iValuation is a key element in bankruptcies. Generally, a higher valuation of a bankrupt firm means larger creditor recoveries, and a higher valuation of pre-petition collateral means a smaller “adequate protection” package for prepetition secured lenders.
But the spate of recent crypto firms in bankruptcy, combined with the extreme volatility of cryptocurrency prices, has brought a new element to traditional valuation-based concerns: unexpected and drastic changes in valuations — of collateral packages and business values — happening early in the bankruptcy process. As a result, stakeholders in crypto-related bankruptcies must educate themselves on the contingencies, procedures, and potential traps should there be a need to change course.
The Core Scientific bankruptcy is the most prominent example of this trend. In large part due to the recent increase in cryptocurrency prices, the cryptocurrency miner, which filed for bankruptcy in December 2022, replaced its $75 million debtor-in-possession financing (so-called DIP financing) with a less expensive package and terminated its restructuring support agreement (RSA) with an ad hoc group of prepetition lenders. Each pivot was fraught with potential pitfalls. The existing DIP had a built-in 15% termination fee, and the RSA could only be terminated by the company pursuant to a “fiduciary out” provision. Now, the parties are having a row about valuation, as shareholders see the potential for a meaningful distribution and have formed an official equity committee.
By way of background, in November 2022, the price of Bitcoin dropped to approximately $15,800 from above $64,000 a year earlier. The next month, Core Scientific filed for bankruptcy in the Southern District of Texas, citing the precipitous and prolonged decline in the price of bitcoin during the “crypto winter” that began in the spring of 2022.
Core Scientific filed with a pre-arranged restructuring documented by an RSA in principle with an ad hoc group of convertible noteholders. In broad strokes, the RSA contemplated that holders of $550 million in convertible notes would receive 97% of new common equity in the reorganized business and that those same holders would provide a $75 million new money DIP which would be rolled into a four-year exit term loan facility on the same terms at the end of the bankruptcy. The DIP also contemplated that $75 million of prepetition debt would be “rolled up” and converted into super-priority DIP loans once the final DIP order was entered.
By the middle of January, Bitcoin rose to above $20,000. And on January 30, Core Scientific announced that it was going to replace its existing DIP with a new and improved DIP facility provided by a different lender. The replacement DIP was $70 million and had a longer maturity, less expensive exit financing, and no roll-up. The replacement DIP lender is also Core Scientific’s largest unsecured creditor.
As is often the case, the pre-arranged DIP, which had been approved by the bankruptcy court on an interim basis, required that the debtor pay significant termination fees. Core Scientific was required to make a $9 million immediate payout to the original DIP lenders for accrued interest, fees, and termination payments. Nevertheless, the debtors deemed the replacement to be superior, and the bankruptcy court approved the replacement DIP over objection by the creditors’ committee, who objected to the termination fees. The bankruptcy court approved the $9 million termination fee.
Core Scientific has also terminated its restructuring support agreement. As is often the case, the RSA contained a so-called “fiduciary out” provision, which allowed company termination if a special committee of board members determines that continued support for the contemplated restructuring would be inconsistent with the exercise of its fiduciary duties. The provision also required the company’s and the ad hoc group’s advisors to use good faith efforts to discuss the reason for termination, prior to termination.
Where does Core Scientific go next? It is not immediately clear, but valuation issues will be at the forefront of plan negotiations. For example, shareholders pushed for the formation of an official equity committee, arguing that the rally in Bitcoin pricing suggests a value well above $1.4 billion and a substantial likelihood of solvency, but the group of prepetition convertible noteholders argued that no official equity committee should be formed because equity was not likely to receive a meaningful distribution. The debtors and the unsecured creditors’ committee agreed to the appointment of an equity committee that is limited in scope to plan negotiations and valuation, and the court ultimately agreed with that construct and to a cap on the equity committee’s fees. In any event, the plan process appears to be back at square one.
More than anything, the case is a prime example of the uncertainty inherent in cryptocurrency-related business valuations. Interested parties need to be nimble and prepared to adapt to the constantly shifting pricing of Bitcoin. It is important to develop fully considered valuation strategies early on in the bankruptcy process. For parties who lock in their rights early, speed is essential.
