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Business & Corporate Law

First-Ever Court Ruling Means Your Utility Token May Be an Unregistered Security

First-Ever Court Ruling Means Your Utility Token May Be an Unregistered Security

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The First-Ever Court Ruling Means Your Utility Token May Be an Unregistered Security 

Which could be bad news for you. Here’s what happened and why you should care. 

What Happened

Last month a federal judge in New Hampshire ruled that LBRY’s utility token was an unregistered security.[1]

LBRY is a decentralized file-sharing platform designed to be “YouTube on blockchain.” LBRY created a native digital token called LBRY Credits, known as “LBC,” which users can buy with U.S. dollars. To view any content on LBRY other than free content, users must pay with LBC. Users can also use LBC to publish content, create channels, and tip other content creators, among other things.

The problem for LBRY came when the Securities and Exchange Commission (“SEC”) sued it for selling unregistered securities. The SEC argued that while users could use the LBC within the LBRY ecosystem, in reality the token was acting more like a security, a financial asset which comes with regulatory requirements LBRY didn’t comply with when it sold LBC to purchasers.

In agreeing with the SEC, the court relied on the three-part Howey test, which originated from a famous case the Supreme Court decided in 1946. Under Howey, to prove something is a security, there must be 1) an investment of money, 2) in a common enterprise, 3) with an expectation of profits to be derived solely from the efforts of the promoter or a third party. The only element in doubt in this case was the last one: “whether the economic realities surrounding LBRY’s offerings of LBC led investors to have ‘a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.’”

In holding that LBC satisfied the third element of the Howey test, the court relied on statements LBRY representatives made to potential LBC purchasers that essentially touted LBC as a good investment and the fact that LBRY’s business model depended on LBC increasing in value, meaning purchasers would expect LBC to increase in value based on the efforts of LBRY employees.

LBRY has appealed, but as things stand today, the utility token LBC is a security.

Why Should I Care

What you may have thought was a currency or a commodity may actually be a highly regulated financial product. This is going to be a paradigm shift for anyone who wasn’t previously aware that utility tokens could be considered securities.

  • If You Issued Tokens: You may have sold an investment product subject to federal and state securities laws. If you did not comply with those laws when you advertised or sold the tokens, you could be liable to the SEC or to your state securities regulator for statutory violations, and you could also be liable if a purchaser sues you.
  • If You Purchased Tokens: You have rights as an investor if the company that sold the tokens to you did not comply with the law. There are federal and state laws specific to financial wrongdoing that you may be able to use to recover money you lost in connection with purchasing a token.

Bottom Line

Don’t ever let anyone tell you that “there are no crypto laws.” There are many laws that apply to digital assets, even if they do not specifically say “crypto” or “token” or use other blockchain-specific terminology.

If you have questions as a token issuer or as a purchaser, feel free to contact us. Technology changes, but the law still applies. We’re here to help.


[1] The case is Sec. & Exch. Comm’n v. LBRY, Inc., No. 21-CV-260-PB, 2022 WL 16744741 (D.N.H. Nov. 7, 2022).

ABOUT THE AUTHOR

PARTNER

Rachel is an experienced trial lawyer, having litigated jury trials and bench trials, and represented clients in private arbitrations. She has worked with U.S. and international clients and with businesses of all sizes, from early-stage ventures to publicly traded companies.

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Business & Corporate Law

The Small Business Reorganization Act and Its Prolonged Adoption Through June of 2024

The Small Business Reorganization Act and Its Prolonged Adoption Through June of 2024

Mike Richardson

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Chapter 11 bankruptcy code generally provides businesses with avenues and protections to reorganize and restructure obligations.  This form of bankruptcy is very often more favorable than Chapter 7 bankruptcy because it allows business owners to stay in the driver’s seat while attempting to negotiate a plan that complies with the bankruptcy code.  In contrast, filing a Chapter 7 petition results in full relinquishment of control of the business and the appointment of a third-party trustee whose primary obligation is to liquidate estate assets for the benefit of unsecured creditors.

Historically, Chapter 11’s benefits have been far out of reach for small-to-mid-size businesses due to the costs and complexities of a typical Chapter 11 case.  For example, to confirm a plan of reorganization, post-petition claims (often amounting to hundreds of thousands of dollars) must be paid in full by the date the plan or reorganization is confirmed.  In addition, in a typical chapter 11, equity owners of a business will lose their interests if any non-consenting class of creditors do not receive full payment of their claims.    

As a response to these costly obstacles small-to-mid-size business owners face when considering bankruptcy protection, Congress enacted the Small Business Reorganization Act (the “SBRA”).  The SBRA falls under Chapter 11 as “Subchapter V.”  Congress signed the SBRA in 2019 and the law went active in February 2020.  When first enacted, the debt limit under the SBRA for total non-contingent, liquidated debt was $2,725,625, meaning that if a business held more debt than that amount, it could not qualify for SBRA protection.  However, the onset of Covid-19 quickly caused Congress to raise the debt ceiling eligibility to $7,500,000 as part of the CARES Act.    

In creating Subchapter V, Congress made clear that it intended to provide a faster, easier, and cheaper version of Chapter 11 bankruptcy to small-and mid-size businesses.  The SBRA eliminates the requirement of establishing an unsecured creditors committee, eliminates the obligation to pay quarterly U.S. Trustee fees, eliminates the requirement of filing a disclosure statement, and provides a reduced period of time for a debtor to file a plan.  The SBRA also permits a debtor to confirm a plan that “crams” down creditors’ claims without the approval of any impaired, consenting class of creditors.  A trustee is also assigned to each estate to facilitate the development of a consensual plan.

Perhaps the most significant benefit afforded to a Subchapter V debtor is the elimination (or relaxation) of the absolute priority rule.  Outside of the SBRA, a debtor’s equity holders cannot retain their ownership in the debtor unless non-consenting creditors receive full payment of their claims, or unless equity holders infuse new capital into the estate.  This requirement – which provides a fundamental level of protection to creditors – can be quite difficult to meet and, as a result, equity owners lose their interests as a result of the bankruptcy.  Under the SBRA, equity owners can retain their interests as long as a proposed plan commits the debtor’s projected, disposable income toward the plan, and as long as the plan “does not discriminate unfairly.”

The SBRA also allowed debtors to pay post-petition claims over the course of a 3–5-year plan.  Outside of the SBRA, a debtor is required to pay such claims (which include administrative expense claims like legal fees, rent, utilities, and other necessary goods and services supplied to a debtor) in full as of the date of plan confirmation.  By permitting such claims to be paid over time, a debtor can infuse more estate funds into the early phase of a plan, theoretically increasing the likelihood of plan confirmation (while also, inversely, increasing the risk that post-petition creditors will be paid in full).  

Since enactment, SBRA filings account for the vast majority of bankruptcy filings in the United States.  More than 3,000 debtors have elected to file under Subchapter V.  Proponents of the law point to higher plan confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed as a traditional Chapter 11.

As mentioned above, Congress quickly increased the SBRA’s debt ceiling to $7,500,000 at the onset of Covid-19 in 2020.  On June 21, 2022, President Biden signed the Bankruptcy Threshold Adjustment and Technical Corrections Act, which freezes the debt limit of the SBRA at $7,500,000 through June 21, 2024.  Given mounting concerns over near-term economic woes, the prolonged adoption of the SBRA’s debt ceiling could provide necessary relief for small-to-mid-sized businesses

ABOUT THE AUTHOR

PARTNER

Mike Richardson joined Milgrom & Daskam as a Partner in May 2022.  His practice focuses on litigation and bankruptcy matters.  He has represented parties on either side of real estate disputes, breach of contract actions, oil and gas disputes, fraudulent transfer claims, and breach of fiduciary duty claims.  Mike has also represented debtors, chapter 7 bankruptcy trustees, and other matters involving financially distressed parties reorganizing under chapter 11 of the U.S. Bankruptcy Code.

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The Small Business Reorganization Act and Its Prolonged Adoption Through June of 2024

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Beneficial Ownership Disclosure: New Reporting Requirements for Small Businesses

On September 30, 2022, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) issued its highly anticipated Final Rule establishing a beneficial ownership information (BOI) reporting requirement under the Corporate Transparency Act (CTA) of 2019. These rules significantly change the obligations of business entities to disclose previously private information regarding the ownership and control of these entities. The primary purpose of the CTA, enacted as part of the Anti-Money Laundering Act of 2020 is to protect the US financial system from being used for illicit purposes, including preventing corrupt actors, terrorists, and criminals from hiding assets in anonymous shell companies. Background for this rule was addressed in prior blog posts including The Corporate Transparency Act (1/31/22) and FinCEN and Real Estate (8/2/22).

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Business & Corporate Law

Beneficial Ownership Disclosure: New Reporting Requirements for Small Businesses

Beneficial Ownership Disclosure: New Reporting Requirements for Small Businesses

Charles Knight

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On September 30, 2022, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) issued its highly anticipated Final Rule establishing a beneficial ownership information (BOI) reporting requirement under the Corporate Transparency Act (CTA)  of 2019.  These rules significantly change the obligations of business entities to disclose previously private information regarding the ownership and control of these entities.  The primary purpose of the CTA, enacted as part of the Anti-Money Laundering Act of 2020 is to protect the US financial system from being used for illicit purposes, including preventing corrupt actors, terrorists, and criminals from hiding assets in anonymous shell companies. Background for this rule was addressed in prior blog posts including The Corporate Transparancy Act  (1/31/22) and FinCEN and Real Estate (8/2/22).

The Final Rule[1]

The Final Rule incorporates public comments to the Notice of Proposed Rulemaking published in December 2021 and becomes effective on January 1, 2024.  Reporting companies created or registered prior to this date have until January 1, 2025, to file their initial reports.  Reporting companies created or registered on or after January 1, 2024, will have 30 days to file their initial report. This final rule is one of three rulemakings planned to implement the CTA. Future rules are expected to establish rules for who may access BOI, for what purposes and what safeguards must be in place to secure the information and another revising FinCEN’s customer due diligence rule.

Who Must Report

The Final Rule applies to any foreign or domestic (a) corporation; (b) limited liability company; or (c) other entity that is created or registers to do business by the filing of a document with the secretary of state or any similar office under the law of a State or Indian Tribe.

There are 23 exemptions to the definition of a Reporting Company, including SEC reporting issuers, banks, credit unions, broker-dealers, businesses registered with FinCEN, tax-exempt entities, U.S. governmental authorities and large operating companies with more than 20 full-time employees in the U.S and more than $5 million in gross receipts or sales annually. Other exemptions are available for inactive entities, pooled investment vehicles operated by a qualifying sponsor, controlled subsidiaries, registered investment advisors and venture capital fund advisors that have filed required reports with the SEC.

The Final Rule specifically targets smaller entities for this additional disclosure.

What Must Be Reported.

In addition to certain identifying information, the Final Rule requires the reporting of information concerning both (1) beneficial owners; and (2) company applicants.

For each Reporting Company, the following information is required:

  • Full legal name of reporting company
  • Any trade or DBA name
  • Business address
  • Initial registration location; and
  • Taxpayer or Employer Identification Number

For each Beneficial Owner or Company Applicant (see definitions below), the following information is required:

  • Full legal name
  • Birth date
  • Current business address of Applicant
  • Current residential address of Beneficial Owner
  • Unique identifying number, issuing jurisdiction and image from:
    • Non-expired US or Foreign Passport
    • Non-expired government or tribal ID; or
    • Non-expired driver’s license.

This information will be reported to and stored within the Beneficial Ownership Secure System (BOSS), a non-public database developed by FinCen.  The information will be available to federal agencies in support of national security, intelligence, and federal, state, local and foreign law enforcement agencies in certain circumstances.

All reported information must be updated in a timely manner. Reporting companies and individuals may also apply to FinCEN for a “FinCEN Identifier,” a unique number that may be submitted to FinCEN in lieu of the above-described information. This will be particularly helpful to frequent filers, including Company Applicants.

Definitions.

The term “Company Applicant” means the individual who directly files the document that first creates or registers the Reporting Company and includes service providers and registered agent firms.

The term “Beneficial Owner” is defined as any individual (i.e., natural person) who, directly or indirectly (1) exercises substantial control over a reporting company; or (2) owns or controls at least 25% of the ownership interests of a reporting company.

The Final Rule’s definition of “substantial control” includes any individual who: (1) serves as a senior officer of a reporting company[2]; (2) has authority over the appointment or removal of any senior officer or a majority of the board; (3) directs, determines, or has substantial influence over important decisions made by a reporting company; or (4) has any other form of substantial control over a reporting company.

The Final Rule’s definition of “ownership interest” includes equity interests, capital or profits interests, convertible interests, options and “any other instrument, contract, arrangement, understanding, or mechanism used to establish ownership.” Ownership includes control through joint ownership with other persons, through a nominee, intermediary, custodian or agent and certain trust arrangements.

The Final Rule requires beneficial ownership reporting for every individual deemed to exercise substantial control over a reporting company and notes that substantial control may be exercised directly or indirectly, including as a trustee of a trust, membership on a board, rights associated with any financing arrangement, control over one or more intermediaries or financial, business, or other arrangements or understandings. The “substantial control” standard for beneficial ownership requires that even those who do not actually possess an ownership interest in a reporting entity will still be required to submit their information to FinCEN. Additionally, the inclusion of the “indirect” standard for substantial control denotes that all layers of beneficial ownership must be disclosed, if, for example, parent entities are used for ownership and management purposes.

Violations

The CTA provides that any willful violation of the reporting requirements can lead to civil penalties of up to $500 per day a violation has not been corrected; and criminal penalties of up to $10,000 and/or imprisonment of up to two years.

Recommendations.

Although existing entities have an almost two-year grace period to report, entities formed after January 1, 2024, will have to report immediately.  Clients considering new entities should understand the new reporting requirements and start identifying all reporting companies in their structures and gathering beneficial ownership information from Beneficial Owners and persons who exercise Substantial Control.  Investors whose personal information will have to be disclosed should be notified about the new rule and complex ownership structures, including family trusts and financing agreements, should be analyzed in order to determine the new reporting obligations.

If you would like more information, you can reach out to one of the attorneys at Milgrom & Daskam to review your business and ownership legal structures and help you prepare for the new reporting requirements.

 


 

[1] This post has discussed some, but not all of the provisions of the final rule.  Interested persons should review the rule which can be accessed at the link above or at 31 CFR 1010, Sec 1010.380 and in the Federal Register, 87 FT 59498.

[2] “Senior Officer” means any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer or any other officer, regardless of official title, who performs a similar function. Does not include ministerial roles with little control including “corporate secretary” or “treasurer.”

ABOUT THE AUTHOR

OF COUNSEL

Charles joined Milgrom & Daskam in June 2020 and focuses on serving entrepreneurs, nonprofits and growth companies from ideation and formation to early and later stage capitalization and through mergers and acquisitions. His expertise includes companies focused on technology, renewable energy, and real estate, including affordable housing and new market tax credit development and financing.

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The Corporate Transparency Act: What It Is and What It Means for Your Small Business

The Corporate Transparency Act: What It Is and What It Means for Your Small Business

Madison Shaner

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On January 1, 2021, as part of the federal Anti-Money Laundering Act (the “AMLA”), Congress enacted the Corporate Transparency Act (the “CTA”) in an effort to increase corporate transparency. The CTA requires certain companies to file information on their businesses, including “beneficial ownership” information, with the Financial Crimes Enforcement Network (“FinCEN”). The impact of the CTA on companies and those who would be required to report information has not been clear. However, on December 7, 2021, FinCEN issued a Notice of Proposed Rulemaking to establish the regulations that would implement the CTA, and provide additional clarity on which businesses would be considered “reporting companies” under the CTA.

Which companies are subject to reporting requirements?

Almost all types of domestic and foreign business entities are included in the CTA’s definition of “reporting companies”. This includes limited liability companies and corporations. That being said, the CTA allows for a number of exemptions for companies that will not be required to make CTA filings. However, these exemptions apply only to large entities and entities that are already subject to various reporting requirements due to size or industry regulations.

Companies that are considered “large operating companies” are not required to make filings under the CTA. The proposed rules clarify that “large operating companies” are those that: (1) employ more than 20 employees on a full-time basis in the United States; (2) filed Federal income tax returns in the prior year demonstrating more than $5,000,000 in gross receipts or sales in the aggregate (including receipts or sales from entities owned by the entity and through which the entity operates); and (3) has an operating presence at a physical office within the United States. The CTA additionally does not require filings for subsidiaries of exempted entities, meaning entities whose ownership interests are entirely owned or controlled by an exempt entity. Subsidiary entities that are partially-owned by exempt entities, are, however, not exempted.

What does a reporting company have to report?

Reporting entities will be required to disclose basic information regarding the entity itself, including the company’s full name, any trade name (or D/B/A), business street address(es), the jurisdiction of formation, and taxpayer identification information (EIN). In addition to entity information, reporting entities are required to report information on their beneficial owners. Meaning that each reporting entity will be required to report the name, birthdate, address, and unique identifying number from an acceptable identification document (such as a passport or driver’s license) with an image of the document. The beneficial owner information must be provided for each company applicant and beneficial owner of the entity. Beneficial owners are defined by the CTA as “any individual who, directly or indirectly” exercises “substantial control” over the reporting company or “owns or controls” at least 25% of the “ownership interests” of the reporting company.” 

While the CTA doesn’t define “substantial control” or “ownership interests,” the proposed regulation clarifies that “substantial control” is viewed through the lens of three specific indicators: (1) service as a senior officer of a reporting company; (2) authority over the appointment or removal of any officer or dominant majority of the board of directors of a reporting company; (3) direction, determination or decision of, or substantial influence over important matters of a reporting company (e.g. sale, lease or transfer of principal assets of the company, entry into or termination of major contracts, major expenditures and investments, compensation of senior officers). The proposed regulations also take an expansive view of what constitutes an “ownership interest” to include both equity in the reporting company and other types of interests, such as capital or profits interests, convertible instruments, warrants or rights, or other options to acquire equity, capital, or other interests in a reporting company.

When do reporting companies have to report their information?

When reporting companies are required to comply with the CTA depends on the date of the company formation. After FinCEN’s regulations become final, new reporting companies will be required to report the information about their beneficial owners upon formation or within fourteen days thereof. Any existing company formed prior to the effectiveness of the FinCEN regulations will be required to report its information within two years of the promulgation of the new regulations. Reporting companies will also need to update their information within a year of any change of beneficial ownership.

Who will be able to see and access information regarding beneficial ownership?

The beneficial owners of consumer facing companies may be concerned about the accessibility of their personal information given the reporting requirements. This concern is largely unfounded, however. The reporting information will be kept in a secure, private, database maintained by FinCEN. The database of reporting information will not be publicly available, and ownership information will be available upon requests only from federal law enforcement agencies; state, local, or tribal law enforcement agencies authorized by court order; a federal agency on behalf of a foreign country if such request is pursuant to an international agreement; or a financial institution for customer due diligence purposes authorized by the reporting company.

The current proposed rulemaking is one of three to implement the CTA. Companies should begin evaluating whether they will fall within the reporting requirements and who within their entity structure may be considered a beneficial owner based on this initial proposed rulemaking.

 

ABOUT THE AUTHOR

ASSOCIATE

Madison (Maddie) Shaner joined Milgrom & Daskam as an Associate in 2019. Her practice focuses on corporate and real estate transactions. Prior to joining Milgrom & Daskam, Maddie was an associate at Tyson, Gurney & Hovey, LLC where she conducted oil and gas title examination and assisted in drafting drilling and division order title opinions for upstream oil and gas clients

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