UKJT releases Legal Statement on Digital Assets and English Insolvency Law

The UK Jurisdiction Taskforce (UKJT) has published its "Legal Statement on Digital Assets and English Insolvency Law." The Statement confirms the view that digital assets are a form of personal property to which insolvency laws apply. It also affirms that the current approach taken by the English courts to determine whether they are the appropriate venue for the commencement of insolvency proceedings works for a company dealing in digital assets. The Legal Statement should also provide confidence that the procedures and powers that ordinarily apply in insolvency proceedings are expected to apply to holdings of digital assets, in a similar way as they do to other intangible forms of property.

Locating the Relevant Jurisdictions for Insolvency Proceedings

Questions can arise about the relevant jurisdictions for opening insolvency proceedings in relation to a company dealing in digital assets. In appropriate cases, the English courts will apply the "centre of main interest" (COMI) test to determine where the main insolvency proceedings should be commenced. The COMI of a company is the place where it conducts the administration of its interests on a regular basis and which is ascertainable by third parties.

The UKJT notes that the common law courts have, so far, had no difficulty determining the COMI for an insolvency proceeding relating to a digital assets company, despite many digital assets existing as records on distributed networks. The COMI approach starts with the rebuttable presumption that a debtor's COMI is located in the jurisdiction in which the debtor has its registered office or (if it does not have a registered office) where it is incorporated. The court will then consider whether this presumption is rebutted by factors which (i) are objective and ascertainable by third parties (including the actual subjective knowledge of creditors); and (ii) show that the debtor conducts the administration of its interests on a regular basis in a different location from the location of its registered office. The COMI can change, but temporary or secretive shifts can be disregarded. Although each case falls to be determined on its own facts, there seems to be no practical difficulty applying the COMI approach.

Claims to Digital Assets

In the normal course, creditors do not have direct claims against the assets of a debtor. Digital assets owned by a debtor form part of its overall estate; to be realised and applied to meet the claims of creditors. Certain creditors may have priority (security) claims that entitle them to enforce their security rights over particular digital assets in priority to other liabilities; for example, where they have a perfected security interest in respect of them.

The Law Commission, in its "Final Report on Digital Assets," has highlighted the need for a new regime to address the challenges of taking security over digital assets. The UKJT does not go in this direction. Instead, the Legal Statement focusses on the possibility of using digital assets as the object of a trust arrangement; eg, when they are held by a custodian for the benefit of its clients. Trust assets do not form part of an insolvent company's estate available to discharge the claims of creditors. Instead, in those cases, digital assets would be held apart from the estate of the debtor and returned to the beneficiaries in accordance with the usual rules. The Legal Statement recognises that trust arrangements can be explicitly or implicitly made, but it may fall to the courts to find the intention to make a trust in any particular case.

Liquidated and Proprietary Claims

On the question of whether a dissatisfied digital asset obligation can be used to wind-up a company, the legal statement concludes that it cannot be used for the most popular option used by petitioners, namely providing evidence that a statutory demand for a fixed sum exceeding £750 has not been satisfied for more than 3 weeks.

The UKJT takes the view that a claim for the delivery of certain digital assets is not a debt for a fixed sum. Rather, failure to perform delivery obligations would give rise to a claim for unliquidated damages. Therefore digital assets cannot form the basis for a statutory demand because digital assets are not (yet) accepted forms of money (notwithstanding the description of certain of them as "cryptocurrencies" in popular language). However, a dissatisfied digital asset obligation could form evidence supporting a winding-up petition on grounds of inability to pay debts.

Also, in a liquidation, administration or bankruptcy proceeding, a claim for the delivery of certain digital assets would be treated as a "provable claim" in common with other claims for damages. This has particular relevance for so-called "loans" of digital assets: depending on how such arrangements are structured, the claim for redelivery of particular digital assets could be treated as a breach of contract and converted to a claim for damages. One consequence is that the "loaned" digital assets could be used to meet the claims of creditors generally. Another is that, in any restructuring proceeding, the interests of the creditor who "loaned" the relevant digital assets would not be protected as a proprietary claim (eg, as the beneficiary of a trust).

Conversion of Foreign Currency

The Legal Statement notes that the Insolvency Rules 2016 provide for debts incurred or payable in foreign currency to be converted to sterling at the beginning of the insolvency proceeding. As digital assets do not represent currently-recognisable forms of money, this rule does not directly apply. However contractual claims for non-delivery of digital assets (or for failure to redeliver, as in the case of a "loan") would be claims for damages, payable in fiat currency. Given the volatility of many digital asset valuations, this has particular importance for creditors whose claims are based on "loans."

Powers and Duties of Office-Holders

The UKJT notes the volatility of digital asset valuations. In order to meet their duty to realise assets for the best price reasonably obtainable for the benefit of creditors as a whole, the Legal Statement suggests that office-holders seek the support of third-party specialists on the valuation and distribution of digital assets or proceeds from their liquidation.

Avoidance of Certain Transactions

The UKJT considers that the range of transactions which are vulnerable to challenge or avoidance in insolvency proceedings generally – including transactions at an undervalue and preferences – applies to digital assets. The technical features of blockchains – including the immutability of transactions – should not prevent the court from making orders for restoring the position to what it would have been had the transaction not been entered into, using the broad powers granted by the Insolvency Act 1986. A party subject to an order to reverse a prohibited transaction should be able to do so by making a transfer or payment in compliance with the court's directions.

Mixing and Shortfalls

The UKJT notes that the rules on tracing of assets by beneficiaries of trusts and the allocation of losses when fungible assets are pooled (eg, in accounts) will generally apply in cases involving digital assets. However, the Client Asset Sourcebook (or CASS regime) for FCA-regulated entities will not apply, in its current form, because digital assets are not yet a relevant form of money. The FCA is considering changes to CASS for digital securities.

Office-Holders

For office-holders, one of the issues raised by the proliferation of digital assets has been the extent to which their existing powers can be exercised to gain access to them. Digital assets are, typically, secured using cryptographic techniques that mean a private key is required to control them (ie, by instructing their transfer). In the view of the UKJT, there are no additional powers required to enable office-holders to compel production of private keys or digital wallets.

Conclusions

The latest Legal Statement should provide assurance to the participants in markets for digital assets that the insolvency regime in England and Wales will continue to apply without any serious difficulty. Creditors will gain confidence that digital assets held by debtors will not be bankruptcy-remote and that the courts and office-holders have the appropriate legal powers to gather them in. At the same time, the beneficiaries of digital asset holdings held on trust by debtors will appreciate the perspective that ordinary rules should apply.

Authors: Drew Sainsbury, Partner; Inga West, Counsel; Charlotte Evans, Expertise Lawyer; Etay Katz, Partner; Bradley Rice, Partner; Simon Helm, Counsel