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07 February 2020
Otonomos BCC Pte Ltd is one of the first technology companies specialising in blockchain technology to be wound up by the Singapore courts. It was a leader in the field of blockchain technology which provided a legally compliant corporate governance platform powered by smart contracts and used blockchain technology to enable the automation of companies' corporate governance.
The liquidators dealt with numerous issues, including realising the cryptocurrencies and other assets owned by Otonomos and fluctuations in the cryptocurrency's value.
As there are likely to be more insolvency and restructuring cases dealing with cryptocurrency in the near future, this article examines:
It is important to determine the legal nature of cryptocurrency in the insolvency and restructuring sphere, as it affects the court orders required in avoidance actions.
Implications in avoidance actions
An avoidance action may be sought where there has been a transaction at undervalue.(1) The Singapore courts will then "make such order as it thinks fit for restoring the position to what it would have been if that individual had not entered into that transaction".(2)
If cryptocurrencies were property, the analysis would be no different from how avoidance actions are decided today. The counterparty would have to either return the debtor the value of the tokens at the date of the transaction or the exact number of tokens it had obtained in the transaction, depending on which position would have been better had the individual not entered into the transaction.
However, if cryptocurrency were currency, the counterparty would need only to return to the debtor the exact number of tokens that it obtained in the transaction.
At present, the judicial view on the legal nature of cryptocurrency varies among jurisdictions. Some jurisdictions, including Singapore, have held that cryptocurrencies have the characteristics of property. Other courts, including the European Court of Justice (ECJ) and courts in the United States, have held that cryptocurrency is a currency.
Singapore recognises cryptocurrencies as property
National Provincial Bank v Ainsworth sets out the classic definition of 'property' as follows:
[I]t must be definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability.(3)
In B2C2 v Quoine Pte Ltd, the Singapore International Commercial Court recently held that cryptocurrencies met all of these requirements and accepted that cryptocurrencies could constitute trust property.(4)
In that case, B2C2 had sought the remedy of specific performance such that Quoine should deliver up the number of bitcoin which it had wrongfully held onto from the cancellation of certain trades. The court did not grant specific performance, but rather ordered that B2C2's remedy lay only in damages.
In declining to grant specific performance, its two primary considerations were whether the person against whom the relief was being sought would suffer substantial hardship and whether damages would have been an adequate remedy. The court found that Quoine would suffer substantial hardship if required to deliver up the bitcoin. B2C2 were market leaders and would not have held on to the bitcoin as investments. In fact, their software had immediately began hedging proceeds by selling bitcoin, whereas specific performance would have required Quoine to deliver up bitcoin which at the time of trial had a price substantially higher than in April 2017 when the breaches occurred. The court rejected B2C2's argument that the damages were difficult to assess because of the volatility of the price of cryptocurrencies and were therefore not an adequate remedy. Instead, it held that "[c]ourts are accustomed to assess damages in relation to volatile assets and [cryptocurrencies] will be no different".(5)
Given that cryptocurrencies are considered property in jurisdictions such as Singapore, is it feasible to use cryptocurrencies as security? Certain companies, such as SALT Lending Holdings, Inc, allow blockchain asset holders to leverage their holdings as collateral for cash loans.(6)
The following section evaluates the feasibility of using cryptocurrencies as security in the form of a pledge, which is the most common form of security in Singapore.(7) As an alternative to pledges, the feasibility of placing charges over cryptocurrencies is also considered.
It would be difficult for a pledge to be created over cryptocurrencies. Under Singapore law, for a pledge to be perfected, the pledgee must reduce the property lawfully into their possession.(8) In the case of a traditional asset such as shares, physical possession of the shares can remain with the pledgor while the pledgee has exclusive control over the shares if the shares are deposited in a safe in the premises of the pledgor, but the keys to the safe are handed over to the pledgee, so long as the pledgee has an irrevocable licence to enter the premises and use the keys.
An analogous way to create a pledge over cryptocurrencies would be for the debtor to transfer the private key to the creditor or transfer the cryptocurrencies from their digital wallet to that of the creditor's digital wallet. However, these are unlikely to be palatable courses of action. A creditor would likely be unsatisfied with the mere sharing of the private key because it does not prevent the debtor from using the private key and transferring the cryptocurrency to a separate wallet.(9) Transferring cryptocurrency to a creditor's digital wallet would be undesirable to the debtor because it would result in them losing the economic benefit associated with the cryptocurrency. Further, concerns about the debtor's solvency and credibility would likely arise. It may be difficult for a debtor to recover cryptocurrency from the insolvent estate of its creditor.(10)
In his article "Taking security over bitcoins and other virtual currency", David Quest QC suggested that a possible solution would be for parties to use a third-party escrow agent to hold the cryptocurrency pursuant to a security agreement. The escrow agent would then transfer the cryptocurrency to the appropriate party based on the fulfilment of obligations under the security agreement. For this arrangement to become workable, parties would have to be willing to incur costs and be satisfied of the reliability of the escrow agent, especially because cryptocurrency-related escrow services have yet to be regulated.(11)
Given the difficulties with delivery of possession of cryptocurrency in order to perfect a pledge, would a charge be a more suitable method of giving security over cryptocurrency? In National Provincial and Union Bank of England v Charnley, Lord Justice Atkin defined a charge as follows:
[W]here in a transaction for value both parties evince an intention that property, existing or future, shall be made available as security for the payment of a debt, and that the creditor shall have a present right to have it made available, there is a charge, even though the present legal right which is contemplated can only be enforced at some future date, and though the creditor gets no legal right of property, either absolute or special, or any legal right to possession, but only gets a right to have the security made available by an order of the court. If chose conditions exist, I think there is a charge.(12)
If a charge is created over cryptocurrency, the private key would remain in the debtor's possession.
Nonetheless, difficulties also arise when giving security over cryptocurrency in the form of a charge. Without the actual transfer of the tokens to the creditor, it would be impossible for the creditor to enforce its security without court intervention if the debtor is uncooperative. Further, without any registration system, a debtor might use the same tokens to secure multiple loans with the various 'secured' creditors completely unaware. In Singapore, companies would not be required to register a charge over cryptocurrency unless it is a charge to secure an issue of debentures under Section 131(3)(a) of the Companies Act.(13)
In insolvency proceedings, insolvency practitioners must be able to determine which court has jurisdiction over an asset in order to realise it for the benefit of the debtor's estate. As previously mentioned, the jurisdiction of a cryptocurrency determines its legal nature, further affecting recovery.
One of the challenges which insolvency practitioners may face is determining which court has jurisdiction over a cryptocurrency in order to realise the asset. Many jurisdictions rely in part on the physical location of assets to determine if they have jurisdiction thereover.(14) The decentralised supply of and intangible nature of cryptocurrency mean that there are a variety of locations where a cryptocurrency could be physically located.
Possible options include:
Where cryptocurrency forms a substantial part of the assets of an insolvent company, the difficulty of ascertaining the location of assets further affects the jurisdiction of the insolvency practitioner. In identifying the jurisdiction in which insolvency proceedings should be carried out, traditional mechanisms such as the centre of main interests might not be so easily applied to companies with global assets, platforms, wallets and software. One good example is the spate of proceedings following the bankruptcy of MtGox concerning the issue of recognition.
Difficulty of clawing back cryptocurrency
Another challenge faced by insolvency practitioners in relation to a debtor's cryptocurrency is that it would be difficult to realise cryptocurrency from antecedent transactions which have been set aside. Even if an insolvency practitioner manages to obtain a court order to set aside an antecedent transaction involving cryptocurrency, it could be an uphill task to realise the benefit to the debtor's estate.
Volatility and fluctuation in value of cryptocurrency
The volatility and fluctuation in value of cryptocurrency can create challenges for insolvency practitioners, as illustrated by MtGox's insolvency. MtGox was one of the first exchanges for trading bitcoin. It was placed into bankruptcy proceedings in 2014 after a cyber-attack resulted in a theft of the bitcoins of 750,000 customers and almost all of its own bitcoins. MtGox lost approximately 7% of all available bitcoins at that time.
Due to fluctuations in the value of bitcoin, MtGox actually became solvent in the process of the bankruptcy. In 2016, when valuing Mt Gox's assets, the trustee had ultimately valued the bitcoins at their lower 2014 market price according to Japanese bankruptcy rules. Had the trustee valued them at their 2016 market price, he would then have been placed in the odd situation of handling the bankruptcy of a solvent company.
In 2018, in order to convert MtGox's assets into cash for distribution to creditors, the trustee sold 35,841 bitcoins for approximately $360 million. This enormous sale drove down the price of bitcoin and the trustee was heavily criticised for failing his duty to maximise the value of the debtor's assets on behalf of the creditors.
The novelty of cryptocurrency and lack of regulation have created significant challenges for insolvency practitioners that have to deal with these unique assets. It is hoped that in time, as cryptocurrency becomes more prevalent and case law develops, insolvency practitioners will have more clarity on how to overcome these challenges. It is likely that judicial decision making in Singapore will be guided by how insolvency proceedings relating to cryptocurrency are decided in other jurisdictions. The development of Singapore's case law relating to cryptocurrency in restructuring and insolvency proceedings is likely to take a pragmatic view, in line with the nation's vision of becoming a leading global financial centre.(15)
For further information on this topic please contact Tan Meiyen or Thenuga Vijakumar at Oon & Bazul LLP by telephone (+65 6223 3893) or email (email@example.com or firstname.lastname@example.org). The Oon & Bazul LLP website can be accessed at www.oonbazul.com.
(6) SALT Lending Holdings, Inc, "What is SALT", 6 March 2019, accessed on 6 September 2019. Available here.
(7) Thomson Reuters Practical Law. "Common forms of security and required formalities", 2019, accessed on 7 September 2019. Available here.
(9) INSOL International, "Cryptocurrency and its impact on insolvency and restructuring", May 2019, accessed on 7 September 2019. Available here at p 27.
(15) Monetary Authority of Singapore, "Development", 6 September 2019, accessed on 8 September 2019. Available here.
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