Celsius paydowns take crypto lender into ‘uncharted territory’

As Celsius Network’s customer withdrawal freeze enters a full month, the beleaguered crypto lender has paid back a string of debts totaling more than $900 million during the same period to decentralized-finance platforms. 

The paydowns have raised the specter of a legal debate on how and in what order should distressed crypto companies pay back creditors — whether they are actual people or platforms governed by computer code referred to as smart contracts. Celsius has made the repayments in stablecoins to the DeFi platforms Aave, Compound and Maker since it halted customer withdrawals on June 12, according to Bloomberg’s tally based on blockchain data. 

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Because loans from DeFi platforms are often required to be overcollateralized, doing so would allow Celsius to reclaim the extra coins locked at the platform, thus securing more assets on a net basis. 

“Like most things crypto, we are in uncharted territory in terms of who should and ultimately can get paid ahead of other parties, which is complicated by the smart contracts implicated and by the intertwined DeFi lending contractual relationships,” said Thad Wilson, an Atlanta-based partner of financial restructuring at the law firm King & Spalding. 

Celsius, one of the crypto lending companies suffering from soured bets in the current bear market, has been exploring options including a restructuring of its liabilities. It hired the law firm of Kirkland & Ellis for advice, people familiar with the matter told Bloomberg.

The company, which at one point had more than $20 billion in user assets, hasn’t disclosed its current assets and liabilities figures. Regulators in Vermont said they believe Celsius is “deeply insolvent” and lacks the assets and liquidity to meet its obligations. Celsius hasn’t said it was considering bankruptcy. The company did not return a request for comment on the debt repayments.

Litigation risk

Legal and credit experts say that while it’s not uncommon for a financially distressed company to repay certain counterparties while not paying others, doing so is not without litigation risk. 

Celsius repaying some debt ahead of a potential bankruptcy raises the issue of so-called preference claims, according to Jared Ellias, a professor who teaches bankruptcy and corporate law at Harvard University. In a Chapter 11 bankruptcy, some creditors aren’t supposed to end up better off than others — and better than they would in an outright liquidation — just because the insolvent company chose to pay them before entering court protection. 

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“It’s fair to say that any payments or exchanges made while not allowing creditors to get their money in the ordinary course of business are potentially subject to clawback actions in bankruptcy,” Ellias said. “I would tell everybody getting money from Celsius to consult with an attorney before making decisions that they may regret.”

Under its terms of service, Celsius said the treatment of customers’ digital assets in the event of an insolvency proceeding is “unsettled” and “not guaranteed,” which may result in customers being treated as an unsecured creditor. Meanwhile, collateralization could mean that the DeFi creditors are “secured” with priority over unsecured creditors, though whether they are actually defined as secured creditors under the law will “likely be a contested issue and would likely be litigated,” said Daniel Gwen, an associate in Ropes & Gray’s business restructuring group. 

“Those payments made to the DeFi protocols will be scrutinized,” said Pat Daugherty, partner at Foley & Lardner who leads its blockchain task force. However, he believes that the DeFi platforms are entitled to priority because they are secured creditors, while customers are treated as unsecured creditors in this case.  

Robert Gayda, a partner at law firm Seward & Kissel’s corporate restructuring and bankruptcy group, shared the same assessment. While certain payments made within 90 days of a bankruptcy filing could be challenged in court, if the creditor did have collateral that exceeded its debt, then “they’d be in a good position to survive a challenge to that payment,” Gayda said.

Transparency

Celsius’s repayment to DeFi platforms might ultimately be the right financial decision, but it still raises the question of transparency as it made these decisions without any input from customers while locking up their funds, said Mike Alfred, a private investor who co-founded BrightScope. “Celsius paying out loans in DeFi apps before paying off its retail creditors and investors is further evidence that it is being managed as an unregulated high risk hedge fund that was marketed as a low risk savings account to retail investors,” said Simon Dixon, co-founder of BnkToTheFuture and a Celsius shareholder who has been sharing his thoughts on how to save or restructure the business on Twitter.

— With assistance from Rachel Butt and Jeremy Hill.