Auros & Interpath: A 99 Day Success Story
What is a Smart Contract?
A smart contract is a computer program that automatically enforces the terms of an agreement between parties, without needing an intermediary. It uses blockchain technology for secure and transparent execution. The rules and conditions of the agreement are coded into the contract, and it only activates when those conditions are met. Smart contracts have many uses, such as in finance, supply chain management, and voting systems.
So, what happens when a loan governed by a smart contract falls due during a restructuring?
Smart contracts add a layer of complexity to any contemplated restructuring. As set out above, smart contracts are self-executing, with the terms of the agreement between the company and the lenders being directly written into lines of code. Accordingly, unless the code fully contemplates how the loan should be dealt with in a distressed situation, there is little flexibility for the parties to restructure.
Immediately following our appointment as JPLs to Auros, and before any formal restructuring plan could be completed, two loans through permissioned USDC and wETH pools on a decentralized protocol fell due. The JPLs could not authorise collateral to be posted, or repayments to be made to these loans without giving rise to a preference under the BVI Insolvency Act.
We worked together with the creditor to negotiate a short-term extension of these loans after the company provided strong financial guarantees. The basis for the extension was that the company would avoid the default interest rates that could deepen the company’s insolvency but additionally, because the loan is a smart contract stored on the blockchain, any default would have been public. This meant by avoiding default, we prevented reputational damage and/or the ability for the company to enter into similar future loans.
However, the short-term extension was just that – without collateral being posted or executing a new loan at a higher interest rate, it was then not possible to continue to roll the loan forward further.
The smart contracts and pools are visible on chain and the market had already commented that prior loans had been rolled over, with no collateral posted, on rates below the market. If this was to continue, there would be reputational and industry damage caused to the creditors and, whilst every effort was made to work with us in our role as JPLs, the creditors also have stakeholders and duties to their other liquidity providers.
To protect the interest of all liquidity providers in the affected liquidity pools, the creditor took the step of impairing the loans. By taking this action the protocol pre-emptively impaired the company’s entire exposure in each pool to ensure all liquidity providers were treated equally with respect to any withdrawals from the platform.
Ultimately, no refinance, or payment was agreed and the loans lapsed. Importantly, in an effort to support the restructuring, the creditor refused to default on the loan and, therefore, it remained in “overdue“ status.
Payment to smart contracts
The creditor had four separate loans outstanding. Envisaged by the restructuring was the payment of 55% of the debt due to creditors; however, given that partial payments into the smart contracts were not possible, the JPLs and the Authorised Managers agreed that the cleanest way to proceed would be, for each outstanding loan, for the following to occur, in sequence:
Repay the entirety of the old loan first by applying the collateral held by the protocol, and then from funds set aside for the 55% payment;
Creditor then issues corresponding new smart contract loans, being 45% of the loan just repaid using the liquidity received from repayment of the old loan;
Company draws down on this new loan, replenishing the funds from which it could make repayments into the next old loan.
This ensured that the total net repayment to the creditor would never be greater than 55% of their total debt, at any stage of this process. This process also removes the counterparty risk that the creditor subsequently refuses to make the replacement loans.
In practice, the way Blockchain technology works, this happened in a matter of minutes and is all visible on chain.
Conclusion
The novel use of smart contracts can and will complicate the traditional restructuring mechanism for companies and insolvency practitioners. However, the technology should be embraced. Fundamentally, the events described above were necessary to arrive at the desired outcome of the company’s restructuring. Without the hard work, empathy and professionalism of both the company and the creditor to work together to achieve this incredible outcome, this may not have been possible.
