Official Committee Of Unsecured Creditors v. BlockFi Inc.

FOR PUBLICATION

UNITED STATES BANKRUPTCY

COURT DISTRICT OF NEWJERSEY

CaptioninCompliancewithD.N.J.LBR9004-2(c)

In re:

BlockFi, Inc.,

Case No. 22-19361(MBK)

Debtor.

Chapter 11

Official Committee of Unsecured Creditors,

Plaintiff,

Adv. Pro. No. 23-01144 (MBK)

v.

BlockFi, Inc., et al., HearingDate: September 21, 2023

Defendants.

U.S. Department of Justice –Civil Division BROWN RUDNICK LLP

Commercial Litigation Branch Robert J. Stark, Esq.

Seth B. Shapiro, Esq. Kenneth J. Aulet, Esq.

Kirk T. Manhardt, Esq. Bennett S. Silverberg, Esq.

Kevin P. VanLandingham, Esq. Seven Times Square

Crystal J. Geise, Esq. New York, NY 10036

Jessica L. Cole, Esq. Counsel for the Official Committee of

P.O. Box 875, Ben Franklin Station Unsecured Creditors

Washington, DC 20044-0875

Attorneys for the United States of America

GENOVA BURNS LLC

BROWN RUDNICK LLP Daniel M. Stolz, Esq.

Tristan Axelrod, Esq. Donald W. Clarke, Esq.

Sharon I. Dwoskin, Esq. Gregory S. Kinoian, Esq.

One Financial Center 110 Allen Rd., Suite 304

Boston, MA 02111 Basking Ridge, NJ 07920

Counsel for the Official Committee of Local Counsel for the Official Committee of

Unsecured Creditors Unsecured Creditors

FAEGRE DRINKER BIDDLE & REATH COLE SCHOTZ PC

LLP Michael D. Sirota, Esq.

Frank F. Velocci, Esq. Warren A. Usatine, Esq.

600 Campus Drive Court Plaza North, 25 Main Street

Florham Park, New Jersey 07932 Hackensack, New Jersey 07601

Richard J. Bernard, Esq. HAYNES & BOONE LLP

Roya Imani, Esq. Richard S. Kanowitz, Esq.

1177 6th Avenue, 41st Floor Richard D. Anigian, Esq.

New York, New York 10036 Charles M. Jones II, Esq.

Counsel for the Joint and Several Provisional 30 Rockefeller Plaza, 26th Floor

Liquidators of BlockFi International Ltd. New York, New York 10112

Attorneys for Defendants and Debtors and

Debtors in Possession

MEMORANDUM DECISION

This matter comes before the Court upon the motion (“Motion”, ECF No. 35) filed by

Defendant, United States of America (“United States”) seeking dismissal of the above-captioned

adversary proceeding filed by the Official Committee of Unsecured Creditors (the “Committee”).

The Committee opposes the Motion (ECF No. 43). Defendants BlockFi Inc. and its related

debtors, debtors-in-possession, and named defendants in the above-referenced chapter 11 cases

and adversary proceeding (collectively, “BlockFi” or “Debtors”) and the Bermuda Joint and

Several Provisional Liquidators of BlockFi International Ltd. both filed a limited response (ECF

Nos. 44 & 52, respectively). The Court has fully considered the parties’ submissions, including

arguments made during the September 21, 2023, hearing. For the reasons expressed below, the

Court DENIES the Motion.

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I. Jurisdiction

The Court has jurisdiction over this contested matter under 28 U.S.C. §§ 1334(a) and

157(a) and the Standing Order of the United States District Court dated July 10, 1984, as amended

September 18, 2012, referring all bankruptcy cases to the bankruptcy court. As explained in detail

below, this matter is a core proceeding within the meaning of 28 U.S.C. § 157(b)(2)(A), (G) &

(E). Venue is proper in this Court pursuant to 28 U.S.C. § 1408 and § 1409.

II. Background and Procedural History

The factual and procedural history of this case is well known to the parties and will not be

repeated in detail here. In relevant part, in October 2022, a federal grand jury in Washington state

returned a criminal indictment for wire fraud and money laundering against two BlockFi account

holders: Sergei Potapenko & Ivan Turogin (collectively, the “Criminal Defendants”).1 “On

November 10, 2022, the Honorable Michelle L. Peterson, Magistrate Judge in the Western District

of Washington, issued four Seizure Warrants [the ‘Warrants’] directing law enforcement to seize

‘all funds—including virtual currencies—from’ the named BlockFi accounts [the ‘Subject

Accounts’].” Motion 13, ECF No. 35. “That same day, BlockFi paused all activity on its platform

due to the FTX collapse and resulting market conditions. Six days later, the United States served

the Warrants on BlockFi, twelve days before BlockFi filed chapter 11 petitions [on November 28,

2022].” BlockFi’s Limited Response ¶ 1, ECF No. 44.

Debtors explain that “[t]he Subject Accounts comprised three account types: (i) BlockFi

Wallet (‘Wallet’), (ii) BlockFi Interest Accounts (‘BIAs’), and (iii) certain loan collateral accounts

1 Indictment [ECF 1, filed Oct. 27, 2022], United States v. Sergei Potapenko & Ivan Turogin, Case No. 2:22-CR-

00185-RSL (W.D. Wash.).

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(the ‘Collateral Accounts’). The total value of digital assets attributable to the Subject Accounts

was, as of the service date of the Warrants, approximately $57 million.” Id. at ¶ 2. The United

States reports that BlockFi partially complied with the Warrants by surrendering roughly $719,665

of digital assets that were attributable to Wallet Accounts. Indeed, this Court previously has ruled

that digital assets held in Wallet Accounts by customers were not property of the bankruptcy estate

and should be distributed to the appropriate account-holder. Order Authorizing the Debtors to

Honor Withdrawals from Wallet Accounts, ECF No. 923. BlockFi retained the remainder of the

assets allegedly subject to the Warrants, which were held in both the BIAs and Collateral Accounts.

Ultimately, BlockFi agreed to transfer the remaining cryptocurrency in the Subject Accounts—

with a stipulated value of over $35 million—to the United States. Before the transfer could occur,

the Committee commenced the instant adversary proceeding and obtained an order from this Court

temporarily enjoining the transfer. Amended Order to Show Cause and for Temporary and

Preliminary Injunctive Relief, ECF No. 10. The parties then entered into a series of Stipulations

and Consent Orders (ECF Nos. 20, 21, & 28) wherein they agreed to a briefing schedule and certain

filing deadlines. On August 10, 2023, the United States filed the instant Motion seeking dismissal

of the adversary proceeding.

III. Standard of Review

Pursuant to Federal Rule of Civil Procedure 12(b)(6), made applicable by Federal Rule of

Bankruptcy Procedure 7012, a motion to dismiss may be granted if the complaint fails “to state a claim

upon which relief can be granted.” FED. R. CIV. P. 12(b)(6). “To survive a motion to dismiss, a

complaint must contain sufficient factual allegations, taken as true, to ‘state a claim to relief that

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is plausible on its face.’ ” Fleisher v. Standard Ins., 679 F.3d 116, 120 (3d Cir. 2012) (quoting Bell

Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S. Ct. 1955, 167 L.Ed.2d 929 (2007)). When

reviewing a motion under 12(b)(6), a court must “view the facts alleged in the pleadings and the

inferences to be drawn from those facts in the light most favorable to the plaintiff, and judgment

should not [be] granted unless the moving party has established that there is no material issue of

fact to resolve, and that it is entitled to judgment in its favor as a matter of law.” Leamer v. Fauver,

288 F.3d 532, 535 (3d Cir. 2002) (citation omitted); see also Davis v. Wells Fargo, 824 F.3d 333,

341 (3d Cir. 2016). A claim has “facial plausibility when the plaintiff pleads factual content that

allows the court to draw the reasonable inference that the defendant is liable for the misconduct

alleged.” Ashcroft v. Iqbal, 556 14 U.S. 662, 678 , 129 S. Ct. 1937, 1949 (2009) (citing Twombly

at 556, 127 S. Ct. 1955, 167 L. Ed. 2d 929). In this matter, the Committee has satisfied its burden

to state a plausible claim for relief.

IV. Discussion

The Motion seeks dismissal of the Committee’s Complaint2 on two bases: lack of subject

matter jurisdiction and failure to state a claim. Prior to filing its Motion, however, the United

States moved the district court to withdraw the reference. Motion to Withdraw the Reference, ECF

No. 1 in Case No. 3:23-cv-03015. Just before oral argument on the instant Motion, the district

court issued its Opinion and Order denying the United States’ Motion to Withdraw the

Reference—finding that mandatory withdraw was not warranted, and that permissive withdraw

2 The “Complaint” refers to the Amended Complaint (ECF No. 24) filed on June 30, 2023, which is the operative

document.

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was premature because the bankruptcy court had not yet made the threshold determination of

whether the issues presented in the adversary proceeding were core or non-core. Opinion Denying

Motion to Withdraw the Reference, ECF No. 14 in Case No. 23-cv-03015. This Court now takes

the opportunity to weigh in on the core v. non-core issue.

A. The matter is a core issue

Pursuant to 28 U.S.C. § 1334 bankruptcy jurisdiction extends to four types matters: (1)

cases ‘under’ title 11; (2) proceedings “arising under” title 11; (3) proceedings “arising in” title

11; and (4) proceedings “related to” a case under Title 11. 28 U.S.C. §§ 1334(b), 157(a); Celotex

Corp. v. Edwards, 514 U.S. 300, 307, 115 S. Ct. 1493, 131 L.Ed.2d 403 (1995); In re G-I Holdings,

Inc., 580 B.R. 388, 423 (Bankr. D.N.J. 2018). “Matters ‘under’ title 11 simply refers to the

bankruptcy petition itself.” In re Rusciano, No. 15-32888, 2020 WL 111470, at *4 (Bankr. D.N.J.

Jan. 8, 2020) (citing Stoe v. Flaherty, 436 F.3d 209, 216 (3d Cir. 2006)).

[A] case “arises under” title 11 if it invokes a substantive right provided by title 11.

Proceedings “arise in” a bankruptcy case, if they have no existence outside of the

bankruptcy. Finally, a proceeding is “related to” a bankruptcy case if the outcome

of that proceeding could conceivably have any effect on the estate being

administered in bankruptcy.

In re G-I Holdings, Inc., 580 B.R. at 423 (citing case Stoe v. Flaherty, 436 F.3d 209, 216

(3d Cir. 2006), as amended (Mar. 17, 2006).

The crux of the Committee’s argument in its Complaint is that the funds sought by the

United States are property of the bankruptcy estate and, thus, subject to the automatic stay. Indeed,

an action to determine the scope of the automatic stay is a core proceeding under 28 U.S.C. §

157(b)(2)(G). The United States maintains that this dispute is—at its heart—a criminal action that

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the Committee is trying morph into a core proceeding by framing it as a violation of the automatic

stay. This Court does not agree. As noted by the district court, the adversary proceeding tasks this

Court with determining whether the funds at issue are included in the bankruptcy estate. See

Opinion Denying Motion to Withdraw the Reference 13, ECF No. 14 in Case No. 23-cv-03015

(“Here, the Adversary Proceeding requires the Bankruptcy Court to interpret the Seizure Warrants

and to determine whether the funds at issue in the accounts are included in the Bankruptcy estate.”).

This task fits squarely within the role of the bankruptcy court and is a fundamentally core issue.

The Court does not share the United States’ view that the adversary proceeding is an

attempt to prevent BlockFi from complying with the Warrants or an effort to prevent the United

States from prosecuting the motion to compel compliance with the Warrants. The Committee has

clarified in submissions and on the record that it is not “seeking to interfere with or alter the

legitimate rights that the United States has by virtue of the Seizure Warrants.” Committee’s Opp’n

to Motion 4, ECF No. 43. Rather, the Committee seeks to prevent the United States from seizing

estate assets that are neither named in the Warrants, nor subject to forfeiture under applicable

criminal statutes. Again, the question of what constitutes estate property is undeniably a core

issue. In this instance, however, that inquiry also requires interpretation of the Warrants and a

determination as to whether Debtors are in possession of the specific property covered in those

Warrants. That analysis implicates other jurisdictional concerns—raised by the United States in

its Motion—which the Court now addresses.

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B. Subject Matter Jurisdiction

The United States first relies on 21 U.S.C. § 853, which provides—in relevant part—that

no party claiming an interest in property subject to forfeiture under this section

may--

. . .

(2) commence an action at law or equity against the United States concerning

the validity of his alleged interest in the property subsequent to the filing

of an indictment or information alleging that the property is subject to

forfeiture under this section.

21 U.S.C. § 853(k).

The United States asserts that the Committee initiated this adversary proceeding after the

filing of the indictment against the Criminal Defendants (the “Indictment”) with the purpose of

alleging an interest in the property subject to forfeiture. “Because the Complaint seeks to

adjudicate the estates’ right to property described in the Indictment, the lawsuit is barred by the

plain language of Section 853(k)(2) and must be dismissed for lack of subject matter jurisdiction.”

Motion 15, ECF No. 35 (citing Brown v. United States, 692 F.3d 550, 552 (6th Cir. 2012)).

The Committee clarifies that it “does not assert an interest in the assets subject to the

Seizure Warrants.” Committee’s Opp’n ¶ 19, ECF No. 43. It is the Committee’s position that the

funds it seeks to protect do not—and never did—belong to the Criminal Defendants. Thus, the

Committee asserts that 21 U.S.C. § 853(k)—which applies only to “property subject to

forfeiture”—is inapplicable. This Court agrees. The purpose of the adversary proceeding is not

to interfere with the criminal forfeiture, but to determine what assets are subject to the criminal

forfeiture. The United States maintains that the bankruptcy court is without jurisdiction to make

this determination.

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Although the United States acknowledges that § 1334(b) of Title 28 permits district courts

to refer “any or all cases under title 11 and any or all proceedings arising under title 11 or arising

in or related to a case under title 11 . . .to the bankruptcy judges for the district,” the United States

asserts that “[n]o federal statute or rule . . . authorizes the delegation of criminal actions or

forfeiture proceedings brought by the United States to the bankruptcy court. The district courts

instead have exclusive jurisdiction over matters related to federal criminal statutes.” In support of

this contention, the United States cites to 18 U.S.C. § 3231, which provides that “[t]he district

courts of the United States shall have original jurisdiction, exclusive of the courts of the States, of

all offenses against the laws of the United States,” and to 28 U.S.C. § 1355, which states that “[t]he

district courts shall have original jurisdiction, exclusive of the courts of the States, of any action

or proceeding for the recovery or enforcement of any fine, penalty, or forfeiture.”

The United States asserts that “[h]ere, the claims seek to interfere with the criminal

proceedings and to declare the parties’ interests in the property subject to forfeiture—matters

governed by criminal statutes. An indictment alleging a violation of the federal criminal code and

seeking forfeiture of assets based upon conviction of such violation necessarily falls under district

court’s jurisdiction.” Motion 18, ECF No. 35. And because the district court has no authority to

delegate that jurisdiction, the United States concludes that this Court lacks jurisdiction over the

issues raised in the adversary proceeding. Again, this Court does not share the United States’ view

of these proceedings.

The question presented in this case can be framed two different ways. The first question

asks whether the funds remaining in Debtors’ possession at the time of the bankruptcy filing are

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property of the bankruptcy estate.3 The second asks whether the funds held by Debtors are subject

to forfeiture under the Warrants. When looked at under the lens of the first question, there is no

question as to this Court’s jurisdiction—as discussed, it clearly invokes a core bankruptcy matter.

When looked at through the lens of the second question, the jurisdictional issue undeniably

becomes murky. Nevertheless, this Court rules that—even when viewed from the perspective of

the United States—this Court still maintains original and exclusive jurisdiction over all estate

assets as described broadly in 11 U.S.C. § 541(a).

As an initial matter, it is not unheard of for bankruptcy courts to determine whether

property is properly subject to seizure under criminal statutes. For example, in In re Reid, 60 B.R.

301, 306 (Bankr. D. Md. 1986), a bankruptcy court conducted a forfeiture hearing in response to

a trustee’s motion for turnover to determine whether $35,595 in currency that had been seized was

subject to forfeiture under Maryland criminal statute, see MD CODE ANN. art. 27, § 297(a)(6)

(repealed). After conducting an analysis of state forfeiture law and applicable state case law, the

bankruptcy court concluded that “$3,000 of the seized currency is not attributable to proscribed

activity and is therefore not forfeitable,” and directed turnover of that amount to the trustee for the

bankruptcy estate. In re Reid, 60 B.R. at 308. This Court’s research revealed several other

instances in which bankruptcy courts interpreted criminal statutes for the purposes of determining

3 As discussed herein, the funds held by the Debtors on the date of filing were accumulated through the liquidation

of all digital assets pledged to or deposited with the Debtors by its customers through their individual BIAs or

Collateral Accounts. Accounts belonging to the Criminal Defendants—like all other customers—held no digital

assets or proceeds thereof on the date of the bankruptcy filing. Rather, account holders merely held claims against

the Debtors for such amounts owing. Even prior to the filing and subsequent liquidation, the digital assets were

never sitting in an account; rather, they were rehypothecated, repledged, or otherwise transferred as part of

transactions with other entities, such as Alameda, FTX, or 3AC.

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whether seized property constituted property of the bankruptcy estate. See, e.g., In re Vitta, 409

B.R. 6 (Bankr. E.D.N.Y. 2009) (interpreting state forfeiture law to determine whether the property

seized by police prepetition, and against which the DA had obtained an order of attachment

prepetition, was property of the estate as of the date the petition was filed); In re WinPar Hosp.

Chattanooga, LLC, 401 B.R. 289, 294 (Bankr. E.D. Tenn. 2009) (citing Chao v. Hosp. Staffing

Servs., Inc., 270 F.3d 374, 383 (6th Cir. 2001) and acknowledging concurrent jurisdiction with the

district court to determine whether the automatic stay precluded a forfeiture proceeding); In re

Thomas, 179 B.R. 523, 527 (Bankr. E.D. Tenn. 1995) (finding the issue to be a core proceeding

and holding that the bankruptcy court “clearly” had jurisdiction to determine whether police

department’s post-petition seizure and collection of property of the estate constituted a violation

of the automatic stay); In re Kurth Ranch, 122 B.R. 759, 763 (Bankr. D. Mont. 1991) (interpreting

the Uniform Controlled Substances Act to determine whether the trustee had any “legal or

equitable right to the property held by the Defendant County pursuant to the forfeiture”); In re

Ryan, 32 B.R. 794, 796 (Bankr. D. Md. 1983) (interpreting state seizure law and deciding the

ultimate question of whether funds seized on the eve of bankruptcy were property of the estate).

Admittedly, limited case law exists supporting the United States’ contention that district

courts have exclusive jurisdiction over matters related to federal criminal statutes. The United

States relies heavily on In re GuildMaster, Inc., No. 12-62234, 2013 WL 1331392 (Bankr. W.D.

Mo. Mar. 29, 2013). In GuildMaster, the bankruptcy court dismissed an adversary proceeding

brought by a debtor against the United States seeking turnover of seized property. The

GuildMaster court explained that it lacked jurisdiction to decide the relative priorities of the

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parties’ interests in the seized property because that inquiry “necessarily involves the interpretation

and application of criminal statutes which are directly at issue in a pending criminal matter.” Id. at

*1. This Court’s research returned several other cases—some of which are also cited by the United

States—suggesting that bankruptcy courts are without jurisdiction to evaluate parties’ respective

interests in property subject to seizure. See, e.g., In re VPH Pharmacy, Inc., No. 18-11280, 2018

WL 3574721, at *3 (E.D. Mich. July 25, 2018) (ruling that district courts, not bankruptcy courts,

have original and exclusive jurisdiction to determine the correctness of a forfeiture action and

explaining that once a judgment of forfeiture is entered, the property belongs to the Government

and ownership dates back to the filing of the case); United States v. DeMiro, 446 B.R. 804, 807–

08 (E.D. Mich. 2011) (holding that because the Government sought forfeiture prior to entry of the

orders of relief, the debtors' legal interest in the assets subject to forfeiture was limited to the right

to petition for a hearing in the district court under 21 U.S.C. § 853(n)(2)); In re Thena, Inc., 190

B.R. 407, 410, 413 (D. Or. 1995).

In resolving this jurisdictional quagmire, this Court first notes that none of the seemingly

contradictory case law is binding on this Court. More significantly, the cases cited are factually

distinguishable in that they all involve a debtor who is the criminal defendant whose property is

subject to forfeiture. In contrast, the Debtors here are creditors of the Criminal Defendants, who

stand in the same shoes—holding unsecured claims against the Debtors—as the over 600,000 other

customers. Ultimately, this Court is persuaded by the Committee, who argues that such line of

cases holding that issues regarding seized property implicated in a criminal proceeding are not

within the purview of the bankruptcy court are “irrelevant in the context of this case.” Committee’s

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Opp’n 10, ECF No. 43. In resolving this adversary proceedings, the Court will not adjudicate the

merits or enforceability of the Warrants; nor will this Court need to interpret or apply any

provisions of Title 18 in determining whether any of the funds in the Debtors’ possession are, in

fact, traceable to the assets deposited by the Criminal Defendants. Instead, the scope of this

Court’s ruling is limited to deciding whether property in Debtors’ possession is estate property or,

alternatively, whether it is property subject to forfeiture pursuant to the Warrants. To be clear, this

is not a determination regarding the priority of interests in the property subject to seizure. Due to

the relation-back provision in 21 U.S.C. § 853(c), title to the property identified in the Warrants

vested with the United States upon the commission of the crime and, thus, never entered the

bankruptcy estate. To the extent property held by the Debtors is not subject to the Warrants;

however, such property falls within the scope of 11 U.S.C. § 541(a) as is property of the bankruptcy

estate. This Court is equipped and authorized to make a determination as to what constitutes

property of the estate—and, indeed, is the court in the best position to make such a ruling. Nothing

in the criminal statutes or case law cited by the United States deprives this Court of such authority.

Therefore, the United States’ Motion to dismiss for lack of subject matter jurisdiction is denied.

C. Sovereign Immunity

The United States’ argument with respect to sovereign immunity is inextricably tied to its

jurisdictional argument. In sum, the government relies on the proposition that a party may not

bring suit against the federal government or its agencies unless the United States has expressly

consented to be sued. See Dep't of Army v. Blue Fox, Inc., 525 U.S. 255, 260, 119 S. Ct. 687, 690,

142 L. Ed. 2d 718 (1999) (citing FDIC v. Meyer, 510 U.S. 471, 475, 114 S. Ct. 996, 127 L.Ed.2d

13

308 (1994)). A plaintiff’s “inability to identify an unequivocal waiver of sovereign immunity by

Congress” will result in dismissal of the claim against the government. Spangler v. Centers for

Medicare & Medicaid Servs., No. 1:18-CV-01297, 2019 WL 4194276, at *4 (M.D. Pa. Sept. 4,

2019) (citing Glob. Fin. Corp. v. United States, 67 F. App'x 740, 742 (3d Cir. 2003)). Because

sovereign immunity is jurisdictional in nature, see FDIC v. Meyer, 510 U.S. at 475, if unequivocal

waiver is not established, the court lacks subject matter jurisdiction over the issues raised. See

Spangler, 2019 WL 4194276, at *4.

Here, the United States asserts that the Committee relies on 28 U.S.C. § 1334(e) in support

of its jurisdictional argument and—because the statute does not abrogate sovereign immunity—

this Court is without jurisdiction to hear the adversary proceeding. The Committee counters by

pointing out that “Bankruptcy Code Section 106 expressly abrogates and waives sovereign

immunity with respect to, among other sections, Sections 105 and 362, and provides that the

bankruptcy court may hear and determine any issue arising with respect to the application of such

sections.” Committee’s Opp’n ¶27, ECF No. 43 (citing 11 U.S.C. § 106(a); Lac de Flambeau Band

of Lake Superior Chippewa Indians v. Coughlin, 143 S. Ct. 1689, 1691 (2023)). As discussed, this

Court agrees with the Committee that the nature of this dispute is more accurately characterized

as a disagreement regarding what constitutes property of the estate and, as a corollary, what

property is subject to the automatic stay. As discussed, contrary to the United States’ assertions,

21 U.S.C. § 853(k) does not bar the adversary proceeding. Therefore, the United States’ sovereign

immunity argument fails for the same reasons as its subject matter jurisdiction argument.

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The United States additionally contends that 11 U.S.C. § 362(b)(4) “exempts the criminal

forfeiture proceedings from the scope of the automatic stay” and, “[b]ecause the automatic stay in

Section 362(a) does not apply, the waiver of sovereign immunity in Section 106(a) for lawsuits to

enforce the automatic stay also does not apply.” Motion 21, ECF No. 35. For reasons discussed

infra, this Court rejects this argument.

D. Whether the Committee’s Claims are plausible

The United States presents a two-fold argument seeking dismissal of the adversary

proceeding based on the Committee’s failure to state a claim upon which relief can be granted.

First, the United States contends that the criminal proceedings are exempt from the automatic stay;

therefore, the Committee’s assertion that relief from the stay is required to enforce the automatic

stay is erroneous. Second, the United States argues that—due to the criminal law relation-back

doctrine—the assets subject to the Warrants never became part of the bankruptcy estate such that

the estate can now control their distribution.

1. The Automatic Stay

When a debtor files for bankruptcy, the Bankruptcy Code imposes a broad automatic stay

that precludes actions to recover against the debtor or property of the estate. 11 U.S.C. § 362(a).

There exist certain statutory exceptions to the operation of the automatic stay. In its Motion, the

United States contends that the exception permitting “commencement or continuation of a criminal

action or proceeding against the debtor” is applicable in this case. Motion 22, ECF No. 35 (quoting

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11 U.S.C. § 362(b)(1)).4 However, the criminal action or proceeding at issue here is not against

the debtor. Therefore, subsection (b)(1) does not apply.

In an effort to seize the funds in the Debtors’ possession, the United States cites to §

362(b)(4), which provides that

The filing of a petition ... does not operate as a stay—

(4) . . . of the commencement or continuation of an action or proceeding by a governmental

unit . . . to enforce such governmental unit's or organization's police and regulatory power,

including the enforcement of a judgment other than a money judgment, obtained in an

action or proceeding by the governmental unit to enforce such governmental unit's or

organization's police or regulatory power[.]

11 U.S.C. § 362(b)(4).

The Committee argues that this section “does not permit the Government to assert its

pecuniary right to repayment and thus take priority over the Debtors’ other creditors.” Committee’s

Opp’n ¶32, ECF No. 43. Indeed, the advisory committee notes to the statute instruct that this

statutory exception “is intended to be given a narrow construction in order to permit governmental

units to pursue actions to protect the public health and safety and not to apply to actions by a

governmental unit to protect a pecuniary interest in property of the debtor or property of the estate.”

11 U.S.C. § 362(b)(4) advisory committee's note. Accordingly, the Third Circuit employs two

tests—the pecuniary purpose and public policy tests—to determine whether proceedings fall

within the police power exception to the automatic stay:

The pecuniary purpose test asks whether the government primarily seeks to protect

a pecuniary governmental interest in the debtor's property, as opposed to protecting

the public safety and health. The public policy test asks whether the government is

effectuating public policy rather than adjudicating private rights. If the purpose of

4 The United States’ Motion mistakenly cites this as language from § 362(b)(4). It is actually the language of §

362(b)(1).

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the law is to promote public safety and welfare or to effectuate public policy, then

the exception to the automatic stay applies. If, on the other hand, the purpose of the

law is to protect the government's pecuniary interest in the debtor's property or

primarily to adjudicate private rights, then the exception is inapplicable.

In re Nortel Networks, Inc., 669 F.3d 128, 139–40 (3d Cir. 2011); see also In re LTL Mgmt., LLC,

645 B.R. 59, 79-80 (Bankr. D.N.J. 2022) (collecting cases).

As to the pecuniary purpose test, the Court determines that the United States’ actions in

this case do not protect public safety and health. Indeed, the public will not be exposed to any

danger if the funds are not recovered. With respect to the public policy test, the United States

refers to the “paramount interest in protecting its citizens through its police power,” and the “well-

recognized public benefits of [a forfeiture proceeding], namely the punishment of criminals and

the deterrence of others who might be like-minded.” Motion 24, ECF No. 35 (quoting Matter of

Davis, 691 F.2d 176, 179 (3d Cir. 1982)); Tr. of Sept. 21, 2023 Hrg. 15:8-10, ECF No. 54.

According to the United States, the forfeiture proceedings against the Criminal Defendants

effectuate these important public policies and, thus, are exempt from the automatic stay.

It is undisputed that BlockFi customers with BIA or Collateral Accounts will be receiving

distributions under the Debtors’ confirmed plan representing only a fraction of the amounts

actually due and owing. Were the United States to be successful in obtaining the full amount

sought under the Warrants, the return to other customers and creditors would be significantly

reduced further. When questioned about the negative impact that the government’s actions would

have on the Debtors’ creditors—namely, requiring innocent creditors to chip in and pay an

obligation owed by the Criminal Defendants—the United States conceded that “allowing the

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forfeiture proceeding to go forward might ultimately benefit the defrauded victims at the expense

of creditors.” Motion 23, ECF No. 35; see also Tr. of Sept. 21, 2023 Hrg. 21:15, ECF No. 54

(acknowledging “some prejudice to be suffered by those unsecured creditors”). Nevertheless, the

United States maintains that this is the scheme created and intended by Congress. See Tr. of Sept.

21, 2023 Hrg. 24:2-8, ECF No. 54. Tr. of Sept. 21, 2023 Hrg. 25:16-18, ECF No. 54 (“[I]t’s the

Government’s view that while we sympathize with those creditors, we think the crime victims are

the larger victims in the general sense of the word here.”); id. at 14:22-24 (“[BlockFi creditors]

should blame Congress, Your Honor. They should not blame the United States Justice

Department.”).5

In both its pleadings and its argument on the record, the United States relies on In re

WinPar Hosp. Chattanooga, LLC, 401 B.R. 289, 291 (Bankr. E.D. Tenn. 2009) in support of its

position. However, the Court finds this case distinguishable. In In re WinPar, a debtor’s principal

purchased a property with proceeds from illegal activity. The debtor then filed for bankruptcy and

the chapter 7 trustee sold the property in question, which was the debtor’s only asset. The

government commenced a civil forfeiture action against the property in question and the proceeds

of sale. When the chapter 7 trustee attempted to invoke the automatic stay to protect the funds,

the bankruptcy court ruled that “forfeiture actions involving alleged proceeds of criminal activity

come within the police power exception to the automatic stay.” In re WinPar Hosp. Chattanooga,

LLC, 401 B.R. at 293 (citing In re James, 940 F.2d 46, 50–51 (3d Cir. 1991). In so ruling, the

5 As the Court noted on more than one occasion during oral arguments, it seems inexplicable that Congressional

intent or public policy somehow is furthered by having innocent BlockFi creditors satisfy the forfeiture obligations

of the Criminal Defendants. Quite simply, such a result would be a windfall for the Criminal Defendants at the

expense of uninvolved innocent third parties.

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bankruptcy court engaged in a thorough discussion and emphasized that civil forfeiture serves as

a means to punish and deter offenders. See id. at 292-93. However, there is a critical difference

between the circumstances in In re WinPar and the instant case. In In re WinPar, the property

subject to seizure was directly traceable to the criminal activity. In contrast, the weight of the

evidence in this case at this juncture suggests that the funds the United States seeks to recover are

not directly traceable to the Criminal Defendants and their criminal activity. Indeed, the digital

assets that were in the Criminal Defendants’ accounts at the time they committed the crime are no

longer in Debtors’ possession. As acknowledged by Debtors and the Committee throughout these

proceedings, the digital assets loaned to or deposited with BlockFi were subsequently

rehypothecated, repledged, or otherwise transferred as part of transactions with other entities, such

as Alameda, FTX, or 3AC. Thus, the Complaint adequately alleges that the United States seeks

to satisfy its Warrants, not by collecting the Criminal Defendants’ digital assets or funds directly

traceable to those individuals, but by collecting other, substituted funds—funds comprised of

contributions made by Debtors’ other innocent customers and creditors. This action—which the

Court accepts as true for purposes of the motion to dismiss, as it must (see Leamer v. Fauver, 288

F.3d at 535)—does not effectuate the public policies of punishment and deterrence identified by

the United States, and potentially serves an inverse purpose by relieving the Criminal Defendants

of their obligation. This is significant given the Third Circuit’s instruction to look “to the purpose

of the proceeding at issue” when interpreting the police power exception. In re Nortel Networks,

Inc., 669 F.3d ta 140.

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Moreover, the Court notes that Congress contemplated a substitution procedure to be used

in circumstances where property subject to forfeiture could not be found or otherwise executed

upon. Pursuant to 21 U.S.C. § 853(p)(2), a court “shall order the forfeiture of any other property

of the defendant, up to the value of any property described” in the forfeiture warrant if

as a result of any act or omission of the defendant--

(A) cannot be located upon the exercise of due diligence;

(B) has been transferred or sold to, or deposited with, a third party;

(C) has been placed beyond the jurisdiction of the court;

(D) has been substantially diminished in value; or

(E) has been commingled with other property which cannot be divided without

difficulty.

21 U.S.C. § 853(p)(1) (emphasis added).

Thus, even if this Court were to accept that Congress intended to give priority to victims

of crime over “victims” in an unrelated bankruptcy proceeding (a determination that this Court

does not make at this juncture), this Court cannot accept that Congress intended to burden an

uninvolved debtor’s creditors by requiring them to compensate victims of a defendant’s crime—

especially when the statute provides a means to compel forfeiture of a defendant’s other property

to compensate his/her own victims. Satisfying the Criminal Defendants’ seizure warrant through

funds not traceable to those Criminal Defendants does not punish or deter offenders and does not

effectuate the remedial purpose of the forfeiture statute. See 21 U.S.C. § 853(o) (“The provisions

of this section shall be liberally construed to effectuate its remedial purposes.”). Accordingly, the

Court is not persuaded by the rationale in In re WinPar and holds that—under the circumstances

of this case—the police power exception to the automatic stay under § 362(b)(4) is inapplicable.

Therefore, the Court declines to dismiss the case on such basis at this juncture.

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2. The Relation-Back Doctrine

Finally, the United States contends that the adversary complaint must be dismissed because

“[t]he Complaint erroneously presumes that cryptocurrency assets subject to the Seizure Warrants

became part of the bankruptcy estate upon deposit, and that the estate may now control their

distribution, assigning the United States a ‘pro rata share.’ ” Motion 25, ECF No. 35. “Under the

relation-back doctrine, the government acquires its interest in the defendant's forfeited property at

the time of the commission of the criminal acts giving rise to the forfeiture.” United States v. Lavin,

942 F.2d 177, 185 (3d Cir. 1991) (citing 21 U.S.C. § 853(c)). The United States explains that in

this case, the Criminal Defendants committed their crimes between December 2013 and August

2022—well before they deposited their assets in the BlockFi accounts and long-before the

bankruptcy filing. Thus, the United States contends it acquired an ownership interest in the assets

subject to seizure well before the bankruptcy, and such assets never became part of the bankruptcy

estate. This Court agrees.

As discussed, this Court will not reexamine the merits of the Warrant or make

determinations as to any third party’s interest in the assets subject to forfeiture. The relation-back

doctrine applies to the property identified in the Warrants. That property never entered the

bankruptcy estate and is not subject to the automatic stay. Thus, the United States properly and

timely received the traceable funds deposited in the Criminal Defendants’ Wallet Accounts. In the

Court’s view, the instant adversary proceeding does not seek to interfere with the seizure of the

property identified in the Warrants. Rather, this adversary proceeding seeks to protect property of

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the estate that is not identified in the Warrants or subject to seizure. See Tr. of Sept. 21, 2023 Hrg.

33:2-7 (“We’re trying to prevent the Government from seizing the assets that are not proceeds of

the crime or derived from proceeds of the crime, and those are the assets that are beyond either

what was actually deposited by the criminal defendants or what the criminal defendants would

receive on account of their claim.”).

The United States contends that it owned the accounts themselves, and not just the funds

inside the accounts—funds which in the course of the Debtors’ operations were transferred,

pledged, traded, or rehypothecated pursuant to Debtors’ contractual rights—and not just the

Criminal Defendants’ right to payment. See e.g., Tr. of Sept. 21, 2023 Hrg. 11:15-25; id. at 12:17-

21 (“[W]e believe we are seizing the account itself and the contents of that account, and that’s why

the Government takes the view that we are not a creditor of the estate, and we are not a -- we are

not seizing some kind of debt obligation or right to payment.”).6 As an initial matter, this position

is contradicted by the language of the Warrants themselves, which describes the property subject

to forfeiture as “[a]ll funds—including virtual currencies—from BlockFi account.” See Warrant -

Exhibit 2 to Motion to Withdraw the Reference, ECF No. 13-3. Regardless, the United States

maintains that it was told at the time the warrants were served that the subject funds were in the

6 As a result of the criminal forfeiture proceeding, the United States stands only in the shoes of the Criminal

Defendants with respect to their interests in all assets arising from or traceable to the alleged criminal activity. See

United States v. Peña-Fernández, 378 F.Supp.3d 130, 132-33 (D. P.R. 2019), quoting United States v. Huntington

Nat’l Bank, 682 F.3d 429, 433 (6th Cir. 2012) (“Section 853 permits the United States to step into [a criminal

defendant’s] shoes, ‘acquiring only the rights [he possessed] at the time of the criminal acts, and nothing more.’ ”).

The Committee does not contest this proposition. However, as a result of the bankruptcy filing, the Criminal

Defendants held only the same rights as all other BIA and Collateral Account holders—to wit, a return of their funds

or a pro-rata share if BlockFi was insolvent—nothing more. An account-holder simply holds a claim and nothing in

Title 18 provides that the United States can be entitled to a recovery that is greater than what the Criminal

Defendants could obtain.

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accounts. During oral argument there was some disagreement and confusion on the record as to

whether that information was accurate. See Tr. of Sept. 21, 2023 Hrg. 39:5-9 (“So, I just want to

make sure the record is clear that there is some dispute about, you know, factually about what

happened here, what money was there when the accounts were seized on the day the warrants were

served, what was there at the time the crimes were committed.”). Nevertheless, all parties seem

to agree that—as of the date of the hearing—those same funds are no longer in the Criminal

Defendants’ BlockFi accounts. Because the Committee plausibly alleges that the United States

attempted to seize property of the estate that was not subject to the Warrants, the Complaint will

not be dismissed at this early stage in the litigation.

Moreover, the United States indicates that it has the ability to trace the funds and

demonstrate what precisely was in the Criminal Defendants’ accounts and, thus, what is properly

subject to seizure. See Tr. of Sept. 21, 2023 Hrg. 22:24 – 23:4, ECF No. 54 (“Once that forfeiture

judgment is entered, if we can show -- and we do have the ability to trace, and we have traced up

until the time when the seizure warrants were issued, and this would come out if we have a trial,

Your Honor, we will be able to show that what the criminal defendants had at that time, and we

should be allowed to seize that.”). Admittedly, the United States contends that the District Court

in the Western District of Washington should be the court to decide any tracing issues, to the extent

tracing is relevant, due to the “jurisdictional framework.” Id. at 39:9-19. For reasons previously

discussed, this Court resolves at this time that it maintains proper jurisdiction to make

determinations as to what constitutes property of the estate. Accordingly, the United States’

argument is rejected.

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V. Conclusion

In sum, this Court does not conclude that it is without jurisdiction to make determinations

as to what constitutes property of the estate, whether such property is protected by the automatic

stay, or whether it may issue an injunction under § 105(a) to protect estate property if the

circumstances so warrant. Jn re LTL Mgmt., LLC, 645 B.R. at 81 (recognizing a bankruptcy court’s

ability to issue injunctive relief under § 105(a) or impose or extend the automatic stay under §

362(a) where the exercise of police power seriously conflicts with the policies underlying the

Bankruptcy Code). Therefore, the United States’ Motion to Dismiss is DENIED and the United

States is directed to file an answer or otherwise move as appropriate within 30 days of the entry of

this Court. Counsel for the Committee is directed to submit a proposed form of order consistent

with this Court’s ruling.

WA be bs Frep—.

Michael B. Kaplan, Chief Judge

U.S. Bankruptcy Court

District of New Jersey

Dated: October 10, 2023

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