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Dispute resolution clause key when seeking recourse from failed crypto entities, say lawyers

Dispute resolution clause key when seeking recourse from failed crypto entities, say lawyers

Source: Business Times
Article Date: 19 Jan 2023
Author: Yong Hui Ting

FTX, one of the world’s largest cryptocurrency exchanges, owed US$3.1 billion to its top 50 creditors when it filed for bankruptcy in November 2022.

Cryptocurrency investors should examine the dispute resolution clause before jumping aboard in order to protect themselves in the event the crypto company collapses, according to lawyers from Rajah & Tann.

The advice comes in the wake of a series of collapses in the crypto industry last year, which left both retail and institutional investors stranded.

FTX, one of the world’s largest cryptocurrency exchanges, owed US$3.1 billion to its top 50 creditors when it filed for bankruptcy in November 2022.

The customers-turned-creditors have resorted to selling their claims for cents on the dollar, given that liquidation processes could take years. 

There is also no guarantee that an investor would get back the full sum of their investment post-liquidation.

But legal experts say it is possible for investors to safeguard themselves from such a situation in future – by reading the fine print.

“One of the key differences between how lawyers or insolvency practitioners approach crypto-related insolvency lies in where the asset is located,” said Yam Wern-Jhien, a partner in the fraud, asset recovery and investigations practice at Rajah & Tann Singapore. 

In a traditional insolvency, it is much easier to find out where the company’s assets are held, since most of these assets – such as property or cash – are tangible, Yam said. 

“But in crypto, the question is completely different,” he added. “The question is: ‘Who holds the private key?’”

“Once you identify the people within the organisation who hold the private keys, you have to then make sure they are kept within jurisdiction or you track their whereabouts.”

Private keys refer to an alphanumeric string that is used to unlock a virtual “wallet” where most cryptocurrency assets are held. It is also used to sign transactions and prove ownership of a blockchain address. 

If the assets are in an offshore jurisdiction, creditors will then have to work with their lawyers to come up with a strategy to determine how they can get orders to compel key company personnel to disclose information about the assets, Yam said. 

This can make the whole process of asset-tracing more difficult. And without information on where the private keys are stored, it would be virtually impossible to recover these assets.

FTX’s liquidators, for example, have faced much difficulty trying to locate the exchange’s assets as little is known about where they are held. This is largely due to poor accounting practices within the organisation. 

To avoid falling into the jurisdiction mess in the event of an insolvency, Rajah & Tann’s Jansen Chow urged investors to scrutinise the fine print in the “terms and conditions” before parking their money with the company. 

The dispute resolution clause, he believes, is of key importance. 

Such a clause determines how a dispute is resolved, where investors must file their claims, and is indirectly related to how much it would cost to recover their monies, said Chow, who is co-head of the fraud, asset recovery and investigations practice at Rajah & Tann. 

“Pursuing a matter in a different jurisdiction will likely lead to additional costs, particularly if the jurisdiction for dispute resolution is different from the jurisdiction where enforcement may take place,” he added.

In addition, investors should take note of where the company holds its crypto assets.

The process is more straightforward if a crypto company holds these assets in a trust. However, this often isn’t the case, said Chow. 

Earlier this month, a US bankruptcy judge ruled that digital assets deposited in Celsius Network’s Earn program belonged to the bankrupt company’s estate, and not individual users. 

This meant that users who had participated in the company’s lending service were now considered unsecured creditors and may recover only a small percentage of their claims as a result.

“Investors should also note where a company holds its crypto assets, how their coins are held, including the various services (offered by the company), as this might have an impact in the event of an insolvency,” said Chow.

Following the recent crypto failures, the Monetary Authority of Singapore (MAS) has published two consultation papers, one of which proposes regulatory measures to reduce the risk of consumer harm from cryptocurrency trading. 

The proposals include restricting cryptocurrency trading via credit, implementing customer-knowledge assessments, and prohibiting crypto service providers from lending out customers’ digital-payment tokens.

However, these measures are still work in progress, which means that some activities, such as lending and staking of tokens, are still unregulated.

Source: Business Times © SPH Media Limited. Permission required for reproduction.

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