Category: Perspectives

Will Delaware Order Elon Musk to Perform?

Posted on by Kelly Somers

Tech giant Elon Musk (“Musk”) has been making headlines recently for announcing the termination of his agreement to purchase the popular social media platform, Twitter, Inc. (“Twitter”). In a court filing on July 12, 2022, Twitter accused Musk of breaching an agreement to buy Twitter for $44 billion.[1] Musk and his lawyers have asserted that he is not in violation of the agreement, which requires Musk to use “reasonable best efforts” to complete the purchase.[2] In support of this position, Musk claims that Twitter has not provided the necessary disclosures regarding the number of spam accounts on the platform and halted ordinary operation of the company while the acquisition was closing. Further, Musk alleges that Twitter’s public disclosures that five percent of its users are bots are materially misleading, which equates to a “material adverse effect” under the terms of the deal.[3]

Twitter was quick to file a lawsuit against Musk following his vocalized desire to back out of the agreement. Twitter stated that it was Musk who was violating the agreement, calling his quick escape from the merger a measure of “bad faith” and a “model of hypocrisy”.[4]

Twitter, which is headquartered in San Francisco, California, is suing Musk in Delaware, where its business is incorporated.[5] Delaware’s Court of Chancery is Twitter’s choice of venue for this litigation predominately for its excellent reputation in dealing with corporate law and for its specialization in being a “Court of Equity”[6]. Twitter has asked newly appointed Chancellor Kathaleen McCormick, to force Musk to abide by his offer to purchase the company at the $44 billion price the two sides agreed upon in just a five-day trial.[7]

Chancellor McCormick did just that, granting Twitter a five-day trial in October, the first win for either side – stating that “the reality is that delay threatens irreparable harm to the seller, Twitter, for the reasons I described earlier: The longer the delay, the greater the risk.”[8]

With Chancellor McCormick’s initial ruling, as well as the difficulty it takes to get out of a legally binding agreement, it appears that Musk has an up-hill battle to face against Twitter.

This is largely a result of the fact that the merger agreement includes a “specific performance clause”. This purpose of this type of provision is to prevent a party from backing out of a deal without good reason. The clause gives Twitter the right to sue Musk to force him to go through with the deal, as long as he still has the debt financing in place. [9]

Courts have enforced specific performance clauses in the past, notably in IBP v. Tyson Foods. This 2001 case saw Tyson agreeing to acquire IBP, a meat distributor for just over $3 billion. However, when the agreement went sour over poor business, Tyson tried to get out of the merger arguing over financial issues at IBP. The court ruled that Tyson had to buy IBP given the contract’s specific performance clause, “as it is the only method by which to adequately redress the harm threatened to IBP and its stockholders”.[10]

In addition to Tyson, a case from 2007 titled Genesco v. Finish Line saw the Delaware Court of Chancery rule in favor of Genesco after Finish Line attempted to terminate the deal. However, rather than going through with the deal, the sides agreed to terminate the transaction, with Finish Line paying Genesco damages.

The Musk litigation team has accused Twitter of a “material breach” of the deal agreement.  Musk’s lawyers argue that Twitter fraudulently reported the numbers of spam accounts, to which the company has estimated about 5% of users. In this case, Musk would have to prove that the number of bots is much higher and to show a material adverse effect on Twitter’s business for grounds to end the deal. A material adverse change is a change in circumstances that significantly reduces the value of a company. Twitter has responded, saying that the issue with bots did not have material adverse effect because its regulatory filings had warned that those figures were estimates. Equally, some commentators have noted that the term “bots” is not found anywhere in the deal documents, thus making it less likely to form a basis for termination.

As stated in the original agreement, a breakup fee of $1 billion is in effect if either side wants out. However, with Twitter’s stock price crashing as a result of Musk’s termination attempt. It seems as if settlement may not be on the table, which means that unless Musk is able to prove that there are many more than admitted bots on Twitter, he may be in for a difficult trial. The expectation is that the lack of substantial legal footing that Musk is leaning on will end in him becoming the new face of Twitter or having to pay the company financial damages (Tenesco v. Finish Line). The strategy to stall these eventualities out seems to be failing at least initially as the Delaware Court of Chancery has set a trial date for mid-October.

 

[1] Why Elon Musk Can’t Back Out of Buying Twitter, According to Twitter (July 2022) https://www.nytimes.com/2022/07/12/technology/twitter-musk-lawsuit-reasons.html

[2] Id.

[3] Id.

[4] https://www.documentcloud.org/documents/22084456-final-verified-complaint

[5] https://www.npr.org/2022/07/13/1111239959/twitter-elon-musk-delaware-court-of-chancery

[6]  https://www.npr.org/2022/07/13/1111239959/twitter-elon-musk-delaware-court-of-chancery

[7] https://www.reuters.com/technology/groundbreaking-judge-will-oversee-twitters-lawsuit-against-musk-2022-07-13/

[8] https://finance.yahoo.com/news/twitter-elon-musk-hearing-152545679.html?guccounter=1

[9] https://www.cnbc.com/2022/07/08/elon-musk-faces-long-legal-war-with-twitter-as-he-abandons-deal.html

[10] https://courts.delaware.gov/OPINIONS/download.ASPx?ID=2530

Is the SEC kicking Crypto when it is down?

Posted on by Kelly Somers

Coinbase Global Inc. (“Coinbase”) is facing an SEC probe into whether it improperly allowed trading of digital assets that should have been registered as securities. Although there have been several court rulings and position statements by the SEC regarding digital assets, it has not halted the trading on crypto exchanges. While the SEC scrutiny of Coinbase has increased since the platform expanded the number of tokens, in which it offers trading, no meaningful regulatory action has occurred with respect to Coinbase.

The drumbeat in Washington for US regulators to do more to oversee crypto has grown louder as digital currencies have tumbled from all-time highs, erasing hundreds of billions of dollars in market value. SEC Chair Gary Gensler has homed in on trading platforms and argued that the SEC should do more to protect “retail investors”.

To determine if a digital asset is a security, the SEC applies a legal test from the 1946 U.S. Supreme Court decision. Generally, the SEC considers monies under its purview if the funding is made with the intention of profiting from the efforts of the issuer. The SEC Commissioner has suggested publically that “many” cryptocurrencies come under the definition. The SEC has not indicated which “coins” are “securities”, and instead has allowed exchanges to decide for themselves.

In the absence of clear guidance this regulatory approach, seems like a game of “gotcha”. Crypto is a young industry and it deserves clear and accurate rules so that its participants can navigate the path forward. The SEC should either test its approach in court, and perhaps it is with Coinbase, or stand down. Ultimately, the U.S. Supreme Court will likely decide the question of how to determine whether crypto coins or tokens are securities. Either way, crypto can thrive if its coins generate enough investor interest, but the rules for regulation and investor protection should be made clear at this point.

Is Cryptocurrency Regulation here yet?

Posted on by Kelly Somers

Is Regulation here yet? The Evolving State of Case Law and the Appropriate Characterization of Crypto as a Security or Not.

For some investors, part of the appeal of tokenized assets is that the sector has been able to dodge regulations from institutions like the U.S. Securities and Exchange Commission (“SEC”), the U.S. Department of Treasury, and the Commodity Futures Trading Commission. Tokenized assets can be fungible or non-fungible. Fungible tokenized assets are both interchangeable and indistinguishable such as Bitcoin and other cryptocurrencies (“Crypto”). Non-fungible tokens (“NFTs”) are unique tokens that are non-divisible and cannot be replaced because each token has its own unique value.[1]

Investors and regulators alike have faced the recurring question of how to make sense of this decentralized digital space. However, more clarity on the guidelines surrounding Crypto and NFTS are forming. On March 9, 2022, President Biden signed an Executive Order on Ensuring Responsible Development of Digital Assets, calling for a closer look into the possible threats and benefits of Crypto.[2] The SEC has shouldered the weight of overseeing the majority of Crypto products and platforms. Regulatory efforts have been a challenge due in part to a major dilemma being weighed by regulators: whether cryptocurrencies should be processed as securities or commodities.

In 2021, a Connecticut federal case involving a securities class action suit against Stuart Fraser, GAW Miners, and ZenMiner began to provide a more definitive answer on how to classify cryptocurrencies; as the federal jury concluded that Paycoin and several other crypto-currency mining related assets were not securities.[3] However, as recently as June 3, 2022, U.S. District Judge Michael P. Shea has granted a motion for a new trial regarding Paycoin.[4]

Judge Shea justified the new trial by citing precedent in SEC v. Kik Interactive Inc., in which Kik Interactive Inc. (“Kik”) failed to register its digital tokens as a security.[5] The SEC was able to demonstrate that under the Howey Test, Kik met the criteria to be considered an “investment contract”. For an asset to be considered an investment contract, it must meet the three criteria of the Howey Test, which was developed and named after the Supreme Court case SEC v. W.J. Howey Co., 328 U.S. 293 (1946).[6]  The Howey Test requires that there be (i) an investment of money (ii) in a common enterprise (iii) that is subject to a reasonable expectation of profits to be derived from the efforts of others.[7] With Kik’s money being invested in a single integrated offering, the court granted the SEC summary judgement and Kik a $5 million dollar penalty.[8]

In addition to Kik, the SEC also brought a lawsuit against Ripple Labs Inc., claiming that over $1.3 billion had been raised as an unregistered digital asset security.[9] The lawsuit has made national news because XRP, the cryptocurrency developed by Ripple, is one of the most valuable in the world. Ripple has been arguing that XRP should not qualify as an investment contract because the company had never promised profits to any of its holders.[10] The case was formally served in December of 2020 and is still ongoing. However, on March 22, 2021, Judge Netburn declared that XRP has monetary value, separating it from bitcoin and Ether.[11]

A regulatory stance that aligns with the initial Paycoin decision would result in more lenient oversight over the Crypto space and likely promote further development in blockchain technology.[12] Conversely, a regulatory stance promoting SEC oversight over tokenized assets could force digital currencies, such XRP, to register as securities. Upcoming legal decisions, particularly the new trial regarding Paycoin, will be crucial in providing investors and legislators with a more concrete understanding of the legal space surrounding tokenized assets and blockchain technology.

 

[1] Tokenization: Opening Illiquid Assets to Investors, BNY Mellon (June 2019), https://www.bnymellon.com/emea/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html.

[2] Executive Order on Ensuring Responsible Development of Digital Assets, The White House (March 2022),

https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

[3] Federal jury Concludes Cryptocurrency Products NOT Securities, The National Law Review (November 2021), https://www.natlawreview.com/article/federal-jury-concludes-cryptocurrency-products-not-securities.

[4] Federal Judge Orders new Securities Trial for Crypto-Product ‘Paycoins’, ConnecticutLawTribune (June 2022), https://www.law.com/ctlawtribune/2022/06/13/federal-judge-orders-new-securities-trial-for-crypto-product-paycoins/?kw=Federal%20Judge%20Orders%20New%20Securities%20Trial%20for%20Crypto-Product%20%27Paycoins%27&utm_source=email&utm_medium=enl&utm_campaign=dailybriefing&utm_content=20220614&utm_term=clt&slreturn=20220529104704.

[5] Id.

[6] Framework for ‘Investment Contract” Analysis of Digital Assets, The U.S. Securities and Exchange Commission, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets (last visited June 29, 2022).

[7] SEC v. Kik Interactive Inc., 492 F.Supp.3d 169, 177 (S.D.N.Y. 2020).

[8] SEC Obtains Final Judgment Against Kik Interactive for Unregistered Offering, The U.S. Securities and Exchange Commission (October 2020), https://www.sec.gov/news/press-release/2020-262.

[9] XRP vs. SEC lawsuit update, Cryptopolitan (June 2022), https://www.cryptopolitan.com/xrp-vs-sec-lawsuit-update/.

[10] The ‘Ripple’ effect: a striking development on defending digital asset securities litigation, Reuters (April 2022), https://www.reuters.com/legal/legalindustry/ripple-effect-striking-development-defending-digital-asset-securities-litigation-2022-04-21/

[11] XRP vs. SEC lawsuit update, Cryptopolitan (June 2022), https://www.cryptopolitan.com/xrp-vs-sec-lawsuit-update/.

[12] SEC vs. Ripple: Case Explained, CNBC (April 2022), https://www.cnbctv18.com/cryptocurrency/sec-vs-ripple-case-explained-13054042.htm.

Weighing the Carbon Footprint of Cryptocurrency

Posted on by Kelly Somers

Cryptocurrency (“Crypto”) is a virtual form of currency that functions through a decentralized system to record transactions and uses encryption, rather than an entity such as a bank, to verify transactions.[1] Crypto’s first mark on the digital world was in 2009 through Bitcoin, which remains the best-known form of Crypto today.[2] Crypto is created through a process known as mining, which involves downloading a unique software that contains all transactions that have taken place through that specific network.[3]

Crypto has had a profound effect on the global economy and has altered our world’s view of currency and financial transactions in general. Any investor with access to the internet can purchase cryptocurrency.[4] Additionally, over 15,000 businesses worldwide now accept Crypto as a form of payment, which has altered the availability of transactions to interested purchasers.[5] A study conducted by Forester Consulting on Crypto using the Total Economic Impact methodology demonstrated that 40% of customers that used Crypto as their form of currency were new customers to the merchant, evidencing intriguing information that Crypto is affording access to new transactions to new demographic groups.[6]

Despite the numerous advantages that Crypto has offered globally, Crypto’s high demand comes at the cost of an impact on our environment, which is currently being addressed at a federal executive level. The process of mining all Crypto was initially designed to be capped at 21 million units; however, the number of units available to mine has caused an increase in computation power exerted in order to mint new units of Crypto.[7] The estimated carbon footprint stemming from a single crypto transaction is estimated to burn 2,292.5 kilowatt hours of electricity, which equates to the amount of power the average U.S. household uses over the course of 78 days.[8] No payment system is foolproof in completely abolishing its carbon footprint and CO2 emissions. However, compared   to VISA, which is another payment system, the average Crypto transaction requires 200,000 times more energy consumption.[9]

The substantial footprint of Crypto is acknowledged by the current administration, which has prioritized climate change mitigation. [10] In an Executive Order on “Ensuring Responsible Development of Digital Assets” which took place on March 9, 2022, United States President Joe Biden addresses the resulting environmental pollution from Crypto and Crypto mining and implements a plan alongside many federal agencies such as the Environmental Protection Agency.[11] The Executive Order recognizes the benefits of Crypto financial markets for consumers, investors, and businesses, however addresses the responsibility the United States has to mitigate contributions to climate change and pollution.[12]

To reach these goals and assure that Crypto’s harms to not outweigh its benefits, and to learn more about how to stray away from harms, the Executive Order calls on the Director of the Office of Science and Technology Policy to prepare a report to the President within 180 days, specifically addressing “the connections between distributed ledger technology and short-, medium-, and long-term economic and energy transitions; the potential for these technologies to impede or advance efforts to tackle climate change at home and abroad; and the impacts these technologies have on the environment…The report should also address the effect of cryptocurrencies’ consensus mechanisms on energy usage, including research into potential mitigating measures and alternative mechanisms of consensus and the design tradeoffs those may entail.[13]

The damages Crypto could potentially have large effects on climate change and the state of our environmental crisis. However, mitigating Crypto pollution is not an impossible feat. Government encouragement in developing sustainable technologies can have social and economic benefits to the Crypto market and remove the serious threat that Crypto can pose to the emission of greenhouse gases and its carbon footprint.[14]

[1]What is Cryptocurrency and How Does it Work?, Kaspersky, “https://www.kaspersky.com/resource-center/definitions/what-is-cryptocurrency”>https://www.kaspersky.com/resource-center/definitions/what-is-cryptocurrency (Last visited March 17, 2022)

[2]Id.

[3] Jake Frankenfield, Cryptocurrency, Investopedia (Jan. 11, 2022) https://www.investopedia.com/terms/c/cryptocurrency.asp#:~:text=Cryptocurrencies%20are%20generated%20by%20mining,have%20occurred%20in%20its%20network.

[4] Jim Probasco, What to Know About Investing in Crypto Exchanges, Investopedia (Nov. 30, 2021) https://www.investopedia.com/buying-and-selling-4689764

[5]Who Accepts Bitcoin and Ether Cryptocurrencies, Currency Exchange International (May 12, 2021) https://www.ceifx.com/news/who-accepts-bitcoin-and-ether-cryptocurrencies#:~:text=More%20than%2015%2C000%20businesses%20worldwide,Microsoft%2C%20AT%26T%2C%20and%20Wikipedia.

[6]Forrester Study Shows Accepting Crypto Attracts New Customers and Boosts AOV, Forrester (Aug. 6, 2020) https://bitpay.com/resources/forrester-report-says-bitpay-adds-new-sales-and-2x-aov/

[7] John Bogna, What is the Environmental Impact of Cryptocurrency? PCMag (Jan. 8, 2022) https://www.pcmag.com/how-to/what-is-the-environmental-impact-of-cryptocurrency#:~:text=The%20environmental%20concern%20comes%20from,household%20for%20over%2078%20days.

[8]Id.

[9]Bitcoin Energy Consumption Index, Digiconomist (2022) https://digiconomist.net/bitcoin-energy-consumption

[10] Executive Order on Ensuring Responsible Development of Digital Assets (Mar. 9, 2022), https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

[11] Executive Order, § 5(b)(vi)

[12] Executive Order, § 1

[13] Executive Order, § 5(b)(vii)

[14] Jon Truby, Decarbonizing Bitcoin: Law and Policy Choices for Reducing the Energy Consumption of Blockchain Technologies and Digital Currencies, 44 Energy Rsch. Soc. Sci. 399 (2018) (Discussing the benefits of Crypto and how the harms can be avoided through commitment to positive government intervention choices).

International, Alternative Methods of Service in a Modern, Mid-Pandemic Society

Posted on by Kelly Somers

The Federal Rules of Civil Procedure (the “FRCP”) provide the common process in which an individual may serve another party. The FRCP provides means to achieve proper service of process of an individual located outside of the United States, which differs from serving a national defendant. The FRCP allows a party, in serving an international party, to take measures such as “any internationally agreed means of service that is reasonably calculated to give notice,” “as prescribed by the foreign country’s law for service in that country in an action in its courts of general jurisdiction,” “as the foreign authority directs in response to a letter rogatory or letter of request,” and more.[1] Rule 4(h) provides further for service of process of an international corporation.[2] The Hague Convention has been widely regarded as the as a primary organization to utilize to serve an international party.[3]

While the FRCP rule dictating service of process appears to list a wide range of methods to serve an international party, serving an individual in a different country can raise difficulty in practice, and challenges in doing so have increased. Delays in services of process are common as a result of the COVID-19 pandemic, fashioning conditions where serving a party in another country is nearly impossible. It can be ambiguous on how to conduct international service where the methods listed in FRCP Rule 4 have been exhausted.

In Group One Ltd. V. GTE GmbH et al.[4],a recent decision in the Second Circuit, the court weighed in on the issue of international service and reaffirmed prior decisions that the Hague Convention is not the only means one can pursue to successfully serve a foreign party.[5] The court agrees that FRCP Rule 4 controls service of process, however it does not create a hierarchy on the best or most preferable means to serve a foreign defendant.[6] Additionally, it is established that means listed in Rule 4(f) need not be exhausted prior to seeking permission allowing alternative service from the court.[7]

This decision also deliberates E-mail as an alternate means for service under FRCP Rule 4, and the court authorizes this method to serve foreign defendants. [8] It is required that the service is likely to reach the defendant in order to comport with due process, and E-mail service is valid in order to satisfy this requirement. [9] More surprisingly, the court decides that E-mail service may be the most reliable and efficient method to accomplish service, as “[a]lthough emails may get lost in a defendant’s spam folder, compared to postal mail, emails are more reliable.[10]

The pandemic and its global effect has contributed to widespread delays in service of process. While ordinary and anticipated delays will arise while serving a foreign party even in the absence of a global pandemic, the courts do not aim to make serving a foreign party impossible by restricting alternative means to precedent or the plain language of FRCP Rule 4. Today, we are observing courts strive to put plaintiffs serving foreign parties at ease by interpreting service of process rules in a way that takes into account the current state of the world today.

During a time where the pandemic is triggering delays in all realms of everyday life, and the growing age of technology and communication via E-mail, the courts in many jurisdictions have encouraged plaintiffs to use E-mail as an alternative method of service.

[1]Fed. R. Civ. P. 4(f)

[2]Fed. R. Civ. P. 4(h)

[3]Convention on the Service Abroad of Judicial and Extrajudicial Documents in Civil or Commercial Matters, art. 1, Nov. 15 1965, 20 U.S.T. 361, The Hauge Convention

[4]523 F.Supp 3d 323 (E.D.N.Y., 2021)

[5]Id. at 341

[6]Id.

[7]Id. at 341

[8]Id.

[9]Id. at 344

[10]Id. at 345

Tokenized Assets: What are They and how are They Regulated?

Posted on by Kelly Somers

As the decentralized world of blockchain continues to grow, tokenized assets have caught the eye of investors and regulators alike. Tokenized assets may be fungible or non-fungible. Fungible tokenized assets are interchangeable and indistinguishable such as Bitcoin and other cryptocurrencies (“Crypto”). Non-fungible tokens (“NFTs”) are unique tokens that are non-divisible and cannot be replaced because each token has a unique value.[1] Tokenized assets result from taking a tangible asset (such as real estate, paintings, and precious metals) or an intangible asset (such as a digital picture or a YouTube video) and converting the asset ownership into a digital token on a blockchain.[2] This process is known as tokenization.[3] By taking a real-world asset and making a digital representation, it creates a broader investor base, geographic reach, and a reduction in transaction times.[4] Moreover, placing the digital token on a blockchain ensures no single authority can erase your ownership in the tokenized asset.[5]

While tokenized assets can allow for a broader base of investors, like the Crypto market, the NFT market lacks clear regulations from the regulatory agencies such as the U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”).[6] Moreover, state regulatory bodies have yet to issue guidance on the tokenized asset market.[7]

The current legal framework was not designed to regulate and guide the creation and trade of digital assets.[8] Moreover, the question of what category an NFT falls into depends on the particular asset that was tokenized.[9] For example, the CFTC has stated that renewable energy credits and emission allowances are commodities as defined by the Commodity Exchange Act.[10] However, the SEC has stated that depending on the facts and circumstances of a given NFT, it might be considered an investment contract under the Howey test, which would cause the NFT to be regulated under the Securities Act of 1933 and Securities Exchange Act of 1934.[11] The legal uncertainty within the NFT market led SEC Commissioner Hester Peirce to recently state that guidelines would help provide the public with an understanding of how the SEC is approaching these issues.[12] The lack of a clear regulatory framework has made investors susceptible to fraud, and it allows for bad actors to avoid domestic and international anti-money laundering laws.[13]

Additionally, there is no standardized set of rights that accompanies an NFT since the seller determines what rights follow the NFT.[14] Therefore, sellers and buyers alike should understand the limitations that a transfer, assignment, or license may have on the NFT.

While tokenized assets allow for quick cross-border investment and increased liquidity of real-world assets, investors are left without a clear regulatory framework and, at times, not knowing what rights follow the purchase of an NFT. As the decentralized world of blockchain continues to grow, it is imperative that investors and businesses use common sense, sound legal advice, and diligence to navigate this market. Given the lack of legal certainty, attorney legal opinions on these assets will likely immunize any reasonable use.

[1] Tokenization: Opening Illiquid Assets to Investors, BNY Mellon (June 2019), https://www.bnymellon.com/us/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html.

[2]Id.

[3]Id.

[4]Id.

[5] What is asset tokenization?, Hedera, https://hedera.com/learning/what-is-asset-tokenization#:~:text=Asset%20tokenization%20is%20the%20process,either%20digital%20or%20physical%20assets.&text=Asset%20tokenization%20could%20convert%20ownership,0.0002%25)%20of%20the%20property (last visited Feb. 3, 2022).

[6] William de Sierra-Pambley, Tokenization: Opportunity and Regulation, Finding a Balance, Sheppard Mullin (Oct. 18, 2021), https://www.jdsupra.com/legalnews/tokenization-opportunity-and-regulation-5158893/.

[7]Id.

[8]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, Jones Day (April 2021), https://www.jonesday.com/en/insights/2021/04/nfts-key-us-legal-considerations-for-an-emerging-asset-class.

[9]Id.

[10]Id.

[11]Id.

[12] Sarah Wynn, SEC’s Peirce says agency guidance on nonfungible tokens needed, Roll Call (Jan. 25, 2022), https://rollcall.com/2022/01/25/secs-peirce-says-agency-guidance-on-nonfungible-tokens-needed/.

[13]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, supra note 11.

[14]Id.

Stablecoins: What are They?

Posted on by Kelly Somers

A little-known area of the growing cryptocurrency market is stablecoins. Stablecoins, a type of cryptocurrency, are not mined through an open network like Bitcoin and Ethereum.[1] Instead, stablecoins derive their value from another asset.[2] Most stablecoins are pegged to a national currency.[3] For example, the USD Coin is a stablecoin that is pegged to the U.S. dollar.[4] Therefore, one USD Coin is always worth one U.S. dollar.[5] By deriving their value from a national currency, stablecoins avoid the volatility that is usually associated with cryptocurrencies.[6] Like other cryptocurrencies, stablecoins are stored in digital wallets.[7]

While Treasury Secretary Janet Yellen has recognized the potential benefits of stablecoins such as “supporting beneficial payment options,” there are no regulations in place to monitor stablecoin reserves. [8] Government regulators are concerned about the implications of a relatively stable cryptocurrency that allows investors to avoid anti-money laundering (“AML”) regulations. [9] Recently, the President’s Working Group on Financial Markets (“PWG”), consisting of Treasury Secretary Janet Yellen, the chairpersons of the Board of Governors of the Federal Reserve, Securities and Exchange Commission, and Commodity Futures Trading Commission, issued a report recommending Congress to pass legislation to regulate the stablecoin market.[10]

The legislation recommended by the PWG report would limit the issuance of stablecoins to insured depository institutions and establish a federal framework to regulate other parties in stablecoin arrangements, such as the party that facilitates the transfer of stablecoins between individuals and the entity that stores the stablecoins.[11] While the PWG believes the proposed legislation should be passed urgently, it recommends in the meantime that agencies use their current authority to address the risks posed by the unregulated stablecoin market.[12] Moreover, the PWG recommends that international AML standards should be implemented to prevent the use of stablecoins by illicit actors.[13]

While stablecoins are still operating in an unregulated environment, one thing is clear: the market is only continuing to grow, and the SEC and other government agencies are taking notice of the unregulated area. Common sense, sound legal advice, and diligence will help any business or investor navigate this market despite the uncertainty surrounding stablecoins.

[1] Julian Dossett, Stablecoins: What they are, how they work and how to buy them, CNET (Dec. 6, 2021), https://www.cnet.com/personal-finance/crypto/stablecoins-what-they-are-how-they-work-and-how-to-buy-them/.

[2]Id.

[3] Kathryn G. Wellman; Neil T. Bloomfield, President’s working group report calls for stablecoin regulation, Reuters (Dec. 2, 2021), https://www.reuters.com/legal/transactional/presidents-working-group-report-calls-stablecoin-regulation-2021-12-02/.

[4] What is USD Coin? Coinbase, https://www.coinbase.com/usdc (last visited Dec. 28, 2021).

[5]Id.

[6] Wellman; Bloomfield, note 3.

[7] Dossett, note 1.

[8] Felicia Hou, Stablecoins are taking over the crypto world hot topic for Congress—here’s what they are and the fastest-rising ones to keep an eye on, Fortune (Dec. 8, 2021), https://fortune.com/2021/12/08/stablecoins-cryptocurrency-congress/ (quoting Janet Yellen.

[9] Wellman & Bloomfield, note 3.

[10] Id.

[11] President’s Working Grp. on Fin. Mkts., the Fed. Deposit Ins. Corp., & the Off. of the Comptroller of the Currency, Report on Stablecoins (Nov. 2021).

[12] Id.

[13] Id.

Application of Business Interruption Insurance to Losses from COVID-19

Posted on by Kelly Somers

In the continued legal battle over whether business interruption insurance policies cover business losses due to the COVID-19 pandemic, a recent case in the United States District Court for the District of Connecticut (the “Connecticut District Court”) adds to the debate. Generally, business interruption insurance covers losses resulting from the closure of the property due to some physical damage or loss to the business premises. In terms of losses incurred from the COVID-19 pandemic, policyholders have argued that the revenue lost from the closure of their businesses is covered by the business interruption insurance. However, insurers have argued that exclusions such as a Virus Exclusion provision prevent any claims resulting from the COVID-19 pandemic. The recent case in the Connecticut District Court provides a great illustration of this ongoing fight for coverage between the insurance industry and business.

In the case One40 Beauty Lounge LLC v. Sentinel Ins. Co., No. 3:20-cv-00643 (KAD), 2021 U.S. Dist. LEXIS 216320 (D. Conn. Nov. 9, 2021), One40 Beauty Lounge, LLC (“One40”) filed a class action against Sentinel Insurance Company (“Sentinel”), claiming the losses it sustained from closing its business due to the COVID-19 pandemic were covered by its insurance policy (the “Policy”) with Sentinel.[1] Sentinel moved for judgment on the pleadings on the ground the Virus Exclusion provision of the Policy unambiguously excluded coverage of any losses resulting from the COVID-19 pandemic.[2] Judge Kari Dooley acknowledged that she was not examining the issue of whether the Virus Exclusion provision prevented One40 from making a claim under the Policy in a vacuum because other courts had previously examined identical provisions and found it to be unambiguous.[3]

One40 argued that even if the Virus Exclusion provision prevented coverage, a subsection of the Virus Exclusion provision allowed limited coverage for 30 days of losses.[4] However, Judge Dooley stated that the subsections of the Virus Exclusion provision must be read together.[5] When viewed as a whole, the subsection One40 relied upon did not provide One40 with limited coverage for 30 days.[6] Since the Virus Exclusion provision unambiguously applied to prevent coverage for losses resulting from the COVID-19 pandemic, Judge Dooley granted Sentinel’s motion for judgment on the pleadings.

While the Connecticut District Court ruled that Virus Exclusion provisions prevent coverage for losses from the COVID-19 pandemic, coverage of business losses from the pandemic is still an open issue. As the COVID-19 pandemic continues to ebb and flow and impacts daily business procedures, policyholders will most likely continue to seek coverage for lost revenue resulting from the closure of their businesses.

[1]One40 Beauty Lounge LLC v. Sentinel Ins. Co., No. 3:20-cv-00643 (KAD), 2021 U.S. Dist. LEXIS 216320 (D. Conn. Nov. 9, 2021).

[2]Id. at *1.

[3]Id. at *7.

[4]Id. at *8.

[5]Id. at *11.

[6]Id.

[7]Id. at *12.

Commercial Mortgage-Backed Securities, COVID-19, and the New Potential Systematic Risk

Posted on by Kelly Somers

A commercial mortgage-backed security (“CMBS”) is a group of bonds comprised of commercial real estate loans commonly contained in trusts which are then sold to investors.[1] As of 2020, the largest loan contributors to the CMBS market include large banks, such as Citibank, Goldman Sachs, Morgan Stanley, Deutsche Bank, JPMorgan Chase, Wells Fargo, and Bank of America.[2] The commercial property loans securitized by CMBS are generally compromised of commercial properties such as apartment buildings, hotels, factories, office buildings and parks, or shopping malls.[3] These bundles of bonds are also referred to as tranches.[4] CMBS loans are ranked – those with the highest rating have the lowest risk, and those with the lowest rating have the highest risk.[5] Lower risked bonds are known as senior issue, and higher risk bonds are known as junior issue.[6] After the bonds are sold, the bank receives the money from the sale.[7] The bank then lends these proceeds to a subsequent borrower to collect additional fees.[8]

Investing in CMBS poses a lower risk to borrowers than a residential mortgage-backed security (“RMBS”) loan because commercial mortgages typically have a fixed term.[9]  CMBS loans are also compromised of fewer loans than RMBS loans.[10] Many investors seek out this loan because they are interested in obtaining property for an extended period of time and CBMS loans provide lower interest rates.[11] Other incentives of CMBS loans include a higher leverage financing, and CMBS loans are nonrecourse loans, and thus have a wider range of accessibility, because investors with lower credit are more readily able to obtain these loans. [12]

Although there are numerous advantages of CMBS loans, there are several disadvantages tied to a CMBS loan investment. First, these loans have prepayment penalties, which penalize a borrower for paying back a loan outside of the fixed term, even in the circumstance where the borrower pays the loan back earlier than the predetermined date.[13] Second, CMBS loans go through a defeasance profess before prepayment, which can be a painstaking process involving the borrower consulting with a financial advisor in order to set up alternative securities to replace any collateral and interest that the lender no longer is obligated to.[14] Lastly, the terms of CMBS loans are more difficult to negotiate, and a borrower has little or no say in the terms of the loans.[15]

The CMBS market has been greatly impacted by the COVID-19 pandemic. A shift towards working from home has created a failure of roughly $5.5 billion commercial mortgage loans since the summer of 2020.[16] The delinquency rate of CMBS loans in June 2020 was reported to be 10.32%. [17] The delinquency rate continued to increase during October of 2020, during the second wave of the pandemic.[18] The trends of CMBS loans due to the financial crisis that the pandemic has caused are almost identical to the trends of CMBS loans during the 2012 financial crisis, which poses an alarming issue when considering the impact the 2012 crisis had on the CMBS market.[19] The rise of delinquency rates is directly correlated to the effects that COVID-19 has had on commercial real estate: apartment owners, retail owners, restaurants, and hotels are bringing in substantially less income, and are left unable to pay mortgage and other commercial property-related debts.[20]

The last financial crisis in 2012 led to grave delinquencies in the CMBS market, which may signal that the CMBS market will undergo similar disruption in the future, indicative of a similar systemic risk.[21] However, much has been learned from former financial crises and the risks they pose on all types of mortgage backed-security loans, to avoid unnecessary risk in the CMBS market. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act after the 2007-2008 financial crisis, which affects CMBS by “including risk-retention requirements for asset-backed security sponsors, increased disclosure requirements, the Volcker Rule and enhanced capitalization requirements for banks.”[22]

These protective measures are an attempt to make the CMBS market a safer space for investors by decreasing the systematic risk that the CMBS market decline may have on the overall economy.[23] An unforeseen consequence has been an increase in the price of entry into the CMBS market which affects retail investors, and aspects such as the Volcker Rule, which decreases market liquidity and restricts proprietary trading by preventing a bank from holding inventories of secondary market securities and disallowing a banks from investing in real estate.[24]

While the effects from the COVID-19 pandemic may affect the CMBS market and make these loans less accessible to borrowers, overall, the Dodd-Frank reforms have likely mitigated a majority of the risk to the CMBS market directly tied to COVID-19 and will provide a lasting benefit by decreasing this systematic risk impacting the overall economy.

[1] Owen Haney, The Virus, Risk, and Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 394 (2021)

[2]Id.

[3]Carol M. Kopp, Commercial Mortgage-Backed Securities (CMBS), Investopedia, (October 25, 2020), https://www.investopedia.com/terms/c/cmbs.asp

[4]Thomas Kenny, What are Commercial Mortgage-Backed Securities?, The Balance, (October 7, 2021), https://www.thebalance.com/what-are-commercial-mortgage-backed-securities-cmbs-416910

[5]Id.

[6]Id.

[7]Id.

[8]Id.

[9]Carol M. Kopp, Commercial Mortgage-Backed Securities (CMBS), Investopedia, (October 25, 2020), https://www.investopedia.com/terms/c/cmbs.asp

[10]Maegan E. O’Rourke, The New Normal: How the Dodd-Frank Risk Retention Rules Affect the Future of CMBS, 51 Suffolk Univ. L. Rev. 77, 81-82 (2018).

[11]Understanding CMBS and CLO Markets, Signet Investments, “https://signetinvestments.com/understanding-cmbs-and-clo-markets/” https://signetinvestments.com/understanding-cmbs-and-clo-markets/ (Last visited November 6 2021)

[12]Commercial Mortgage-Backed Securities (CMBS): A guide, Quicken Loans (January 27, 2021), https://www.quickenloans.com/learn/cmbs

[13]Id.

[14]Id.

[15]Id.

[16]Dorothy Neufield, Commercial Mortgage Delinquencies Near Record Levels, Visual Capitalist (July 16, 2020), https://www.visualcapitalist.com/mortgage-delinquencies/

[17]U.S. CMBS Delinquencies Resume Increase in October, Fitch Ratings (November 6, 2020), “https://www.fitchratings.com/research/structured-finance/us-cmbs-delinquencies-resume-increase-in-october-06-11-2020” https://www.fitchratings.com/research/structured-finance/us-cmbs-delinquencies-resume-increase-in-october-06-11-2020

[18]Id.

[19]Owen Haney, The Virus, Risk, and Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 394 (2021)

[20] Peter J. Irwin et al., CMBS Loan Workouts During COVID-19: A Borrower’s Perspective, Debevoise & Plimpton (May 14, 2020), https://www.debevoise.com/-/media/files/insights/publications/2020/05/20200514-cmbs-loan-workouts-during-covid-19.pdf https://www.debevoise.com/-/media/files/insights/publications/2020/05/20200514-cmbs-loan-workouts-during-covid-19.pdf

[21]Steven L. Schwarcz, Systematic Regulation of Systematic Risk, 2019 Wis. L. Rev. 1, 1 (2019).

[22]Owen Haney, The Virus, Risk, And Commercial Mortgage-Backed Securities: Examining Dodd-Frank’s Impact in the Midst of a Pandemic, 26 Fordham J. Corp. & Fin. L. 391, 401 (2021)

[23]Craig Furfine, The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages, 58 J. FIN. SERVS. RSCH. 91, 93 (2020).

[24]Volcker Rule, The Real Estate Round Table https://www.rer.org/policy-issues/capital-credit/volcker-rule https://www.rer.org/policy-issues/capital-credit/volcker-rule (Last visited November 6, 2021)

Federal Jury Rules Four Cryptocurrency products are not Securities

Posted on by Kelly Somers

A recent decision in the United States District Court for the District of Connecticut appears to be the first of its kind in the nation. In the case Audet et al v. Garza et al, a federal jury recently weighed in on whether cryptocurrency products were considered securities.[1] The jury held that four digital-asset products linked to cryptocurrency were not securities.[2]

In the case, a class of customers brought an action against GAW Miners LLC (“GAW Miners”) and ZenMiner LLC (“ZenMiner”) for running a cryptocurrency Ponzi scheme.[3] When GAW Miners and ZenMiner were faced with demands from customers for the physical cryptocurrency mining equipment which they could not meet, GAW Miners and ZenMiner turned to Hashlets, Hashpoints, Paycoin and HashStakers (collectively the “Digital Assets”). [4]  These Digital Assets provided customers with a portion of the computing power without owning the physical hardware.[5] Moreover, the Digital Assets served as virtual wallets for the promissory notes and virtual currency of GAW Miners and ZenMiner.[6] The plaintiffs argued that these Digital Assets were investment contracts and therefore were unregulated securities.[7]

The plaintiffs asked Judge Michael Shea to rule as a matter of law that the Digital Assets were securities under the Howey test. [8] The Supreme Court in Howey stated an investment contract exists when “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” [9] However, in an unusual decision, Judge Shea declined to rule as a matter of law that the Digital Assets were securities.[10] Instead, the judge left the issue of how to classify the Digital Assets for the jury.[11] Despite the SEC previously referring to one of the Digital Assets, Hashlets, as a security in a case against one of the former defendants in this case,[12] the jury ruled that the Digital Assets were not investment contracts, and therefore, they were not securities.[13]

The issue of how to define cryptocurrencies is an ongoing debate, and the federal jury’s ruling in this case does not settle it.

[1] Elise Hansen, Crypto Mining-Linked Products Weren’t Securities, Jury Finds, Law360 (Nov. 2, 2021), https://www.law360.com/articles/1436790/crypto-mining-linked-products-weren-t-securities-jury-finds.

[2] Id.

[3] HHR Wins Groundbreaking Jury Verdict in Crypto Fraud Trial, HHR (Nov. 3, 2021), https://www.hugheshubbard.com/news/hhr-wins-groundbreaking-jury-verdict-in-crypto-fraud-trial.

[4] Id.

[5] Hansen, supra note 1.

[6] Id.

[7] Id.

[8] Alison Frankel, In apparent first, Conn. class action jury finds crypto products are not securities, Reuters (Nov. 3, 2021), https://www.reuters.com/legal/transactional/apparent-first-conn-class-action-jury-finds-crypto-products-are-not-securities-2021-11-03/.

[9] SEC v. W. J. Howey Co., 328 U.S. 293, 298­–99 (1946).

[10] Id.

[11] Id.

[12] HRR, supra note 3.

[13] Hansen, supra note 1.