What happens to Celsius creditors if crypto prices recover?

Assume that bitcoin’s (BTC) price doubles in the coming months. Would the hundreds of thousands of customers whose cryptocurrency holdings are frozen within the stricken lending platform Celsius Network come out ahead, or simply break even?

This is uncharted territory for a US bankruptcy court.

The high volatility of cryptocurrencies created the extreme market conditions that led to crypto lender Celsius freezing customer withdrawals in early June and later admitting a $1.2 billion hole in its balance sheet. But an equally dramatic rise in cryptocurrency prices could conceivably happen before the case – in the US Bankruptcy Court for the Southern District of New York – is concluded.

The possibility of a thaw in the crypto winter was mentioned during the initial bankruptcy hearing by Patrick Nash – a partner at Kirkland & Ellis, the law firm representing Celsius – who added that the majority of clients are expected to remain “long crypto”.

The strategy of waiting for a possible change in the crypto climate was echoed by Vincent Indelicato, a partner at law firm Proskauer focused on corporate restructuring.

“There may well be stakeholders who want to use the bankruptcy process to wait out the crypto winter and hibernate until it thaws a bit so they can capture the upside of the decline,” Indelicato said in an interview with CoinDesk.

The option to take recoveries in crypto sounds like it could be a boon for Celsius account holders, but a lot depends on what it means in practice, said Daniel Besikof, partner at law firm Loeb & Loeb.

“The general rule is that creditors in bankruptcy have claims at face value [U.S. dollars], measured on the date of the bankruptcy filing. It will be interesting to see how that rule is applied in this unique setting, Besikof said in an interview.

Imagine a hypothetical account holder who has $1 million worth of bitcoin on the bankruptcy date of his or her exchange, Besikof suggested. In this example, if bitcoin goes down, the recoveries on the claim are likely to go down as well. But if bitcoin doubles, would that creditor have a claim now worth $2 million? Could he or she recover more than $1 million?

It is the courts that must decide, said Besikof.

“I could see exchanges arguing that the account holder’s recovery is limited to $1 million, even though the exchange is flush with cash and crypto assets from the price increases,” he said. “That argument would create a potential windfall for equity holders, but would be highly detrimental to account holders. This concern could be alleviated if the plan provided for the return of some or all of the customer’s crypto.”

The situation is somewhat analogous to certain oil and gas companies that signed up at the bottom of that market, only to become solvent later in the case as oil prices rose, Besikof said. “However, in these cases the creditors were actually paid in full – the value of what they owed did not also increase with the price of oil.”

It is worth highlighting ongoing legal disputes involving cryptocurrency firms, such as the now infamous customer losses associated with the collapsed exchange Mt. Gox, which entered bankruptcy proceedings in Japan in 2014.

A decision on the legal status of the ownership of cryptoassets – approximately 200,000 BTC held by Mt. Gox bankruptcy estate which continued to increase in value until it eventually took over the total legal claim value of all creditors – may have been helpful. But the court addressed the case by moving to civil rehabilitation, a type of procedure in Japan that bears some resemblance to US Chapter 11 restructuring, where a debtor retains the power to continue managing its business.

That said, Mt. Gox is really just an indication of how things have developed within the slow-moving jurisdiction of Japan, and does not give a clear indication of what will happen under the U.S. bankruptcy code, noted Thomas Braziel, the founder of 507 Capital, a firm that has bought Mt. Gox bankruptcy claims.

“The problem with talking about past cases is that it’s not U.S. bankruptcy law, or even U.S. law at all,” Braziel said in an interview. “So while it’s certainly interesting, I don’t think the U.S. Bankruptcy Court is going to consider this property that’s not real estate, and it’s all held in trust.”

The terms attached to Celsius’ escrow wallets, which were solely for storage and paid no interest, seem to suggest that the firm should return this property to these customers, but these assets make up only 4% of the outstanding pie (about $180 million) . at today’s prices). The rest of the assets are locked up in Celsius’ high-yielding Earn program. According to the company’s terms and conditions, customers who choose to use this service will “grant to Celsius all right and title to such digital assets, which Celsius may use in its sole discretion while using the Earn Service.”

However, these Terms of Use are not the end point in a case like this; they’re more like the starting point, Braziel noted. “There are tons of contractual terms that are totally unenforceable in bankruptcy court, let alone any court,” he said. “And if the firm didn’t follow the rules within a given jurisdiction where something was offered, then the terms of service don’t even apply.”

Just one of the cans of worms to be opened further into the bankruptcy proceedings concerns the non-accredited investors (basically mom-and-pop investors) who were brought into the Earn program by Celsius when the firm was under investigation by state regulators, but who actually wanted felt at home in the wallet if they stayed on the platform.

“There are different pockets that are very interesting,” Braziel said. “The guys who got grandfathered should probably form an ad hoc group; basically a group of people with common interests who like an argument enough to pay the bill themselves.”

Some of these issues may well become relevant, or at least secondary, if stakeholders can find the right conceptual framework for a reorganization plan that works for customers, Proskauers Indelicato said.

Bankruptcy cases often become a tug-of-war between groups of stakeholders who may turn out to be the customers and shareholders in this case, Indelicato noted. These parties will focus on who gets the biggest piece of the pie, and how you measure a piece of that pie, he said.

“If you are a shareholder, you may want to argue that the crypto assets should be frozen and valued at the time of filing, not as they value over the life of the case – assuming we see market growth on cryptocurrency prices.”

An increase in the value of the crypto market, should it happen as the case rumbles on, would be a major driver for Celsius customers, who already have convictions in the technology and may also want to avoid taxes and other unintended consequences of withdrawals, Indelicato said.

“This is very uncharted territory, and because of that, I think the conventional toolbox and rule set is really being thrown out the window,” Indelicato said. “Just take the playbook and tear it up. For these reasons, the Celsius and Voyager Digital cases will require innovation, creativity and people who can think outside the box.”