Despite the public launch, the ambiguity on claims ranking and recourse is a concern.

by Celebrus Advisory

The following was published as a LinkedIn post on Mar 30, 2023 at this link.

What happens when the issuer of an #IEO (initial exchange offering) goes into default? Can token holders get their money back?

We’ve raised this question repeatedly before and got reminded again by the recent Credit Suisse collapse. There is a repayment hierarchy when a company is liquidated – it means who gets paid first. Creditors get paid before shareholders. Senior debt gets paid before junior debt, preferred stocks before common stocks. As you may have read, when UBS acquired Credit Suisse, they sort of upended this hierarchy. It sparked so much outcry from Asian investors until the regulators (Singapore MAS and Hong Kong HKMA) had to issue pacifying statements.

How will this apply to an #IEO?

Under Malaysian law, token holders are neither shareholders nor creditors of the company. Therefore, it begs the question of when (or whether) tokens will be repaid. If token holders get paid before shareholders, then the question is whether shareholders have agreed to waive their shareholder claims to the prior satisfaction of token holders and consented to absorb losses including all indebtedness and liabilities arising out of the IEO. If another company acquires the failing issuer, can they write off the obligations to the tokens?

Token holders don’t own any equity in the company. Their tokens are generally unsecured. To afford better investor protection, some issuers may back these tokens with collateral. But beware, this is not easily achieved. Sometimes it’s downright misleading. And many tokenization models touted out there are not applicable here.

Establishing the legal linkage between tokens and collateral assets can be nebulous. From the cases we’ve seen, direct interest in the collateral cannot be established so token holders must bring their claims against the issuer instead – which means they’re back to square one. If you look close enough, the collateral assets may not have been pledged at all but merely ‘pegged’ (in terms of price), or they were not properly custodied or registered, or they cannot be legally tied back or stapled to the tokens, etc.

Don’t just take the issuer’s word in the whitepaper that the tokens are “asset-backed”. Demand to see documentation and verify them. Ask your lawyer about the efficacy of the arrangement. If there’s still an iota of doubt, just stick to asset classes with clear repayment rules like good old-fashioned bonds and shares.

PS: We welcome clarity and feedback from the #IEO operators (approved by the Securities Commission Malaysia).