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Timothy Q. Karcher

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Timothy Karcher is a partner in the Business Solutions, Governance, Restructuring & Bankruptcy Group where he focuses his practice on bankruptcy, financial restructuring, insolvency, crisis management, financial reform, and the acquisition and sale of assets and troubled companies in and out of chapter 11.

He is currently serving as counsel to the Debtors in Murray Metallurgical Coal Holdings, LLC. He played a leading role in the representation of the Creditors Committee in the chapter 11 cases of Westinghouse Electric Company, one of the largest chapter 11 cases of 2017 with estimated liabilities of several billion dollars. He is also counsel to the Trustee in ITT Educational Services, Inc., the largest for-profit college bankruptcy, and has held significant roles in some of the most important restructuring cases of the past decade, including Pacific Exploration and Production Corp. (debtors’ counsel for $6 billion international oil and gas exploration restructuring), Rotech Healthcare, Inc. (debtors’ counsel in $800m restructuring), MF Global (committee counsel), Enron Corporation (debtors’ counsel), Ames Department Stores (debtors’ counsel), G-I Holdings (debtors’ counsel), and Regal Entertainment (debtors’ counsel). In addition, Timothy has represented individual creditors, statutory committees and ad hoc groups in the restructuring cases of OneWeb Global Limited, McDermott International, iPic International, Weatherford International PLC, ENNIA Caribe Holding BV, Ultra Petroleum Corp., BFN Operations, TransCare Corporation, Hoop Holdings (Disney Stores), Kodak, New World Pasta, Coram Healthcare, American Airlines, Blockbuster, Trident Microsystems, Innkeepers Trust USA, Chrysler Financial Corporation, Midway Games,, and New Stream.

Timothy has substantial experience representing public and private companies, secured and unsecured creditors, investors, hedge funds, private equity, family offices and financial institutions in a broad range of U.S. and international business restructuring and litigation cases. He advises companies and creditors in a wide array of industries, including oil and gas, health care, retail, technology, hospitality, financial services, airline and entertainment.

In addition to his focus on financial restructuring, Timothy has extensive experience in the field of regulatory reform. He led a Proskauer team that worked with federal regulators from the Federal Reserve Board and the Office of the Comptroller of the Currency as part of Independent Foreclosure Review to reform mortgage servicing and foreclosure practices for borrowers who have sought bankruptcy protection. He has advised large institutional clients to develop strategies to ensure compliance with consent orders with the Federal Reserve Board and the Office of the Comptroller of the Currency. In connection with his work for ITT Educational Services, Inc., he has litigated against (and achieved consensus with) the Consumer Financial Protection Bureau (CFPB), Securities and Exchange Commission (SEC), Department of Education (ED) and multiple states attorney’s general.

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When it rains, it pours.  On January 23, 2023, the New York Department of Financial Services announced that it had issued certain Guidance on Custodial Structures for Customer Protection in the Event of Insolvency in which it emphasized the importance of sound custody and disclosure practices to protect customers in the event of an insolvency or similar proceeding.  This month, the Securities and Exchange Commission (“SEC”) followed suit.

On February 15, 2023, the SEC proposed amendments to the Custody Rule under the Investment Advisers Act of 1940, which, among other changes, expands the current custody rule’s application to a broader array of client assets under the rule managed by registered investment advisers and clarifies certain aspects of the existing rule (see more digestible SEC Fact Sheet here).

The SEC’s proposed amendments are aimed at reducing the risk of loss of client assets by expanding the types of assets covered by the rule beyond “funds and securities” that will be subject to custodial safeguards and helping ensure assets are properly segregated. The proposed amendment would also impose certain reporting and compliance requirements on investment advisers, including requiring them to provide information about their practices in safeguarding client assets. Notably, if the amended rule is adopted after the 60-day comment period, which is not certain, then crypto assets will undoubtedly be affected. In a statement discussing the proposed amendments, SEC Chair Gary Gensler noted that the rule “covers a significant amount of crypto assets” and that “most crypto assets are likely to be funds or crypto asset securities covered by the current rule.”

Custody is a safekeeping activity by a financial institution involving storing, protecting, and securing assets separately from those of other customers or the investment firm itself. TradFi investment advisers are typically required to maintain customer funds and securities with a qualified financial firm (i.e., a custodian).  Most assets are intangible assets held “on account” with a broker-dealer (i.e., stocks and bonds, which are rarely held in certificate form), though some assets may consist of physical certificates, cash, or other tangible assets.  On the other hand, crypto custody consists primarily of bookkeeping because there is no physical asset and no centralized ownership record for a digital asset: the blockchain records wallet activity and balances.  While there is the option for self-custody of crypto assets, a crypto investor may allow a custodian or crypto exchange to hold their private keys for them, enabling the custodian to use the wallet to transact. This arrangement potentially opens up a range of risks, including the risk of hacking, insolvency risk, or malfeasance involving the commingling of investors’ cryptoassets with those of other investors or institutional assets.

Demand for virtual currency services, including custody services, has soared in the past several years.  Like their counterparts in traditional finance, these custodians are stewards of retail and institutional customer funds and serve an important and valuable function.  However, as evidenced by a number of headline-grabbing failures during the lingering crypto winter, inadequate disclosures and poor custodial practices can seriously harm retail and institutional customers alike.  For many virtual currency customers, this recognition – in an industry built on the pillars of trust and transparency – was realized too late.  Recent disclosures emerging from notable bankruptcies involving crypto companies have led to allegations of fraud and mismanagement in connection with custodial services.  These allegations strike at the very core of the custodial relationship, and have had repercussions throughout the crypto industry.

Seemingly in direct response to these developments, on January 23, 2023, the New York Department of Financial Services (“NYDFS”) issued industry guidance to Virtual Currency Entities (“VCEs”) who act as custodians (“VCE Custodians”).  Entitled “Guidance on Custodial Structures for Customer Protection in the Event of Insolvency” (the “Guidance”), the Department emphasized the “paramount importance of equitable and beneficial interests always remaining with the customer” and reminded covered institutions of their obligations in connection with “sound custody and disclosure practices in the event of an insolvency” or similar proceeding.

The Guidance comes on the heels of developments in two high-profile insolvency proceedings: (1) the FTX proceedings, where, among others, the SEC has alleged co-founder Samuel Bankman-Fried concealed the diversion of FTX customer funds to the co-founder’s private crypto hedge fund, and (2) the Celsius proceedings, where the chief judge for the United States Bankruptcy Court for the Southern District of New York issued a decision holding that Celsius’ Terms of Use made clear that customer deposits into Earn Accounts became Celsius’ property at the time of deposit, such that the digital assets now constitute property of the debtors’ bankruptcy estate.  In Celsius, customers argued that the deposits in the Earn Accounts were held by Celsius as a custodian, but the court found that the plain language of the Terms of Use made clear that ownership interest had passed to the debtors.

On July 5, 2022, cryptocurrency brokerage Voyager Digital filed for chapter 11 in the Southern District of New York Bankruptcy Court, citing a short-term “run on the bank” due to the “crypto winter” in the cryptocurrency industry generally and the default of a significant loan made to a third party as the reasons for its filing.  At Voyager’s first day hearing on July 8, 2022, the Bankruptcy Court asked the critical question of whether the crypto assets on Voyager’s platform were property of the estate or its customers.  Voyager asserted the crypto assets were assets of the estate pursuant to the terms of its customer agreements, but the question of ownership was more problematic in the context of a liquidation.  In that context, Voyager’s plan of reorganization proposes to resolve any mystery of ownership by delivering the reorganized company to its customers.

On July 13, 2022, cryptocurrency lender Celsius Network filed for chapter 11 in the Southern District of New York Bankruptcy Court.  Celsius had frozen customer withdrawals on June 12, 2022 and, at the time of its chapter 11 filing, indicated that it would not be requesting court authority to allow customer withdrawals.  Celsius noted in a press release that customer claims would be addressed through the chapter 11 process.

Voyager’s and Celsius’ chapter 11 bankruptcy filings highlight the question of whether crypto assets held by an exchange, or similar platform, may be considered property of a bankruptcy estate and, therefore, not recoverable by the customer, who would then likely be an unsecured claimholder of the debtor.

While some commentators have suggested that crypto assets might be considered property of the exchange’s bankruptcy estate, existing common law, existing provisions of Uniform Commercial Code (UCC) Article 8, and proposed amendments to the UCC recognize that if the arrangement and relationship between the exchange and its customers is one that is characterized as “custodial,” the crypto assets held by the exchange should remain property of the customer and, hence, not subject to dilution by general unsecured claimholders.