Crypto-Collateral Disputes Within Receiverships: Do Bitcoin Mining Proceeds Fall Under Collateral Equipment Pledges?

Introduction

An August 2023 ruling from the British Columbia Supreme Court (the “BCSC” or the “Court”) in NYDIG ABL LLC v. IE CA 3 Holdings Ltd.^[1] is a key Canadian determination on the extent to which security interests extend to bitcoin where it is mined using equipment pledged as collateral under master equipment financing agreements.

In NYDIG, the Honourable Mr. Justice Milman held that collateral under certain financing agreements did not extend to bitcoin that was received through mining pools using hashpower acquired pursuant to intercompany agreements, where the equipment was originally pledged as collateral. This holding by the BCSC emphasizes the drastic need for bitcoin miners and crypto-asset companies to carefully draft their security and financing agreements. While both sides argued that the language of the underlying agreements “clearly and unambiguously support[ed] their respective positions,” the BCSC held that the agreements contained “seemingly contradictory terms, making the task of discerning the parties’ common intention as to the intended scope of the collateral particularly challenging.”^[2] The ultimate decision in NYDIG turned on fact-specific analyses and the contractual language entered into between parties.

Accordingly, what parties hope to achieve in an agreement and what is actually realized can vary greatly due to the difficult nature of describing crypto-assets. NYDIG symbolizes the need for careful, sophisticated and explicit drafting by legal professionals dealing with security disputes relating to crypto-assets. Crypto-asset companies should take heed of NYDIG to explicitly clarify the wording of collateral, so that courts can readily interpret commercial contracts in line with the intention of parties at the time of execution of the underlying contract.

Factual Background

1. The Parties

Iris Energy Limited (“IEL”) was an owner and operator of bitcoin mining data centres.^[3] IEL purchased and operated mining equipment through various subsidiaries (the “Debtors”).^[4] A second set of IEL subsidiaries acted as hosts and acquired leases for the premises where various crypto-equipment was stored and operated.^[5] Revenue was earned through specific intercompany agreements (“Hashpower Agreements”).^[6]

NYDIG, a company which finances bitcoin mining operations, offered financial services to companies such as IEL via loans required to purchase mining equipment.^[7]

2. The Agreements

Certain master equipment financing agreements (“MEFAs”) were entered into between the various parties. Significantly, by the fall of 2022, the parties entered into a Digital Asset Account Control Agreement, and Digital Asset Custodial Agreement, which required a subsidiary of IEL to deposit bitcoin mined with the purchased equipment into a digital wallet, the contents of which were to act as security under a MEFA. Significantly, the bitcoin collateral was only to be deposited after an event of default under the MEFA in question.^[8]

3. Default and Receivership

From the beginning, the Debtors were not financially viable on the basis of the fees they charged IEL via the Hashpower Agreements; the Debtors relied heavily on IEL to make the loan payments owed to NYDIG.^[9] Since the fall of 2022, the Debtors’ subsidiaries were in default under their respective MEFAs.^[10] On February 3, 2023, the BCSC appointed a receiver over the Debtors on NYDIG’s application.^[11]

NYDIG then brought an application to the Court seeking a declaration that the MEFAs granted NYDIG “a security interest in all Bitcoin mined using the Equipment and the proceeds derived from the sale of it, regardless of how IEL and its subsidiaries may have structured their affairs internally.”^[12] In the alternative, NYDIG also sought a number of declarations, including that the transactions between IEL and the Debtors under the Hashpower Agreements were void as fraudulent conveyances through which IEL improperly appropriated the Debtors’ assets.^[13] For the purpose of this case comment, this analysis is limited to examining the first security interest question in detail.

Analysis

NYDIG’s Security Under the MEFAs Did Not Include Mined Bitcoin or Proceeds Thereof

To understand the scope of NYDIG’s security under the MEFAs, the Court began by identifying the following applicable principles of contract interpretation, as set out by the Supreme Court in Sattva Capital Corp v. Creston Moly Corp. (emphasis added):^[14]

The overriding concern is to determine “the intent of the parties and the scope of their understanding” … a decision-maker must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract.

At the same time, the BCSC noted that the Supreme Court in Sattva was aware that an overreliance on the surrounding circumstances could result in the courts rewriting contracts, and provided that:^[15]

While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement … courts cannot use them to deviate from the text such that the court effectively creates a new agreement . . .

With these principles in mind, the Court in NYDIG set out to interpret the MEFAs and found the text of the agreements which referred to the mined bitcoin were acknowledged by NYDIG to be “surplusage,” as “the parties understood that the Debtors would never actually hold any Bitcoin … before an event of default.”^[16]

The specific words added into the text of the MEFAs were highly determinative and dispositive to the Court’s ruling. The practical counterargument raised by NYDIG that “no prudent lender would finance the acquisition of equipment that depreciated [quickly], without taking additional security beyond the equipment itself” was rejected.^[17] Instead, the Court focused on the language of a parent letter agreement, which described how the right to use the hashpower would revert only with the termination of the original Hashpower Agreement by NYDIG in the wake of a default.

Based off of this language, NYDIG’s actual security in mined cryptocurrency was only intended to extend to that collateral after the triggering event of a termination. The settled language between the parties was for a weaker right to redirect the hashpower back to an IEL subsidiary after an event of default. Significantly, the Court also considered NYDIG’s abandoned demand that IEL itself be added to the MEFA for the purposes of a guarantee and pledge of the bitcoin obtained by IEL using the hashpower generated by the equipment. The abandonment of this additional security also added to the Court’s ultimate conclusion in favour of IEL.

On these analyses set out above, the Court held that NYDIG’s collateral under the MEFAs did not extend to the bitcoin that IEL mined using the hashpower it acquired via Hashpower Agreements, let alone the proceeds derived from IEL’s sale of bitcoin.^[18]

Conclusion

Two important implications for contracting parties, especially parties dealing with complex crypto-asset lending arrangements, arise from the decision of the Court in NYDIG. First, surrounding circumstances will colour the courts’ interpretation of a contract and its purported “commercial reasonableness” in disputes where contractual language is vague or difficult to understand. In NYDIG, NYDIG’s decision to not take an additional guarantee or pledge coloured the Court’s understanding of the unclear language between the parties.

Secondly, the language used in financing agreements will always be strongly deferred to by the courts. Words added to the text of the MEFAs were ultimately highly dispositive and relied upon by the BCSC in its judgment, including the use of defined terms such as “Mined Cryptocurrency” and “in Borrower’s possession.”^[19] In order to avoid complex litigation, crypto-asset companies should seek legal advice when taking collateral over equipment to ensure that additional protection is clearly contemplated within the agreements where companies intend to extend the definition of collateral to include mining proceeds or other crypto-assets.