Hong Kong’s lack of insolvency protection for companies makes a fate similar to MtGox more likely. Creditors, not Bitfinex, are the ones who get to decide whether to socialize losses.
Socialized Losses? Not So Fast
Bitfinex, a bitcoin exchange based in Hong Kong, was hacked last week and suffered a loss of roughly $70M USD. The company appears insolvent after announcing a loss of roughly 36-37 percent of its assets. Bitfinex has since stated that they intend to “socialize” these losses, meaning they expect creditors (anyone with any form of BTC funds at the exchange) to share in the losses equally.
However, under Hong Kong law, Bitfinex will not be able to force creditors to accept its proposal. Unlike in the US and Japan, Hong Kong does not have a system of bankruptcy protection to facilitate a Bitfinex reorganization. By arguing that Bitfinex is insolvent, creditor lawsuits could force Bitfinex into liquidation where creditors can take control.
How Will Bitfinex Differ from MtGox?
MtGox had more opportunities at restructuring than Bitfinex will. This is because Japan adopted a US-style system of insolvency protection, providing companies the equivalent to filing for “Chapter 11”. A Chapter 11-style bankruptcy filing benefits companies in three basic ways:
- filing activates the “automatic stay” provisions of the Bankruptcy Code, which stops lawsuits and turns them into bankruptcy claims;
- non-accepting creditors will be bound to the reorganization plan approved by the court and;
- management remains in place.
Similar protections gave MtGox room to breathe when financial pressure became too great in 2014. With creditors held at bay, MtGox’s management had some time to seek financing, formulate a plan to repay creditors and emerge from bankruptcy profitable. In March and April 2014 numerous parties approached MtGox and its court-appointed trustee with rehabilitation plans. But despite intense arguments favoring rehabilitation MtGox opted to liquidate the company instead.
Hong Kong, however, does not have a Chapter 11-style system, and as a result, Bitfinex is essentially at the mercy of creditors. Creditors owed at least $10,000 HKD can petition the court to wind-up (liquidate) Bitfinex if their debt remains unpaid for three weeks following written statutory demand. Unlike at MtGox, Bitfinex’s creditors do not have to patiently wait in the dark while the CEO hears rehabilitation proposals for months.
What If Creditors Petition to Liquidate Bitfinex?
Once in liquidation, lawsuits against Bitfinex would be stayed, management removed, and a trustee appointed to preserve assets. Creditors would then have some time to organize and consider alternative proposals before deciding whether the court should handle the job.
A competitor exchange might emerge, offering distribute assets to creditors, as Kraken did with MtGox. It is possible for creditors to approve of such a plan and have the court appointed liquidator removed, speeding up the distribution.
Bitfinex has one main legal mechanism to use against creditors seeking to liquidate it: petition the court for a “scheme of arrangement”, which is essentially a court-enforced agreement between the Bitfinex and the creditors. But 75% of creditors must agree on the scheme and the court must approve it.
Due to the associated legal expenses and complexity involved, smaller companies often just come to informal workout agreements with creditors. Bitfinex’s creditors are diverse and are scattered across the globe. Unless Bitfinex can organize support for its socialized losses plan across a diverse set of creditors, dissenting creditors may be able to decide its fate.
Will Bitcoin’s Unique Attributes Affect the Plan?
The fluid nature of Bitcoin is a factor. Despite the socialized losses plan, there is a risk that Bitfinex could repay aggressive creditors in full to stop their liquidation petitions and buy time to continue operations.
In theory, payments by an insolvent Bitfinex to these creditors would be clawed back by court order once a creditor’s petition to wind-up the company is accepted. But in practice, clawing back payments appears hard to enforce here. Most of the creditors are not located in Hong Kong, do not have assets there and know how to use Bitcoin to move their funds quickly. Aggressive creditors with minimal ties to Hong Kong might threaten liquidation to game the system and get a greater repayment.
Unless Bitfinex can give assurances they are dealing with all creditors at arm’s length, this factor might eventually convince creditors and the court that it is best to have a court-appointed liquidator take custody of the assets.
What Else Can Bitfinex Offer to Save Itself?
When news of the scale of MtGox’s insolvency first reached the Internet, things seemed hopeless. My idea was for MtGox to perform a debt-equity swap with creditors: have creditors trade their claim for shares in a newly capitalized MtGox under new management. This was the fastest way to push the company to solvency and create a true incentive for creditors to want MtGox’s survival. The idea was well received and could at some point be considered by Bitfinex.
Bitfinex was a successful exchange with fewer problems than MtGox. We can’t yet be sure, but the loss may have been caused by mistakes implementing BitGo’s multi-signature wallet system and not due to ordinary exchange operations. If this is the case, then Bitfinex does not appear to have suffered from systemic issues like MtGox, and perhaps returning to the previous cold-wallet system would restore consumer confidence.
If pressure from creditors builds over the coming weeks, offering some large creditors an option to trade their claim for shares in the exchange could be one way to balance Bitfinex’s books and rally creditors behind the company.
Do you think Bitfinex has a future? Do you agree with its socialized losses plan? Let us know in the comments below!
Images courtesy of Bitfinex, twitter.com
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