The current economic news presents a bleak picture. Whilst Covid lockdowns have eased, businesses and consumers now face inflation levels not seen in a generation as well as rising interest rates.
All businesses will be impacted by reduced consumer spending power and higher energy costs. Given this, it is not surprising that recent statistics report that insolvencies are up by 13 per cent in three months, and are 81 per cent higher than the same period last year. There is a risk that this trend will not reverse any time soon.
For Insolvency practitioners (“IPs”), this is likely to be a busy time of taking new appointments and investigating potential recovery actions to realise assets for creditors.
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In addition to this increased workflow, one emerging trend is the presence of crypto assets as being either an asset in the insolvency that requires realisation, or being appointed over a business that engaged in crypto trading or market-making, such as a defunct crypto exchange.
There have been a number of recent cases where it has been established that a cryptocurrency is deemed to be a recoverable asset within the insolvent estate and that it can be traced, secured and realised like any other intangible asset. Cryptocurrencies do however give rise to a number of novel issues for IPs, including how to access the private key of a relevant wallet, and turning the asset into money that can be returned to creditors, given they are notoriously volatile and can trade in illiquid markets.
It is clear however that with a market capitalisation In the hundreds of billions of pounds, cryptocurrencies as an asset class are here to stay. The size of the market, and the size of potential insolvencies, has recently been underscored by a number of crypto companies and funds of size going into an insolvency process.
For example, Three Arrows Capital (“3AC”), a Singapore-based hedge fund dealing predominantly in cryptocurrency trading, collapsed in June 2022 after defaulting on a $670m loan to cryptocurrency broker Voyager Digital. 3AC has an estimated outstanding creditor balance of US$3 billion, and Teneo in the BVI have been appointed as liquidators.
The recovery action will be long and complex with the focus not only on realising remaining crypto assets, but likely investigating former officeholders and potentially bringing claims for monetary compensation.
In that sense, whilst caused by the volatility of the crypto market (and the use of excessive leverage), the insolvency is likely to run a similar course to the collapse of any other financial institution.
Indeed, the likelihood of recovery of crypto assets may in fact be higher than in traditional insolvencies, as the developing case law means it’s now possible to pursue crypto exchanges for defrauded sums, rather than having to locate a fraudster and trace the assets.
For IP’s, capital will be required to investigate potential legal claims then pursue those that are meritorious. Claims against negligent or fraudulent directors and third parties, as well as the freezing and recovery of dissipated crypto assets, are likely starting points. Whilst IP’s could fund this work on risk, or creditors could pay for it, neither option is particularly attractive. But third party funding for the litigation might be a route to explore.
IP’s have long had access to litigation finance to assist with litigation. As a recap, litigation finance is available to provide the funds to pay for lawyers and the IP’s themselves to investigate and enforce meritorious claims.
A funder will also take on the risk of any adverse costs, i.e. the costs of the other side which may be payable by the insolvent estate if the case is unsuccessful.
If the case loses, the funder loses its investment, and the IP or insolvent estate pays nothing. If the claim wins, the funder receives a pre-determined share of the recovery proceeds, approved by the creditors prior to the commencement of any funding arrangement.
Funding is available on both an individual case level and also on a portfolio or group of cases. Portfolio funding is available where an insolvency practitioner may have a number of similar claims, such as against the same crypto exchange. Grouping these claims usually allows a litigation funder to spread the risk of funding, enabling the relevant insolvent estates to keep a greater share of any recoveries as spread risk usually means lower pricing.
There is also the option of a funding facility for the insolvency firm. This provides funds to progress their work on cases, and can also include working capital for things like additional staff and technology that can be put to work on contentious cases.
This could be particularly useful in hiring new staff with the relevant technical expertise to undertake the exercise of realising crypto assets and understanding the operation of this market.
When engaging a litigation funder in any scenario, let alone an insolvency, it is important to determine that a defendant has the ability to satisfy any judgment against it. Historically this will be traditional assets like shares, cash or real estate. So long as the IP and legal team have identified crypto (and other more traditional) assets and have a strategy to identify, recover and monetise those assets, the case will be amenable to funding.
This is an exciting and emerging area. IPs that are well versed in how cryptocurrencies operate and can be recovered and converted to cash will be in strong demand. Litigation funding will also be important to provide the necessary capital to finance these actions.