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Nov 20th, 2020

Here to stay: A crypto asset as property of a bankrupt estate under 11 U.S.C. § 541

By Shirley Palumbo

The possibilities for use of crypto currencies in various levels of industry and financial markets through a blockchain distributed ledger are endless. Crypto currencies can be used as a way to transfer money, to invest, to create contracts, to provide services, or to digitize an asset—and these are only some of the possibilities that come to mind. Under this reality, legal advances regarding cryptocurrencies are steadfastly being developed. Regulation on investments, consumer protection, taxation and protection against illegal activities, such as money laundering and terrorism, are but some of the legislative considerations being reviewed worldwide, and new laws in this digitized era are being created constantly.


A crypto token is given a value by a group or organization, and supported by an existing blockchain platform. Tokens are generally considered fungible assets and, therefore, tradeable, (a token for a token) but some are uniquely created and not interchangeable; i.e., non-fungible tokens (“NFT”). An NFT may be a lottery ticket or a patent, a song, a digital baseball card, a meme, or a work of art. See, Zach Hein, The weird, wild and expensive world of blockchain art, August 30, 2018 at https://www.engadget.com/2018/08/30/cryptokitties-gods-unchained-blockchain-art/.


NFTs present challenges to trustees of an insolvent estate that seek to administer and maximize the value of the asset. These NFTs currently are not legally defined either under federal or Florida law. The “Crypto Currency Act of 2020” was proposed by Congress to clarify which federal agencies regulate digital assets, while also attempting to categorize a crypto asset into 3 different types: Crypto-currencies, Crypto-Commodity; and Crypto-securities. In Florida, the changes in the law are slow and limited. SB 1870/HB 1391 proposes amendments to allow digital services and products to be tested, but the Senate bill has already been amended 10 times. See SB 870 c2. The last proposed amendments made by the Appropriations Committee propose to establish a Florida Digital Service within the Department of Management Services department to revamp Florida state agencies to include digital technology and information services. Id, March 5, 2020. Notably, a specific category for NFTs has not been explicitly addressed under the State’s Legislature or case law, and as such, the legal status of NFTs are yet unclear.


A central issue in insolvency proceedings involving crypto-assets is whether the token is an asset of the insolvent estate. In this legislative void, it may fall on bankruptcy courts to determine whether an NFT falls under 11 U.S.C. § 541(a). Section 541 includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a) (2019). This frequently includes intangible assets, such as good will, brand recognition, customer lists, a cause of action; as well as copyrights and all intellectual property license agreements. See United States v. Inslaw, Inc., 932 F.2d 1467, 1471 (D.C.Cir.1991). Thus, presumably an NFT would become part of the debtor’s estate upon the filing of the bankruptcy petition.


Various Bankruptcy Court decisions have favored a presumption that proprietary rights exist over a cryptocurrency. For instance, in Pearce v. MizuhoBank, Ltd., the court compared Bitcoin, a digital coin, to money. In Pearce v. MizuhoBank, Ltd., 2018 WL 4094812 (E.D. Pa. Aug. 27, 2018). Whether Bitcoin was property of the estate was not questioned. In In re Hashfast Technologies, LLC, the court found Bitcoin not to be equivalent to U.S dollars. See, Hashfast Technologies LLC v. Lowe, 2016 WL 8460756 at *5 (Bankr. N.D. Cal. Feb. 5, 2016). On the issue of whether the bankruptcy estate had rights to cryptocurrencies, the court ruled that the Bitcoin should be classified as intangible personal property and, consequently, the token was deemed an asset of the bankruptcy estate, particularly as to actions for fraudulent transfers under section 550 of the Bankruptcy Code. Id.


Both bankruptcy and non-bankruptcy courts have categorized cryptocurrency as a commodity. See, e.g., Id.; Commodity Futures Trading Comm’n v. McDonnell, No. 1:18-cv-00361-JBW-RLM, slip op. (E.D.N.Y. Mar. 6, 2018) (mem.). However, in a bankruptcy setting, treating cryptocurrency as a commodity would likely have different results because commodities under the Bankruptcy Code are limited to forward contracts that contemplate the delivery and payment of the goods more than two days after execution of the contract. See 11 U.S.C. sec. 101(25)(A). As a commodity, bankruptcy law might provide fewer protections for cryptocurrencies than defining them as currency. See Chelsea Deppert, Bitcoin and Bankruptcy: Putting the Bits Together, 32 Emory Bankr. Dev. J. 123, 131 (2015). Treating NFT as currency may involve an exchange into U.S. dollars, which may likely be treated as a “swap agreement” under the Bankruptcy Code. Id. at 146.


Properly defining the property interest is pivotal in the bankruptcy proceedings if the NFT is going to be considered property of the estate. Yet, by its very essence, the NFT fits none of these definitions. Some commentators’ approach is to define any crypto asset that is not a currency or security token as a utility token, “built for a particular, usually non-transactional, purpose its functional existence supplied directly by the businesses who issued it.” See, Hardfork, Three types of cryptocurrency tokens explained as quickly as possible, The Next Web at https://thenextweb.com/hardfork/2018/11/19/cryptocurrency-tokens-explained/. Nevertheless, utilities laws, defined as essential services, such as water, electricity, transportation, or communication provided to the public by private business organizations, may fit certain rights and interests in the blockchain, but these laws will not necessarily accommodate the interests of an NFT, let alone realize value, determine ownership rights and security interests in a bankruptcy sphere. See Hg.ORG, Utilities Law at https://www.hg.org/utilities.htm (definition of utilities laws)


Whether an NFT is property of the estate will likely depend on the type of rights and interests it embeds or that a court grants by analogy to another legal interest. Yet, interests in property cannot rise above those that debtor possessed pre-bankruptcy. 11 U.S.C.A. § 541(a). Thus, if an NFT does not carry a particular monetary or property interest, then it, arguably, may not be administered as property of the estate. If there is no legal classification of the token, then, how is there a legal interest to administer? Hence, the trustee is limited by the available proprietary and contractual rights in Florida which would allow the bankruptcy court to entertain expanding the theories of property and contract laws and make them applicable to the NFT.

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