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

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.

Footnotes

1. 2023 BCSC 1383 [NYDIG].

2. Ibid at para 101.

3. Ibidat paras 11-12.

4. Ibidat para 13.

5. Ibidat para 14.

6. Ibidat para 15.

7. Ibidat para 31.

8. Ibidat paras 47-48.

9. Ibidat para 50.

10. Ibidat para 52.

11. Ibidat para 59.

12. Ibidat para 6.

13. Ibid.

14. 2014 SCC 53 at para 47
[Sattva].

15. Ibid at para 57.

16. NYDIG, supra note 1 at para 107;
Specifically, the bargain struck was such that security would be
given “but only in respect of Bitcoin mined by IE CA 4 after
NYDIG terminated its Hashpower Agreement” with IEL following
an event of default – none of which occurred.

17. Ibid at para 114.

18. Ibidat para 119.

19. Ibid at para 109

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