Digital assets in insolvency

The definition of “property” set out in s.436(1) Insolvency Act 1986 is so wide that there is no doubt it encompasses digital assets. Of course, whether or not a specific digital asset is “property” within any given insolvency procedure depends (as with all potential assets) upon the facts of the case.

Sometimes the way in which a digital asset is held may mean it is trust property. For example, a trust may (depending on the circumstances) arise where there is a centralised digital asset custodian (such as an exchange) holding the digital assets of multiple clients in one place. This needs to be considered where a restructuring is proposed, because a scheme of arrangement, restructuring plan or CVA cannot be used to modify the proprietary rights of a beneficiary under a trust.

Digital assets, even where they are used as a means of payment, do not constitute money. Or at least, according to the UKJT, “not yet”. The UKJT also takes the view that digital assets do not constitute foreign currency but “may become “currency” at some point in the future, if and when they are (as a matter of fact) commonly and continuously accepted as a means of exchange or a unit of account”.

For present purposes, this means that digital assets cannot form the basis of a statutory demand. It also means that, in the UKJT’s view, the rules contained in the FCA’s Client Assets Sourcebook are unlikely to apply.

The definition of “debt” for a “liquidated sum” for the purposes of a statutory demand differs to that of “provable debt” for the purposes of making a claim in an insolvency. Accordingly, even though digital assets are not money, a creditor can still make a claim in an insolvency process in respect of an obligation to pay (or deliver) a specific quantity of digital assets.

The usual statutory duties and obligations apply to office-holders when realising digital assets. The UKJT acknowledges that “the volatile nature of digital assets presents a particular challenge regarding the fair realisation of value”, and this is certainly a concern for many Insolvency Practitioners when digital assets are identified as part of the insolvent estate.

Existing insolvency legislation allows for office-holders to make a distribution of non-cash assets amongst the creditors where necessary and with creditor consent. However, it is likely to be appropriate for office-holders to consult a third party specialist in most circumstances in order to determine the appropriate time and method of realisation of digital assets.

The UKJT takes the view that the courts should continue to apply existing COMI principles when determining the correct jurisdiction for a debtor with significant digital assets. The nature of digital assets and distributed ledger technology is that such assets could potentially have a connection to a number of different jurisdictions.

The UKJT acknowledges that separate questions may arise as to the lex situs (law of the state where assets are located) of digital assets, but that a discussion of this is beyond the scope of the statement. While not addressing these questions specifically, the UKJT notes that they may be relevant for the purposes of allocating insolvency jurisdiction otherwise than on the basis of COMI. Specialist advice should be taken where there is any doubt about jurisdiction.

The transfer of digital assets prior to insolvency can be challenged by office-holders under existing legislation. However, the way in which digital assets are transferred on blockchain means that it is not practically possible for a transfer to be literally undone if a legal challenge is upheld. The UKJT takes the view that the courts would deal with this by making an order bringing about effectively the same result. As an example, the court could make an order requiring the recipient to make an equal and opposite transfer on the blockchain.