Cryptocurrency Meets Bankruptcy Law: A Call for Creditor Status for Investors in Initial Coin Offerings

Abstract

In 1973, experts Homer Kripke and John Slain published a seminal study titled “The Interface Between Securities Regulation and Bankruptcy.” That lengthy analysis, contributed by, respectively, a former Securities and Exchange Commission official and a professor of law, examined the status quo and concluded that investors were receiving unfair priority vis-a-vis creditors in bankruptcy proceedings administered under the federal Bankruptcy Code. Focusing on the traditional “absolute priority rule,” the study pointed out that the Securities and Exchange Commission (SEC) support for the investor priority was unfounded and urged deference to the notion of general creditors coming first. Since then, a host of developments has complicated both the analysis and the traditional view of Kripke and Slain. First, the pivotal determination of “rescinding shareholder” has been made complex by, inter alia, an expanded notion of “sophisticated investor” occasioned by phenomena such as “crowdfunding.” Second, stock swaps, hedges, repurchase agreements and other hybrid responses to financier discomfort have clouded the definition of “investor.” Finally, the explosive growth of cryptocurrencies (and the ventures that would sell, distribute, trade or package them) has highlighted the need for a new, softer line between creditor and investor. Accordingly, the present authors re-visit the “absolute priority rule” with a view towards historic SEC involvement with Bankruptcy law and contemporary classification of some cryptocurrency-related entities as securities issuers. The article concludes that in light of the existing provisions and interpretations, the “absolute priority rule” examined through the lens of today’s innovative securities should be rethought to give investors in initial coin offerings creditor status. Whether the reader agrees or not is likely subordinated to the need for a conversation on the most egalitarian response – under both the securities laws and the Bankruptcy Code – to the investor’s claim for in pari passu treatment normally reserved for creditors, and likewise the general creditors’ opposition to sharing a legally enforceable priority.