February 16, 2023

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This is a follow-up post outlining certain noteworthy progress of the FTX Trading Ltd. ("FTX") Chapter 11 proceeding. Items or events described below are compiled as of the date of this writing.

Issues concerning appointment of independent examiner

The U.S. Trustee, FTX's lawyers and the company's unsecured creditors' committee has been heatedly discussing and litigating with respect to the necessity of appointing an independent examiner as proposed by the Department of Justice. The court held a hearing on February 6, 2023 to hear the parties' arguments and, after requesting the parties to work on a "consensual resolution," ultimately ruled against the U.S. Trustee's motion on February 15, 2023. Despite the court's ultimate rejection, some noteworthy takeaways could still be drawn from the submissions and oral arguments that either support or oppose the proposed appointment.

1. Whether it is mandatory to appoint an independent examiner

The major argument advanced by the U.S. Trustee is that the conditions under Section 1104(c) of the Bankruptcy Code were met, so the appointment of an independent examiner is mandatory. The concerned conditions are (i) appointment is in the interests of creditors, any equity security holders, and other interests of the estate, and (ii) the debtor's fixed, liquidated, unsecured debts … exceed $5 million dollars. FTX and the unsecured creditors' committee opposed such interpretation of Section 1104(c) on the ground that the court should have the discretion to approve or deny a motion to appoint an examiner pursuant to the express language of the provision and the phrase "as is appropriate" contained therein. As argued by the opponents, to construct Section 1104(c) as imposing a mandatory obligation on the court could result in the slippery slope effect that all courts hearing a bankruptcy case in the future will be required to appoint an independent examiner as long as the described two conditions stated are satisfied.

The court appears to have sided with FTX and the unsecured creditors' committee with its ultimate rejection of the proposed appointment of an independent examiner, suggesting that the "mandatory" interpretation of Section 1104(c) would not prevail (at least in this incident) given relevant precedents, the statutory language and the context laid out by the parties' arguments. That being said, following the U.S. Trustee's attempt, whether the "mandatory" interpretation would be advanced (and even succeed) in future cases would be an interesting point to look out for (especially when a case where the debtor itself has not initiated a comprehensive internal investigation) as the discretionary element of the provision has been a key threshold on which a court would rely to direct the progress and direction of a case.

2. Scope of independent examiner's investigation

Another issue heatedly contested in the hearing is the scope of the independent examiner's investigation, which relates directly to the amount of costs and expenses that will be incurred from the independent examiner's work. In connection with the motion to appoint an examiner, the U.S. Trustee did not specify the scope of the examiner's investigation but instead submitted to the court that such scope will be defined by the appointed independent examiner pursuant to the examiner's determination and discretion. The opponents raised several questions regarding such approach, including:

(i) Regardless of the scope of the proposed investigation, FTX and the unsecured creditors' committee have already conducted their own investigations, rendering the mandate of the proposed independent examiner duplicative;

(ii) FTX has been collaborating with federal and state regulators and providing information upon request, and has thus minimized the need for an independent examiner acting as a neutral third party discovering and disclosing information to the competent authorities; and

(iii) An investigation by an outside third party could impose the risk of compromising the security measures safeguarding the company's existing assets.

While the scope and the budget were not ultimately addressed by the court as the motion to appoint an examiner was denied, one could still draw on the investigation report prepared by Celsius Network LLC's examiner to get a sense of what an independent examiner would look at and how such investigation could be conducted in a bankruptcy case involving (alleged) frauds and insufficient internal controls over crypto assets. In general, the Celsius court expressly ordered that the scope of investigation should consist of (i) examination of Celsius Network LLC's cryptocurrency holdings (including whether different types of accounts are commingled), (ii) examination as to why the change in account offerings beginning in April 2022 was effected; (iii) examination of Celsius Network LLC's tax-paying procedures and compliance with applicable laws, (iv) examination of Celsius Network LLC's current utility obligations of the mining business, and (v) matters prescribed under Sections 1106(a)(3) and (4) of the Bankruptcy Code. (The court later issued an order on October 18, 2022 to clarify that the scope of investigation should include Celsius Network LLC's native tokens and its representations to the customers.) The examiner's final report accordingly reflects the parameters set by the Celsius court and detailed, among other things, various key aspects of Celsius Network LLC's business model, its CEL Token, the deficiencies underlying Celsius Network LLC's governance and risk management, the company's representations to the consumers and customers and the collapse of the company. While a debtor in a Chapter 11 proceeding could certainly achieve the same goals (e.g., uncover fraud) that an independent examiner aims to achieve by conducting its own internal investigation under the supervision of the new management and the appointed counsel, such independent examiner's investigation report could still be helpful and cost/time-saving for individual creditors who seek to bring actions against debtor and/or debtor's executives for their fraudulent misrepresentations while navigating numerous crypto asset classes and programs offered by the debtor.

Proposed sale of FTX's certain businesses

The court had approved the proposed sale of FTX's certain businesses and applicable bid procedures on January 12, 2023 in connection with FTX's efforts to generate sale proceeds and use the proceeds to repay FTX's creditors. Pursuant to the filings on the docket, the deadlines for bidding for Embed Business, FTX Japan and FTX Europe Business have been extended, and how such bid and sale would fare is worth looking out for given the following reasons:

  • FTX previously indicated in its submission to the court that the purchase price of those FTX businesses might diminish quickly due to customer attrition and regulatory uncertainty.

  • Starting on February 21, 2023, customers having accounts with FTX Japan may restart withdrawing fiat and crypto assets from the local entity. Whether such open for withdrawal would implicate the purchase price of the business remains to be seen. (It should be safe to assume that value of FTX Japan's assets (e.g., available cash and crypto assets that remained in FTX Japan's possession throughout and after the sale) would (significantly) affect the ultimate purchase price of the business. According to FTX's Interim Financial Update released on January 31, 2023 for the period through December 31, 2022, FTX Japan K.K. had a cash balance of $181,548,568 (consisting of unrestricted cash of $126,005,904 and custodial cash in an amount of $55,542,664), FTX Japan Services K.K. had unrestricted cash of $802,786 and FTX Japan Holdings K.K. had unrestricted cash of $510,903. The portion of the combined unrestricted cash appears to make up the majority of FTX Japan's cash position and might thus not be subject to the described withdrawal, but the company also noted in the interim update that the "classification of custodial accounts is still under review and does not imply that any customer has an interest therein," so whether and how the unrestricted cash portion would be adjusted (and thereby affect the ultimate purchase price) is to be seen throughout the bidding process.

Other aspects to monitor

  1. The court has approved an information sharing protocol for FTX's unsecured creditors' committee to share non-confidential and non-privileged information with (unsecured) creditors and for creditors to request for information. Sharing and release by the unsecured creditors' committee can be accessed through Epiq's website. For unsecured creditors who are not represented by counsel and find it overwhelming to follow FTX's Chapter 11 progress, it is a good idea to visit the website from time to time for updates. The unsecured creditors' committee also has a Twitter account sharing all important updates on this case.

  2. Several sources have reported that certain "FTX Users' Debt" tokens have been listed and traded. FTX has clarified that the company has not issued any debt token and such offerings are likely a scam. Creditors should only refer to official sources for FTX-related progress.

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