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US Bankruptcy Court’s ruling could help HashFast trustee recover $1.3 million

28 Feb 2016, 00:00, ,

Judge Dennis Montali, presiding over the United States Bankruptcy Court for the Northern District of California, ruled that Bitcoin should be classified as “intangible personal property.”

The Internal Revenue Service (IRS) considers bitcoin property, the Commodity Futures Trading Commission (CFTC) considers bitcoin a commodity, the Securities and Exchange Commission (SEC) and Financial Crimes Enforcement Network (FinCen) both consider the cryptocurrency to be currency or money, falling under their jurisdiction.

Last week, Judge Dennis Montali, presiding over the United States Bankruptcy Court for the Northern District of California, ruled that Bitcoin should be classified as “intangible personal property.”

This ruling was provided during an adversary proceeding case against bitcoin mining company HashFast Technologies LLC (HFT), following its collapse. Claims against the Hashfast Estate currently total approximately $40,754,674, according to the liquidating trustee. The trustee is tasked with recovering property for the benefit of the estate, or if the court so orders, the value of the property.

The trustee is currently suing California physician Marc A. Lowe, in an attempt to recover 3,000 bitcoins which HashFast paid him, in addition to a $37,800 refund, damages and interest from the date of each payment.

Berger Singerman LLP“This transfer is subject to a ‘clawback’ action by the bankruptcy estate (either as an avoidable preference or fraudulent transfer), which asserts that the transfer was fraudulent or unauthorized.”
— – Isaac M. Marcushamer and Andrew M. Hinkes, Berger Singerman LLP

Hashfast started selling pre-orders for its flagship product, the BabyJet miner, in August 2013. In the same month, the company executed a memorandum of understanding with Lowe, paying him to endorse the company’s products on forums and message boards.

HashFast paid Lowe 3,000 BTC in commission during September 2013, worth $363,861.43 at the time, for a total of 160 posts, or an equivalent of $2,274 per post. Lowe had also purportedly joined HFT’s board of advisors, according to the court document.

Unable to deliver all of the presold BabyJets, HashFast sank money into ordering products on expedited delivery schedules, sending the production costs skyrocketing, while continuing to accept orders and promising guaranteed dates.

By January 2014, many customers were requesting refunds. Lowe himself requested a refund of $36,000, paid for a personal order of mining equipment. He, unlike most customers, received a full refund plus a five percent bonus, which totaled $37,800, and was received by wire transfer in January 2014. By May 2014, HashFast’s then-CEO Eduardo deCastro told Ars Technica that "we pretty much emptied the bank account into refunds.”

Since the dispute concerns 3,000 BTC, whose value has spiked since the date of the transfer, the court’s determination whether Bitcoin is property or currency is significant in determining how much the trustee could be entitled to. Since bitcoin is not included in the Bankruptcy Code, this is an issue of first impression before the bankruptcy court.

Baker Hostetler LLP“Currently the Bankruptcy Code does not account for cryptocurrencies like bitcoin – which the judge was also quick to point out. In a slew of recent cases, this is yet another example of technology moving faster than the law.”
— – Madiha M. Zuberi, Litigation Associate, Baker & Hostetler LLP

If Bitcoin is considered a currency, the trustee would be entitled to only the historical value at the time of the transfer, $363,861. Alternatively, if Bitcoin is considered a property, the trustee would be entitled to receive the value of the BTC at the transfer date or time of recovery, whichever is greater. The present value of the BTC is approximately $1.3 million.

Brave New Coin spoke with Grant Fondo, Partner at Goodwin Procter’s Securities Litigation & White Collar Defense Group, regarding the ruling and its implications. Fondo is a federal prosecutor that has represented a number of technology and digital currency companies, including Sand Hill Exchange in its alleged violations of US securities law and settlement with its digital currency stock exchange and Ripple Labs’ before the federal government.

Grant Fondo“The court simply said a bitcoin is not a U.S. dollar. What I think the parties’ briefs and court’s order demonstrate is that a court’s answer to the question likely may depend on the specific circumstances of the statute/regulation at issue, and how the bitcoin is being used, rather than a broad decree. Even how bankruptcy courts treat bitcoin may change under the circumstances of the issue before the bankruptcy court.”
— – Grant Fondo, Goodwin Procter’s Securities Litigation & White Collar Defense Group

Citing the CFTC treatment of bitcoin, the trustee argued that bitcoin should be treated as a commodity, so the bankruptcy court should order the return of the bitcoins or their current value, which has more than tripled since the transfer to Lowe. This “would maximize recovery to the bankruptcy estate pursuant to the policy underlying 11 U.S. C. §550(a),” according to Marcushamer and Hinkes.

On the other hand, the SEC ruled that bitcoin is a security or money, in the case against Trendon Shavers and his company Bitcoin Savings and Trust (BTCST). The SEC argued that their bitcoin investments met the definition of a security and the US District Court sided with the agency, finding “no reason to conclude that Bitcoin is not money.” FinCen treats bitcoin as a currency in defining convertible "virtual" currency as a “medium of exchange that operates like a currency in some environments.”

Citing the SEC and FinCen definitions, Lowe urged the bankruptcy court to view bitcoin as a currency, therefore only allowing the trustee to avoid and recover the value of the bitcoins at the time of the transfer. The bankruptcy court ultimately sided with the trustee.

“As noted by the parties, courts and regulatory agencies have treated bitcoin differently depending on the regulations and circumstances, and this court appears likely to keep its ruling fairly narrow such that it will be difficult to cite this case for the proposition that under all circumstances bitcoin should be treated as a commodity, currency or something else.”

  • Fondo

At the time that HashFast was facing financial issues, the most infamous bankruptcy case in bitcoin history began, that of bitcoin exchange MtGox, which filed for bankruptcy protection in Japan during February 2014. The case is currently under ongoing investigation.

Bitcoin exchange Kraken was selected to assist Tokyo District Court-appointed Trustee Nobuaki Kobayashi in the investigation of missing Bitcoin, receiving claims and distributing remaining assets to MtGox creditors. Kraken recently revealed that 24,733 people worldwide have filed bankruptcy claims related to MtGox exchange, totalling ¥2,695,239,249,594. Almost 10 thousand people filed bitcoin-only claims, of which more than 80 percent have been approved. The Trustee currently has 202,163.41191816 bitcoin.

Later in the same year another bitcoin mining hardware company, Butterfly Labs, was also facing problems. At the request of the Federal Trade Commission (FTC), a federal court shut down Butterfly Labs for deceptively marketing bitcoin mining computers in September 2014.

The FTC revealed that Butterfly Labs took at least $20 million from consumers, and potentially up to $50 million. This month, Butterfly Labs and two of its operators, part-owner Sonny Vleisides and general manager, Darla Drake, agreed to settle FTC charges. However, even though the judgment was $38.6 million against the company, the FTC agreed to collect only $15,000 because they were unable to pay more.

FTC Bureau“Even in the fast-moving world of virtual currencies like Bitcoin, companies can’t deceive people about their products. These settlements will prevent the defendants from misleading consumers.”
— – Jessica Rich, FTC Bureau of Consumer Protection Director

With last Friday’s ruling, Fondo believes that it sets “currently little” precedent for the courts and other parties. “It appears the court, at least for now, is passing on the broader question raised by the liquidating trustee’s motion as to whether bitcoin is a commodity or currency. That is common—judges tend to keep their rulings narrow to the facts of the matter before them,” he added.

“Even if the bankruptcy later does rule on the broader question, I suspect this will not end the debate…Rather, any future decisions by this court may, at most, provide guidance in bankruptcy proceeds and a talking point when applied to non-bankruptcy matters. But only time will tell.” – Fondo


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