Restructuring

This is the fifth post in our Bitcoin Bankruptcy series on the Weil Bankruptcy Blog.  We have concluded that a hypothetical U.S.-based bitcoin exchange likely would not constitute a stockbroker or a commodity broker under the Bankruptcy Code.  Therefore, unless the bitcoin exchange is a certain type of bank, it is probably eligible for chapter 11 relief.  This entry explores the question of whether a bitcoin exchange might be considered a bank. 
The short answer is that it is highly unlikely that a bitcoin exchange would be considered a bank, and so the bitcoin exchange probably would be eligible to file a chapter 11 case.  Banks receive deposits; bitcoin exchanges generally do not.  Even if bitcoin wallets constituted deposit accounts, bitcoin exchanges are not presently regulated like banks and have no available resolution framework outside of bankruptcy law.  Whereas banks are regulated entities governed by intricate legal frameworks, the entire bitcoin system attempts to avoid prudential regulation through a system based on transparency and degrees of mathematical certainty.  Accordingly, bitcoin exchanges are probably eligible for chapter 11 relief because they would not be considered the types of banks that are ineligible to file a bankruptcy case.
So much for the short answer.  The long answer involves what can really be considered the Bankruptcy Code’s esoterica, including some provisions that have been used either rarely or never at all.  But the novel legal structure of a bitcoin exchange calls for this kind of analysis.  As always, it starts with the text of section 109.
Section 109 of the Bankruptcy Code
Under section 109(d) of the Bankruptcy Code, one type of company that can be a chapter 11 debtor is “an uninsured State member bank, or a corporation organized under section 25A of the Federal Reserve Act, which operates, or operates as, a multilateral clearing organization pursuant to section 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991 [“FDICIA”]. . . .”  This type of entity is also known in the Bankruptcy Code as a “clearing bank.”  Aside from being expressly eligible for chapter 11 relief, clearing banks are an important exception to the general rule that banks cannot be debtors in bankruptcy.
Section 109(d) also provides that a person eligible for relief under chapter 7 of the Bankruptcy Code may be a chapter 11 debtor.  Under section 109(b)(2), “a person may be a debtor under chapter 7” unless that person is, among other things, one of the following types of entities:

a domestic . . . bank, savings bank, cooperative bank, savings and loan association, . . . credit union, or industrial bank or similar institution which is an insured bank as defined in section 3(h) of the Federal Deposit Insurance Act . . . .

Whether a bitcoin exchange could constitute a clearing bank or other type of bank depends on several factors, but it is ultimately unlikely.
A Bitcoin Exchange Is Probably Not a Bank.
The term “bank” is not defined in the Bankruptcy Code.  Thus, courts have articulated three different tests for whether an entity constitutes a bank:

1. The “independent classification” test: “This test ‘construes section 109(b) itself, considering the text of the section, its legislative history and court interpretations, to determine whether a petitioner is an excluded entity.’”
2. The “state classification” test: “The state classification test involves examination of the entity’s status under the law of the state of incorporation. If state law classifies the entity as one that is specifically excluded from being a debtor under section 109(b)(2), the inquiry generally ends there.  If state law does not so classify the entity, the question then becomes whether the entity is the substantial equivalent of those in the excluded class.”
3. The “alternative relief” test: This test “emphasizes ‘congressional intent and factors of practicality and policy’ to determine whether, given a state reorganization and liquidation scheme to wind up a particular entity, federal bankruptcy relief would nonetheless be a satisfactory alternative to the state procedure.”

In analyzing whether an entity is eligible for chapter 7 relief, “[c]ourts . . . have applied the three tests somewhat erratically.”  Attempting to resolve the confusion surrounding these tests, the United States Court of Appeals for the Seventh Circuit has held that “there should not really be three separate tests for ascertaining whether an entity is excluded from the protection of the Bankruptcy Code.  Rather, absent express classification under section 109 or some other federal statute, the classification of an entity should generally follow the law of the state of its incorporation, so long as that classification does not frustrate the purposes of the Code.”  Other courts, including the United States Court of Appeals for the Second Circuit, historically followed this same principle under the statutory predecessor to the Bankruptcy Code.
Under New York law (which would govern our New York-based hypothetical bitcoin exchange), a bank is “any corporation, other than a trust company, organized under or subject to the provisions of article three of” the New York Banking Law.  That article establishes the powers and duties of banks under New York law.  Among other things, banks have the power [t]o receive upon deposit for safe-keeping for hire upon terms and conditions to be prescribed by the bank or trust company, money, securities, papers of any kind and any other personal property.”
Bitcoin exchanges clearly do not fall within New York’s definition of “bank.”  They are neither “organized under [n]or subject to the provisions of article three of” the Banking Law.  Even if bitcoin wallets maintained by the bitcoin exchange constituted “deposits,” the exchange would not have the “power” to maintain those wallets unless it were governed by the other provisions of — and subject to the obligations established by — the New York Banking Law.  Consistent with this, bitcoin exchanges do not fall within any of the types of banking entities regulated by the New York State Department of Financial Services.  It is therefore unlikely that a bitcoin exchange would constitute a “bank” under section 109(b)(2) of the Bankruptcy Code, and so it is probably eligible to be a chapter 11 debtor.
Clearing Banks, Bitcoin Exchanges, and the Bankruptcy Code
For the sake of completeness, it is worth considering whether a bitcoin exchange could constitute a clearing bank under the Bankruptcy Code.
There is a dearth of writing on clearing banks in the bankruptcy context.  Not one reported case analyzes the clearing bank provisions of the Bankruptcy Code.  We found no academic articles that discuss the clearing bank provisions of the Code.  Collier on Bankruptcy cites no source other than the Bankruptcy Code in its discussion of the clearing bank language in section 109.  And — perhaps most surprising — the very definition of “clearing bank” in the Bankruptcy Code relies on a provision of the FDICIA that has since been repealed.  It is possible that clearing banks as defined in the Bankruptcy Code no longer exist.  If this is true, it would render subchapter V of chapter 7 superfluous.
A clearing bank is, as mentioned above, “an uninsured State member bank, or a corporation organized under section 25A of the Federal Reserve Act, which operates, or operates as, a multilateral clearing organization pursuant to section 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991 . . . .”  This definition has three parts: (i) uninsured State member banks; (ii) Edge Act corporations; and (iii) multilateral clearing organizations.  We will consider each one in turn.
Uninsured State Member Banks
An “uninsured State member bank” is “a State member bank (as defined in section 3 of the Federal Deposit Insurance Act [“FDIA”]) the deposits of which are not insured by the Federal Deposit Insurance Corporation.”  Under section 3(d)(2) of the FDIA,  “[t]he term ‘State member bank’ means any State bank which is a member of the Federal Reserve System.”  Bitcoin exchanges, then, obviously are not uninsured State member banks.
Edge Act Corporations
Section 25A of Federal Reserve Act (which section is also known as the Edge Act) provides as follows:

Corporations to be organized for the purpose of engaging in international or foreign banking or other international or foreign financial operations, or in banking or other financial operations in a dependency or insular possession of the United States, either directly or through the agency, ownership, or control of local institutions in foreign countries, or in such dependencies or insular possessions as provided by this section, and to act when required by the Secretary of the Treasury as fiscal agents of the United States, may be formed by any number of natural persons, not less in any case than five: Provided, That nothing in this section shall be construed to deny the right of the Secretary of the Treasury to use any corporation organized under this section as depositaries in Panama and the Panama Canal Zone, or other insular possessions and dependencies of the United States.

Bitcoin exchanges plainly are not Edge Act Corporations either.
Multilateral Clearing Organizations
The Bankruptcy Code defines “multilateral clearing organization” by reference to the definition set forth in section 409 of the FDICIA.  Section 409 of the FDICIA prescribed the scope of entities that could operate multilateral clearing organizations but did not itself define what constituted a multilateral clearing organization.  The operative definition was set forth in section 408 of the FDICIA (and, by way of the Bankruptcy Code’s reference to section 409, presumably applied in bankruptcy as well): “The term multilateral clearing organization means a system utilized by more than two participants in which the bilateral credit exposures of participants arising from the transactions cleared are effectively eliminated and replaced by a system of guarantees, insurance, or mutualized risk of loss.”
The trouble with the term “multilateral clearing organization” is that the Bankruptcy Code’s statutory referent — section 409 of the FDICIA — as well as section 408 were repealed by section 740 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Yet the clearing bank provisions of the Bankruptcy Code were left standing.  Accordingly, it appears that literally nothing today operates “pursuant to” section 409 of the FDICIA as is required for an entity to constitute a clearing bank under the Bankruptcy Code.
Conclusion
For the foregoing reasons, a bitcoin exchange likely does not constitute a type of bank that is barred by section 109 of the Bankruptcy Code from being a debtor in bankruptcy.  A bitcoin exchange likely also does not constitute a clearing bank. Indeed, following the passage of the Dodd-Frank Act, it is possible that no entity at all could constitute a clearing bank under the Bankruptcy Code.  Because a bitcoin exchange is probably not a stockbroker, a commodity broker, or an ineligible bank, we believe it is likely that a bitcoin exchange would be eligible for relief under chapter 11 of the Bankruptcy Code.
This concludes our series on the eligibility of bitcoin exchanges, but we plan to consider in the future some of the other novel issues that bitcoin may present for restructuring practitioners.  We look forward to further developments in the laws governing virtual currencies.
As a reminder, the Weil Bankruptcy Blog does not provide or purport to provide legal advice on bankruptcy, securities, or any other areas of law.  The discussion herein reflects the opinion of the author, not that of Weil, Gotshal & Manges LLP.  This discussion is strictly hypothetical and may not be relied upon for the purpose of trading bitcoins, securities, or any other instrument of value.