On March 11, 2021, Cred. Inc. and its affiliates confirmed a liquidating plan under chapter 11 of the U.S. Bankruptcy Code. Though many matters in the Cred bankruptcy cases remain unresolved — including potential criminal and civil claims against the company’s former management — confirmation of the liquidating plan is a key milestone in unwinding a complicated enterprise in an even more complicated industry. Notably too, these cases represent the first instance where a major U.S.-based cryptocurrency operation sought relief and eventually confirmed a plan under chapter 11.
Cred was founded in 2018 and operated a cryptocurrency-centric financial services platform. As Cred described, the company and its affiliates were lenders that utilized financial technologies to provide business and retail credit based on borrowed crypto- and fiat-currencies. As part of Cred’s businesses, customers transferred cryptocurrency to Cred pursuant to a loan or financing agreements. Cred then utilized its customers’ cryptocurrency in a variety of investment strategies involving third-party asset-managers. Cred earned revenue through the returns generated by these investments.
Cred’s obligations to its customers were repaid, with interest, as set forth in the customer’s contract. Generally, customers were entitled to receive their principal and interest back in the same type of cryptocurrency the customers had transferred to Cred. Because Cred’s business model was premised on generating a return for customers by investing the deposited cryptocurrencies with third-party asset-managers, Cred generally did not themselves hold significant amounts of cryptocurrency.
Cred experienced rapid growth in 2018 and 2019, driven in part by successful global partnerships and explosive market interest in cryptocurrencies. By the beginning of 2020, however, Cred was suffering significant financial distress as a result of multiple concurrent events. First, the price of Bitcoin and other cryptocurrency dropped sharply in March 2020. Consequently, Cred exited certain long-term futures positions in Bitcoin and other cryptocurrencies, which “locked in” significant losses and eliminated Cred’s margins. Second, Cred became overexposed on loans made to an unaffiliated entity controlled by a Cred co-founder, moKredit. At one point in 2019, moKredit had drawn approximately $70 million on a line of credit issued by Cred. When Cred attempted to recover principal from moKredit in March 2020, its efforts were allegedly stymied by the Chinese government’s ongoing response to the COVID-19 pandemic.
In addition to these market events, Cred was involved in two significant fraud events. In, March 2020, Cred’s then-Chief Capital Officer allegedly embezzled 225 Bitcoin (valued at approximately $6 million in December 2020). Then, in 2020, Cred discovered the loss of another 800 Bitcoin (valued at approximately $10 million in October 2020) through a “social engineering” scheme. The scheme involved a fake investment opportunity and Cred’s deposit of the 800 Bitcoin with an imposter custodian, which was only discovered months later when Cred attempted to withdraw a portion of its deposits.
These events significantly impaired Cred’s financial condition. They also created negative press, which in turn eroded customer and partner confidence in Cred’s management and the company’s business. Unable to continue its operations, Cred and its affiliates filed petitions for chapter 11 relief on Nov. 7, 2020.
On Nov. 18, 2020, Cred sought approval of a process to market and sell the company as a going concern or, alternatively, for the purchase of its assets at auction. Cred did not receive any bids acceptable to the creditors’ committee appointed in these cases. The cases thereafter focused on liquidating Cred’s assets through a chapter 11 plan.
A hearing to consider confirmation of the plan was held on March 9, 2021, before Judge Dorsey of the U.S. Bankruptcy Court for the District of Delaware. The plan provided that all of Cred’s assets would be transferred to a liquidating trust for distribution in accordance with the plan. Despite a pre-petition valuation of $69 million, as of the petition date Cred held less than $1 million in cash and approximately $5.3 million in liquid cryptocurrencies. Cred’s estimated unsecured liabilities exceeded $170 million. It is thus expected that the majority of creditors will not receive a meaningful recovery in these cases.
The plan also included certain limited releases given to case professionals and certain other stakeholders. The U.S. Trustee objected to these releases, but Judge Dorsey overruled that objection on the ground that releases were narrowly tailored to the professionals who had substantially contributed to the cases. Indeed, Judge Dorsey noted that “given the hornets’ nest that the professionals walked into with all the things that were going on with this debtor, including what appears to be fraud, misrepresentations and outright theft based on the examiner’s report,... the work they did in this case went above and beyond what would ordinarily be required in a Chapter 11 proceeding[.]”
This “hornet’s nest” was well documented in these cases by a report completed by Examiner Robert Stark just prior to confirmation. In December 2020, the bankruptcy court authorized the appointment of an examiner to investigate allegations of fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in Cred’s pre-petition operations. In January 2021, the U.S. Trustee appointed Stark as the examiner.
The examiner’s report is illuminating. At the outset, the examiner notes the “dueling narratives” offered by the company, which blamed bad actors for its demise, and by other constituencies, which alleged gross failures and fraud by the company’s incumbent management. Ultimately, the examiner cited a “grave” and “chaotic” dereliction of duty by management. In perhaps a warning to other cryptocurrency operations (and their partners, investors and customers), the examiner’s report found that Cred “excelled at its marketing objectives; but, its failures in the most basic of business functions portended its eventual demise.”
The story of Cred does not end with confirmation of the liquidating plan. The company’s management — who were not subject to the plan’s release provisions — continue to face potential criminal and civil liability. Indeed, the former Chief Capital Officer allegedly remains a fugitive in the U.K. and was recently subject to contempt charges before the Delaware bankruptcy court. How those matters resolve, and whether creditors and investors will ever see any meaningful recoveries, remains to be seen. For now, Cred and its affiliates should serve as a cautionary tale for cryptocurrency companies and investors alike that traditional corporate controls remain necessary, even in this new and emerging industry.