Restructuring

Introduction

On January 4, 2022, Judge Martin Glenn of the Bankruptcy Court for the Southern District of New York ruled that customer deposits in Celsius’s Earn Program constituted property of the bankruptcy estate and not customer property.¹ In reaching this decision, the Court determined that the terms of use to which customers agreed when opening Earn accounts constituted a binding contract between customers and Celsius. Because customers agreed in those terms of use that they were transferring ownership of cryptocurrency assets in the Earn accounts to Celsius, when Celsius filed for chapter 11, those assets became property of the bankruptcy estate.  This means Celsius can monetize the cryptocurrency in those accounts to pay operating and other administrative expenses, while Earn customers will have general unsecured claims that will be paid under a chapter 11 plan to the extent Celsius has value after the payment of all secured, priority, and administrative claims.

This summer, Weil wrote here about how the Celsius bankruptcy and other crypto insolvencies will help shape the legal and regulatory landscape for the cryptocurrency industry. Judge Glenn’s ruling on a novel legal issue represents one such development. And, as the Crypto Winter shows little sign of thawing, similar developments may further shape the space. 

Celsius’s Earn Program

Prior to its bankruptcy filing, Celsius maintained different types of customer accounts at various times, including the Earn Program, the Custody Program, and the Withhold Program.² Each account type provided a different mechanism by which Celsius held crypto assets on behalf of customers, and the Court may ultimately rule differently as to whether customer deposits in the Custody Program and Withhold Program are property of the estate.

Celsius’s flagship “Earn Program” enabled customers to deposit crypto assets in an online account, which Celsius would then intermingle with other customers’ assets and collectively deploy to generate revenue.³ Celsius would reward customers with “interest” on deposited amounts by sharing with them the proceeds of these deployments, which included lending, hypothecating, selling or otherwise monetizing the crypto assets. Id.

Beginning in May 2021, multiple state securities regulators and the SEC initiated investigations of the Earn Program as an unregistered securities offering. These investigations, combined with a similar investigation and settlement related to competitor BlockFi, prompted Celsius to stop offering its Earn Program to unaccredited investors.⁴

As of Celsius’s July 13, 2022 petition date, the Earn Program included more than 600,000 users, and assets deposited in the program totaled more than $4.2 billion in value.⁵

Debtors’ Position: Earn Program Assets Are Property of the Estate

The question whether customer deposits in the Earn Program are property of the estate arose when Celsius sought to sell stablecoins deposited by customers into the Earn Program. Celsius took the position that the stablecoins are property of the estate and argued the terms of use to which customers agreed when depositing assets in the Earn Program (across all iterations, the “Earn Terms of Use”) control on the question.

More than forty separate parties—many of them individual customers filing pro-se—objected to the Debtors’ motion to sell stablecoins, and by extension, any conclusion that Earn Program assets are property of the estate.

Celsius argued that the Earn Terms of Use created a binding contract between customers and Celsius.⁶ And, because the Earn Terms of Use granted Celsius ownership of assets transferred into the Earn Program (as set forth below), those assets became property of the estate when Celsius filed for chapter 11.⁷

Celsius argued that the Earn Terms of Use constitute an enforceable “clickwrap” agreement.⁸ And even though the Earn Terms of Use changed over time, Celsius required via pop-up windows that customers accept each successive iteration of the Earn Terms of Use to continue using the platform. These successive acceptances modified customers’ original contract with Celsius, or in the alternative established new contracts with Celsius.⁹

Version 8 of the Earn Terms of Use—which Celsius argued is the controlling version—provides as follows:

     In consideration for the Rewards payable to you on the Eligible Digital Assets using the Earn Service . . . and the use of our Services, you grant Celsius . . .  all right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere . . . . You acknowledge that with respect to Digital Assets used by Celsius pursuant to this paragraph:

1. You will not be able to exercise rights of ownership;
2. Celsius may receive compensation in connection with lending or otherwise using Digital Assets in its business to which you have no claim or entitlement; and
3. In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws.¹⁰

Court’s Ruling

After conducting a hearing on December 5, 2022, the Court ruled on January 4, 2023, that the Earn Program assets are property of the Celsius bankruptcy estate and largely adopted the Debtors’ reasoning.

The Court found that ownership of the Earn Program assets was a matter of contract law, and applied a two-step analysis to resolve the issue.  First, it found that the Earn Terms of Use constituted a valid, enforceable “clickwrap” agreement,¹¹ and each subsequent iteration of the Earn Terms of Use were valid, enforceable modifications of the original agreement.¹² Second, it found the Earn Terms of Use unambiguously provide that customers transferred ownership of their crypto assets to Celsius when they deposited the assets into the Earn Program.¹³

Judge Glenn dismissed arguments raised by Earn Program customers that use of the term “loan” in the Earn Terms of Use made the deposits equivalent to loans where title remains with the customer.¹⁴ Despite the use of this term, he noted the Court “cannot ignore the plain and clear language in the Transfer of Title Clause” which expressly transferred title to the crypto assets to Celsius.  Doing so would ignore the “bedrock principal of contract interpretation” that all terms of a contract must have meaning.¹⁵

The Court further clarified that customers’ defenses to contract formation and claims for breach of contract would be reserved for the claims resolution process.¹⁶ If, for example, certain customers wish to argue that CEO Alex Mashinsky’s representations fraudulently induced them to enter into their contracts with Celsius, they may ultimately do so.¹⁷ But any such argument would require the Court to first address the threshold issue that a valid contract existed between customers and Celsius.¹⁸

For these reasons, Judge Glenn ultimately held:

The Court concludes, based on Celsius’s unambiguous Terms of Use, and subject to any reserved defenses, that when the cryptocurrency assets . . . were deposited in Earn Accounts, the cryptocurrency assets became Celsius’s property; and the cryptocurrency assets remaining in the Earn Accounts on the Petition Date became property of the Debtors’ bankruptcy estates.¹⁹

Conclusions

This ruling represents a major development for the distressed cryptocurrency industry. The most obvious consequences fall on customers: individuals who deposited assets into the Earn Program are now general unsecured creditors. They can recover value only through the claims process, and will not have Earn Program assets returned to them. Celsius, for its part, can use the Earn Program assets and, in the short term, plans to sell $18 million worth of stablecoins to fund its administrative expenses in chapter 11. More broadly, this decision establishes a framework that other courts presiding over cryptocurrency bankruptcies may look to in determining whether customer deposits are property of the estate. To be clear, this decision does not bind the courts in FTX, BlockFi, or other cases. Moreover, even under this framework, the particular language of the user agreement in any particular situation could lead to different results. And, additional considerations, such as the presence of a fraud, material misrepresentations, or other criminal activity may further complicate the analysis of whether customers may be entitled to recover their deposits in a cryptocurrency insolvency. But, in Celsius at least, the question of who owned the assets at issue turned on the Terms of Use. And this decision will likely reverberate through the sector as the Crypto Winter wears on.