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What Could Go Wrong When a DIP Maintains a Large, Uninsured Deposit Account at Silicon Valley Bank?

posted by Adam Levitin

You gotta feel for BlockFi customers. First, they find themselves creditors in BlockFi's bankruptcy. And now they've found out that BlockFi had a large, uninsured deposit...at Silicon Valley Bank. Yup, it seems that BlockFi had $227 million in a money market deposit account at SVB. (The UST refers to it as a "money market mutual fund," but that cannot be right, or it wouldn't be at SVB or have any insurance. [See "Another update" below regarding possibility that it was a money market mutual fund sweep account, in which case the money would in fact be protected.]) That would mean there's a $226.75 million uninsured deposit. Given what we know about SVB, part of that $226.75 million in uninsured funds is likely lost if it's still at SVB.  

The US Trustee filed a motion today to force BlockFi to put the funds in insured accounts, but it sure looks as if the cow's out of the barn already. If the money's lost, then the question is who's going to pay for this screw up, and it's especially juicy because it's all tied up with venue competition. 

Let's be clear: the enormous uninsured deposit is a situation that shouldn't have happened. Section 345(b) of the Bankruptcy Code requires that the debtor's money be place in insured deposits (or other investments that bear the eagle) or that are secured by an adequate bond. (What's more, the debtor was allegedly in violation of the Cash Management Order, which required compliance with section 345(b) absent court approval for deviation.)

The US Trustee, to its credit, was urging the debtor to rectifying the situation as far back as March 6. If the debtor had complied with the US Trustee's demands on March 6 (or just complied with 345(b) from the get-go), the BlockFi estate wouldn't be looking at the unpleasant position of possibly being an unsecured creditor in the SVB receivership.

The really interesting question is what the consequences will be from this screw up. There are two issues that will need to be sorted out.

First is whether the debtor's management and counsel can continue in their roles. Screwing up on a 345(b) matter, especially one expressly required by the debtor's own cash management order, to the tune of up to $226.75 million, especially after the US Trustee's repeated demands, brings to mind words like "gross mismanagement" and "malpractice" and "willful." I don't know if that speaks to a trustee motion or a motion under 327(d) to end the retention of debtor's counsel.

Beyond the question of whether the debtor's management and counsel should continue in their roles, there's the question of who's going to pay. The estate's creditor's should NOT be left holding the bag for this sort of screw up. There's a question about whether the responsibility here rests on the debtor's management or on debtor's counsel, but typically management does what counsel says to do on cash management matters, so I think this is probably on the debtor's counsel. Does that mean a reduction in fees? A payment from the malpractice insurance carrier? Something else?

Here's what I know: if this were a two-bit small business case, debtor's counsel would get skinned alive. But this is a mega-case with K&E as co-counsel for the debtor. That it's K&E is no small matter, as K&E is the leading case placer for megacases. BlockFi is also one of the two recent mega-cases in DNJ (the other being LTL Management, which originally filed in WDNC, but was transferred to DNJ, where the debtor ended up with a very friendly judge.) Given that LTL's bankruptcy is (pending further appeals) dismissed, BlockFi is DNJ's chance to show that it's a good jurisdiction for megacases to file. Already, there's the strange intra-district assignment of the case:  under the New Jersey bankruptcy court's local rules, the case should be in the Newark vicinage, not Trenton.

So here's the problem: if the bankruptcy court comes down hard on K&E, everyone knows what the result will be:  K&E will simply not file cases in DNJ. Instead, K&E will take its business to a more accommodating venue, like Delaware or Houston. Trenton's brief run in the competition to attract mega-cases will be at an end. This isn't speculation--that's exactly what K&E did after Judge Sontchi (rightly) blew up at K&E for pulling a fast-one on a pro se creditor in Samson Resources. K&E didn't file a case in Delaware for months afterwards. (Query what got them to return...) We'll have to watch what happens here.

Update:  It turns out that among Kirkland & Ellis's clients is ... a Silicon Valley Bank affiliate. Kirkland's conflicts disclosure in BlockFi listed SVB Leerink LLC as a client. SVB Leerink LLC is now known as SVB Securities LLC. I have no idea if this had any impact on decision-making in BlockFi, but it's not a good look. 

Another update:  It's possible that the "money market mutual fund" the UST referred to was part of a sweep account in which SVB would sweep all funds on deposit over some specified threshold into a money market mutual fund account in the name of BlockFi. If that were the case, then the funds in the money market mutual fund account would not be part of the FDIC receivership estate. That would be a much happier outcome for BlockFi creditors--they wouldn't have incurred a loss. There'd still be a violation of 345(b) and the cash management order, but it could be one that has not harmed the estate. We'll find out more at Monday's hearing. 



If the estate loses funds here, then the UCC ought to move for contempt against the directors and officers. Complying with cash management orders is not optional.

Also, any judge worth their salt should make decisions based on the law and not attracting mega-cases. Seriously, if they care about attracting debtors’ counsel, they have no business being a judge.

Ex-K&E--that sounds right to me, but what's the recovery going to be? Will the D&O policy cover what might be a willful violation?

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