Due to its novelty and highly volatile nature, cryptocurrency raises a number of issues when it comes to bankruptcy litigations. To a recent poll conducted by INSOL International, only some 5% of insolvency practitioners answered that they had a “comprehensive or practical/working understanding” of cryptocurrency.

This might come as good news for those who face forceful liquidations, as the ignorance of court trustees, could keep their cryptoassets from becoming a target at an inauspicious time. The reverse side of the coin is an increased difficulty in using your crypto assets as collateral or inaccurately estimating your solvency as a crypto owner.

Before going into some of the options available to crypto owners who face bankruptcy, we should focus a little on the issues this new form of virtual currency poses upon the legal system.

Legally Speaking, What Is Crypto?

There is no legal consensus on whether crypto should be treated as a currency, commodity, or anything in between, with courts deciding upon a status on a case by case basis.

In the U.S. District Court for the Eastern District of New York, Judge Jack Weinstein ruled in 2018 that virtual currencies are to be considered commodities and subject to the Commodity Exchange Act. His argument was that cryptocurrencies are not issued by governments and vendors are not required to accept these as payment.

For the purposes of a 2013 Texas criminal trial which involved the use of Bitcoin in a Ponzi-scheme, the virtual tender was considered regular currency, on account of acting as such despite lacking the political status.

In some instances where cryptocurrency was involved in bankruptcy litigations, judges chose to rule it as a “general intangible”, giving the creditor a security interest over the debtor’s crypto assets but abstaining from including it into any of the above categories.

Why Are These Distinctions Important?

During bankruptcy proceedings, the currency is valued based on what it was worth historically at the moment when the agreement between debtor and creditor was made. Meaning that if you used one bitcoin to secure a loan back in 2018, you would still owe your creditor around $12,000.

Meanwhile, the value for commodities can be taken either historically inaccurately or currently, with the creditor being entitled to benefit from any potential appreciation, while also protected from any decrease in the price of the security.

There is no easier way to put it, but as long as crypto has been defined as part of your estate, any form of liquidation you might be engaged in is designed to favor the creditor. The last thing you could do is argue that crypto is treated as actual currency so that the opposite party can’t take more than it is owed.

Chapter 11 Can Save Your Crypto From Liquidation

As opposed to the more dramatic Chapter 7 form of bankruptcy which involves selling your assets to payout loans, Chapter 11 only deals with reorganizing payments over subject under court supervision. This is mostly seen as a solution for companies to stay afloat, but it can also be undertaken by private individuals with significant assets.

Once the process is underway, creditors are forbidden to enact any measures for recouping their debts outside what has mutually been agreed upon in court. This is often used by small entrepreneurs who want to avoid losing their houses or other real property, but it can just as well keep creditor’s hands away from your crypto wallet.

In the vast majority of cases, no court trustee is appointed to govern over a day to day business operations and re-payment of debts, with this duty falling upon the owner as a “debtor-in-possession”.

Other Useful Features of Chapter 11

After the initial filing with your local bankruptcy court, the next step of Chapter 11 consists of detailing your financial situation with both the authorities and creditors through a disclosure agreement. Since cryptocurrency is mostly unregistered, Bitcoin enthusiasts might ponder here on whether to come forward with *all* of their assets.

Some might prefer their privacy, but declaring your crypto to a bankruptcy court could prove advantageous along the way. Under the provisions of Chapter 11, you are entitled to take favorable loans that would help the business back to its feet, and any additional assets can improve your image to potential lenders.

The most important step of Chapter 11 is formulating a plan with all the changes you wish to enact for better debt management, and getting it approved by all the other parties involved. Courts favor restructuring proposals that are very detailed and precise, so the volatile nature of cryptocurrency will make it a poor candidate for inclusion as an economic asset. However, crypto might still be sold at your own leisure if not included in a court provision, which is done on a case by case basis.

About the author:

Kevin S. Neiman, the principal attorney and President of the Denver, CO-based the Law Offices of Kevin S. Neiman, pc, successfully represented the firm’s clients in areas of the law such as bankruptcy and commercial litigation, appeals of bankruptcy matters, and other areas such as dispute resolution, asset planning, and judgment collection. Bankruptcy is not an easy decision to make and therefore, Kevin takes a genuine and caring approach to help solve all of his clients’ legal problems.