Why FTX’s Generous Bankruptcy Payouts Still Leave Some Creditors Cold

Despite the collapsed crypto exchange’s claim of recovering enough funds to pay back most creditors, some former customers argue they’re being left in the lurch.

_{By Nina Bambysheva, Forbes Staff}

Last month, lawyers overseeing FTX’s bankruptcy filed a reorganization plan that would not only repay nearly all of the failed cryptocurrency exchange’s customers in full but give them 18% interest for the period in which their investments were tied up. If the majority of creditors and the bankruptcy judge agree to the plan, checks would come within two months.

By typical bankruptcy standards that’s a great deal. Rarely do all creditors get paid in cash, and some can wait years to recoup only a fraction of their claims. But not all creditors are jumping for joy.

Some are dissatisfied because they won’t be getting their cryptocurrency back from the exchange. Instead, former customers will be repaid in dollars based on the value of their holdings at the time of FTX’s bankruptcy filing in November 2022, when cryptocurrencies were depressed by the industry tailspin that brought the company to its knees. Since then, the value of bitcoin has nearly quadrupled, with many other tokens also reaching new highs—a lost opportunity for those investors whose crypto was trapped on the exchange. Many lawyers–including those working for the current version of FTX—contend that is how bankruptcy works, but a chorus of creditors, commentators and academics claim they have been wrongfully deprived of their property, and that’s not the only thing they are upset about.

They say FTX—now led by bankruptcy specialist John J. Ray III and represented by a host of legal and financial firms —is failing to maximize the company’s value, neglecting the best interests of former customers and other creditors. Recurring complaints have been made against Sullivan & Cromwell, the main law firm representing the current FTX and also its counsel for various pre-bankruptcy issues.

Arush Sehgal, a representative of the FTX Customer Ad-Hoc Committee (CAHC), which includes more than 1,700 former customers of the exchange, and a former member of the Official Committee of Unsecured Creditors, summarized the frustration: FTX is “peddling this narrative that everybody’s been made whole plus interest, but the fact is that there are assets in the estate that they are valuing at zero. Also by our estimate, they destroyed over $10 billion and up to $16 billion worth of value, and as long as John Ray retains unilateral authority with no creditor-appointed board, there’s nothing in this plan that can be trusted.”

Some of the major issues are summarized below, along with detailed responses from FTX:

I. Creditors allege FTX sold some assets at bargain prices

a) Take Ledger X, ​​a crypto derivatives platform that FTX founder Sam Bankman-Fried bought for nearly $300 million in October 2021. The entity was sold to an affiliate of Miami International Holdings, which operates several options exchanges in the U.S., for $48.8 million in May 2023, far below its net equity as of December 31, 2022, which amounted to $98.8 million, according to a financial statement audited by Grant Thornton in March 2023.

In a class-action lawsuit against Sullivan & Cromwell, filed in February 2024, a group of FTX investors also claimed that the lawyers “decided to intentionally keep FTX US Derivatives (formerly LedgerX) out of the FTX bankruptcy proceedings, with the knowledge that it was in possession of approximately a quarter billion dollars of diverted FTX customer funds from which it could (and has) extracted significant revenue.” The suit alleges that Sullivan & Cromwell was complicit in the fraud that eventually brought down FTX by dint of its relationship before the bankruptcy filing. “FTX could not have achieved fraud of such tremendous scale alone,” the complaint reads. “S&C’s immense resources, connections to regulators, expertise, and assistance were vital to perpetuating the scheme.”

The independent examiner in the case, former federal prosecutor Robert J. Cleary, largely defended the FTX companies involved in the bankruptcy–known as debtors–in a report released on May 28 but recommended a further inquiry into two pre-bankruptcy transactions involving Sullivan & Cromwell: Bankman-Fried’s purchase of shares in online brokerage Robinhood and the acquisition of LedgerX.

As with most of its responses, FTX referred to the report: The independent Examiner appointed by the Court has already investigated and reported on this issue. He found that “S&C did not make any final decisions as to which entities would file for bankruptcy” and that “[John] Ray and the directors made the final decision[s].… At the time of filing, Ray believed that LedgerX was solvent and a noteworthy exception to the Debtors’ general lack of corporate controls…The Examiner has seen no evidence that calls into question the decision to leave LedgerX out of the bankruptcy filings.”

The Examiner found that “the Debtors received six non-binding indications of interest” but only two actual bids for $35 million and $14 million. The Debtors negotiated a higher final sale price of approximately $50 million, and the “agreement was (1) approved by the Debtors’ board, (2) subject to review and objection by parties in interest (with no objections received), (3) subject to an auction process that permitted the submission of higher or better offers, and (4) approved by the Court” based upon uncontested “evidence that the sale transaction was the ‘highest or otherwise best bid.’” The Examiner found that the inability to obtain a sale price near the purchase price suggests that FTX overpaid for LedgerX in October 2021, and therefore claims against certain of the original sellers should be investigated.

b) Millions of SOL cryptocurrency (tokens native to Solana blockchain) owned by FTX, whose dollar value increased more than five-fold since the exchange filed for bankruptcy, were sold at steep discounts—up to 60% of their market prices—to a host of large crypto companies and hedge funds including billionaire Mike Novogratz’s Galaxy Digital, which helped FTX orchestrate the sale. Most of the tokens were locked on multi-year vesting schedules, but Kavuri and others claim those sales were the bankruptcy action most costly to creditors. Firms like Galaxy Digital could reap billions in profits from their opportunistic purchases.

In April 2023, FTX sold its stake in Mysten Labs, a developer of the Sui blockchain, for $96 million, $5 million less than the initial investment. It also sold warrants for 890 million associated SUI tokens that would be exercisable once the platform launched. The following month, the tokens hit the market, quickly surging above $1, which would have made FTX’s initial investment worth nearly $1 billion.

“A simple review of the secondary market for SUI would have shown them that it was not profit-maximizing to sell the tokens at that discounted price and before a public launch. Moreover, it raises questions about whether the estate simply was unsophisticated or negligent in its approach,” writes Rob Hadick, general partner at crypto-focused venture firm Dragonfly, in a statement shared with Forbes.

FTX’s response: The Debtors, Bankruptcy Court and their advisors approved the sale of the tokens prior to any launch of the token. The token traded at initial high values but traded down to the sale price within a few months and has been extremely volatile since issuance. Certain coins and tokens can be highly illiquid and volatile without any underlying fundamentals, which drive trading price. While assets in the short or long term will demonstrate extreme price swings, which attract those willing to gamble with their own assets, the FTX estate is not a hedge fund, long term investor or gambler. Additionally, the tokens were subject to a 4-year lock-up vesting period. Locked tokens sell at a substantial discount to the market price due to this vesting timeframe.

II. FTX 2.0

Creditors claim that FTX could have extracted additional hundreds of millions of dollars in value had it decided to reboot its trading platform, which before the collapse was one of the largest in the world.

“Within our group of 1,600-plus creditors with almost a billion dollars in claim value—that’s 10% of the estate’s liabilities—we’ve conducted a survey and have received commitments amounting to $200-$300 million of claims who are willing to convert their claims to equity in new FTX (FTX 2.0). If debtors allowed FTX 2.0 and a debt-to-equity swap, that would increase everybody’s recoveries by 3%. The simple fact of John Ray counting FTX to zero is detrimental to all creditors,” says Sehgal, the Customer Ad-Hoc Committee member.

But Dragonfly’s Hadick is skeptical, citing FTX’s relationship with the hedge fund Alameda Research, which was owned by Bankman-Fried: “The exchange technology itself doesn’t have much value at all. It worked well, in large part, because of the agreement they had with Alameda Research, which acted as the internal market maker and operated at a loss to provide a better experience for FTX traders. This arrangement would clearly not exist in a restarted version of the exchange,” he says. “There is value to the client base if you can retain them when the exchange restarts, but any reasonable estimate would expect large attrition and the valuation depends heavily on an estimate of what that retention would be.”

Still, a number of firms including Bullish, a crypto exchange run by former New York Stock Exchange President Tom Farley; Figure Technologies, a fintech startup; and Proof Group, a private investment firm, expressed interest in buying the exchange last year.

FTX’s response referred to the disclosure statement issued in conjunction with its reorganization plan (pages 45-49): A relaunch was exhaustively considered and rejected only when it was clear it could not work. In a joint process designed with the Official Committee of Creditors, and under the supervision of the U.S. Bankruptcy Court, the Debtors reached out to dozens of investors. Every investor who conducted due diligence reached the same conclusion: the offshore exchange’s operating systems were deficient. The exchange had no adequate custody, security and financial reporting arrangements, and no reconciliation between customer “positions” and actual underlying assets. Mr. Bankman-Fried left a mess, and the docket of both the chapter 11 case and the criminal trial describe – in part – the problems with FTX’s business. After an exhaustive marketing process, it became clear that no serious investor was willing to spend the time and money necessary to build these systems and rehabilitate the offshore exchange. The estate and its creditor fiduciaries also explored a sale of the offshore exchange business to a…