Cryptocurrency holders with assets in bankrupt cryptocurrency interest account providers like Celsius Network were introduced to a new scary term– clawback provisions.

A cryptocurrency clawback provision effectively states that customers (and insiders, execs, and other parties we’ll describe below) who withdraw their cryptocurrency assets before 90 days of a debtor (company going bankrupt) declaring bankruptcy may be required to return the assets to the debtor. 

“But, it’s my money! What gives them the right to take back my own money I rescued from their collapsing platform!”

You’ve got a point; thousands of angry customers subject to the customer clawback provision share the sentiment. 

As menacing as the term sounds, it at least provides an educational glimpse into how bankruptcy proceedings go down in the whacky world of cryptocurrency. 

The following guide explores how clawback provisions work and how they may impact the cryptocurrency industry. Please note this is not meant to be legal advice or construed as such; consult with a legal professional as needed. 

Why Does a Clawback Provision Even Exist?

Contrary to how cryptocurrency clawback provisions feel to the average customer who narrowly escaped with their life savings, a clawback provision actually exists to keep executives and insiders accountable and protect companies and investors.

For example, if Bobster the Fraudster knows his crypto lending company is doomed and withdraws $500,000 weeks before the collapse, the clawback provision would give courts legal access to take those funds back. 

Clawback provision usage gained prominence in the early 2000s, notably with the Sarbanes-Oxley Act of 2002, passed in response to major accounting scandals involving companies like Enron and WorldCom. Section 304 of the Act requires CEOs and CFOs to reimburse their company for any bonus incentive-based compensation or stock sale profits.

Clawback provisions are a means to align company interests with those of shareholders and stakeholders– which can be a broad array of creditors, from investors, lenders, and customers. 

The specific type of clawback provision we see referenced in cryptocurrency clawback cases originates in Section 550 of the Bankruptcy Code, with a few key sections allowing trustees to “claw back” assets into the bankruptcy estate for the benefit of all creditors.

• Fraudulent Transfers (11 U.S.C. § 548): This allows the bankruptcy trustee to avoid transfers or obligations incurred by the debtor made with intent to hinder, delay, or defraud creditors or were made for less than reasonably equivalent value when the debtor was insolvent or undercapitalized.
• Preferences (11 U.S.C. § 547): This allows the bankruptcy trustee to nullify transfers made to a creditor on account of an “antecedent debt,” or past debt, while the debtor was insolvent within 90 days before filing for bankruptcy. This also extends to a one-year period if the creditor is considered an insider. 
• Post-Petition Transfers (11 U.S.C. § 549): This allows the bankruptcy trustee to nullify certain transfers made after the bankruptcy filing if they weren’t authorized by the court or as part of the bankruptcy code.

Clawback provisions have a place in other facets beyond bankruptcy court. For example, clawback provisions are often included in executive compensation contracts, allowing companies to claw back a portion of the exec’s compensation (bonuses or stock options) if the exec engages in misconduct harming the company’s reputation and stock price. 

How Much Do I Have to Return in a Cryptocurrency Clawback?

Most cryptocurrency clawback cases thus far are uncertain, difficult to enforce, and seemingly arbitrary. Bankruptcy-specific laws can also vary from state to state.

For example, in the case of Celsius Network, an arbitrary threshold was set at $100,000. 

• Users with withdrawals of over $100,000 would have to pay back 27.5% of that full amount. So, $27,500 in the case of exactly $100,000.
• Users with withdrawals under $100,000 wouldn’t have to pay back anything. 

One can imagine the frustration of one Celsius customer with exactly $100,000 petitioning the courts for a staggered approach to clawbacks– pleading only the amounts over $100,000 be subject to the 27.5%. In his case, unfortunately, one penny ($0.01) would cost him $27,500. 

What Does the UCC Do in Crypto Clawbacks?

The Unsecured Creditors’ Committee, commonly referred to as the UCC, plays a crucial role in advocating for unsecured creditors, with the largest claims in Chapter 11 bankruptcy proceedings in the United States. 

Appointed by the U.S. Trustee, the UCC acts as an intermediary between this unit of unsecured creditors it represents and the debtor to secure the interests of unsecured creditors. This includes things like negotiating the terms of the debtor’s reorganization, investigating the debtor’s conduct and business operations, informing creditors about the progress and seeking input on major decisions, and hiring professionals such as attorneys, accountants, and other professionals (costs typically paid from the bankruptcy estate). 

According to the U.S. Bankruptcy Code, the debtor (the bankrupt company) must consult with the UCC on significant administrative actions, like asset sales,  attorney retention, or reorganization plan formation. 

In the various crypto clawbacks going on, the UCC is how the general massive blob of customers interface with the bankruptcy proceedings in each case.

Technically Speaking, How Does a Crypto Clawback Even Work?

Ok, so a judge orders the return of a customer’s BTC and ETH. 

“Over my dead body,” says the customer, tightly gripping their Ledger Nano X. 

Remember, BTC and ETH are blockchain-based. Transactions on the blockchain are final and irreversible once they’ve been added to the ledger. There’s no wire-reversal or forced ACH. If the digital assets are on a cold hardware wallet, they’re not connected to the Internet– so there’s no way to get the assets without physically obtaining the wallet and password, or recovery phrases. 

There is no currently available data or precedent of bankruptcy courts seizing the average retail customers’ cryptocurrency, either physically or digitally. In the Celsius Network crypto clawback example, since customers within the clawback range of over $100,000 may still have assets on the platform, they may be required to accept a settlement with that 27.5% clawback figure less.

As far as getting the other assets, time will tell.

When it comes to large organizations like FTX, Three Arrows Capital, Genesis, etc, amounts are typically requested to be returned, and key employees, such as Sam Bankman-Fried, are in and out of government custody. 

For example, three notable groups– the DNC, the Democratic Senatorial Campaign Committee, and the Democratic Congressional Campaign Committee, have all received formal requests (and fulfilled them) to return the funds to FTX’s creditors in December 2022. 

Final Thoughts: What Precedent Do Cryptocurrency Clawback Outcomes Set?

The events of 2023 and early 2024 will set an important precedent for the scope and role of CeFi companies that custody their users’ assets. 

On one hand, these clawback provisions are helping untangle the complex web of lending relationships, executive salaries, donations, and insider activity, attempting to give the bankruptcy estate the best chance at making creditors whole. 

However, these bankruptcy proceedings ain’t cheap. As of writing, crypto companies have spent over $713.9 million dollars on legal fees and expenses– FTC ($326.8 million), Celsius Network ($186.5 million), Voyager Digital ($88.2 million), BlockFi ($59.5 million). These fees and expenses have come under much scrutiny from creditors, forced to watch lawyers spend thousands of dollars for hotel stays and catering, in addition to the $500+ to $2,000+ per hour billing rates. 

On the other hand, clawback provisions have added fuel to the nightmares many customers have been forced to endure for over year. It’s bad enough they’re assets are locked on a platform, and their very ownership has come under question, but some are even being told a sizeable portion of their withdrawals within 90 days must be returned. In this case, a provision meant to protect is doing more harm than good– failing to differentiate between true insiders and vulnerable customers. 

For example, up until Celsius paused withdrawals on June 12th, 2022, Alex Mashinsky assured customers the company had “more than enough” assets to satisfy withdrawal requests. A few weeks prior, Mashinsky, his wife Kristine Mashinsky, and Co-Founder Daniel Leon withdrew a total of $19 million between May 27th and May 31st, 2022.