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Blockchain — Not Bitcoin — in Bankruptcy

In the past several weeks, we have seen an uptick in crypto-related insolvencies; most recently Giga Watt, a Bitcoin-mining firm, filed for chapter 11 relief in the Eastern District of Washington. Often, the questions arising out of a crypto-related bankruptcy revolve around the value of Bitcoin or other cryptocurrency. However, while cryptocurrency is certainly how blockchain technology was first deployed, it is by no means its only utility. For example, in the organics food industry, retail giants like Walmart have employed blockchain technology to shore up their supply chains. If there is a need to identify precisely from where a SKU of organic lettuce was sourced, blockchain technology now affords Walmart the ability to do so in a matter of seconds instead of days.[1] Thus, while often discussed in connection with Bitcoin, blockchain technology in the bankruptcy context is not exclusively a conversation about a bitcoin’s worth.

What Is Blockchain Technology?

A blockchain is an “incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”[2]Digital data is recorded in “blocks,” each of which is assigned a unique “hash.” The hash serves as an identifying “seal” that ensures that the data on the block have not been tampered with. Each block also contains on it the hash of the preceding block, which is what allows for the formation of a “chain.” If one attempts to change the data residing on a given block, a new hash will be generated for that block and the chain will be broken, since the hash of the block coming after the tampered block will no longer reflect the correct hash. This is what makes a blockchain so difficult to “hack.”

A key attribute of a blockchain is that the data is shared or “distributed.” Imagine a spreadsheet containing digital data (a digital ledger) that is duplicated thousands of times and distributed to numerous different computers on a vast network. A copy of that spreadsheet is updated every time a single item is changed. The new version of the spreadsheet is redistributed to those computers—each of which stores its own copy of the same spreadsheet, including every version of that spreadsheet from its creation. Because each computer on the network stores its own copies of every single historical version of the entire spreadsheet, there is no one “central” repository or administrator of the data. Rather, the distributed ledger is “decentralized.”

Let’s apply the above analogy to Bitcoin. Think of the Bitcoin blockchain as a very large spreadsheet that contains all Bitcoin transactions. If Company A wishes to transfer to Company B 10 bitcoins, it will publish its intention to do so in the bitcoin network. The network of computers will then go to work: They will verify numerous items, including (1) Company A’s identity (by checking its public key — a unique identifier that serves as a digital “signature”), (2) that Company A has at least 10 bitcoins, and (3) the identity of Company B.

What blockchain technology permits is the removal of the “central administrator.” There is no “bank” that confirms that Company A has enough coins to transfer to Company B, and that the parties to the proposed transaction are who they say they are. Rather, the transaction is completely self-executing and relies on technology for the security that is often times taken for granted when dealing with banks, escrow agents and other financial institutions that facilitate these transactions — at a cost (e.g., fees, human error and fraud, to name just a few).

Potential Uses of Blockchain Technology in the Bankruptcy Process

If the purported benefit of blockchain technology is “cutting out the middle man,” its potential for use in the bankruptcy context is readily apparent.

Auctions

The auction of a debtor’s assets under 11 U.S.C. § 363 can involve numerous parties: the debtor (i.e., the seller), potential buyers (qualified bidders), the debtor’s secured lender, the stalking-horse bidder, the U.S. Trustee’s office and, of course, the auctioneer retained to oversee the auction. Sale-procedure motions are often replete with terms aimed at winnowing down the herd of potential buyers by requiring that they meet a minimum threshold bid, produce the requisite documentation, possess a certain level of capital or provide other proof of financial wherewithal to purchase the proposed assets. Typically, estate professionals are tasked with reviewing sometimes thousands of bids to determine which of them are “qualified” to participate in the auction. Once the auction commences, estate professionals must assess not just the eligibility of each incoming bid, but its order in the sequence of bids.

Blockchain technology could streamline this process by automating portions, if not the entirety of, the auction process — i.e., by cutting out the “middleman.” The debtor, the stalking-horse bidder, the debtor’s lender and any other parties in interest can agree to the parameters of the auction process and, once approved by the bankruptcy court, build a blockchain environment based on those parameters. In lieu of professionals, computers on the network would verify a proposed bid to check, among other things, whether the bid is a “qualified bid” under those pre-approved rules. Each bid, once accepted onto the blockchain, would be stamped with a hash so that its position in the relative order would be incorruptibly established.

With computers — not humans — deciding whether a bid gets through the door and into the auction will reassure potential bidders that each bid will be treated equally. There can be no preferential treatment because so-and-so knows someone in the debtor’s C-Suite. There will be no human error, either — such as a bid that sits too long on an assistant’s desk while the lawyer is on trial and thus does not get time-stamped or the wrong dollar figure being entered onto the auctioneer’s spreadsheet. These types of inherent flaws in the existing system can deter otherwise-qualified bids that could otherwise maximize value for chapter 11 estate.

Claims Administration

Blockchain technology can be employed throughout the entire claims-administration process, from the creation of the claims registry to distribution to allowed claimholders. Virtually every large or complex chapter 11 case issues dozens of the same omnibus objections: “Objection to Time-Barred Claims” and “Objections to Duplicate Claims.” Rather than having professionals tasked with sifting through thousands of claims to determine whether they are time-barred or duplicative, the technology can verify that the claim is timely and nonduplicative before recording the claim onto the blockchain. As with the example described above, there is no human error or human “compulsion” that comes into play. All potential claimants are treated equally on the blockchain. Similarly, once the bankruptcy court confirms a chapter 11 plan outlining what constitutes an “allowed claim,” the priority scheme of such claims and the distribution mechanisms, all of those parameters can be programmed into the blockchain to ensure a timely and automated distribution process.

Because the blockchain is a decentralized network, all parties-in-interest (i.e., those who have requested notice) can be given access to the blockchain to see for themselves which transactions have been recorded. Notice parameters can be built in such that any “rejections” can trigger the generation of a notice of rejection (which could, in turn, cause the debtor’s professionals to file an objection). Indeed, these potential benefits in the context of claims administration is why blockchain technology appears to be particularly alluring to the insurance industry.

Vote Tabulation

Given the vaunted security of blockchain technology, it is no surprise that states have viewed its potential for fighting election tampering and low voter participation. West Virginia offered mobile blockchain voting applications for overseas votes in the past November 2018 election for this exact reason.[3] A similar concept can be applied to the voting process under 11 U.S.C. § 1126. For example, one of the rules programmed into the blockchain could be that a vote can only be counted if it is an “allowed claim” under 11 U.S.C. § 502. In other words, if an objection has been lodged against the claimant attempting to cast a vote, the vote will be rejected. As with the sale process and claims administration, blockchain technology has the potential to alleviate some of the inherent inefficiencies of vote-tabulation under the current system.


Conclusion

Blockchain is not just a tool for fancy new currencies. It is a technology that can be employed in any context involving large amounts data. The bankruptcy process is no exception, so practitioners and professionals alike would be well-served by keeping an eye on how a blockchain might play a role in a bankruptcy court near you.

[1] “From Farm to Blockchain: Walmart Tracks Its Lettuce,” New York Times (Sept. 24, 2018).

[2] Don & Alex Tapscott, Blockchain Revolution (2016).

[3] Aaron Wood, “West Virginia Secretary of State Reports Successful Blockchain Voting in 2018 Midterm Elections,” Coin360 (Nov. 17, 2018).

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About this Author

Joanne Lee Molinaro Finance lawyer Foley Lardner
Partner

Joanne Molinaro is a partner and a trial lawyer with Foley & Lardner LLP’s Chicago office. She is a member of the firm’s Business Litigation & Dispute Resolution and Bankruptcy & Business Reorganizations Practices. She is also a member of the E-Discovery Industry Team, the Blockchain and Cryptocurrency Task Force, and the Cross-Border Insolvency Team.

Joanne is a seasoned trial lawyer, litigating class action, antitrust, and other high stakes lawsuits across multiple industries. In addition to developing a practice managing complex litigation, she possesses expertise in...

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