Crypto Firm Terraform Labs’ Use of Estate Funds for Legal Fees Challenged by SEC

News | March 4, 2024 By:

On Tuesday, February 27, 2024, the United States Securities and Exchange Commission (SEC) filed an objection in the United States Bankruptcy Court for the District of Delaware regarding the motion filed by Terraform Labs Pte. Ltd. (Terraform), the company behind the stablecoin TerraUSD.

Terraform had filed for Chapter 11 bankruptcy protection on January 21, 2024, citing potential liabilities from an ongoing securities fraud lawsuit brought by the SEC. In that lawsuit, the SEC alleges that Terraform and its CEO Do Hyeong Kwon defrauded investors and violated securities laws through an unregistered offering of five crypto asset securities between April 2018 and May 2022.

According to the SEC’s objection, Terraform raised billions of dollars from retail investors worldwide through promotional materials containing fraudulent misrepresentations. When the crypto assets collapsed in May 2022, over $40 billion in investor wealth was lost. Prior to the collapse, the SEC contends Terraform transferred as much as $122 million to its legal counsel Dentons in the 90 days before filing for bankruptcy.

In their recent objection, the SEC argues Terraform’s current motion in bankruptcy court seeks to inappropriately use estate funds without court oversight. Specifically, Terraform’s motion had requested permission to pay legal fees for multiple current and former unnamed employees, as well as undisclosed “critical vendors,” using estate assets.

However, the SEC believes Terraform failed to demonstrate it is legally obligated to advance litigation costs for employees. The documents cited by Terraform in support of this alleged obligation either do not require cost advancement, apply only to a third-party staffing company, or deal with indemnification rather than advancement.

Additionally, the SEC expressed concern that the payments benefit Terraform insiders at the expense of estate creditors like the SEC. They argued such claims should not receive priority outside of a reorganization plan. The SEC contends the bankruptcy code provisions cited do not permit using estate funds in this manner.

Going forward, the SEC asked the Delaware bankruptcy court to establish certain safeguards before approving any reimbursements from Terraform’s motion. This includes more disclosure on individuals covered, governing laws and transparency into funds spending.

Please contact BlockTribune for access to a copy of this filing.