If FTX eventually collapses, how can creditors get their assets back?

In the past few days, the center of the storm in the crypto market has undoubtedly been the FTX incident.

In the early morning of November 8, Binance founder Changpeng Zhao (CZ) posted a message saying, "Binance intends to fully acquire FTX." Just two days later, the wind direction changed again. Binance officially issued a message stating that based on the results of the company's due diligence and the latest news reports on improper handling of customer funds and the so-called US agency investigation, it decided not to pursue a potential acquisition of FTX.com.

In addition, Bloomberg quoted people familiar with the matter as saying that SBF said FTX is facing a funding gap of up to $8 billion and is trying to raise funds through debt, equity or a combination of the two; FTX has serious financial loopholes and said that without capital injection, FTX will file for bankruptcy.

Once the bankruptcy is liquidated, how can users on the FTX platform get back their encrypted assets? As a multinational blockchain group, how can creditors use legal weapons to protect their legitimate rights and interests? Do previous FTX investors need to bear related liability for related debts? Odaily Planet Daily contacted two lawyers to interpret the above legal issues for readers: Xiao Sa, director of the China Banking Law Research Association, and Wang Zhonghan (Vincent), a lawyer at Vault 30 Law Firm in the United States and the initiator of LegalDAO.

Attorney Wang Zhonghan believes that for a multinational exchange like FTX, it is often necessary to file for bankruptcy in multiple jurisdictions, which also increases the difficulty of future repayment. In addition, the creditors of ordinary users on the platform may not have a high priority and rank behind other creditors.

Of course, if FTX can find new investors who are willing to inject capital, it can avoid liquidation. However, attorney Xiao Sa said that if the acquisition cycle is too long, FTX will face more uncertainties, which may deepen its liquidity crisis. "The length of the acquisition cycle varies from project to project. If the transaction method is simple and the acquisition target is clear, it may take one or two months to complete the transaction; but if the transaction model is complex, the acquisition target is large or complex, and the decision-making and approval procedures to be performed are complex, the entire acquisition cycle may take several years."

The following is a lawyer's interpretation, compiled by Odaily Planet Daily:

Odaily Planet Daily: The latest news is that Binance has decided not to make a potential acquisition of FTX.com. In addition, Bloomberg quoted an insider as saying that SBF said FTX's funding gap is as high as $8 billion and it will file for bankruptcy if there is no capital injection. For a multinational blockchain group like FTX, what is the process of filing for bankruptcy liquidation? (Are there any reference cases and how long it takes?)

Wang Zhonghan: For a multinational exchange like FTX, it is often necessary to file for bankruptcy in multiple jurisdictions, which also increases the difficulty of future repayment. For example, the Bitcoin exchange Mt. Gox filed for bankruptcy in Japan and the United States in 2014, and their creditors did not enter the compensation process until 2022.

Odaily Planet Daily: Crypto assets have their own particularities. It is difficult to trace on-chain assets. How to determine the remaining assets during liquidation?

Wang Zhonghan: First of all, according to legal requirements, debtors need to truthfully declare their assets. Violators will face fines or even criminal penalties. As the actual controller of FTX, SBF needs to declare truthfully, otherwise he may face imprisonment. Secondly, the bankruptcy administrator can apply to verify the assets of the bankruptcy applicant. There are also many on-chain analysis institutions that have a lot of experience in asset tracing, and they can assist in the investigation as a third party.

Odaily Planet Daily: Currently, FTX platform has stopped withdrawing coins. How should ordinary users with smaller funds get back their crypto assets? In bankruptcy liquidation, how are creditors prioritized?

Wang Zhonghan: Taking the US bankruptcy law as an example, secured claims > unsecured priority claims (bankruptcy administrator fees + tax claims + employee salary claims) > unsecured ordinary claims.

In the FTX Terms of Service, FTX clearly states that the ownership of user assets belongs to the user themselves. In other words, FTX is the custodian of user assets. Therefore, user assets will not be included in the liquidated assets. This is a good thing for users. However, there have been recent reports that FTX has misappropriated customer funds. If verified, there is a possibility that user assets that cannot be repaid will be changed into unsecured claims.

Odaily Planet Daily: Once bankruptcy liquidation is carried out, will FTX’s investors in previous rounds of financing (such as Sequoia Capital) be listed as one of the debtors and bear relevant compensation liability for FTX’s related debts?

Wang Zhonghan: Generally not. Investors bear limited liability and are only responsible for the company's debts within their investment share.

Odaily Planet Daily: After Binance gave up the acquisition, FTX must find new investors to inject capital as soon as possible to save the collapsing building. In a letter from SBF to internal employees, it stated that FTX still has the possibility of raising funds in theory, which is FTX's top priority next week. At the same time, Sun Yuchen, as a potential investor, is already in dialogue with him. Could you two lawyers first introduce to us what specific steps are required to achieve the process of completely acquiring another company? How long does the entire acquisition cycle take? If the cycle is too long, will it deepen FTX's liquidity crisis?

Wang Zhonghan: In terms of time, it can be as fast as 20 weeks or as slow as more than a year. It also depends on the specific time clauses discussed in the LOI. If the current market environment continues to be sluggish, it will indeed deepen the crisis, mainly because market sentiment is focused on this point, and there is no information explosion to divert attention like in the bull market. If the market improves, FTX's liquidity crisis may be alleviated through other direct or indirect means.

Xiao Sa: (1) Generally speaking, a company’s acquisition process includes the following steps:

The first step is that the two parties to the transaction have preliminary consultations and sign a letter of intent to reach a preliminary intention on the acquisition. In some company acquisition projects, the seller may require the acquirer to pay a certain amount of earnest money to confirm that the acquirer is indeed sincere in the acquisition; if the acquisition project involves disclosure or pre-examination by regulatory authorities, the parties need to disclose and apply for approval at the stage of signing the letter of intent;

The second step is for the acquirer to conduct business, financial and legal investigations on the target to be acquired, and to evaluate the asset value and acquisition risks of the target to be acquired. The acquirer can perform the required internal decision-making (such as shareholders' meeting, board of directors decision-making) and external approval procedures at the same time or after the investigation and evaluation according to the acquisition expectations;

The third step is to start consultation and negotiation on the acquisition method, acquisition conditions and transaction documents based on the results of investigation, evaluation, decision and approval;

The fourth step is to sign the acquisition contract and revise the articles of association. The acquisition contract usually stipulates the conditions for effectiveness, and common conditions for effectiveness include the internal decision-making and external approval procedures required by all parties to complete the acquisition;

The fifth step is the handover, which includes payment, replacement of directors, supervisors and senior managers, handover of seals and other management rights, and handling of equity or property ownership change registration and filing procedures.

The above steps can be combined or further broken down. The first four steps may be initiated one after the other or simultaneously, and require flexible responses based on the specific circumstances of the acquisition project.

(2) The length of the acquisition cycle varies from project to project. If the transaction method is simple and the acquisition target is clear, the transaction may be completed in one or two months; however, if the transaction model is complex, the acquisition target is large or complex, and the decision-making and approval procedures to be followed are complex, the entire acquisition cycle may take several years.

(3) FTX is a cryptocurrency trading platform. Its liquidity crisis is closely related to the tokens it issues, its own asset-liability structure, and external factors such as the token market environment. The long acquisition cycle may have many impacts on it. Whether it will affect its liquidity needs to be considered comprehensively in combination with internal conditions, external environment and other factors. But overall, if the acquisition cycle is too long, FTX will face more uncertainties, which may deepen its liquidity crisis, but it is not absolute.

Odaily Planet Daily: Many people have also noticed that Binance previously signed a letter of intent to acquire FTX, and Zhao Changpeng (CZ) also stated that Binance has the right to withdraw from the transaction at any time. We would like to know what the legal effect of this letter of intent is?

Xiao Sa: After the acquisition letter of intent meets the conditions for the establishment and effectiveness of the contract, it is a legally binding contract for the contracting parties. As for its effectiveness, it needs to be judged based on the content of the letter of intent. Zhao Changpeng (CZ) said that Binance has the right to withdraw from the transaction at any time. If this is true, it is probably because they agreed on a mechanism for Binance to withdraw at any time in the acquisition letter of intent, which is also common in acquisition transactions.

Odaily Planet Daily: Based on the public opinion in the past few days, many people believe that the sharp drop in crypto finance this time is due to Binance suppressing FTX to achieve a hostile takeover? How is a hostile takeover defined in law? Does Binance's behavior meet this condition?

Xiao Sa: The acquisition of control rights between industry leaders often has a significant impact on the entire industry, not just the cryptocurrency industry. However, whether it constitutes a hostile acquisition needs to be determined based on the specific circumstances of the transaction and the applicable laws.

A hostile takeover usually refers to an acquisition by the acquirer that bypasses the decision-making body of the acquiree. A common example of a hostile takeover is to acquire shares through a tender offer in the stock market to control the acquiree. Whether Binance's acquisition of FTX constitutes a hostile takeover depends on factors such as whether the acquisition method is friendly and the decision of the acquiree FTX on the transaction. However, since Zhao Changpeng (CZ) has publicly stated that the two parties have signed a letter of intent and are ready to conduct due diligence, it may mean that the two parties are conducting the acquisition under friendly negotiation, and it cannot be asserted that it is a hostile takeover.

Odaily Planet Daily: A few days ago, there was a view that Binance's acquisition of FTX might trigger an antitrust investigation by regulators. Because Binance is currently the world's largest cryptocurrency exchange by trading volume, and FTX ranks in the top five. What are the conditions for triggering an antitrust investigation? Does this mean that the top exchanges cannot acquire FTX in the future, otherwise it will trigger an antitrust investigation?

Wang Zhonghan: First of all, I personally think that this acquisition is unlikely to trigger an antitrust investigation, of course I am referring to the US antitrust. The US antitrust can basically be simplified into two starting points: 1. Per se illegal (itself illegal) 2. Rule of reasoning (rational rule). If the first two are triggered, then the Ministry of Justice will definitely intervene. As for the ROR part, it actually needs to be judged by the Ministry of Justice first.

Although Binance is the industry leader in terms of trading volume and number of users, and FTX is the fourth, in fact, the two combined only barely exceed 60%. It is hard to say whether 60% of the market will be defined as possessing market power in the larger market.

It can be seen that with so many large CEXs in the market, there are still many entrepreneurs entering this field, which means that at least this field has not yet been monopolized. Of course, how to define the market is another question. If the Ministry of Justice can find a small market angle, such as the futures contract market, to determine that this merger will manipulate the market, it is also possible to trigger an antitrust investigation in the United States.

Xiao Sa: Failure to report monopolistic behavior that should be reported according to law may trigger an antitrust investigation. The types of monopolistic behavior mainly include monopoly agreements, abuse of market dominance, concentration of operators, abuse of administrative power to exclude or restrict competition, etc. The most directly related to Binance's acquisition of FTX is concentration of operators. Whether there may be other types of monopolistic behavior needs to be judged based on the specific circumstances of the acquisition.

As you said, both parties to the transaction, Binance and FTX, are cryptocurrency exchanges, and Binance's spot trading market share exceeds 50%. This acquisition of control is a typical horizontal acquisition. Therefore, the direct impact of the acquisition is that Binance's market share will expand, competition will decrease, and its market dominance will become more obvious. It is very likely that it will be deemed to constitute a concentration of operators and must be reported in accordance with the Anti-Monopoly Law. Failure to report in accordance with the law will trigger an antitrust investigation.

Odaily Planet Daily: What penalties might it face if it is found to be punished under the Antitrust Law? As a multinational blockchain group, which country's agency can initiate an investigation?

Xiao Sa: Different jurisdictions have different administrative penalties and penalties for violations of antitrust laws. Cryptocurrency trading is a global market, and Binance and FTX also serve global customers. Therefore, once Binance successfully acquires FTX, it may trigger antitrust reviews in multiple countries or regions. Taking the United States as an example, according to the U.S. Sherman Act, serious violations of antitrust laws and monopolistic behavior may result in fines of hundreds of millions of dollars. If you violate the law and are fined in the United States, then Binance and Mr. Zhao himself may be "unwelcome" to conduct activities in the United States. We think this may also be a reason for finally giving up the acquisition.

Odaily Planet Daily: Reuters reported that the direct cause of the FTX liquidity crisis was that FTX had misappropriated more than $4 billion to rescue Alameda Research. The financial relationship between the two is relatively complicated. How to achieve penetrating supervision in this case?

Xiao Sa: How to achieve penetrating supervision is a very big question. Because regulatory agencies in different countries and regions may have different attitudes towards digital currency transactions and implement different regulatory policies at different times. Traditional penetrating supervision usually involves checking the source of funds. Digital currency trading platforms based on blockchain technology should be able to rely more on digital and intelligent technologies such as big data and algorithms to analyze and identify risks on the basis of fully obtaining information.