By Amy Castor and David Gerard
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The Celsius Network bankruptcy hearing on December 7 dealt with the Custody and Withhold accounts. Do they belong to Celsius as part of the debtor’s estate, or do they belong to the customers? [Agenda, PDF]
To spoil the ending for you: Judge Martin Glenn decided that if any assets clearly belong to individual creditors, then these should go back to them ASAP. But the details have to be worked out.
Celsius filed a motion in September asking the court to reopen withdrawals for certain Custody and Withhold customers — so that they could withdraw cryptos that were theirs and not the company’s. Phase I of this proceeding deals with any objections to the motion. [Doc 670, PDF]
Phase II looks at what the bankruptcy estate can claw back from customers. In a bankruptcy, the trustee or the debtor has the ability to demand the return of some payments in a 90-day period prior to the date the petition was filed. These are also referred to as “preference demands” or “clawbacks.” In Phase II, Celsius’ lawyers Kirkland & Ellis will have to decide whether they want to reach out and clawback 50,000 users who withdrew their funds in the 90 days before Celsius declared bankruptcy.
Phase I and Phase II are spelled out in the schedule, which the parties agreed to in October. [Scheduling, PDF]
Earn, Custody and Withhold accounts
Earn was Celsius’ main product. You put cryptos into Earn and you were paid interest.
Regulators were turning up the heat on Celsius. So on April 15, 2022 — just 89 days before the company filed for bankruptcy — Celsius launched Custody for US customers, replacing Earn. New customer deposits to Earn after this date went into Custody accounts. [Celsius blog, archive]
In nine states where Celsius could not legally offer Custody accounts, Earn deposits were moved to Withhold accounts. These Withhold accounts were just supposed to be Celsius holding the coins for customers to take out later. Earn deposits after April 15 in these states also went into a Withhold account.
Celsius didn’t consider Withhold to be a product as such, so it didn’t create terms of service for Withhold. This would become a problem in the bankruptcy.
As of September 2022, there were $220 million in Custody accounts and $15 million in Withhold accounts. About $44 million of this was “Pure Custody” and $702,000 was “Pure Withhold,” which means the funds had never been in an Earn account. [Doc 670, PDF, p. 13]
Compared to the billions of dollars that Celsius owes its creditors, these are paltry sums — but they’re important to the people who want their money back.
Custody, pure or not
There’s no dispute with respect to “pure” Custody account holders, whose cryptos never touched an Earn account. Celsius, the Unsecured Creditors’ Committee (UCC), and the ad-hoc account holders all agree that the title to the contents of pure Custody accounts is held by the customers.
In this hearing, Judge Glenn verbally authorized Celsius to release pure Custody accounts back to customers. He also said that Custody customers, pure or impure, who held less than $7,575 — the statutory cap for clawbacks under rule 547(c)(9) — would get all their funds back.
“There is no preference,” he said. “There is no good faith argument of an avoidable preference against them. There is no dispute as to their having title, and the assets should be returned to them.”
The judge told Celsius’ lawyers at Kirkland and the UCC’s lawyers at White & Case to work out the details, and directed Celsius lawyer Chris Koenig to prepare a suitable order for him.
Aaron Colodny, for the UCC, noted that there were fewer assets in Custody than total liabilities — a shortfall of about 6%, mostly bitcoin. This was an artifact of Celsius’ terrible reconciliation process, as noted by the examiner.
Judge Glenn asked Celsius and the UCC to work out which cryptos did not have a shortfall, and submit a proposed order on how to deal with these.
While some Custody account holders will get their funds back in short order, others will remain in limbo until other details are ironed out down the road.
Clawbacks on Custody accounts
Customer deposits into Earn probably legally belonged to Celsius, who then had a liability to the depositor. Because Earn funds were moved to Custody within 90 days, Celsius can claw back anything that left the Earn program.
These preference claims will be litigated in Phase II. [Scheduling, PDF]
Celsius has two years after its initial bankruptcy filing to bring preference actions.
Everyone agrees that preference issues are complex and difficult. So this needs to be sorted out.
“How much the Custody holders get back is largely going to be determined by the preference issue,” the judge said.
Withhold
Judge Glenn said that he struggles with the fact that there were no terms of service for Withhold accounts. “What I have puzzled about is that in the absence of a written contract with the Withhold issues. What is the contract construct? How do I determine what are the rules? Is it an implied contract?”
Deborah Kovsky-Apap from Troutman Pepper Hamilton Sanders, for the Withhold ad-hoc group, wanted the Withhold group to be treated the same as Custody.
Kovsky-Apap noted that Withhold assets are sitting in an aggregated wallet, which Celsius was using as investment capital — even as they claimed these were customer assets and not company assets. Celsius didn’t even segregate Withhold accounts from their large general pool of cryptos.
Kovsky-Apap asked if at least some of these coins could be set aside. Judge Glenn told her to confer with Celsius’ lawyers at Kirkland to see about separating these out.
Celsius and the Withhold ad-hoc group agreed that pure Withhold cryptos should go back to the account holders.
Colodny, for the UCC, did not agree — he argued that because Celsius commingled the Withhold cryptos and treated them as assets to invest, the assets should now be treated as part of the general bankruptcy estate.
“To take the assets and distribute them now would take them away from other Earn holders who may have an equal entitlement to those assets,” he told the judge.
You might think that Celsius’ bad practices wouldn’t just destroy someone else’s property rights — but the UCC’s interest is to make the general estate as large as possible, and minimise carve-outs.
Judge Glenn told Koenig for Celsius to work with Kovsky-Apap and the UCC on what could be returned immediately. “I would like whoever can get their property back now, to get it back now.”
The judge did not grant an order on Pure Withhold or Transferred Withhold: “I don’t have anything decided today.”
Next up
The December 8 hearing covered the proposed sale of GK8, the Israeli crypto custody company that Celsius bought in November 2021, to Galaxy Digital. We’ll be covering that next.
Phase II is not scheduled as yet, but it should be a doozy.
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