The British Virgin Islands is a popular jurisdiction for incorporating entities that own, trade, or invest in cryptocurrencies and other digital assets. Recently, BVI courts have faced a number of new issues regarding crypto-related fraud and liquidations of insolvent companies holding crypto assets. In doing so, courts have generally applied principles of English law regarding the treatment of cryptocurrencies as a form of property and have, where appropriate, granted freezing orders, injunctions regarding crypto-related fraud and instructions liquidators seeking to preserve and realize crypto-assets for the benefit of creditors of insolvent companies.
This article highlights some important, high-level considerations for crypto fund administrators and managers during these difficult times, particularly in light of the Chapter 11 bankruptcy filing 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.
Some actions may be urgent in order to avoid a run on the fund which could potentially, in the worst case, lead to a situation of insolvency of the fund itself. Issues related to determining a net asset value (NAV) and how to value trapped assets on the exchange are also relevant as they impact a fund’s ongoing trades.
Here are some of the issues faced by BVI crypto funds – especially open-ended crypto funds – and steps that could be taken to mitigate the risks a BVI fund could face if it sees a rush in redemptions, as well as general considerations. this would apply in the event of liquidation of the BVI fund or to ensure its continued operation.
For assets held in accounts or portfolios managed with a crypto exchange that is facing liquidity issues (the affected assets) and where withdrawals or transfers are prohibited (or where such assets are dissipated as a result of a suspected hacking), BVI fund managers and administrators should discuss with their fund administrators and auditors how this will impact the valuation of the affected assets and, therefore, the net asset value of the fund. The valuation treatment must be agreed before the next valuation day (when the net asset value of the fund will be established).
The FTX saga has had a knock-on effect in the market, and therefore broader valuation issues may arise beyond the points raised around impacted assets and administrators, and BVI fund managers should remain vigilant.
Investors in the fund may lose confidence and seek to redeem their investments (not only due to the situation with the exchange itself, but also due to the subsequent impact on the crypto market as a whole). However, in order for redemptions to be satisfied, it is necessary that the BVI fund be able to establish a net asset value and have sufficient liquidity to be able to pay out redemption proceeds. Therefore, decisions must be made as to how to value and manage the assets involved.
Where the net asset value of the fund cannot be determined until the next valuation day or where a substantial part of the assets of a fund is traded on an exchange where trading is strictly restricted or suspended, BVI fund managers and administrators must determine whether a temporary suspension of the calculation of the net asset value and of transactions is justified by the fund’s incorporation documents and the conditions of offer. As a general rule, BVI fund administrators and managers have broad powers to declare a temporary suspension of the determination of the net asset value, as well as subscriptions and redemptions of participating shares, in predefined circumstances.
Imposing such suspensions on net asset value and redemptions is serious action as it also hampers the fund’s ability to accept new subscriptions and may be unpopular with investors whose ability to make redemptions is then reduced. However, fund administrators should consider the best interests of the fund and determine whether this is a prudent option to take.
Given the serious implications on investors’ ability to redeem their investments, funds declaring suspensions should notify investors of the declaration (with details) as soon as possible after the declaration has been made. It is also imperative that BVI fund operators and managers consider whether the fact that the fund has suspended redemptions should be reported to the relevant regulatory authorities (e.g. the Cayman Islands Monetary Authority for funds registered in the Islands Caymans).
Some, but not all, fund documents will allow redemptions to be triggered. Where these mechanisms are included in fund documents, administrators have the ability to limit redemptions on any redemption day to a specified percentage of the fund’s net asset value. Investors who have submitted redemptions but whose redemption request has been deferred may, subject to fund documentation, see their preferred redemptions to newly submitted redemption requests. Therefore, the activation of lock-up provisions may, in itself, induce investors to consider submitting redemption requests to secure themselves in the priority line.
For BVI funds that include side-pocketed mechanisms, subject to the terms of the offering (in particular, limits and restrictions on side-pockets), the relevant assets could be side-pocketed, thereby suspending redemption rights corresponding shares attributable to these “side pocketed” assets. This allows the fund to continue to strike a net asset value on the rest of its assets and process subscriptions and redemptions, excluding pocket assets.
Other options may be available depending on fund documentation and fund circumstances. Restructuring options may also be considered, such as synthetic side pocket arrangements, whereby the relevant assets are transferred into a securitization vehicle created by the fund for these purposes, or to transfer the relevant assets to a liquidation.
Due to the potentially significant impacts on funds and their investors, directors are advised to take timely advice.
From a litigation perspective, when a crypto exchange collapses, the timeline often begins with the commencement of liquidation and restructuring proceedings against the affected entities. Given the popularity of the use of offshore incorporations in the blockchain industry, these insolvency proceedings often originate from offshore jurisdictions. Three Arrows Capital (3AC), currently in liquidation, is a prime example of this scenario. The chain of events leading to 3AC’s collapse arguably began with the de-anchoring of Terra Luna in mid-May 2022. Within weeks, on June 24, 2022, liquidation proceedings had been initiated by 3AC’s creditors. .(1) On June 27, 2022, only three days later, the BVI courts, aware of the urgent nature of the matter, appointed joint liquidators on 3AC.
3AC’s liquidation process illustrates how quickly such disputes can be resolved. This opportunity in the appointment of co-liquidators has enabled the rapid implementation of protective measures on a global scale, in an industry where time is running out when it comes to preserving assets. This facilitated additional investigative work to support recovery, prompt filing of Chapter 15 bankruptcy proceedings in New York, as well as recognition of liquidation proceedings in Singapore.
The British Virgin Islands is well equipped to handle cryptocurrency litigation due to its versatility and flexibility in applying conventional corporate 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 recognizing crypto assets as a form of “asset” for the purposes of the BVI Insolvency Act 2003, over which property rights can be enforced . This has a wide range of legal implications, including:
- allow ownership injunctions to be granted over crypto assets, in addition to freezing injunctions against a person;(3) and
- allowing liquidators to collect and realize crypto assets for distribution to creditors.
With further turmoil anticipated on the horizon for the crypto market, significant legal developments can be expected in offshore jurisdictions as they become increasingly efficient at handling cryptocurrency disputes.
For more information on this subject, please contact Kate Hodson, Alan Wang, Justin Davis or Grant Carroll in Ogier by phone (+852 3656 6000 or +1 284 852 7300) or email ([email protected], [email protected], [email protected] or [email protected]). The Ogier site is accessible at the address www.ogier.com.