By design or happenstance, giant crypto exchange Celsius, holding $3.8 billion worth of crypto assets and deposits and $6.7 billion liabilities, filed for US bankruptcy court relief under Bankruptcy Code, Chapter 11, rather than Chapter 7 or liquidation under the Securities Investor Protection Act of 1970 (“SIPA”).

The procedural and economic advantage of filing under Bankruptcy Code, Chapter 11 cannot be overstated. Chapter 11 of US Bankruptcy Code, having in mind the goal of providing a “fresh start,” largely leaves the control and administration of bankruptcy estate to the Debtor (post-petition, technically becoming a Debtor-in-possession). Post-petition, the Debtors-in-possession, rather than US Trustee or creditors, have “exclusive period” to propose a Chapter 11 plan.

Bankruptcy Code §1107 places the Debtor-in-possession in the position of a fiduciary, with the rights and powers of a Chapter 11 Trustee, to perform all but the investigative functions and duties of a Trustee.

Should Celsius trade as a SEC registered broker/dealer or a bank, it would be prohibited from filing a petition under Bankruptcy Code, Chapter 11.

Those considered “stockbrokers” (defined generally to include any securities broker), or commodities brokers are ineligible for relief under chapter 11 of the Bankruptcy Code. As a result, the alternative would be liquidation under either chapter 7 or SIPA.

Under SIPA (and Chapter 7), Celsius platform account depositors and users would be customers, with certain legally mandated protection in liquidation. A SIPA “customer” is any person who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral security, or for purposes of effecting transfer. The term also includes “any person who has deposited cash with the debtor for the purpose of purchasing securities.”

The question, therefore, arises as to the bankruptcy treatment of customers or account users’ crypto assets deposited. To start, good and persuasive legal arguments can be made on Uniform Commercial Code (“UCC”).

Under UCC Article 8, a “securities intermediary” is defined to include a “custodian” of a “financial asset” who otherwise meets the definition of a securities intermediary. The plain language of UCC §8-503(a) confirms the ownership interest of a customer whose crypto assets (as long as being treated or viewed as a “financial asset”) is held by an intermediary such as an exchange, if the exchange is a “securities intermediary,” has agreed with the customer to treat the cryptocurrency as a “financial asset,” and has credited the financial asset to a securities account. This customer ownership rule remains even if the securities intermediary holds the financial assets in fungible or commingled form.

Most recent, 2022 UCC Amendments include more explicit, workable rules for distributed ledger technology and virtual currencies, and add clarifications to certain provisions of Article 8 governing investment property—most notably in the context of the indirect holding system in which a securities intermediary and its customer may agree to treat various types of digital assets as “financial assets” under the Article.

Two countervailing forces, however, may push the Celsius (and similar crypto exchanges) bankruptcy reorganization case toward bailing-in the firm, and reducing customer’s crypto deposit claims to unsecured, general creditor claims.

First, the overarching legislative goal is to provide a “fresh start” or “reorganization” to bankruptcy firms, as Debtors-in-possession, providing, among others, self-governing power and “exclusive period” to propose a Chapter 11 plan. The bankruptcy estate gains better chance of a confirmable, administrable bankruptcy “reorganization” plan, by taking title and ownership interest of the crypto assets held.

Second, Celsius’ legal argument of deriving “intent of the contract by its plain meaning.” Presumably, the customers, when register and sign up to deposit cryptos with Celsius, electronically signed form contracts including transfer of title or ownership interest of the crypto assets. Though one may think the signing away of title or ownership interest of cryptos to the exchange platform conceptually and technically alien, a bankruptcy court, as a federal court sitting on a contract dispute, interprets substantive contract law question pursuant to the contract’s choice of law—in the case of Celsius, the governing New York contract law (as in many crypto exchange User Agreements).

Indeed, Celsius, in its most recent motion filings, argues that “under New York law, which governs the Latest Terms of Use, contracts are interpreted and enforced in accordance with their plain meaning and clear and unambiguous terms.” “The ultimate objective in interpreting an agreement is to determine ‘the intention of the parties as derived from the language employed.’ [citing] In re Lehman Bros. Holdings Inc., 439 B.R. 811, 825 (Bankr. SDNY 2010)”

As such, it further argues that the title and ownership of “Pure Custody Account crypto assets” as determined by the contract, the “Latest Terms of Use”, should remain with the customers, and “title and ownership of assets in the Earn Program and the Borrow Program are held by the Debtors.”

The argument presumably follows—to the extent their “title and ownership…are held by the Debtors (here, Celsius),” crypto assets held in the “Earn Program and the Borrow Program” would thereupon become part of Celsius bankruptcy estate, subject to Chapter 11 bankruptcy plan administration and claims in accord with claim and credit priority to be proposed by the Debtor-in-possession.