...though if they have already agreed to a settlement otherwise, they would likely not.
If you've been asked to return money that you received from FTX to the bankruptcy estate, you absolutely should seek legal advice. If that legal advice suggests that you should give it back, you could consider seeking a second opinion.
(I am not a lawyer. I am not your lawyer. An org that I'm involved with was contacted in the last year by the good folks at Sullivan & Cromwell regarding a return of funds, and I thought that some of the specific things I learned in the process should be better-known in our community. I'm writing as a throwaway account because I don't feel comfortable poking Sullcrom in the eye under my name, even with the defense that it's just spreading knowledge of the law.)
1. Avoidance actions as explained by Claude 3.5 Sonnet
Here's a conversation with Claude 3.5 Sonnet. It's unabridged, except that I will move some side questions to footnotes from the main text. It has not been endorsed by my legal knowledge, because I am not a lawyer.
In the case that company A gives a grant to organization B on October 1, 2022, and on November 11, 2022 it is discovered that company A had a huge fraud and it enters bankruptcy. Let's say that the A estate brings an avoidance action against organization B, and is successful in avoiding the transfer. Please first explain what an avoidance action is, and then explain what might happen subsequently in the case that general unsecured creditors of A become eligible for payouts in the reorganization plan.
(Claude 3.5 Sonnet answers:) I'll explain avoidance actions and then address the scenario you've described.
Avoidance action:
An avoidance action is a legal proceeding in bankruptcy law where the bankruptcy trustee or debtor-in-possession seeks to "avoid" (cancel or undo) certain transfers of property or obligations incurred by the debtor before filing for bankruptcy. The purpose is to recover assets for the benefit of the bankruptcy estate and ensure fair distribution among creditors. Common types of avoidance actions include:
- Preferential transfers
- Fraudulent transfers
- Post-petition transfers
- Statutory liens
- Setoffs
In your scenario, the avoidance action was successful, meaning the transfer (grant) from Company A to Organization B was voided.
Subsequent events:
If general unsecured creditors of Company A become eligible for payouts in the reorganization plan, the following might occur:
- Asset recovery: The avoided transfer (grant money) would be returned to Company A's bankruptcy estate.
- Claim reassessment: Organization B may now be considered an unsecured creditor of Company A for the amount of the grant they had to return.
- Pro rata distribution: The recovered funds, along with other assets of Company A, would be distributed among all eligible unsecured creditors on a pro rata basis according to the reorganization plan.
- Potential reduction in payout: The inclusion of Organization B as an unsecured creditor might slightly reduce the percentage payout to other unsecured creditors, as there would be more parties sharing in the distribution.
- Timing considerations: The payout to creditors would occur according to the timeline established in the reorganization plan, which could be months or even years after the initial bankruptcy filing.
- Possible preference claim defense: Organization B might argue that the transfer falls under one of the preference claim defenses, such as the "ordinary course of business" defense, potentially affecting their status in the creditor hierarchy.
- Tax implications: Both Company A and Organization B may need to address tax consequences related to the avoidance and subsequent inclusion in the reorganization plan.
It's important to note that the specific outcomes would depend on various factors, including the total value of Company A's assets, the number and value of other creditor claims, and the details of the approved reorganization plan.
Please expand on your answer #6 -- you said it could "affect their status in the creditor hierarchy"; would the effect be positive or negative?
(Claude 3.5 Sonnet answers:) I apologize for the ambiguity in my previous response. Let me clarify and expand on point #6 regarding the potential effect of a successful preference claim defense on Organization B's status in the creditor hierarchy.
If Organization B successfully argues that the transfer falls under one of the preference claim defenses, such as the "ordinary course of business" defense, the effect on their status would generally be positive. Here's why...
What are some conditions that might lead to organization B not receiving a claim reassessment to become considered an unsecured creditor of Company A for the amount of the grant they had to return?
(Claude 3.5 Sonnet answers:) There are several conditions that might lead to Organization B not receiving a claim reassessment to become an unsecured creditor of Company A for the returned grant amount. Here are some potential scenarios:
- Fraudulent involvement:
If Organization B is found to have been complicit in Company A's fraud or had knowledge of it when accepting the grant, they might be denied creditor status as a form of penalty.
- Violation of grant terms:
If Organization B violated the terms of the grant agreement in a significant way before Company A's bankruptcy, they might lose the right to claim creditor status.
- Statute of limitations:
If Organization B fails to file a claim within the specified time frame set by the bankruptcy court, they may lose the right to be considered a creditor.
- Equitable subordination:
The bankruptcy court might subordinate Organization B's claim below other creditors if it finds that Organization B engaged in inequitable conduct related to the grant.
- Regulatory restrictions:
Depending on the nature of Organization B (e.g., if it's a non-profit or government entity), there might be regulatory restrictions preventing it from becoming a creditor in a commercial bankruptcy case.
- Waiver of claims:
If Organization B signed an agreement waiving their right to become a creditor in case of avoidance, they might be prevented from claiming creditor status.
- Court determination of no value given:
If the bankruptcy court determines that Organization B provided no value or consideration in exchange for the grant, it might deny creditor status.
- Specific exclusion in reorganization plan:
The approved reorganization plan might specifically exclude certain types of avoided transfers from being eligible for claim reassessment.
- Prior settlement agreement:
If Organization B had previously entered into a settlement agreement with Company A that included provisions about potential bankruptcy scenarios, this might prevent them from claiming creditor status.
- Lack of good faith:
If the court determines that Organization B did not receive the grant in good faith, it might deny creditor status as a remedy.
These scenarios highlight the complex nature of bankruptcy proceedings and the various factors that can influence creditor status. The specific outcome would depend on the details of the case, applicable laws, and the court's interpretation of the circumstances.
Please expand on answer #5 -- what kind of regulatory restrictions might prevent a non-profit from becoming a creditor in a commercial bankruptcy case?
(Claude 3.5 Sonnet answers:) While it's relatively uncommon for regulatory restrictions to completely prevent a non-profit from becoming a creditor in a commercial bankruptcy case, there are some situations where regulations could complicate or limit a non-profit's ability to participate as a creditor. Here's an expanded explanation...
...It's important to note that these restrictions typically don't outright prohibit a non-profit from becoming a creditor, but they may create hurdles or require careful consideration and possibly legal counsel to navigate. In many cases, a non-profit can participate as a creditor in a commercial bankruptcy case, but it must do so in a way that aligns with its charitable purpose and complies with applicable regulations.
2. FTX's plan of reorganization as disclosed by Sullivan & Cromwell
Docket item #19143 on the docket of in re: FTX Trading Ltd. (download link) is the "Disclosure Statement for Debtors' Joint Chapter 11 Plan of Reorganization of FTX Trading Ltd. and Its Affiliated Debtors and Debtors-in-Possession".
In particular, pages 19 through 28 of the pdf (pages 13 through 22 of the document) give a "Summary of Treatment of Claims and Interests and Estimated Recoveries", giving an estimated more-than-full recovery to Class 6A General Unsecured Claims (pdf page 22).
Note that Claude's answer above was that the organization would typically become an unsecured creditor in the amount that they returned, and receive an (eventual) payout pro rata with unsecured creditors. I can't endorse that prediction, because I am not a lawyer.
3. Talk to your lawyer
At least one org executive that I talked to was not aware that a recipient who has funds "clawed back" by FTX is in most cases legally entitled to get in line to receive them back with general creditors (who are estimated to get paid more-than-in-full). They had assumed that if they were required to return money, it would be lost to them forever. I recommended that they talk further with their lawyer. Last I heard, their lawyer was investigating whether they would have to return the funds at all, given that the rigamarole of returning and then re-receiving funds would be economically pointless and not to the benefit of any of the other creditors anyway.
If you are looking for a recommendation for a lawyer -- given by a throwaway account on the EA Forum -- I have been impressed by the lawyer my org retained to work on the case. He now has rather a lot of context on the FTX bankruptcy (which is billable hours you won't pay for!) and I have found interactions with him to be remarkably productive and effective. DM this account and I can have his firm reach out to you to schedule a free consult. (I'm not getting anything from the referrals, as you can verify in writing with them if you like.)
(Not a lawyer, not legal advice, but if anyone reads OP and does consult a lawyer, I think they should get advice on the below.)
You focus on answer #5 from Claude for why this may not apply. Do you have anything to say about #7, quoted below? That's the reason I was expecting charities to have to give everything back.
Donations are usually made in return for 'no value or consideration'; this is part of what makes them donations:
It's true that in general, avoidance actions or 'clawbacks' are designed to create equity among creditors who withdrew and those who didn't, and this usually means those who withdrew retain some of the money. For example here's a recent Matt Levine description, bold added:
The issue I see is that if a nonprofit received a donation from insolvent FTX/Alameda, 'what they would get in the bankruptcy' is likely nothing. Insolvent companies are meant to be paying back creditors, not making donations.
However, if a nonprofit was holding other funds on FTX - perhaps it took in crypto donations via transfers to its FTX account, sold the crypto for USD, and withdrew the USD in the run up to bankruptcy - then yes absolutely check what you're entitled to and speak to a lawyer before you settle anything.
No particular opinion. I don't think it's so disqualifying that it should stop you from seeking legal advice (twice to be sure, if you don't like the first advice), and I don't know what I would say here that you should weigh over that advice.
My layman's guess is that there is a more-than-colorable argument that Alameda-of-2022 intrinsically valued the work of the grantees that it chose to grant to (including via the FTX Foundation), and so Organization B provided value by being able to work on its goals. The fact, then, that Alameda-of-2024 no longer values the same things (in no small part because it is run by different management) doesn't enter into it.
But more generally, the main thing that I -- as a non-lawyer -- have learned in my interactions with the bankruptcy process is that most things come down to the spirit of the law as interpreted by one judge in Delaware. Even things that don't reach a litigation tend to resolve along the lines of what the parties think that judge would rule after thinking about it for about an hour. It is not obvious to me that that hypothetical judge would rule that the spirit of the law is better-fulfilled by a grantee remitting funds that will ultimately go to government fines (according to the plan), and so it doesn't feel like Sullcrom's position is overwhelmingly strong here. "Come on, this feels borderline and a bit silly; let them keep it" can be a surprisingly valid position in the process as it actually happens, and I wouldn't assume defeat based on my own attempt to steelman the opposing position based just on the text.
The second thing that I have learned is that the estate's counsel and de facto management has broad discretion over what to pursue and what settlements to strike, and that while their goals may be furthered by the opportunity to do work that increases the number of legitimate billable hours, it's a material risk to them to be billing hours that will later appear to be illegitimate. While maximizing total recoveries is supposed to be their paramount concern, it is perhaps the case that billing and the perception of legitimacy occasionally enter into their decisions, and that it would be consistent with those concerns to try sending pointed letters to former recipients of funds, accept voluntary returns, and not follow up vigorously against the small-to-medium (up to a few $mm) recipients that have more-solid cases and appear prepared to fight for their rights.
We agree that this is a point that the reader should discuss with their counsel, based on the specifics of their case.