Most people are thrilled when invited to serve on the board of directors of a startup, especially when a transformative technology is the focal point. Increasingly, the need for directors is coming from startups hoping to create, invest, securitize, trade, distribute, or otherwise commercialize cryptocurrencies and cryptoassets. Like any startup, the crypto youngster will encounter growth challenges, and more than a few will land in financial distress.
What's a director to do when that happens? When does the director need to consider creditors' needs first and shareholders' expectations second? Is the director liable if the firm fails an insolvency test? How should cryptoassets be valued when insolvency is in the air? PwC, one of the Big Four global accounting firms, recently published a handy guide meant to get crypto firm directors thinking along the right lines.
The concern has heightened, notes PwC, since "many crypto players are facing challenges due to a broad range of issues, from a fall in cryptoasset prices to more regular start-up challenges. This is forcing many well-intentioned crypto firms into financially distressed situations with the need to urgently restructure their operations or redefine their business strategy in order to stay afloat."
But that can be tricky for directors and senior managers. PwC notes:
"[I]n many jurisdictions, an insolvency test involving a cash flow and/or balance sheet assessment is used to determine a company's financial status: a. Cash flow test – does your company have the ability to service its debts as and when they fall due? b. Balance sheet test – are your company's assets greater than its liabilities? Should your company's finances fail to meet one or both of these tests, your company may be deemed to be insolvent."
Tough Times at the Casbah
As readers surely know, cryptoasset markets have been rocked by intense volatility in benchmark digital currency prices, supply, and demand in the past 18 months. Add to that a large cloud hovering over the scene due to lack of clarity on the accounting treatment of cryptoassets and gnawing questions about how to accurately value them. When a board of directors and senior managers are faced with evaluating a crypto firm's solvency status, these ill winds may converge in ways that can expose all of these people to personal legal liability, public censure, or (rarely) criminal proceedings.
PwC paints this picture:
"If a disgruntled creditor takes enforcement action to appoint a liquidator, you lose control of the process. There will be a scrutiny of your actions; in particular if and how quickly you took action to preserve value … You will be held to account for both what you did and what you failed to do."
Not a director? Any member of senior management who is not an official director may also be painted with the responsibilities and obligations of a director. PwC says this could be the case "if you typically take on roles associated with a director. Whilst this will be assessed on a case by case basis, if you are deemed to be a shadow or de facto director, then the statutory duties of a director apply to you too." The vagaries of accounting rules in jurisdictions globally, combined with the current lack of consensus among international accounting rule-setters, are addressed in yet another report by PwC that ties directly to the issues mentioned earlier.
Given the tortoise pace at which global accounting and corporate governance policies gain consensus, it will be quite some time before many of the crypto accounting and valuation regimes are settled. And as the world turns, there will be failures in this new and exciting field. Be careful. If you get a board invitation from a crypto entrepreneur, take time to speak to a well-versed lawyer or accounting/tax advisor before signing on.