Can a ‘crypto-debt’ form the basis of a winding-up petition or bankruptcy petition?

Posted: 20/12/2022

This article will discuss whether or not a winding-up petition or bankruptcy petition can be based upon a liquidated amount of crypto which is due and payable by one party to another (a crypto-debt).

An example of such a case could be where party A agrees to transfer 100 widgets to party B in exchange for five bitcoin. Assume party A delivers the widgets, and party B accepts receipt and raises no issue with the widgets, and does not dispute their liability to transfer five bitcoin to party B.

Party A may then find themselves considering whether presentation of a winding-up petition, where party B is a company (including limited companies, PLCs and LLPs) or a bankruptcy petition, where party B is an individual, sole trader or unlimited partnership, is appropriate.

The hurdles

Liquidated debt
The first issue which comes to mind is evidencing that the crypto-debt in question is liquidated and is in excess of the statutory threshold. As a reminder, the threshold for a winding-up petition is currently £750 and the threshold for a bankruptcy petition is £5,000.

In the current climate, where the value of crypto-assets is fluctuating wildly, it is easy to see the risk that a court will not be persuaded that the debt in question exceeds the threshold. A court may, however, be persuaded that this hurdle has been cleared if the debt in question vastly exceeds the statutory threshold (for example, if the debt were 20 bitcoin).

In addition, it will need to be carefully considered as to whether the crypto-debt should first be converted into a debt payable in a fiat currency. A careful analysis will be required as to whether or not the cryptocurrency is capable of constituting a debt which can form the basis of either a winding-up or bankruptcy petition. It is however likely that a crypto-debt should be provable in an insolvent estate as it does not appear within r.14.2 of The Insolvency (England and Wales) Rules 2016 (IR 16), and does constitute a ‘liability to pay money or monies worth’ under r.14.1 of IR 16.

Looking at a potential parallel, in terms of proving for a debt in a foreign currency, conversion to GBP is required at the prevailing rate given by the Bank of England pursuant to r.14.21 of IR 16. Whether the court will be prepared to treat cryptocurrency as equivalent to a foreign currency is of some doubt, and of course the Bank of England does not publish conversion rates for the thousands of tokens in circulation.

Crypto-debts, and the correct method for their valuation in an insolvent estate, may therefore need to be considered by the Insolvency Rules Committee, and/or Parliament, to ensure that the current statutory framework and the courts are equipped to deal with such digital assets in insolvency situations.

Undisputed
Winding-up and bankruptcy petitions may only be used where a debt is undisputed. The court will however be live to frivolous disputes which have no prospects of success. A helpful rule of thumb is to ask oneself whether or not the dispute (or debtor’s defence) could be struck out and summary judgment obtained if court proceedings were issued in relation to the debt.

An important point to remember when it comes to an undisputed debt is the need to explain your case in short order, given the condensed nature of both the bankruptcy and winding-up lists, as well as the relative novelty of crypto-assets to much of the judiciary.

Centre of main interest
The courts of England and Wales may only make a bankruptcy or winding-up order where they are satisfied that the debtor has its/their ‘centre of main interest’ (COMI) within the jurisdiction. The test for COMI is complex, and very fact specific, but given the common issue of locating the holders of crypto assets, as well as identifying them, COMI is an issue that would need considerable thought applying in any prospective case. In addition, arguments as to the location of assets in dispute remains live in crypto-asset litigation.

The courts of England and Wales do have jurisdiction to wind-up foreign companies under section 221 of the Insolvency Act 1986. The act gives no guidance as to the criteria which will justify the courts of England and Wales assuming jurisdiction, so it has been left to the jurisdiction of the courts. In practice, it is normally considered a sufficient nexus for the company to have, or have had, a place of business or branch office within the jurisdiction, or to have assets here, but other factors can be regarded as relevant.

However, the court must be satisfied that there is a reasonable possibility that the winding-up order will benefit those applying for it, and the court must be able to exercise jurisdiction over one or more persons interested in the distribution of the company’s assets.

Pseudonymity
It is vital to know who the debtor is when considering a winding-up or bankruptcy petition. This is for a multitude of reasons, which include the need to advertise the petition, or register it with HM Land Registry. In the event that the identity of the debtor is unknown, presenting a winding-up or bankruptcy petition is unlikely to be possible.

Service
A winding-up petition and bankruptcy petition must, in accordance with The Insolvency (England and Wales) Rules 2016, be personally served upon the debtor. In the event that personal service is not possible, an application for substituted service will be required. While we have seen such applications in crypto-claims, with service having been effected by way of an NFT deposited into a designated crypto-wallet, we are not aware of any reported equivalence in a winding-up or bankruptcy petition context. It is, however, conceivable for the courts to grant permission for service to be effected on a wallet address where, for instance, it can be shown that a debtor is keeping out of the way to avoid service of the petition.

Other risks
The main risk of presentation of a bankruptcy or winding-up petition is that if an order is not made, generally, the petitioning creditor will be ordered to pay the respondent’s costs on the indemnity basis (potentially 90% of costs). In addition, if it is deemed that the petition was an abuse of process, the petitioning creditor may find themselves liable for consequential losses the respondent has suffered due to the freezing of their bank accounts/failure to obtain credit etc.

Conclusions

While a bankruptcy petition against an individual, or a winding-up petition against a company, may, in principle, be presented based upon a crypto-debt, they may not be the best options available. It is important to remember that a compulsory winding-up order and a bankruptcy order are class remedies, and the petitioning creditor may therefore end up achieving little more than a pyrrhic victory. They are also draconian remedies and so the court will exercise caution before an order is made.

Creditors must remember that each case and claim will turn on its individual merits and that just because winding-up or bankruptcy may not be attractive options, this does not mean there are no options available.

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