the Southern District of Texas, citing the steep and prolonged decline in the price of bitcoin during the “crypto winter” that began in the spring of 2022.

Core Scientific filed with a pre-arranged restructuring documented by an RSA in principle with a ad hoc group of convertible certificate holders. Roughly speaking, RSA estimated that holders of $550 million in convertible notes would receive 97% of new common equity in the reorganized business, and that those same holders would provide a new $75 million DIP that would be rolled into a four- year’s exit term loan on the same terms at the end of the bankruptcy. The DIP also considered that $75 million in prepetition debt would be “rolled up” and converted to super senior DIP loans when the final DIP order was entered.

In mid-January, Bitcoin rose to over $20,000. And on January 30, Core Scientific announced that it would replace its existing DIP with a new and improved DIP facility provided by another lender. The replacement DIP was for $70 million and had a longer term, less expensive exit financing and no roll-up. The replacement DIP lender is also Core Scientific’s largest unsecured creditor.

As is often the case, the pre-agreed DIP, which was provisionally approved by the bankruptcy court, required the debtor to pay substantial termination fees. Core Scientific was ordered to make an immediate payment of $9 million to the original DIP borrowers for accrued interest, fees and termination payments. Debtors nevertheless considered the relief to be superior, and the probate court approved the replacement DIP after objection from the creditors’ committee, which objected to the termination fees. The bankruptcy court approved the $9 million termination fee.

Core Scientific has also terminated its restructuring support agreement. As is often the case, the RSA contained a so-called “fiduciary out” provision, which allowed the company’s termination if a special committee of directors determined that continued support for the planned restructuring would be inconsistent with the exercise of its fiduciary duties. The provision also required the company’s and the ad hoc the group’s advisors must use good faith to discuss the reason for the termination, before the termination.

Where is Core Scientific going next? It is not immediately clear, but valuation issues will be at the forefront of the planning negotiations. For example, shareholders pushed for the formation of an official equity committee, arguing that the surge in Bitcoin pricing suggests a value well above $1.4 billion and a significant likelihood of solvency, but the group of prepetition convertible noteholders argued that no official equity committee should be formed because equity was not likely to receive a meaningful distribution. The debtors and the unsecured creditors’ committee agreed to the appointment of an equity committee limited in scope to planning negotiations and valuation, and the court ultimately agreed to this construction and a cap on the equity committee’s fees. In any case, the planning process seems to be back to square one.

More than anything else, the case is a good example of the uncertainty inherent in cryptocurrency-related business values. Interested parties must be nimble and prepared to adapt to the ever-changing prices of Bitcoin. It is important to develop well-considered valuation strategies early in the bankruptcy process. For parties who lock in their rights early, speed is of the essence.

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