Breaking down FTX’s bankruptcy: How it differs from other Chapter 11 cases

Collapsed crypto exchange FTX and 130 affiliates filed for bankruptcy in Delaware on Nov 11. Chaos followed as a number of FTX creditors, investors and industry experts began to question what would happen next. 

Laura Shin, crypto journalist, author and host of the Unchained Podcast, sent a tweet on Nov. 15 questioning whether the alleged inter-loan agreement between FTX and Alameda — the company’s venture capital arm — will affect creditors’ and customers’ ability to get back funds.

Could one big venture success out of FTX Ventures be a viable path to recovery for FTX creditors & customers? @wassielawyer and @ThomasBraziel think so, although that could take up to…10 years. full episode: https://t.co/xyHyTC59sw pic.twitter.com/DpDXg1oORK

— Laura Shin (@laurashin) November 15, 2022

Caitlin Long, founder of Custodia Bank — a Wyoming-based bank specializing in digital assets — tweeted that this would be the most complex bankruptcy in U.S. history.

I DON'T THINK IT'S AN UNDERSTATEMENT to predict that @FTX_Official Chapter 11 will be most complex bankruptcy in US history. No clear commercial law roadmap re:#crypto for the judge to follow. US bankruptcy law has "presumption against extraterritoriality." Every creditor doxxed pic.twitter.com/RFipf062RS

— Caitlin Long ⚡️ (@CaitlinLong_) November 11, 2022

According to Long, the international corporate structure of FTX will create complexities. This already appears to be the case, as Bahamian liquidators recently mentioned that their actions may impact the Chapter 11 case, according to Reuters. Moreover, on Nov. 14, FTX filed a document revealing that the exchange may have more than one million creditors involved in the bankruptcy case.

How the FTX bankruptcy differs

Given the complexities involved with the FTX bankruptcy, it’s become clear that this case will likely differ from other United States bankruptcy proceedings. Joseph Moldovan, chair of business solutions, restructuring and governance practices at Morrison Cohen — a New York-based law firm — told Cointelegraph that while there have been complex bankruptcy proceedings in the United States, the FTX Chapter 11 case is unique due to the unknowns. 

“What’s most unusual about the FTX bankruptcy is that the debtors are complex entities with significant amounts of debt. Normally, there are months and months of preparation. Corporate bankruptcies are usually very granular, choreographed and developed processes before they are filed,” he said, adding, “This is simply not the case with the FTX bankruptcy. We (creditors and other interested parties) are still waiting for the most basic information related to the 130 various entities that have filed.”

Moldovan added that while bankruptcies like Lehman Brothers and Enron have involved multiple billions of dollars in assets, debt and numerous affiliated entities, the amount of debt, assets and creditors associated with FTX remain unclear.

“What you normally have in a U.S. bankruptcy case that you don’t have here are first day hearings, in which the lead counsel for debtors walks the court and the public through why the case was filed. This gives a sense of what the long-term goal is and how it may be achieved. We have not yet had a first day hearing in the FTX case,” Moldova further remarked. As a result, Moldovan noted that FTX creditors and interested parties are still questioning outcomes:

“We simply don’t have adequate information to obtain answers yet.” 

One of the biggest questions that remains to be answered is whether FTX creditors get their money back and if so, when? Margaret Rosenfeld, a corporate securities lawyer, specializing in digital assets, told Cointelegraph that she believes it will take years before any FTX creditors receive a penny back. “This includes FTX customers and other parties FTX may have owed money to,” she said. 

Moldovan explained that it is not unusual for creditor recovery to take significant time. In the United States, bankruptcy cases claims of creditors have to be filed by a certain date set forth by the bankruptcy court.

“Once this date is set, a claims agent will take these forms, scan them, and separate the claims by cases. Each of these claims will then be compared with the company’s books and records,” Moldovan said.

Yet, due to the large number of creditors involved with FTX — potentially in excess of one million — along with no current visibility into the company’s bookkeeping practices, Moldovan believes that this process will take longer than normal:

“You can’t make creditor distributions until these claims are analyzed. It’s also way too early to speculate on what kind of distribution creditors will get back. Though in mega cases, such as this, full recovery would be unusual.”

In regard to creditors who took their money off FTX before the exchange collapsed, Rosenfeld explained that these funds can be clawed back, or voided, by a bankruptcy court. “U.S. bankruptcy rules state that money can be clawed back by the court, so don’t assume that money is yours. If a creditor was paid out 90 days before the bankruptcy, a trustee can ask for that money to be paid back,” she said.

While it may take years for FTX creditors to get their investments back, Moldovan also pointed out that the case will be expensive, which will likely result in smaller payouts for creditors. He explained that this is because the funds used to pay for a bankruptcy case come from a bankruptcy “estate,” which consists of all debtors’ property.

“The funds used to pay for all of the costs of the bankruptcy case and all of the professionals retained — lawyers, accountants, restructuring advisors, and others — come out of this estate, which therefore reduces the amount available for distribution,” he said.

Given this, on Nov. 14, FTX filed what is called a “matrix” motion. Normally, Chapter 11 debtors are required to file a matrix providing a mailing list of names and addresses of creditors or parties of interest involved in a bankruptcy case. Notices and other pleadings filed in the bankruptcy proceeding are then mailed to all of the individuals listed on the matrix.

Yet, Moldovan explained that in this case, the administrative costs of compliance “has to be modified in order to reduce estate costs.” Therefore, the debtors have asked the court to authorize email service and make some other accommodations. “The bankruptcy court has the flexibility and power to do this,” he added.

What’s next: The restructuring of a distressed company 

Although a number of unknowns remain in regard to the FTX bankruptcy case, it’s important to point out that John Ray, the new CEO of FTX, will be responsible for the restructuring of the company. 

Moldovan explained, “Jon Ray is the new chief restructuring officer, meaning he will lead the restructuring of the distressed company and has been delegated with all corporate powers and authorities, including the ability to appoint independent directors to assist in the governance of various entities, which he has already done.”

According to aforementioned court document filed on Nov. 14, Ray has identified some of these directors: former Federal district judge Joseph J. Farnan, Jr. will serve as the lead independent director, while FTX debtors have engaged Alvarez & Marsal as proposed financial advisers. The document further states, “The appointment of Mr. Ray and the independent directors ensures that the Debtors can navigate the chapter 11 process independent of any conflicts and involvement in FTX's prepetition activities.”

While details are yet to be revealed around the FTX Chapter 11 case, Moldovan further remarked that one of the benefits of the U.S. bankruptcy court system is the transparency it provides:

“Unless there is a need for secrecy, everything will be said in open court in which anyone can listen. All pleadings and other documents in the case will be filed within a publicly accessible website for any member of the general public to visit.”

How the U.S. Bankruptcy Court intends to handle a case involving digital assets also remains a concern, especially given the lack of regulatory clarity in the United States, along with regulators who may not be familiar with cryptocurrency. However, Moldovan has expressed optimism regarding the court’s ability to deal with the complexities of the crypto ecosystem.

He said, “Everyday in the United States, bankruptcy courts analyze, value, and determine ownership of esoteric assets, crypto being one. At the heart of all this analysis is basic contract law. What do the documents that create the assets, state rights of ownership, and set forth the respective rights and relationships of the parties to the contract actually say? This analysis is fundamental to the bankruptcy process.That the courts have not made certain determinations yet, merely reflects the novelty, meaning the newness, of the particular issues raised in a crypto bankruptcy. However, this will all be sorted out.”