A group of former customers of bankrupt crypto exchange FTX are rebelling against a proposed plan that would return the entirety of the money they lost. In a lawsuit filed this week, the customers argue they are due a whole lot more.
The plan laid out by FTX in December to return customer funds does not reflect the full scope of the firm’s obligation to customers, claims Pat Rabbitte, one of the plaintiffs in the lawsuit—particularly given an upswing in the price of crypto since the bankruptcy. “We’ve filed a lawsuit seeking fair recovery. This is a key piece of the puzzle that should have been resolved a long, long time ago,” says Rabbitte.
FTX collapsed in November 2022 after failing to meet a surge in withdrawal requests. Billions of dollars’ worth of customer money was missing. A year later, FTX founder Sam Bankman-Fried was convicted of multiple counts of fraud and conspiracy in connection with the fall of the exchange.
The messiness of the FTX bankruptcy has led to uncertainty about the amount of money it will return to customers; over the past year, bankruptcy claims being traded on the secondary market have experienced major price swings. In a hearing on January 31, Andrew Dietderich, a lawyer representing FTX, provided a concrete indication, telling the bankruptcy court that the company expects to have “sufficient funds to pay all allowed customer and creditor claims in full.” Dietderich stopped short of guaranteeing customers a full recovery but said the objective is “within reach.”
A development that might look like a reason to celebrate, though, is for some FTX customers a bitter pill. In their lawsuit, Rabbitte and others object to the way their claims have been valued under FTX’s plan. Many customers held crypto assets like bitcoin on the FTX platform, but through a process common to bankruptcy proceedings known as dollarization, their claims have instead been assigned a dollar value based on the price of those assets on the date of the bankruptcy petition.
When FTX fell, the crypto market was in the doldrums, but it has since rebounded. The value of bitcoin, for example, has risen from roughly $16,000 in November 2022 to more than $40,000 per coin. The market recovery is part of the reason FTX is in a position to repay customers in full, but it also means that customer claims could be less than half as valuable, dollarized, as they would be if mapped to the present value of crypto assets.
In the court hearing, Dietderich acknowledged that some customers might feel that dollarizing claims does not represent “true payment in full from where they started” but said it was the appropriate method under the bankruptcy code. The same day, the presiding judge, John Dorsey, ruled that FTX’s “methodology for estimating the claims is fair and reasonable.”
In their lawsuit, however, the former customers argue that stipulations in the FTX terms of service complicate the picture. The terms, they claim, make clear that “digital assets held in customer accounts expressly were not the property of and could not be loaned to FTX.” Therefore, the argument goes, FTX should not be able to sell off those assets in order to repay customers and other creditors—and especially not to repay customers at a rate that reflects an outdated valuation.
Beyond the question of proper compensation, the plan to distribute claim repayments in the form of dollar checks, claims Rabbitte, presents various other difficulties for FTX customers. It could create a taxable event for customers, for example, or by revealing their dealings with FTX to banks—which have been known to withdraw accounts from people with crypto ties—expose them to potential discrimination.
Rabbitte hopes the lawsuit will force the judge to reckon directly with the property-rights issue and the implications for the way claims are valued. The plaintiffs are not asking for crypto assets to be returned to customers, per se, but for a more handsome compensation package that reflects their ownership of the crypto FTX has recovered. FTX did not respond to a request for comment.
The argument made by the plaintiffs is “straightforward” and couched in sensible legal theory, says Alan Rosenberg, a partner at the law firm Markowitz Ringel Trusty and Hartog and a member of the American Bankruptcy Institute. But the practicalities of assessing which specific cryptocoins belong to whom—a necessary step in applying this different approach to administering the bankruptcy estate—might count against them as the judge considers a ruling. “If the court made a ruling like this, it could completely alter the trajectory of the case,” says Rosenberg. “It’s difficult to tell what will happen.”
To some it looks like the FTX customers are grasping at straws on the distant chance it brings them a greater return. Dollarization has always been the expected outcome among those with knowledge of the bankruptcy process, says Bradley Max, director at Cherokee Acquisition, a company that operates a marketplace for buying and selling claims in bankruptcy proceedings. The possibility that an appreciation in value of assets recovered by FTX might create a pot of funds greater in value than the sum owed to customers is irrelevant to the valuation of claims, says Max. Instead, any excess money will flow down the “waterfall,” he says, into the pockets of other parties with a stake in the bankruptcy, like FTX equity holders. It’s just how bankruptcy works, he says.
The freedom of creditors in a bankruptcy to lodge objections to the debtor’s plan says nothing about the legitimacy of those complaints or the likelihood of their succeeding. The judge in a bankruptcy case, though, has the necessary latitude to “fashion flexible solutions that benefit everyone,” says Rosenberg, which means it is “not impossible” for a compromise favorable to the plaintiffs to be reached in this instance.
“Bankruptcy is flexible,” says Rosenberg. “That is the beautiful thing about it.”