Introduction
Valuation
Restrictions on redemptions and gating
Side pockets
Other options
Dispute resolution
Comment
The British Virgin Islands is a popular jurisdiction for the incorporation of entities that own, trade or invest in cryptocurrencies and other digital assets. Recently, the BVI courts have grappled with a number of novel issues concerning crypto-related frauds and the liquidations of insolvent companies owning crypto assets. In doing so, the courts have generally applied English law principles concerning the treatment of cryptocurrencies as a form of property and have, in appropriate cases, granted orders for freezing injunctions in respect of crypto-related frauds and directions to liquidators seeking to preserve and realise crypto-assets for the benefit of creditors of insolvent companies.
This article highlights some important, high-level considerations for directors and managers of crypto funds during challenging times, in particular in light of the filing for Chapter 11 bankruptcy by Futures Exchange (FTX) in the United States and liquidation in the Bahamas, which had been one of the largest crypto exchanges in the world.
Certain actions might be time-sensitive in order to avoid a run on the fund which could potentially, in the worst case, lead to an insolvency situation of the fund itself. Issues around striking a net asset value (NAV) and how to value assets trapped on the exchange are also pertinent as they impact the ongoing operations of a fund.
The following are some of the issues faced by BVI crypto funds – in particular, open-ended crypto funds – and steps that might be taken to mitigate the risks a BVI fund might face if it sees a rush for redemptions, as well as general considerations that would apply in the case of the winding-up of the BVI fund or when providing for its ongoing operation.
For assets held in accounts or wallets maintained with a crypto exchange that faces liquidity issues (the impacted assets) and where withdrawals or transfers are prohibited (or where such assets are dissipated following an alleged hack), BVI fund managers and directors should discuss with their fund administrators and auditors how this will impact the valuation of the assets affected and, consequently, the NAV of the fund. The valuation treatment should be agreed before the next valuation day (when the NAV of the fund will be struck).
The FTX saga has had a ripple effect in the market, and so broader valuation issues may arise beyond the points raised around impacted assets and directors, and BVI fund managers should remain vigilant.
Restrictions on redemptions and gating
Investors in the fund may be losing confidence and seeking to redeem their investments (not just related to the situation regarding the exchange itself but also due to the consequential impact on the crypto market as a whole). However, for redemptions to be met, it is necessary for the BVI fund to be able to strike a NAV and have sufficient liquidity to be able to pay out the proceeds of redemptions. Therefore, decisions must be made as to how to value and deal with the impacted assets.
Where the NAV of the fund cannot be determined prior to the next valuation day or where a substantial part of the assets of a fund are traded on an exchange where trading is severely restricted or suspended, BVI fund managers and directors should consider whether a temporary suspension of the NAV calculation and dealings is warranted under the fund’s constitutional documents and offering terms. Typically, BVI fund directors and managers are given wide powers to declare a temporary suspension of the determination of the NAV, as well as subscriptions and redemptions of participating shares, under pre-defined circumstances.
Imposing such suspensions on the NAV and redemptions is a serious action because it also impedes the fund’s ability to accept new subscriptions and may be unpopular with investors whose ability to make redemptions is then curtailed. However, directors of the fund must consider the best interest of the fund and consider whether this would be a prudent option to take.
Given the severe implications on the ability of investors to redeem their investments, funds that declare suspensions should notify investors of the declaration (with details) as soon as practicable after the declaration has been made. It is also imperative for BVI fund operators and managers to consider whether the fact that the fund has suspended redemptions needs to be reported to the relevant regulators (eg, to the Cayman Islands Monetary Authority for funds registered in the Cayman Islands).
Some, but not all, fund documents will allow for gating of redemptions. Where these mechanics are included in the fund documents, the directors have an ability to restrict redemptions on any redemption day to a specified percentage of the NAV of the fund. Those investors that have submitted redemptions but had their redemption request deferred might, subject to the fund documentation, have their redemptions preferred over newly submitted redemption requests. Therefore, activating the gating provisions can, of itself, trigger investors to consider submitting redemption requests to secure themselves in the line of priority.
For BVI funds that include side-pocket mechanisms, subject to the offering terms (in particular, limits and restrictions regarding side pockets), impacted assets could be side pocketed, thereby suspending the redemption rights of the corresponding shares attributable to such side pocketed assets. This allows the fund to continue to strike a NAV on the remainder of its assets and process subscriptions and redemptions, excluding the side pocketed assets.
Other options may be available depending on the fund documentation and circumstances of the fund. Restructuring options may also be considered, such as synthetic side-pocket arrangements, whereby the impacted assets are transferred into a special purpose vehicle established by the fund for these purposes, or to transfer impacted assets to a liquidating trust.
Due to the potentially significant impacts on funds and their investors, it is recommended that directors take advice in a timely fashion.
From a litigation perspective, upon the collapse of a crypto exchange, the timeline often begins with the commencement of liquidation and restructuring proceedings against the relevant entities. Given the popularity of utilising offshore incorporations in the blockchain sector, such insolvency proceedings frequently originate from offshore jurisdictions. Three Arrows Capital (3AC), currently in liquidation, is a prime example of this scenario. The chain of events leading to the collapse of 3AC, arguably began with the de-pegging of Terra Luna in mid-May 2022. Within a matter of weeks, on 24 June 2022, liquidation proceedings had been commenced by creditors of 3AC.(1) On 27 June 2022, only three days later, the BVI courts, being acutely aware of the time-sensitive nature of the matter, appointed joint liquidators over 3AC.
The 3AC liquidation proceedings illustrate the velocity at which such disputes can be dealt with. That expedience in the appointment of joint liquidators enabled the swift implementation of protective measures on a global scale, in a sector where time is of the essence when seeking to preserve assets. This facilitated further investigative work to support recovery, the prompt filing of Chapter 15 bankruptcy proceedings in New York, as well as the recognition of the liquidation proceedings in Singapore.
The British Virgin Islands is well-equipped to deal with cryptocurrency disputes by reason of their versatility and flexibility when applying conventional company and insolvency law principles. This is demonstrated by the recent case of Torque Group Holdings Limited (in liquidation),(2) in which the BVI Commercial Court had no difficulty in recognising crypto assets as a form of “asset” for the purpose of the BVI Insolvency Act 2003, over which proprietary rights can be enforced. This has a broad range of legal implications, including:
- enabling proprietary injunctions to be granted over crypto assets, in addition to freezing injunctions against a person;(3) and
- allowing liquidators to collect and realise crypto assets for distribution to the creditors.
With further anticipated turbulence on the horizon for the crypto market, significant legal developments can be expected across offshore jurisdictions as they become increasingly more effective at dealing with cryptocurrency disputes.
For further information on this topic please contact Kate Hodson, Alan Wong, Justin Davis or Grant Carroll at Ogier by telephone (+852 3656 6000 or +1 284 852 7300) or email ([email protected], [email protected], [email protected] or [email protected]). The Ogier website can be accessed at www.ogier.com.
Endnotes
(1) In the matter of Three Arrows Capital Limited BVIHC (COM) 2022/0119.
(2) Philip Smith and Jason Kardachi (in their capacity as joint liquidators of Torque Group Holdings Limited) v Torque Group Holdings Limited (in liquidation) BVIHC (COM) 2021/0031.
(3) Chainswap Limited v The Owner of Digital Wallet et al BVIHC (COM) 2022/0031.
