The Celsius Bankruptcy

Update - Notes from Sept 1, 2022 Hearing:

Celsius Hearing in the United States Bankruptcy Court in the Southern District of NY

The court received over 800 zoom requests to attend the hearing.

The Debtors claimed to be focused on finding a path forward and pointed to recent lawsuits filed against a former employee Jason Stone, and against Prime Trust as an important step to getting more funds for the creditors.

The “earn and borrow” program is all titled to Celsius, customers have no right of ownership to these funds, and any proceeds will be distributed at the end of the bankruptcy proceedings

Issue 1: Custody. An important development at the outset was an admission by Celsius that the cryptocurrency held in “custody and withhold” will be considered distinct from the “earn and borrow” program. The Custody and withhold assets will not be subject to the bankruptcy, and will be returned to the Users. There is $215mm, but Celsius is attempting to separate it into three tranches.

Not all the assets have always been in this category, some were moved from the earn and borrow program over to the custody program within 90 days of Celsius’s bankruptcy, so Celsius is contesting that those people should still not have a good title to their crypto.

Celsius concedes that 48 million is owned by “pure” custody holders. The rest is being contested as either having been transferred too late, or being valued at less than $7,575, a number that comes from the bankruptcy preference statute. So the small accounts, or late accounts are being treated differently than the “pure” custody accounts. There are tens of thousands of accounts that don’t meet this $7,575 cut off that cumulate $11mm in total. Approx. 160 mm will be left in the custody after the distribution (subject to price fluctuation).

Kyle Ortiz, on behalf of the creditors, stated that the conclusion that the custody assets were titled to the account holders was a welcome relief, but given this admission, Celsius needs to release this property immediately since it’s no longer considered property of the bankruptcy estate. Celsius is not at liberty to determine what to do with it, they must return it, and holding it may even be a violation of due process.

Deb Kovsky, who represents an ad hoc group of creditors, pointed out that these coins are being illegally held by Celsius at this point, and Celsius is not licensed to be a custodian of crypto assets.

Greg Pesce, who represents the creditors, stated its important to make sure insiders, like Machinsky and his wife, are not being paid out through this custody account, the names of the payouts need to be disclosed.

Hermann, who represents a group of creditors, argued that the Earn program should also not be property of the bankruptcy estate, because it represents unaccredited investors who illegally were allowed to invest in unregistered securities and invested more than they could afford to lose with their deposits. While Celsius changed their TOS after the initial investments, depositors should have been notified that the investment was not suitable for non-accredited investors, and investors should have been forced to withdraw or moved to the custody program. Rather, Celsius encouraged them to deposit more. Celsius modeled its new TOS almost verbatim from the BlockFi TOS after their settlement with the SEC and state securities regulators. The Earn product was positioned to investors as if it was safer than a bank. Insiders were able to withdraw their funds from the program days before the freeze on withdrawals was implemented and bankruptcy was initiated.

Judge Glenn stated that the parties should confer on those issues and try to work them out amongst themselves as much as possible and come back on October 6 to get a final verdict on how to handle the custody assets.

Issued 2: Appointing the Examiner:

The Official Creditors Committee has submitted over 250 diligence requests, Celsius has responded to 160, and is in process of continuing to disclose thousands of pages of documents, and given electronic access to certain wallets that allow them to research historical transaction data. Celsius states that it is trying to be as open and transparent as possible.

Greg Pesce, on behalf of the Official Committee, thanked Celsius for its work over the past two weeks, and stated that they are being responsive to the demands. Mr. Pesce stated the OCC has concerns that an examiner would cost additional funds, and the OCC has only just now started their examination. The Company doesn’t have money to go into hibernation during an exam. The OCC asked the Trustee to hold off on the examiner.

Judge Glenn - stated if an Examiner is appointed, there will need to be a protocol for information sharing to assure as little duplication of effort as possible.

Issue 3: Privacy of Creditor Names

Celsius is claiming there will be significant harm if the information about the creditors is published - citing cybersecurity or physical safety risks for the US creditors and GDPR violations to certain EU creditors. Looks like they will publish the names, but not the addresses or email addresses. The Texas AG, Layla Milligan, was on the call and stated they absolutely wanted the names of the creditors available. The judge alluded that it will make the information available upon request to interested parties. The decision on this matter was postponed.

Issue 4: Diminimus assets.

The Parties seem to have resolved the matter without needing court intervention. The Trustee will get notice of any sales under $300,000, and any sales between $300,000 - $4mm will be added to the docket so any party can object to the sales. The Court granted the motion with the revised order.

Issue 5: Cash Management Motion

• The coin report needed to be updated because there was a $61mm loan that was listed as a stablecoin receivable, which is actually a USD receivable.

Original Post Below: -- Background. Celsius Network, a crypto lending company, was founded in 2017 by Alex Mashinsky. Users can deposit their digital assets such as Bitcoin and Ethereum for high-interest rates, paid through cryptocurrency or the company’s own CEL token. Celsius users can also take out loans by pledging their digital assets.

In June 2022, Celsius’ liquidity reserves were revealed for the first time after two lawsuits were filed against the firm. After halting customer withdrawals due to “extreme market conditions,” the company filed for Chapter 11 bankruptcy last July 13, 2022.

Lawsuits. One of the lawsuits alleged that Celsius’ lending platform was a Ponzi scheme, and in the bankruptcy filing, claimed that its stablecoin was in fact backed by Tether which resulted in a 97-million-dollar loss for Celsius. It is also alleged that the company was selling unregistered securities and violating the state money transmitter statutes. The results of these investigations were not made public, and Mashinsky has since dodged questions about these issues in an interview with Yahoo Finance.

However, it appears that the company has been unable to service customer loans as they fall due—a situation that may have led to its insolvency. Following its withdrawal freeze, the firm revealed it had significantly depleted its liquidity reserves, thanking customers for their patience and “understanding that the current period is temporary.”

Celsius also lost money due to the BadgerDAOs $130M hack, and received the corresponding restitution tokens - but then sold them against all the on-screen warnings - and suffered another loss.

Financials. In their bankruptcy filing, a $1.2 billion gap in their balance sheet was disclosed ($5.5B liabilities and $4.3B assets), owing most of the liabilities to their users. Under the Chapter 11 bankruptcy proceedings, these users are categorized as unsecured creditors and may not be able to recover their investments.

According to their Monthly Cash Flow Forecast, liquidity is $66M in August, $11M in September, and -$33M by October. For these three months, the allocated budget for payroll is $13M, $57M for a new mining venture, and $33M for restructuring activities.

Most of Celsius’ assets are in the form of crypto ($600M CEL tokens, $467M ETH, $620M crypto-denominated loans) - not money, cash equivalents, or other assets under the US GAAP, which means that it isn’t clear how these assets should be valued in the financial statements.

Top 10 Creditors

Celsius owes its top 10 creditors $183.3M, with the top of the list being a Cayman Island company called Pharos, which is owed $81 m. Pharos was reported by Bloomberg as being related to Lantern Ventures, whose CEO Tara Mac Auley, a co-founder of SBF’s Alameda Research. She also worked for a charity where SBF was the director.

Everyone wants to stay in crypto denomination - both Celsius and the creditors, so Celsius has invested heavily into setting up bitcoin mining rigs to try and mine their way out of the hole.

Miners are nothing like as profitable as they report to the public stock markets that they are. Celsius is mining at a rate of 0.6-0.08 per kilowatt-hour. Riot blockchain, for example, is at 0.025.

Regulatory Action

Despite the Chapter 11 bankruptcy filing which allows Celsius to operate and restructure their finances to pay creditors, it is already banned in some states like Alabama, New Jersey, Texas, and Kentucky for unregistered securities offerings, and unlicensed money transmission. California issued cease and desist on Aug 8, 2022.

SEC took a harsh stance against Blockfi earlier this year, it would be surprising if they didn’t take some action against the Earn program, but at the same time, a hefty fine assessed against a bankrupt company might not be the best look for “protecting investors” - would be more like kicking investors while they are down.

Bankruptcy Proceedings:

Judge Glenn asked for all the Terms of Service dating back to 2018 to figure out what is or isn’t property of the bankruptcy estate, and said, “Little did I know there were going to be 1,100 pages of them,” he said.

Trustee and judge were shocked when Celsius wanted to sell assets they claimed were “de minimis” which is usually like - extra furniture, and found out Celsius’ idea of de minimis was notes/bonds and equity outstanding in other crypto companies.

Trustee: “Certainly I had no inkling the debtor was proposing to sell millions of dollars of equity or notes/investments in other crypto businesses. Those were not what I would normally consider to be de minimis assets, so I want some better definition.”

DIP

Since Celsius has publicly stated they will run out of money in October, they are attempting to get a DIP (debtor-in-possession) financing - which allows a company in bankruptcy to raise capital to fund its operations as the bankruptcy case runs its course. DIP financers usually step

in front of other creditors.

Examiner:

There are a lot of moving components in this case, and the examiner's task is to explain Celsius' financial situation in a report that Celsius' numerous creditors can easily grasp.

The statutory vehicle for examiner appointments is section 1104(c) of the Bankruptcy Code. It provides that a bankruptcy court has the authority to appoint an examiner "on request of a party in interest" in order to investigate "any allegations of fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in the management of the affairs of the debtor of or by current or former management of the debtor."

Section 1104(c) also states that an examiner "shall" be appointed under the following circumstances:

(1) if the appointment is in the interests of creditors, any equity security holders, and other interests of the estate; or

(2) if the debtor's fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5,000,000.

The independent examiner's task will be to look behind the scenes in order to determine how

much Celsius' creditors can anticipate receiving at the end of the investigation because Celsius has not been transparent about how much money they owe certain creditors.

Through the Department of Justice, taxpayers cover the cost of the examiner's time.

Prime Trust Lawsuit

Celsius sued Prime Trust, their crypto custodian on August 23, claiming that it was in possession of 17 million of Celsius' assets. Prior to all the state authorities issuing cease and desist, Prime Trust terminated their contract due to many red flags.

Before sending the money back to Celsius for customers in New York and Washington, Prime Trust required all users to sign new terms; however, not all users complied. $119M were returned by Prime Trust, and it appears that $17M are still in their custody.

Conclusion:

I’m not sure how long this will continue before the “restructuring” turns into a liquidation, and Celsius management is booted. Likely not before Celsius burns through the rest of their customers’ funds, pays as many of their friends as possible, and the bankruptcy attorneys make their millions.

The next Celsius hearing is September 1.

By Sasha Hodder, Crypto Attorney & Bitcoin Enthusiast