Trading in Bankruptcy Claims Is Dominated by Crypto and Binary Claims

What’s been going on in the bankruptcy claims marketplace over the past year? Crypto, crypto, crypto, sprinkled in with a little bit of trucking, courtesy of the Yellow Corp. case. [1]

In general, over the past several years investing in bankruptcy claims has become increasingly challenging. One reason for this is because there are fewer and fewer cases that result in distributions to unsecured creditors. Retail bankruptcy cases, which have historically been good sources of bankruptcy claims for claims investors because they have many vendors, have been wipeouts. For example, such cases as Bed Bath & Beyond Inc., [2] Party City Holdco. [3] David’s Bridal LLC [4] and Tuesday Morning Corp. [5] all have provided no recovery for general unsecured creditors. Other cases, such as Sears Holding Corp., [6] have only provided a recovery to administrative expense unsecured creditors — creditors that provided goods to a debtor within 20 days prior to the bankruptcy filing date or post-petition.

Today, there are only a handful of bankruptcy cases that will pay out a distribution to unsecured creditors or investors. Two of the most significant cases, Celsius Network, LLC [7] and FTX Trading Ltd., [8] are cryptocurrency cases.

Celsius has a confirmed plan that recently went effective. There are approximately 600,000 account-holders who qualify as general unsecured creditors. The aggregate amount of unsecured claims is $3.75 billion. The average claimant holds a claim with a face value in excess of $6,600. In Celsius, approximately 300 creditors opted to sell their claims. This is less than .05%, a paltry number. While purchasing claims at a discount is a compelling business proposition, it does not provide investors with an opportunity to deploy large amounts of capital. Even the most persistent claims-purchaser has only able to purchase over 10-15% of the Celsius claims, still not a large percentage of the overall claims pool.

There are several explanations for the low volume of claims-trading in Celsius. First, in cryptocurrency cases, bankruptcy courts have allowed debtors to redact creditor information in publicly reported documents such as Schedules of Liabilities and Proofs of Claim. This has made it substantially harder for claims-traders to contact creditors.

Notwithstanding the Bankruptcy Code’s provisions requiring full disclosure, debtors are protective of their customers’ information. Part of the reason might be that controlling information allows debtors and their professionals to control the process. However, debtors mask this motivation by arguing that by redacting the names and all associated identifying information of their customers and withholding from publication any proofs of claim, they are preserving the estate’s assets.

While it is true that customer lists, and related customer data, are assets of the estate, customers may still choose to take their business elsewhere once a cryptocurrency exchange files for bankruptcy protection. The responsive argument is that publicly disseminating the customer lists would not give the debtor’s competitors an unfair advantage and would not interfere with the debtor’s ability to sell its assets and maximize value for their estates. However, in numerous bankruptcy cases, courts have recognized that customer lists are entitled to protection under § 107(b)(1) of the Bankruptcy Code and have thus limited access to the debtor’s schedules and other court filings containing sensitive customer information.

Finally, debtors have argued that disclosing this information could lead to negative publicity or identity theft. While most claims-traders would dispute these arguments, no investor at the outset of a bankruptcy case has standing to contest this issue, nor do they want to spend money litigating what is likely to be a losing argument. Nonetheless, these arguments by the debtor could ultimately hurt the very parties they seek to protect: the creditors. Requiring the disclosure of creditors’ names and addresses could result in more solicitations to purchase claims, which would provide creditors with the current market value of their debt.

Another explanation for the paltry claims-trading statistics is the claims-traders’ concerns with the integrity of the bankruptcy claim. Is there some issue that would impair the claim? The foremost issue buyers are concerned about is preference exposure. Given that many customers actively traded in their accounts, there is a high degree of likelihood that they transferred assets within the 90-day period prior to the bankruptcy filing. Fortunately, in both Celsius and FTX, preference exposure has been limited by a materiality threshold in their respective plans of reorganization.

Additional concerns about claims-trading in cryptocurrency cases has to do with the currency risk to investors. In Celsius, the distribution will be largely in Bitcoin and Ethereum. Over the past several months, Bitcoin has moved up and down over 30%. That dramatically impacts the recovery to investors. This same concern is not present with respect to FTX, because the distribution is going to be in U.S. dollars.

The other major cryptocurrency case, FTX, has seen a meteoric rise in claims-trading recently. This is due in part to the rise of Bitcoin and in part because of the value of its investment in AI startup Anthropic. Furthermore, counsel for FTX recently indicated it is likely there will be a par recovery on claims.

There are approximately 1 million FTX account-holders who qualify as general unsecured creditors. The aggregate amount of customer claims is approximately $11.5 billion. While the average size of a customer claim has not been reported, there have been 1,129 transfers of claims. It is difficult to know whether some claims have been transferred multiple times due to the rapid increase in the price of claims in a relatively short time. After all, the beauty of Federal Rule of Bankruptcy Procedure 3001(e) is that transferring bankruptcy claims is easy. Notwithstanding, even today, in the face of 80% offers for claims of over $1 million, relatively few claims have traded in the FTX case considering the size of the case.

Finally, several claims have traded in the Yellow Corp. case in the 30% price range. Most of these claims are extremely small, under $20,000. These claims may be wage claims under § 507(a)(4) of the Bankruptcy Code and hold priority status in an amount up to $15,150. To the extent that they have priority status as wage claims, they are likely to receive par. If they are not wage claims, they may be paid nothing. Accordingly, it is risky to purchase claims in this case.

In addition to the cryptocurrency cases and Yellow Corp., I am often asked to value or purchase what I call “bespoke” or “one-off” claims by various trustees and receivers. These claims, while extremely difficult, require deep analysis and access to data. Let’s face it: Fiduciaries are typically not seeking to sell highly liquid, collectible claims. They are looking to sell their dogs, pigs and cats to obtain liquidity and close an estate. Claims against defaulted real estate fall into this category. I often refer to these claims as “binary claims” because the outcome of recovery is binary. If one is successful, the buyer is happy; if not, you end up with a goose egg. Investors need to buy these claims at a deep discount and realize significant upside upon distribution in order to take these risks. They need to tread cautiously, as there are pitfalls that need to be navigated. Based on the significant number of real estate loans expected to default in the near future, investors anticipate that there will be many more binary claims for sale.

In summary, over the past several years the vast majority of bankruptcy claims-trading has occurred in cryptocurrency cases. While the upside for the traders has been there, relative to the number of claims very few creditors have sold. Furthermore, going forward, claims-traders anticipate seeing many one-off claims for sale, such as real estate-related claims. While these types of claims are interesting, in order to balance risk and reward, claims-traders need to do extensive due diligence and purchase these claims at a steep discount to par in order to protect their downside.