On November 11, 2022, FTX and certain of its affiliates filed for bankruptcy in Delaware in one of the highest profile cryptocurrency bankruptcy cases ever, leaving an estimated 1 million customers and other investors facing total losses in the billions of dollars. The crypto exchange is said to owe its 50 largest creditors alone nearly $3.1 billion. Meanwhile, the Royal Bahamas Police Force in the Bahamas, where FTX is based, is investigating whether any criminal misconduct took place in relation to the company's implosion.

Practical Law asked Dennis O'Donnell, Stuart Brown, and Noah Schottenstein of DLA Piper to share their views on the implications of the FTX bankruptcy and how the FTX bankruptcy is unique from the other cryptocurrency bankruptcies that have filed in recent months. Dennis O'Donnell is part of DLA Piper's US Restructuring practice and a nationally recognized partner in their New York office. Stuart Brown is part of DLA Piper's US Restructuring practice and a nationally recognized partner in their Wilmington, DE office. Noah Schottenstein is a senior associate in DLA Piper's US Restructuring practice in the Dallas office. Combined, the DLA Piper restructuring team has more than 85 years of experience representing secured and unsecured creditors, debtors, equity holders, purchasers of distressed assets, and other parties in interest in a wide range of restructuring matters, including cases under Chapter 11, out-of-court workouts, and cross-border insolvency proceedings.

For more information on cryptocurrency Chapter 11 proceedings, see Practice Note, Crypto Chapter 11 Proceedings: Overview.

The crypto markets were rocked on November 11, 2022, by the collapse and bankruptcy of FTX and Alameda Research in the US and the institution of liquidation proceedings over FTX Digital Marketing in the Bahamas. Within a few short days, Sam Bankman-Fried (SBF) and his companies went from an industry leader and an apparently stabilizing force for the crypto markets, to being the cause one of the greatest disruptions in digital asset market history.

The destabilization of FTX began in October 2022 and stemmed from leaked FTX and Alameda Research financial data. On November 2, 2022, Coindesk published an article reporting that approximately $5.8 billion of Alameda Research's $14.6 billion balance sheet consisted of FTT Tokens (the native token issued by FTX). On November 8, 2022, FTX announced that it was suffering a liquidity crisis and was unable to meet withdrawal requests, something that should not have been the case as, according to FTX's terms of service, users retained title to and control over digital assets, including users' e-currency, on the FTX platform.

On November 10, 2022, the Wall Street Journal reported that FTX transferred approximately $10 billion to Alameda Research. At the same time, Binance, the world's largest cryptocurrency platform, was making public comments first about its intent to purchase FTX to save it, then its intent to liquidate its FTT holdings, then its conclusions that FTX had too many regulatory and financial problems for Binance to move forward with the purchase. Within 24 hours, regulators around the globe announced actions against the FTX operating entities within their jurisdictions. Finally, on November 11, 2022, FTX and Alameda Research, along with their affiliated companies (FTX Debtors), filed Chapter 11 bankruptcy cases in Delaware (Lead Case No. 22-11068), which have been assigned to US Bankruptcy Judge John T. Dorsey.

Also on November 11, an independent restructuring professional, John J. Ray III, who led the recovery efforts in many notable cases, including the Enron bankruptcy, was appointed as CEO and CRO for all FTX Debtors. Since his appointment, Mr. Ray has assembled an independent team of professionals, stabilized the FTX workforce, and has been working to secure FTX assets wherever they are located, identify or recreate reliable books and records, assemble the information necessary for the bankruptcy court, and respond to numerous inquiries from multiple regulators and government authorities. In his First Day Declaration that was filed in the bankruptcy case on November 17, 2022 (as supplemented by a Supplemental Declaration on November 21, 2022, and together, the First Day Declaration), Mr. Ray states that "never in [his] career ha[d] he seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information" as in this case.

When a debtor commences a Chapter 11 bankruptcy, the debtor typically files an array of pleadings which, among other things, explain why the debtor filed for bankruptcy and its goals for the case, seek authority for the company to finance and operate the debtor's business on an interim basis, and list the debtor's top 20 or 30 unsecured creditors. For more on first day pleadings, see Practice Note, First Day Motions: Overview.

Then, the US Trustee, an officer of the US Department of Justice responsible for overseeing the administration of the federal bankruptcy system, uses that information to form a creditors' committee. The creditors' committee serves as a fiduciary for all unsecured creditors in the case, including customers. The committee participates in the case and represents the interests of all unsecured creditors. The US Trustee is currently in the process of soliciting interest from creditors to serve on the creditors' committee. If formed in the FTX case, the creditors' committee is then likely to include, as it did in the Voyager and Celsius cases, several FTX customers, as well as be representative of the four Silos of the FTX businesses, discussed below. For more information on the role of Chapter 11 creditors' committees, see Practice Note, Chapter 11 Creditors' Committees.

As of the date of publication, the FTX Debtors have filed the First Day Declaration and have procedural motions to consolidate all FTX's 102 related cases, to modify filings requirements for creditor disclosures, and to allow service by email. The FTX Debtors have confirmed that unauthorized transactions from FTX occurred and that the remaining crypto assets were transferred into cold storage. They have additionally confirmed that representatives of the FTX Debtors have been in contact with the US Attorney's Office, the SEC, the CFTC and dozens of other federal, state and international regulatory agencies.

The First Day Declaration described the CEO's five core objectives for the future:

The First Day Declaration also included a framework for the corporate organization of the FTX Debtors, and aggregated them into the following four silos:

Each of the Silos was controlled by SBF with minority interests held by SBF's co-founders. The WRS Silo and the Dotcom Silo also have third party equity investors, including investment funds, endowments, sovereign wealth funds, and families. In the First Day Declaration, the CEO states his belief that "no single investor other than the co-founders owns more than 2% of the equity of any Silo." The First Day Declaration also provides that the most recent unaudited balance sheets (that the CEO is not confident are correct because they were produced while the FTX Debtors were controlled by SBF) show for each of the Silos and related Debtor entities (some of which the CEO preliminarily estimates may be solvent):

The following new independent directors have been appointed as directors of the primary companies in the FTX Group to provide corporate governance:

Other developments since the bankruptcy filing include:

On November 23, 2022, the Wall Street Journal reported that during a bankruptcy court hearing, the FTX Debtors' attorneys stated that a "substantial amount" of assets are either missing or stolen (see FTX Debtors' First Day Hearing Presentation, November 22, 2022). Also on November 23, 2022, the Delaware Bankruptcy Court entered several interim first day orders, including an interim order authorizing the FTX Debtors to pay prepetition and ongoing compensation and benefits, pay certain critical vendors, and operate a postpetition cash management system. The Bankruptcy Court is to receive additional pleadings on maintaining the list of creditors sealed and a hearing is to follow on December 17, 2022.

The more constituents involved in a bankruptcy case, generally the more complex it becomes to get all the constituents aligned and to make the best of the situation for all constituents. Some of the factors that add complexity to this case include:

Given the lack of transparency before the chapter 11 filing from the FTX Debtors, it is challenging to evaluate next steps for the FTX Debtors and the impact of the bankruptcy case on its customers and other unsecured creditors. A Chapter 11 debtor that has a viable plan of reorganization generally can build support from creditors and conclude the Chapter 11 process within 6 to 12 months or even more quickly, which preserves significant value for all stakeholders. For more information on the Chapter 11 plan process, see Practice Note, Chapter 11 Plan Process: Overview.

However, under the current circumstances, a sale of the FTX's remaining assets appears more likely and an expeditious and well-organized liquidation proceeding may also yield potential meaningful recoveries for customers and unsecured creditors (see Practice Note, Buying Assets Under a Chapter 11 Plan). It is said that the FTX platform was investor grade and may have intrinsic value to other parties in the market. This type of sale is likely to be followed by efforts to undo prior FTX transactions or otherwise claw back funds and assets for the benefit of customers and unsecured creditors (see Practice Notes, Fraudulent Conveyances in Bankruptcy: Overview and Preferential Transfers: Overview and Strategies for Lenders and Other Creditors).

Consider the example of MF Global, which entered bankruptcy in similar circumstances to the FTX Debtors. MF Global was a large, multinational commodities brokerage firm that was supposed to have held customer funds in custodial accounts in which customers retained title. MF Global was not allowed to use customer funds for proprietary purposes. In 2011, the company suffered unexpected losses at its proprietary trading desk, which gave rise to a cycle of customer withdrawals and margin calls that overwhelmed the company in a matter of days. On the way down, however, the company misappropriated customer funds to attempt to cover certain of the losses at its proprietary trading desk.

On October 31, 2011, MF Global filed for bankruptcy with a $6.7 billion shortfall. A trustee was quickly appointed to recover customer funds and liquidate assets. By April 2014, the trustee announced that customers were to be made 100% whole. Similar scenarios have played out in the Refco, Lehman, and Madoff bankruptcies, where long-term efforts to recover creditor value that appeared gone forever at the outset of bankruptcy have proven more successful than anticipated.

Although FTX and MF Global have similar stories, there are key differences that prevent a direct comparison at this stage of the FTX cases. Unlike MF Global and its more traditional commodities trading business, there are substantial legal uncertainties concerning decentralization and property rights in crypto holdings and the application of regulatory schemes to the FTX Debtors' businesses. Efforts are currently under way in the Celsius and Voyager Digital bankruptcy cases to address certain of these uncertainties, but certainty, both as a general matter and as specifically applicable to the facts of the FTX cases, is not likely to be achieved any time soon.

There are also many factual questions about how the FTX Debtors were run that are currently only the subject of speculation, especially concerning the apparent hacks on the eve of bankruptcy that resulted in an additional $300 million to $500 million in cryptocurrency being lost. Further factual investigation and legal developments are likely necessary. At this point, however, customers should not lose hope. Although much depends on how those legal and factual questions are resolved, the stories of MF Global, Refco, and other similar cases provide examples of creditors being made whole, even after suffering multibillion-dollar losses.

A vast array of US and international civil and criminal regulators have already begun investigating the FTX entities, including the US Commodity Futures Trading Commission, the US Attorneys' Office for the Southern District of New York, the US Securities and Exchange Commission, and Congress. Other regulators are likely to investigate as well. Significantly, these regulators are not bound by the automatic stay and have enormous power to search for, freeze, and seize assets. Several regulators have already acted to freeze FTX's operations in their respective countries. With a likely limited pool of assets, FTX customers should act quickly to evaluate how these regulators may impact customer recoveries and the potential outcomes for the FTX Debtors' bankruptcy proceedings.

For more information on the police and regulatory exception to the automatic stay, see Practice Note, Understanding the Police and Regulatory Exception to the Automatic Stay.

On November 10, 2022, the Securities Commission of the Bahamas obtained a court order placing FTX Digital Markets Ltd. into liquidation proceedings and appointed joint provisional liquidators to administer the assets of that company. FTX Digital Markets was not an entity that filed for bankruptcy in Delaware. On November 15, 2022, the provisional liquidators filed a petition in the US Bankruptcy Court for the Southern District of New York (Case No. 22-11516) for recognition of the Bahamas liquidation proceeding as the foreign main proceeding, which has been assigned to Judge Michael E. Wiles. On November 17, the FTX Debtors filed an emergency motion to transfer the Chapter 15 petition relating to FTX Digital Markets that was filed in the Southern District of New York to Delaware and for a stay of the Chapter 15 case until their emergency motion is heard. The pleadings filed by the provisional liquidators suggest a potentially adversarial relationship with the US FTX Debtors, but the provisional liquidators have announced to the Delaware Bankruptcy Court their intent to cooperate on the development of joint protocols so that the two proceedings can be coordinated to some extent. Customers should act quickly to assess how these developments may impact their claims and what strategies may be employed to safeguard their property and help maximize their recoveries.

For more information on Chapter 15 cases, see Practice Note, Chapter 15 Overview: US Bankruptcy Cases Ancillary to Foreign Proceedings.