Surviving the Crypto Winter: Tips for Limiting Counterparty Risk – Insolvency/Bankruptcy
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As crypto markets decline, companies in the crypto industry face real risks of failure. Everyone in the industry thinks, or should think, about counterparty risk. Much has been focused on how crypto users can protect themselves (i.e. “not your keys, not your crypto”), but less on guidance to help crypto businesses protect themselves. If you work with companies in the crypto space, here are some handy tips:
- Act now to protect yourself from clawbacks. If your business is paid for goods or services, you should consider taking steps to protect yourself while you’re still getting paid. If the company that pays you later files for bankruptcy, payments you received within 90 days of bankruptcy, or even longer in some cases, could be clawed back unless you take steps to protect yourself. A “preferential” lawsuit brought by the bankruptcy estate generally seeks reimbursement of payments made by a bankrupt business within 90 days of filing for bankruptcy.
There are several ways to protect against a future preference lawsuit; here are some of the best protections:
- Look up payment terms in advance (CIA): Advance payments are not subject to cancellation as preferences. If you are concerned about a company’s financial situation, request advance payment before providing goods or services.
- Consider Contemporary or COD. Payments:These payments are also not subject to cancellation as preferences. However, if there is a significant gap between the time the goods or services were provided and the date of payment, this defense may not be available.
- Ask for security: Secured creditors are often protected from preferential lawsuits. However, it is often difficult or commercially impossible to obtain security over the assets of crypto companies. Additionally, any privilege granted during the preference period may itself be a preferential transfer, so the sooner you act, the better.
- A letter of credit is a form of guarantee that can provide strong protection against a claim of preference, even if it is never used. To provide meaningful protection, the letter of credit must include a number of special provisions relating to drawing conditions, expiration and renewal. You should therefore consult an attorney if you are relying on a letter of credit for payment or preference protection.
If you have received a payment from a company that has filed for bankruptcy or are concerned about filing soon, and you do not have any of these protections, several other defenses may still apply to a claim of preference. . You should consult a lawyer if you have any concerns about large payments you receive from a business in financial difficulty.
Payments made by a guarantor, affiliate or other third party are not preferences. However, if the third party declares bankruptcy, the payments could be recovered under a different legal theory, potentially with a lookback period much longer than 90 days. If you notice that the wire transfers or checks you receive are from someone other than the crypto company with which you have a contract or do business, you should consult an attorney to determine whether you can and should take steps to protect yourself with respect to these payments. You should also consult a lawyer if payments are made under suspicious circumstances.
- Examine long-term contracts. Long-term contracts present unique risks in bankruptcy because the Bankruptcy Code gives the debtor special powers with respect to pre-petition enforceable contracts (contracts the substantial performance of which is still due and payable by both parties at contract). Many standard service contracts are considered enforceable contracts.
- Once the business has filed for bankruptcy, the bankruptcy code’s automatic stay generally prevents a contract counterparty from terminating an unexpired contract or lease. The debtor, on the other hand, has several options and usually has a considerable amount of time to decide what to do with the contract. The debtor can:
- Refuse the contract. The refusal will excuse any new execution by the service provider. The service provider will be left with a general unsecured claim for most pre-bankruptcy services provided to the debtor and for damages resulting from the early termination of the contract. In many cases, general unsecured creditors are paid pennies on the dollar, or worse. And to add insult to injury, a party to a rejected contract could also face preferential litigation for payments made within 90 days of bankruptcy.
- Assume the contract. The debtor may seek to assume the contract or lease, but must remedy all monetary defaults and provide adequate assurance of future performance. If the contract is assumed (usually because it is cheaply priced or the debtor cannot find an acceptable replacement service provider), the service provider may well be compensated. Supporting a contract also generally prevents a claim of preference from being asserted against the service provider at a later date.
If it would present a substantial problem for your business if a counterparty were to declare bankruptcy and exercise one of these options, consult a lawyer to find out what you could do to avoid the problem before it happens.
- Additional Considerations for Suppliers of Hardware and Other Goods. Physical goods, such as mining processors or other hardware, are treated the same as services in many respects, but have additional considerations.
- Adequate insurance (Uniform Commercial Code (UCC) §2-609). If you are a seller of goods to a crypto firm and you have reasonable grounds for insecurity about the crypto firm’s ability to pay you, in some cases you may require adequate assurance of performance before proceeding. to ship other goods. If the buyer does not provide you with insurance, the contract may be deemed terminated.
- Recovery (UCC §2-702). A seller of goods generally has the right to collect goods delivered to an insolvent buyer (usually within 10 days under most state laws) and may also stop goods in transit.
- If the crypto firm files for bankruptcy, the Bankruptcy Code extends the seller’s right to reclaim the delivered goods within 45 days, but this right is “subject to any prior rights of a security holder in such goods or the product thereof”. Therefore, in the event of bankruptcy, the strength of your claim rights will depend on whether the buyer has granted a lien on its assets to a lender or other secured party.
- The Bankruptcy Code also grants suppliers an administrative priority claim for the value of goods that the debtor receives within 20 days of filing for bankruptcy. However, in many cases of bankruptcy, even administrative priority claims may remain unpaid. , and so the value of that right will depend on the facts and circumstances of the case.
Diligence is rewarded when dealing with a distressed counterparty. If you have concerns about the financial situation of your counterparties:
- Pay attention to the warning signs of distress. Look for bad press, slow or partial payments, third-party payments, and other warning signs.
- Do not hesitate to exercise your contractual and UCC rights before bankruptcy.
- Look for protection against preference claims – there’s nothing wrong with demanding advance payments, if any.
If you have significant exposure to a crypto firm that is or may be in trouble, you should consult your lawyers now to find out how best to protect yourself.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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