BlockFi Collapse: $300M To Be Returned, But Who Loses Out?

BlockFi clients can expect the return of almost $300 million held in custodial wallets, following a decision by New Jersey Bankruptcy Judge Michael Kaplan Thursday. 

He ruled that these assets belong to the customers and not the bankrupt crypto lender's estate, Coindesk reported.

Kaplan denied the repayment of an additional $375 million that clients attempted to withdraw from BlockFi's interest-bearing accounts (BIA) after the company froze funds last year due to the FTX collapse's impact on the crypto sector.

Kaplan stated, "The court finds that all digital assets held by the debtors in custodial omnibus wallets are indeed client property, and not property of the bankruptcy estates, subject, of course, to possible avoidance and clawback rights."

He said that no transfer requests initiated after 8:15 p.m. on Nov. 10, 2022, were completed, even though the user interface appeared to confirm the successful transfer of funds.

BIA account holders deposited their assets knowing they were taking on risks for the possibility of higher returns, the judge said. 

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In contrast, custodial wallet holders did not share these risks or returns and should not have their non-estate property ownership diluted by those who took on such risks.

Under bankruptcy law, customer-owned funds can be returned immediately instead of being distributed among the company estate's creditors.

In this case, reimbursement was delayed by a dispute over the status of funds held in BIA accounts, which customers attempted to liquidate between November 10 and 18 after BlockFi paused transfers and made corresponding changes in the app.

At a hearing on Monday, Deborah Kovsky-Apap of Troutman Pepper argued that her clients, who all tried to transfer BIA holdings during that period, should be included in any repayment.

She said it is "not fair to be able to ignore the plain language of the terms of service" that promises instant transactions.

Michael Slade, representing BlockFi, countered that no sale of assets was completed, even though clients received email confirmations, as the user interface had been "deliberately divorced" from underlying transactions.

BlockFi filed for Chapter 11 bankruptcy Nov. 28, 2022, shortly after seeking a bailout from FTX in June.

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