What Could Go Wrong When a DIP Maintains a Large, Uninsured Deposit ...

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.) That would mean there's a $226.75 million uninsured deposit. Given what we know about SVB, much 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. 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 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 $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. Indeed, given that the estate now has a $226.75 million malpractice claim against debtor's counsel, I don't know how counsel can continue in its current role--the conflict is really inescapable. 

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.

P.S. We'll have to see how much of the mess up here was K&E as opposed to co-counsel or someone else, but I'll just note K&E's screw up about the Voyager bar date (which it set itself).