BlockFi Customers Can Be Repaid $300M Held in Custodial Accounts, Judge Says

BlockFi custodial wallet users can be returned nearly $300 million, as a New Jersey judge ruled on Thursday May 11 that assets sitting in the wallets belong to clients rather than the estate of the bankrupt crypto lender.

Bankruptcy Judge Michael Kaplan ruled against repaying a further $375 million in funds that clients tried to withdraw from BlockFi’s interest-bearing accounts, known as BIA, after the company froze funds last year, as ripples from the collapse of FTX spread through the crypto ecosystem.

“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,” Kaplan said, but had less happy news for BIA customers.

“No transfer request by customers between the BIA and the custodial wallet accounts initiated after 8.15 pm on November 10, 2022 were effectuated and completed,” Kaplan said, despite the crypto company’s user front-end appearing to confirm that they had successfully shifted funds.

“BIA account holders deposited their assets into these accounts with the full knowledge that they were undertaking certain risks in exchange for the chance of greater returns,” he said, but custodial wallet holders “did not share this risk or return and should not have their ownership of non estate property diluted by those who took on such risks.”

Under bankruptcy law, funds which are deemed to belong to customers can be returned immediately, rather than being divided up among creditors of the company’s estate.

In this case reimbursement was held up by a dispute over the status of funds held in BIA which customers tried to liquidate after Nov. 10, when BlockFi paused transfers, and Nov. 18, when it made corresponding changes in the app.

At a hearing held Monday, Deborah Kovsky-Apap of law firm Troutman Pepper argued that her clients – who all attempted to transfer BIA holdings in that interim period – should be included in any repayment.

It’s “not fair to be able to ignore the plain language of the terms of service” that promises transactions will happen instantly, Kovsky-Apap said, adding that BlockFi was effectively trying to discriminate in treatment among customers who were all in the same situation.

Michael B. Slade, representing BlockFi, said that no sale of the assets had been completed, even though those clients received email confirmation that it had, as the user interface had been “deliberately divorced” from underlying transactions.

BlockFi filed for Chapter 11 bankruptcy on Nov. 28, 2022, a few weeks after FTX, from which the crypto lender had sought a bailout in June.

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