Analysis Of The Interplay Between Insolvency And Cryptocurrency

Introduction

As per a recent study, Asian countries like India are outgrowing the rest of the countries in terms of cryptocurrency usage. There has been a massive uprise in the number of cryptocurrency users in India ever since the Supreme Court held the RBI circular dated 4th April 2018, prohibiting banks and financial institutions under its control from providing services to any individual or legal entity dealing in cryptocurrency as invalid in the case of Internet Mobile Association of India v. Reserve Bank of India (‘IMAI’). Moreover, it was also clarified by the RBI via its notification dated 31st May 2021 that the 2018 circular is no longer valid and banks cannot same use the same to warn their users against dealing in cryptocurrency.

In addition to the aforementioned developments, the Ministry of Corporate Affairs made amendments to Schedule III of the Companies Act, 2013 making it mandatory for the companies to disclose their crypto-assets and transactions involving cryptocurrency in their balance sheets. These developments have a given major boost to the cryptocurrency ecosystem in India and the same indicates that the government’s stand regarding cryptocurrency is softening and the same is expected to give a further push to cryptocurrency transactions and assets in India.

However, it should be noted that at present there exists a void of regulation and identification over cryptocurrency in the country. Hence, it becomes essential to analyse the interplay between the pre-existing statutes and cryptocurrency. In regard to the same, the authors in the following sections of this article have tried to analyse how the Insolvency and Bankruptcy Code of 2016 would come into play if any of the companies having crypto-assets or dealings in cryptocurrency would go under an insolvency process as per the provisions enshrined under the code.

Real Identity of Cryptocurrency under the Indian Law

Scholars and industry experts are conflicted to this date regarding the position of cryptocurrency in the line of traditional finance. The Apex Court in the IMAI case analysed how cryptocurrency is treated in various jurisdictions but remained indecisive on the issue of categorising cryptocurrency into a specific type of financial instrument. The Court in this case stated that cryptocurrency lacks legal tender and therefore it cannot be classified as currency. Moreover, a careful interpretation of the definition of the term currency, as found under Section 2(h) of the Foreign Exchange Management Act, 1999 vis-à-vis Section 28A of the RBI Act, 1934, further suggests that cryptocurrency does not fall under the definition of the term currency.

Additionally, if cryptocurrency is considered to be a form of currency then the same would not be taxable under the Income Tax Act of 1961 as the term income enshrined under Section 2(24) of the Act excludes the term currency from the ambit of the word income. However, the Government of India recently clarified that the gains arising from the transfer of cryptocurrency would be taxable under the Income Tax Act of 1961. This move of the government clarifies that cryptocurrency would not be classified as currency and the same would fall under the category of goods as per Indian law. The said claim is also supported by the fact that the government of India might levy 18% GST on foreign crypto exchanges on transactions with Indian citizens and cryptocurrency would be considered as goods for the said purpose.

Moreover, the statement that cryptocurrency is a form of goods is also supported by the analysis done by the Supreme Court in the IMAI case regarding how various forms of cryptocurrency like Bitcoin and Ethereum are treated in various jurisdictions around the world like the United States of America and the United Kingdom. The Apex Court in this case noted that the USA treats cryptocurrencies like Bitcoin and Ethereum as commodities. Taking the above-mentioned analysis into consideration, it can be concluded that cryptocurrency would fall under the category of goods as per Section 2(7) of the Sales of Goods Act of 1930 because the same enshrines that the term goods includes all kinds of movable property like stocks, shares, and commodities.

Applicability of IBC to Cryptocurrency

A proceeding under the Indian Insolvency regime consists of a creditor, debt/liability, and a debtor. As per Section 3(11) of the Insolvency and Bankruptcy Code, 2016 a debt could be of financial or operational nature. Additionally, as per Section 5(21) of the Code, a debt involving cryptocurrency would fall under the category of operational debt since cryptocurrency can be categorised as goods. Furthermore, a corporate debtor would be liable to pay if default in regard to an operational debt involving cryptocurrency occurs.

Once the default is established by the Adjudicating Authority and a restructuring order has been passed, the creditor with the help of the appointed insolvency professional could take control of the debtor’s property to resolve the payment default. As per Section 3(27) of the Code, the term property includes money, goods, land, or actionable claims. Since cryptocurrency falls under the category of goods, an insolvency professional can take control of the same while handling a restructuring process, even if it is placed in a private cryptocurrency wallet. Moreover, if there exists a doubt regarding the specific categorization of cryptocurrency even in that case, it would be a subject of an insolvency proceeding because Section 18(f) of the Code enshrines that an insolvency professional can take control of debtor’s assets (goods and intangible assets) while handling a restructuring process.

Problems and way ahead

As mentioned above, due to the nascent nature of cryptocurrency there exists a lacuna of regulation and identification regarding the same. This is bound to create several issues for an insolvency professional while dealing with a restructuring process that involves cryptocurrency. One such issue would be related to the determination of the existence of cryptocurrency assets of the debtor. However, due to the recent amendments made by the government to Schedule III of the Companies Act, 2013, companies are required to disclose their cryptocurrency assets and the same would make it easier for insolvency professionals to establish the existence and location of the assets.

An insolvency professional would also require the full cooperation of the debtor in order to take control of his cryptocurrency assets while handling a restructuring process because usually cryptocurrency is stored in a private cryptocurrency wallet and could be accessed only by a private key. Moreover, if the cryptocurrency assets of a debtor are stored in a custodial cryptocurrency wallet rather than a private cryptocurrency wallet then the insolvency professional might face some inconvenience while segregating the debtor’s cryptocurrency assets from the cryptocurrency assets of the other customers of the custodial cryptocurrency wallet provider.

The insolvency professional would also have to be very cautious about the volatile nature of cryptocurrency while liquidating the assets of the debtor. If the insolvency professional liquidates a large part of cryptocurrency assets in one go or in a short period of time, the same might affect the price of the concerned cryptocurrency. One such incident took place in 2018 when the trustee converted a considerable segment of cryptocurrency assets into cash for distribution to creditors and the same drove down the price of the concerned currency. The decision of the trustee was heavily criticised by the creditors as they claimed it was against the trustee’s responsibility to maximise the value of the assets on behalf of the creditors.

Conclusion

The lack of regulation and identification regarding cryptocurrency in India is bound to create several challenges for an insolvency professional while handling a restructuring process involving cryptocurrency. The government has been trying to come up with a set of regulations governing cryptocurrency for quite some time now but has not been successful yet. It would be beneficial if the government could issue clarifications regarding the interplay between the existing statutes and cryptocurrency while it is trying to come up with new regulations governing cryptocurrency. With the increase in the number of cases involving cryptocurrency, it is further hoped that rules and regulations concerning the interplay between insolvency and cryptocurrency would become transparent and pervasive.

(This post has been authored by Aniruddh Saraswat and Oindrala Mondal. Aniruddh and Oindrala are 4th year students at National Law University Odisha, Cuttack.)

Cite As: Aniruddh Saraswat and Oindrala Mondal, ‘Analysis of the Interplay between Insolvency and Cryptocurrency’ (The Contemporary Law Forum, 30 August 2021) <https://tclf.in/2021/08/30/analysis-of-the-interplay-between-insolvency-and-cryptocurrency> date of access. 

 

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