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March 11, 2021 – The Court hearing the Cred cases confirmed the Debtors’ Modified First Amended Plan of Liquidation [Docket No. 629].
Subsequently, on March 29, 2021, the Court issued an order extending the periods during which the Debtors have an exclusive right to file a Plan and solicit acceptances thereof, through and including May 24, 2021 and July 20, 2021, respectively [Docket No. 689]. Absent the relief, the Plan filing and solicitation periods were scheduled to expire on March 8, 2021 and May 6, 2021 respectively.
The centerpiece of the Plan of Liquidation is the distribution to general unsecured creditors ($170.9mn of aggregated claims) of whatever of the Debtors' assets can be marshalled into a liquidating trust by a trio of liquidation trustees. The Debtors' liquidation analysis (see below) has an estimate of $37.2mn of distributable proceeds for this class and a 21% recovery.
On November 7, 2020, Cred Inc. and four affiliated Debtors (“Cred” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 20-12836. At filing, the Debtors, operators of a San Mateo, California-based cryptocurrency global financial services platform serving customers in 183 countries, noted estimated assets between $50.0mn and $100.0mn; and estimated liabilities between $100.0mn and $500.0mn. In a subsequently filed amended Schedule A/B, the lead Debtor noted $59,630,263.82 of assets and $144,593,639.93 of liabilities [Docket No. 443].
On March 10, 2021, the Debtors filed a revised Modified First Amended Combined Plan of Liquidation and Disclosure Statement and a revised proposed Plan confirmation order (with blackline) [Docket Nos. 619 and 620, respectively]. On January 21st, the Court issued an order approving (i) the adequacy of the Disclosure Statement portion of the First Amended Combined Document (conditionally) [Docket No. 399].
The most informative document filed in respect of these cases is a March 8, 2021 Examiner's Report filed by Examiner Robert J. Stark [Docket No. 605]
Stark was asked to “investigate allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the Debtors of or by current or former management of the Debtors” and play arbiter as to “dueling narratives,” further to which “Cred, on the one hand, pinned much of its troubles on its former Chief Capital Officer [James Anderson], failed investments in a Chinese entity named moKredit, and a failed investment in an entity named QuantCoin. Other case constituents have put blame elsewhere, raising allegations of gross mismanagement and potentially fraud.”
In his detailed report, Stark concedes that significant deleterious contributions came from numerous corners (including convicted felon and jailbird Anderson), but that ultimately the of these contributions were largely manifestations of management incompetence. Stark writes: “The specific causative event was a ‘flash crash’ in cryptocurrency trading value in March 2020, followed by a run-up in April and May 2020 resulting in a liquidity crisis. The Examiner believes, however, that the firm’s failure is more aptly attributed to dereliction in corporate responsibility. Swings in cryptocurrency trading value were, after all, a foreseen aspect of the firm’s business model. But, Cred’s corporate managers did not run the business to effectively counterbalance such risk, as was promised to customers. This dereliction was grave. Noticeable failures include, among other things: (i) un-systemic, chaotic and, in some instances, non-existent diligence, accounting, and compliance functions; (ii) allowance for currency migration to non-Cred entities operating in mainland China (moKredit), without legal or practical capacity to repatriate capital as and when requested/needed by Cred; and (iii) allocation of important managerial and operating functions to an individual with an extremely worrisome past. Cred, it seems, excelled at its marketing objectives; but, its failures in the most basic of business functions portended its eventual demise.”
As to the Debtors’ most colorful character Mr Alexander (in a crowded and competitive field), Stark adds: “Neither Cred’s CEO, Dan Schatt, nor the Cred Board, nor any other employee at Cred appears to have conducted any meaningful diligence (e.g., background search, credit check) with respect to Mr. Alexander either prior to his hiring or during his period of employment. It has come to the Examiner’s attention that Mr. Alexander was convicted on December 3, 2007 in the United Kingdom for crimes related to illegal money transfers, for which he was sentenced to three years and four months in prison to be served at HMP Ford Prison in West Sussex, England. At the time of his incarceration, there was a prison break at this facility. Mr. Alexander has been identified by the UK government as a fugitive.”
In their memorandum of law in support of Plan confirmation (the "Memorandum") [Docket No. 595], the Debtors state, "The Plan is the product of months of negotiations between the Debtors and the official committee of unsecured creditors (the 'Committee') that resulted in the parties agreeing to the terms of a consensual plan as outlined in the Amended Plan Support Agreement (the 'Amended PSA')… Under the Plan, the Debtors’ assets, cryptocurrency and estate causes of action will be transferred into a liquidation trust to be managed by three Liquidation Trustees. The Liquidation Trustees, who are members of the Committee, will monetize the assets in a manner that will maximize the value of such assets for the benefit of holders of Class 4 General Unsecured Claims, under the supervision of the Trust Advisory Board….
The Modified First Amended Combined Document provides: "On the Effective Date, the Debtors will transfer all of their Assets to the Liquidation Trust, for Distribution in accordance herewith. The Confirmation Order shall be deemed to, pursuant to sections 363 and 1123 of the Bankruptcy Code, authorize, among other things, all actions as may be necessary or appropriate to effect any transaction described in, approved by, contemplated by, or necessary to effectuate the Combined Plan and Disclosure Statement.
The Liquidation Trustees shall be selected by the members of the Committee and shall be identified in the Liquidation Trust Agreement to be filed with the Bankruptcy Court with the Plan Supplement… the Liquidation Trustees’ duties shall commence as of the Effective Date. The Liquidation Trustees shall administer the Combined Plan and Disclosure Statement and the Liquidation Trust and shall serve as a representative of the Estates under section 1123(b) of the Bankruptcy Code for the purpose of enforcing Causes of Action belonging to the Estates."
The following is an amended summary of classes, claims, voting rights and expected recoveries showing highlighted changes (defined terms are as defined in the Plan and/or Disclosure Statement; see also the Liquidation Analysis below):
- Class 1 (“Other Priority Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan.
- Class 2 (“Secured Tax Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan.
- Class 3 (“Other Secured Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The aggregate amount of claims is unknown and the estimated recovery is 100%.
- Class 4 (“General Unsecured Claims”) is impaired and entitled to vote on the Plan. The aggregate amount of claims is $170.9mn and the estimated recovery is unknown. Each Holder will receive either: (i) a Cash payment equal to such Holder’s Distribution Pro Rata Share of Net Distributable Assets; or, if permitted, (ii) with respect to any such Holder that makes a Cryptocurrency Election a good faith effort shall be made to make distributions in an Equivalent Cryptocurrency Distribution.
- Class 5 (“Convenience Claims”) is impaired and entitled to vote on the Plan. The aggregate amount of claims is $500k and the estimated recovery is 30%. Each Holder will receive Cash in an amount equal to 30% of the amount of such Convenience Claim on or as reasonably practicable after the later of (i) the Effective Date or (ii) thirty (30) days after the date on which such Claim becomes Allowed.
- Class 6 (“Subordinated Securities Claims”) is impaired, deemed to reject and not entitled to vote on the Plan.
- Class 7 (“Equity Interests in Debtors”) is impaired, deemed to reject and not entitled to vote on the Plan.
On March 4, 2021, the Debtors' claims agent notified the Court of the Plan voting results [Docket No. 593], which were as follows:
- Class 4 (“General Unsecured Claims”): 405 claim holders, representing $104,796,824.33 (79.91%) in amount and 93.97% in number, voted in favor of the Plan. 26 claims holders, representing $26,348,370.41 (20.09%) in amount and 6.03% in number, rejected the Plan.
- Class 5 (“Convenience Claims”): 359 claim holders, representing $125,030.92 (95.07%) in amount and 92.29% in number, voted in favor of the Plan. 30 claims holders, representing $6,489.95 (4.93%) in amount and 7.71% in number, rejected the Plan.
The Memorandum provides: "The Debtors received four formal objections and one informal objection to the Plan. The Debtors were able to resolve the informal objection of the Ad Hoc Committee of Bitcoin Lenders (the 'Ad Hoc Committee') by making certain changes to the proposed Confirmation Order as detailed below and in the objection chart attached hereto as Exhibit A (the “Objection Chart”). The Ad Hoc Committee resolution was reached after extensive negotiations between the Committee and the Ad Hoc Committee, with input from the Debtors, and provides as follows: (a) the Ad Hoc Committee can appoint two members of the Trust Advisory Board; (b) the Plan and Confirmation Order would not constitute a determination that a General Unsecured Claim must be calculated as of the Petition Date; and (c) the members of the Ad Hoc Committee’s acceptance of the Plan would not be deemed to be acceptance of the Third Party Release.
Additionally, the Debtors are hopeful they can resolve the formal objection of the United States, on behalf of the Internal Revenue Service, and are working constructively to that end. However, at this time, no final resolution has been reached, and so the Debtors have responded to the United States’ concerns in the Objection Chart.
The Debtors were unable to reach resolution with the other objectors to the Combined Plan and Disclosure Statement. In this regard, the U.S. Trustee argues, among other things, that the releases in the Plan do not comply with Third Circuit law. But these contentions do not square with applicable precedent and the dozens of other plans with similar provisions that have been confirmed by the Bankruptcy Courts in this District. As set forth below and in the Objection Chart, the Debtors believe that the objections raised by the U.S. Trustee are without merit or are adequately addressed by new language in the Confirmation Order and certain modifications to the Plan and should be overruled.
UpgradeYa asserts that the disclosure of the Causes of Action and the potential defenses thereto is not adequate within the meaning of Bankruptcy Code section 1125, and that the Plan improperly (a) disallows Claims under Bankruptcy Code section 502(d) and (b) extends the automatic stay, and therefore, should not be confirmed. As set forth in the Objection Chart, each of UpgradeYa’s assertions is without merit, and should be overruled with prejudice. Alexander objects to the Plan on the basis that he is the sole director of Debtor Cred Capital, Inc. ('Cred Capital') and, therefore, the Debtors are not authorized to, among other things, administer the assets of Cred Capital. As set forth in the Objection Chart, this Court has already ruled against Alexander on these issues, and therefore, Alexander’s objections, even if he has standing to assert an objection, should be overruled."
The confirmation order now deletes the following as to UpgradeYa: "UpgradeYa Investments LLC. Notwithstanding any other language in the Combined Plan and Disclosure Statement or this Order, anything in Sections 1.57 and 14.7 of the Combined Plan and Disclosure Statement Disallowing a Claim on the basis of Bankruptcy Code section 502(d) will be deemed to no longer apply to the Claim of UpgradeYa upon the earlier of (a) the Court entering a Final Order in favor of UpgradeYa in connection with an action brought against UpgradeYa under Chapter 5 of the Bankruptcy Code or (b) the statute of limitations expires without any action under Chapter 5 of the Bankruptcy Code having been brought against UpgradeYa."
Events Leading to the Chapter 11 Filing
In a declaration in support of the Chapter 11 filing (the “Schatt Declaration” [Docket No. 16]), Daniel Schatt, the Debtors’ co-founder and chief executive officer, detailed the events leading to Cred’s Chapter 11 filing. The Schatt Declaration provides: “The Debtors’ chapter 11 filings were necessitated by a confluence of events that culminated in mid-October, resulting in a significant deterioration of the Debtors’ balance sheet. Of particular note, a material loss connected with the onboarding of a fraudulent asset manager by former Chief Capital Officer, James Alexander, and his misappropriation of certain Debtors’ digital assets severely impaired the Debtors balance sheet and limited the ability to hedge their investments against fluctuations in the price of cryptocurrency. Additionally, significant time, attention, and legal costs had to be devoted to litigating against Mr. Alexander.
In the early stages of its operations in 2019, the Debtors invested most of their cryptocurrency assets with moKredit and dedicated a portion of their assets to hedge against crypto pricing volatility. Loans to moKredit generally earned interest of approximately 15% to 24% per annum. As of the Petition Date, approximately $39 million in loans to moKredit remained outstanding. By the end of 2019, the Debtors had a positive net income and a balance sheet reflecting an asset to liability ratio of 1.2. The Debtors entered 2020 with the goal of diversifying their fund allocations. In particular, the Debtors’ leadership team decided to cease any new loans to moKredit and to allocate all new incoming funds to U.S. asset managers in the form of in-kind placements rather than in the form of U.S. stablecoin, which the Debtors had initially utilized. The decision was prompted in part by the growing COVID-19 crisis in China, as well as new regulations that reduced the income the Debtors could generate from moKredit. In addition, placing funds in-kind with U.S. asset managers would lessen the necessity to hedge cryptocurrency, lower the Debtors’ exposure to moKredit and allow the Debtors to return funds to customers in the same form as initially transferred without additional conversion.
Cred began to execute this strategy in January and February 2020. In March 2020, as the COVID-19 crisis prompted the price of bitcoin to drop more than 50% from its February 2020 high, the Debtors found themselves without sufficient reserves to maintain some of their hedging positions, thereby leaving the Debtors short on bitcoin as prices rebounded. [Cred co-founder Lu] Hua also provided 300-bitcoin loan to Cred to assist the Debtors with establishing new hedging positions. Notwithstanding the significant pricing volatility in March 2020, the Debtors ended the first quarter of 2020 with an asset to liability ratio around 1.0.
Also in March 2020, the Debtors directed their then-Chief Capital Officer, Mr. Alexander, to incorporate Cred Capital as a Delaware entity that would be controlled by Cred for the purposes of (a) creating a vehicle that would assist the Debtors with arranging (through a Luxembourg vehicle) bond offerings for companies in need of capital and (b) oversee the Debtors’ asset management strategies. However, in violation of this directive, Mr. Alexander instead tried to install himself as the sole director of Cred Capital. Moreover, rather than assigning the majority of Cred Capital’s voting shares to Cred, Mr. Alexander assigned only Class B, non-voting shares to Cred, and assigned Class A voting shares to a purported third-party 'investor' who purported to give Mr. Alexander a proxy to control the vote on the Class A voting shares. Notwithstanding the agreement with the purported investor, Cred Capital never received the promised capital contribution from such investor. Worse, Mr. Alexander did not use the proceeds of Mr. Hua’s loan of 300 bitcoin to establish hedging positions as he had been instructed to do, but instead used a portion of the loan to make a series of vendor payments in connection with establishing Cred Capital. Upon discovery of the foregoing, the Debtors directed Mr. Alexander to take corrective action; however, despite still being an employee of the Debtors at that time, Mr. Alexander refused to comply.
Thereafter, in late June 2020, Mr. Alexander was terminated as an employee and was locked out from access to the Debtors’ systems. The Debtors were forced to file a corrected corporate charter for Cred Capital to regain ownership and control of Cred Capital and correct the stock ownership. In July 2020, the Debtors also discovered that Mr. Alexander had absconded with the remaining bitcoin loaned by Mr. Hua – currently worth over $3 million – that had been intended to establish hedging positions for the Debtors, and moved the assets to a private ewallet. Despite the Debtors’ demands, Mr. Alexander has refused to return these assets to the Debtors. Shortly thereafter, the Debtors commenced litigation against Mr. Alexander in California state court seeking, among other things, injunctive relief to prevent Mr. Alexander from any further dissipation of the Debtors’ property, an award of compensatory and punitive damages due to Mr. Alexander’s improper and illegal conversions, breach of his employment contract, breach of implied covenant of good faith and fair dealing and breach of employee loan agreement, among other things. Litigation remains pending.
Notably, on July 17, 2020, the California state court granted Cred and Cred Capital’s motion for a temporary restraining order requiring the preservation of the digital assets Mr. Alexander transferred from Cred Capital. However, as a result of Mr. Alexander’s actions and the pendency of litigation, Cred currently does not have access to the approximately $3 million worth of bitcoin and stable coin misappropriated by Mr. Alexander. While the Debtors’ asset management strategy again delivered significant returns in July and August 2020, because of continued liquidity pressure and considerable expenses tied to the lawsuits with Mr. Alexander, the Debtors were forced to withdraw funds from asset managers prematurely.
Mr. Alexander’s conduct also negatively affected the Debtors’ ability to raise outside capital. During the summer of 2020, the Debtors sought to raise outside capital in the form of convertible notes. This capital infusion was meant to provide the Debtors with additional liquidity and support the growth of their business. Initially, the Debtors received commitments for more than $5 million in capital. However, after the Debtors disclosed the lawsuit against Mr. Alexander and the irregularities connected with Mr. Alexanders’ tenure as Chief Capital Officer, many investors decided not to participate. As a result, the Debtors were only able to raise approximately $2.6 million in convertible notes….
In addition to Mr. Alexander’s malfeasance in connection with the formation of Cred Capital, the Debtors also suffered a loss of bitcoin (worth over $10 million as of October 10, 2020) as a result of a fraudulent investment scheme. Specifically, in February 2020, while still the Chief Capital Officer of the Debtors, Mr. Alexander informed the Debtors’ investment committee of a potential investment opportunity with an entity that purported to be Quantcoin (the 'Imposter'). Based on Mr. Alexander’s representations and purported due diligence, Mr. Alexander was given permission to hire the Imposter to manage a portion of the company’s bitcoin allocation. In a series of transactions in February and April 2020, Mr. Alexander directed the transfer of a total of 800 bitcoin to the Imposter. After these transfers, the Debtors were set up with an administrator purporting to be Scott Foster with Kingdom Trust. The alleged Mr. Foster provided what appeared to be performance updates to the Debtors on a monthly basis.
In July 2020, the Debtors requested a withdrawal of $2 million from their account with the Imposter. Initially, it was agreed that the distribution would be made during the first week of September 2020. However, after confirmation of the withdrawal request, the Imposter stopped responding to emails from the Debtors. On August 24, 2020, the Debtors contacted Kingdom Trust to inquire as to the July monthly statement. Representatives for Kingdom Trust indicated that they had no records of any accounts for the Debtors, and noted that while Scott Foster was employed by Kingdom Trust, the contact email for Mr. Foster that had been provided to the Debtors was fake. Upon learning of the deception, the Debtors promptly contacted the pertinent law enforcement agency, which has initiated an investigation into the matter.
As a result of the theft by the Imposter and the misappropriation of digital assets in connection with Mr. Alexander’s actions, the Debtors have been deprived of over $13 million worth of digital assets and would-be returns which the Debtors intended to devote to improving their hedging positions. In the absence of such hedging positions, a rapid 30% increase in the price of bitcoin during a short span in October 2020 significantly increased the Debtors’ liabilities relative to their assets. Further complicating matters, negative press in connection with the theft by the Imposter, Mr. Alexander’s actions, and the overall impact on the business prompted some of the Debtors’ core partners to close their accounts with the Debtors. Additional investment of outside capital also failed to materialize as a result of the legal and PR concerns associated with the Imposter. As a result of the growing liability gap, and the lack of liquidity (due to the material loss of a bitcoin connected to the above fraud and Mr. Alexander’s malfeasance), the Debtors determined in late October that they should cease the inflow and outflow of all digital assets to assess their financial position and right-size their balance sheets….
The Debtors have determined that given their financial condition, they cannot reasonably expect to recover and, accordingly, on November 7, 2020, the Debtors commenced these cases under chapter 11 of the Bankruptcy Code.
The Debtors have not issued any secured debt. In August and September 2020, Cred issued approximately $2.6 million in unsecured convertible notes (the “Convertible Notes”) through a private placement. The Convertible Notes bear interest at a rate of 3% per annum and have a stated maturity date in September 2024. As of the Petition Date, approximately $2.6 million (which includes accrued interest) remains outstanding on the Convertible Notes. Other than the Convertible Notes, the Debtors do not have any outstanding funded debt. As of the Petition Date, the Debtors’ liabilities to customers were approximately $140 million. Because of the nature of the Debtors’ business, the Debtors’ liabilities to customers fluctuate with changes in the price of cryptocurrency. The Debtors have ordinary course trade debt of approximately $1 million.
Exhibits attached to the Combined Document [Docket No. 308]:
- Exhibit A: Causes of Action List
- Exhibit B: Liquidation Analysis
The Debtors filed an Amended Plan Supplement to their First Amended Combined Joint Plan of Liquidation, which attaches:
- Exhibit A: Trust Advisory Board [Docket No. 589].
Liquidation Analysis (see Exhibit B of Docket No. 380)
About the Debtors
According to the Debtors: “Cred is a global financial services platform serving customers in 183 countries. Cred is a licensed lender and leverages a substantial balance sheet and proprietary technology to provide business and retail credit and to allow its customers to earn a yield on more than 15 crypto and fiat currencies through its partner network.
Founded by former PayPal veterans and based in the San Francisco Bay Area, Cred brings together a diverse team of entrepreneurial leaders to leverage machine learning and the power of blockchain technology.
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