Virtual assets and insolvency – A practical overview from the Cayman Islands
It is almost impossible to avoid the noise surrounding virtual assets in recent years. Therefore, it is inevitable that Cayman Islands insolvency practitioners (IPs) will have to grapple with the concept as they become a more prevalent asset class. The purpose of this article is to provide a high level overview of some key considerations for IPs to bear in mind as they seek to realise value in an estate with a virtual element.
One could be forgiven for seeing the liquidators’ toolbox as being inadequate when it comes to ‘getting in’ virtual assets. The reality, however, is that the same options that would be deployed in a conventional liquidation are likely to be very valuable in the context of virtual assets too. For example, a liquidator can require certain persons to prepare and submit a statement as to the affairs of the company – these persons include past and present directors and officers, past and present professional service providers and past (within one year preceding the commencement of the winding up) and present employees. It appears likely that the statement of affairs could be amended to request private keys or other information relevant to quantifying, accessing and controlling virtual assets.
Official liquidators’ power to privately examine relevant persons can be buttressed by order of the court, including in relation to relevant persons outside of the jurisdiction, and where necessary by formal procedures for judicial co-operation between countries. Where, for example, an individual has in their possession documents or property to which the company appears to be entitled, a court can order the individual to hand over those documents or that property.
A common characteristic of virtual assets is that the apparatus creating and supporting their existence and use is truly global in nature, particularly virtual assets are held on any one of a number of international virtual asset exchanges. For that reason, there will likely be cross-border considerations for liquidators to consider when exercising their functions. The options available to liquidators include letters of request, applications for recognition of foreign judgments, 1782 proceedings (if there is an exposure to the US) and Norwich Pharmacal orders.
Exchanging virtual assets into hard currency
In the context of a custodian virtual asset exchange, title to and control of the virtual asset rests with the exchange through its hot or cold wallets (meaning connected to the internet and not connected to the internet). The first issue liquidators will need to consider is whether the virtual asset is available for distribution among the general body of creditors or whether the asset is held on trust for individual account holders, in which case, the assets must be dealt with in accordance with the terms of the trust, ie governed by the relevant terms and conditions which form the contract between the customer and the platform. Where virtual assets are concerned, the liquidator’s fundamental duty remains unchanged, that being the duty to realise the assets in the most efficient way and so as to obtain the highest possible price for the assets. While a winding up should not be protracted, a liquidator can apply its good commercial judgement to postpone the sale of virtual assets until conditions are better. As a general example for virtual assets held privately, it may be better to postpone the sale of virtual assets pre-sold as part of a project or company’s initial capital raise until they are listed on a secondary virtual assets exchange (usually within a few months of the initial sale), or become directly exchangeable for more recognised and tradeable tokens through a token-swapping service. The courts tend to recognise that liquidators are often unable to obtain the same price as an ordinary seller. In any event, liquidators need the sanction of the court to sell any of the company’s property and sanction is also needed to deal with all questions in any way relating to or affecting the assets or the winding up of the company. The principles that apply to sanction applications are well-known.
Liquidators can also make distributions in specie, typically where the assets cannot be readily sold or realised, as may be the case when property is held on trust. In circumstances where there are expected to be more and more insolvencies connected with virtual assets, it is likely that courts will be amenable to requests for directions on how to deal with the assets.
JOLs’ functions and the proceeds of crime
On occasion, it will be necessary for liquidators to consider whether it is appropriate to make applications pursuant to proceeds of crime laws. The law governing proceeds of crime has not necessarily caught up with the language of virtual assets and so we operate on the assumption that, in all likelihood, clear jurisprudence will emerge which treats virtual assets unequivocally as property.
In much the same way that the stay of proceedings operates upon the making of a winding up order or the appointment of provisional liquidators, an application to recover property cannot be made without the leave of the court. Similarly, if a restraint order is in being over assets at the time a winding up order is made, a liquidator may not exercise its function over those assets. If a winding up order has been made or a resolution to voluntarily wind up has been passed, the court will not inhibit the function of the liquidator for the purpose of distributing property held by the company or to prevent payment of expenses, including liquidators’ fees. It should be noted, however, that it remains open to liquidators to apply for leave to make an application to vary or discharge restraint orders so as to enable them to deal with assets. In this regard, it can be useful to engage in dialogue with the investigating and prosecuting authorities.
There have been few fully argued decisions in the common law world considering the nature of virtual assets. The most recent was the decision of the New Zealand High Court in Ruscoe & Moore v Cryptopia, which found that virtual assets are property in the classic sense, and are capable of being the subject of a trust. Courts have also drawn from the influential paper from the UK Jurisdiction Taskforce.
It is clear that virtual assets pose some difficulties when it comes to conventional remedies, but it is expected that as time goes on, there will be more and more concrete examples of courts’ treatment of virtual assets in the context of insolvency.
One thing is certain, the next twelve months promise a fascinating interrogation of the concept of virtual assets in a liquidation context.
This article was originally published in INSOL World Q1 2021 and was co-authored by Kalo's Restructuring Director Yungdung Gurung.