This Part of the 2023 edition of R+I In Brief provides key industry and sector insights relating to the restructuring space over the past year. These hot topics include:

  • challenges gripping the Australian construction industry in an era of pre-COVID fixed-term contracts and soaring construction and funding costs;
  • the latest movements of Australia’s largest creditor, the Australian Taxation Office;
  • the prevalence of ‘whitelists’ in debt documentation and the need to rethink their use; and
  • the emergence of cryptocurrency in the insolvency arena.

What you need to know:

  • Recent corporate insolvencies in the Australian construction industry have highlighted the challenges faced by the sector.
  • The collapse of residential builder Porter Davis Homes received widespread media attention, with thousands of aspiring homeowners left in a state of uncertainty.
  • Legal frameworks, including the ipso facto regime and Australian personal property security framework set out in the Personal Property Securities Act 2009 (Cth) play a crucial role in responding to insolvencies in the construction industry.

Recent corporate insolvencies in the Australian construction industry have generated widespread media coverage and public interest. Events including the collapse of residential builder Porter Davis, have brought to light the significant challenges confronting the industry. Unstable and unpredictable economic conditions, cost overruns fuelled by inflation and high interest rates have presented real challenges for many construction businesses that threaten their ongoing viability. These factors have caused strain on financial stability across the industry and in some cases resulted in insolvencies, leaving many construction projects incomplete and in a state of uncertainty.

In this industry spotlight, we explore recent developments and shed light on the issues affecting the Australian construction industry, with a particular focus on the residential sector and what legal frameworks and governments are doing to respond to these challenges.

The industry

The Australian construction industry is a vital sector that plays a significant role in the country's economy and is a significant contributor to Gross Domestic Product and employment. The industry encompasses residential, commercial, and infrastructure construction businesses, each presently facing unique challenges as set out below:

Economic conditions

Challenging economic conditions, including rising interest rates, higher cost of living and earlier declines in household wealth (Reserve Bank of Australia, Statement on Monetary Policy – May 2023), have significantly impacted the industry, leading to reduced demand in some sectors. According to statistics released by the Australian Bureau of Statistics earlier in 2023, the total number of dwellings approved (by local government authorities and other principal certifying authorities) in April 2023 was at the lowest level in over a decade, since 2012. The decline was principally driven by a fall in approvals for private sector dwellings excluding houses. While the month of May was more positive, with the total number of building permits issued in Australia surging 20.6% from the prior month, approvals were still down 9.8% year on year.

This graph shows that the total number of dwellings approved (by local government authorities and other principal certifying authorities) in April 2023 was at the lowest level since 2012. While May 2023 was more positive (due to an uptick in approvals for private sector dwellings excluding houses), total approvals were still down 9.8% year on year

Cost overruns

Cost overruns caused by various factors including inflation and labour shortages have also put significant financial strain on many construction businesses (especially those locked into fixed price contracts). While supply chain issues have eased since the height of the pandemic, material costs are continuing to challenge project profitability. CoreLogic's Cordell Construction Cost Index reached its highest point ever, with a remarkable 11.9% surge in costs recorded during the 2022 calendar year.

In statistics published by the Australian Securities and Investments Commission (ASIC), external administrator appointments of companies operating in the construction industry significantly out number insolvencies in other industries. As illustrated in the graph below, the construction industry saw 2,677 external administration appointments from 1 July 2022 to 18 June 2023, representing an increase of 73.16% from the prior corresponding period.         

This graph shows that the most significant number of external administration appointments during FY23 (to 18 June 2023) occurred in the construction sector. Comparing FY22 to FY23 (both to 18 June), there was at least a 24% increase in the number of external administration appointments in every sector except for Other Services

The big collapse: Porter Davis

In a recent surge of residential builder collapses, the Porter Davis Homes liquidation was of particular notoriety. On 31 March 2023, liquidators were appointed over 14 companies in the Porter Davis Homes group. The liquidation left thousands of aspiring homeowners in a state of uncertainty and at the time of the liquidation, the group was the 12th biggest home builder in Australia. Of significant concern in the collapse was that, for many customers, it was discovered that Porter Davis had not lodged insurance policies as required under relevant building contracts to protect monies paid as deposits for home builds.

Government intervention

In response to the collapse, the Victorian Government pledged to reimburse customers who paid deposits but were not provided with insurance as promised, with the establishment of the Porter Davis customer support payment scheme. The scheme has provided refunds of deposits of up to 5% of contract value to customers at an estimated total cost to the State of around $15 million. Despite the implementation of a scheme in this instance, it remains to be seen how State and Commonwealth governments will respond in similar future collapses.

In the aftermath of the collapse, the Victorian government also announced plans to enhance enforcement of the State's building insurance scheme, including by reforming the Domestic Building Contracts Act 1995 (Vic) and strengthening residential building insurance requirements.

Other outcomes of liquidation

The liquidators of Porter Davis were also successful in selling Porter Davis’ intellectual property to two buyers and the company’s multiple-dwelling business, enabling some positive outcomes for projects.

Legal considerations

Looking back: government enquiries and reviews

A number of the issues currently impacting the construction industry in Australia have been longstanding. Both Commonwealth and state governments have previously undertaken to deal with challenges facing the industry, as exhibited by the following notable reviews and inquiries:

  • The Inquiry into Construction Industry Insolvency in NSW was established over a decade ago, on 9 August 2012, by the Government of New South Wales following a string of collapses of well-established construction companies.
  • The Commonwealth Senate Economics References Committee published the report Insolvency in the Australian construction industry in 2015, after conducting an inquiry into insolvencies in the industry. The report made 44 recommendations to deal with what the Committee identified as a “completely unacceptable culture of non-payment of subcontractors for work completed on construction projects”. The report highlighted, amongst other issues, significant concerns with illegal ‘phoenix’ activity and other misconduct in the industry.
  • The Review of Security of Payment Laws led by John Murray AM was commissioned by the Commonwealth government in 2017 with the aim to pinpoint optimal approaches within the construction industry, with a particular emphasis on addressing payment concerns and enhancing safeguards for subcontractors. Comprising 86 recommendations, the report aimed to establish uniform security of payment laws across Australia. The objective was to guarantee payment for subcontractors' services in situations involving insolvency, irrespective of the specific state or territory where operations are conducted.

Legal frameworks designed to respond to insolvencies in the construction industry

Despite the efforts made by both Commonwealth and state governments to reform the law, previous reform attempts have been limited, with high rates of insolvency continue to be evident in the construction industry. Nonetheless, various legal frameworks are of heightened importance to insolvencies in the construction industry, including:

Ipso facto regime

An ipso facto clause creates a contractual right for a party to terminate or modify the operation of a contract upon another party commencing a specified insolvency or restructuring process, even if the other party has complied with its obligations under the contract.

A prohibition on reliance on ipso facto clauses came into effect on 1 July 2018 through the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth). The ipso facto regime introduced a general prohibition on the application of ipso facto clauses, subject to various exceptions. The primary purpose of the regime is to enable companies that have entered into a restructuring process to continue to trade.

In the context of the construction industry, the ipso facto regime has significant implications. The regime seeks to provide relief to contractors facing liquidity issues and attempting to facilitate project completion. By preventing the termination of construction contracts solely based on insolvency events, the regime aims to minimise disruption within the industry. For principals and owners, while the ipso facto regime restricts their ability to terminate contracts solely based on a contractor's insolvency, it does not prevent termination for other reasons, such as non-performance.

Notably, several exceptions to the ipso facto regime under section 5.3A.50 of the Corporations Regulations 2001 (Cth) are specifically relevant to the construction industry. Contracts entered into after 1 July 2018, but before 1 July 2023, for the provision of building works of at least $1 billion are excluded from the regime. Additionally, the regime does not apply to contracts that were executed prior to 1 July 2018, which may be relevant in the context of construction projects of a complex nature that span multiple years.


The Personal Property Securities Act 2009 (Cth) (PPSA) is of considerable importance to insolvencies in the construction industry as it governs the creation, registration, and enforcement of security interests in personal property, including construction equipment, machinery and building materials.

By registering security interests in accordance with the PPSA, contractors, suppliers, and others can protect their rights in the event of insolvency or default by a counterparty. The PPSA also provides a framework for determining priority between competing security interests. In the construction industry, this is particularly important in circumstances where multiple parties have security interests over the same assets.

The PPSA is also of particular importance in the context of equipment leasing, including in relation to security interests in leased or financed assets which are commonplace in the industry.

Director disqualification

Finally, the director disqualification framework contained within the Corporations Act 2001 (Cth) (Corporations Act) is also relevant in light of the prevalence of liquidations, illegal ‘phoenix’ activity and other misconduct which has been identified in the construction industry.

ASIC has the power to disqualify a director for up to 5 years if the person is a director (or a director within the last 12 months) of 2 or more companies that have been placed into liquidation in the previous 7 years pursuant to section 206F of the Corporations Act.

Additionally, the court may make orders disqualifying persons from managing corporations including in circumstances where the court has previously made a declaration that the person has contravened a civil penalty provision of the Corporations Act. A director may also be automatically disqualified in some circumstances (see for example section 206B of the Corporations Act).

Looking forward

The outlook for the rest of 2023 in the construction industry appears conservative, with a projected decrease in both residential and non-residential construction activity. This poses a harsh reality for construction businesses that have already endured the challenges of the pandemic and economic conditions at present. However, the legal framework outlined above and the various external administration and other formal/informal restructuring options serve to help businesses in the industry to weather these uncertain times.


What you need to know:

  • The Australian Taxation Office (ATO) is a major player in the restructuring and turnaround space, being the largest creditor in Australia and responsible for numerous corporate winding up applications.
  • The ATO's policies and strategies have a substantial influence on external administrations and turnarounds, making its movements important to track when forecasting insolvency activity.
  • The impact of the ATO's new digital strategy on corporate insolvency and turnaround remains to be seen but is expected to be significant and far-reaching.

It appears that the tsunami of insolvencies that corporate Australia has been bracing for is upon us, with external administrations up 65% on the previous year (for the period July 2022 – May 2023). As Australia’s largest creditor and, according to creditor reporting bureau CreditorWatch, responsible for the greatest number of company windups prior to the pandemic in 2019, the ATO can fairly be described as an influential, if not dominant, player in the restructuring and turnaround space and in corporate Australia more broadly.

The ATO’s influence on the insolvency landscape

The ATO’s response to the COVID-19 pandemic demonstrates the influence of Australia’s tax office in shaping the country’s corporate landscape.

  • As part of the Federal Government’s plan to assist companies during the pandemic, the ATO largely deferred debt collection for two years, and initiated only three corporate windups between 1 July 2020 and 31 March 2021. This resulted in its collectable debt rising to $38.5 billion for the FY20/21.
  • The ATO also managed a range of support and stimulus measures, including the critical “JobKeeper" program. The outcome, which is primarily attributable to the ATO’s actions, was a nearly 50% reduction in insolvency appointments compared to pre-pandemic levels. In simple terms, approximately half of the companies that would have likely faced collapse without the ATO’s intervention and initiatives during the pandemic were arguably able to stay afloat.

In May 2022, the ATO confirmed the revival of its debt recovery activities and the adoption of a more assertive approach, including garnishees, recovery of director penalties, disclosure of business tax debts, and legal actions including summons, creditors petition, wind-up and insolvency action. It should come as no surprise that the resumption of the ATO’s debt recovery efforts this year has coincided with a surge in external administrations. CreditorWatch has reported a rebound in debt collections to levels seen before the pandemic, with external administrations rising by 46% in FY 21/22.

As at August 2022, the ATO reported issuing 120 Director Penalty Notices (DPN) per day, with that number expected to increase. A DPN allows the ATO to pursue directors personally for a penalty equal to the value of a company’s outstanding superannuation, PAYG withholding and GST obligations, which effectively pierces the corporate veil that protects directors from personal liability. Anecdotally, the receipt of a DPN will compel a board of directors to take proactive action to avoid personal liability, including seeking legal advice to assess the risk of insolvent trading, devising contingency plans and exploring the protective measures provided by the safe harbour provisions.

The ATO itself has acknowledged its influence on Australia’s insolvency landscape. At The Tax Institute Tax Summit on 20 October 2022, Second Commissioner Jeremy Hirschhorn said that:

“Many stakeholders have also made clear to us [the ATO] the system-wide role that the ATO has in helping struggling businesses understand that they should move to finalisation of the business rather than struggle on as ‘zombie businesses’”.

Looking to the future: ATO’s new digital strategy

With its recently announced plan to create “a future where tax just happens”, the ATO may transcend its role as an influencer and become a true agent of change, altering the corporate landscape in Australia as we know it.

While the full details of the plan have not yet been disclosed, ATO Commissioner Chris Jordan revealed that the ATO’s executive group had “endorsed a new digital strategy” coined “Tax 3.0”, which would see the ATO become a “fully digitalised tax office by 2030”. Described as the ATO’s “North Star”, the digitalisation strategy aims to automate reporting, payment and real-time compliance checks which are to coincide with the taxable event. Commissioner Jordan foreshadowed the possibility of a “BAS-free future”!

The implications of a fully digitalised tax office for the corporate insolvency space might include the following.

Loss of #1 creditor ranking

If payments to the ATO happen automatically, the ATO may lose its position as Australia’s largest creditor. While this is an unenviable title, holding the prime position comes with power. For example, during a voluntary administration, the fate of a company is decided by a majority of creditors voting in both value and number. If the ATO is the largest creditor by value, it is essential that the ATO supports any restructure (including by way of Deed of Company Arrangement (DOCA) proposal to sell or recapitalise a company) in order for it to be successful. While the Commissioner has confirmed that the ATO will generally endorse DOCA proposals which have no adverse features and would result in a greater and more timely recovery than would be achieved in a liquidation, it is also less likely to support certain DOCA terms, including non-cash items (eg shares or other property) being offered to creditors and in some cases, the use of a creditors’ trust.

Only time will tell whether the ATO’s proposed digitalisation strategy will lead to a decrease in its influence on DOCA terms and on voluntary administrations more generally, creating an opportunity for new influential creditors to emerge.

Fostering early action

Many distressed businesses delay or fail to pay tax to continue trading and stay afloat. The automation of payments to the ATO will make it more challenging for struggling businesses to maintain the cashflow necessary to continue trading.

One of the biggest challenges to business recovery and turnaround is a crippling leverage ratio which cannot be tackled through a restructure. If companies are prevented from accruing significant amounts of debt (at least to the ATO), and if directors are prompted to address cashflow issues in their company at an earlier stage, the outcomes may be more positive.

Alternatively, the forced cash payment of tax debts to the ATO may push distressed businesses into external administration rather than continuing to trade and survive by accruing tax debts (and thereby incurring more debts in the process).

Reduction in director liability

Automation of tax payments may also reduce the number of DPNs issued by the ATO. If tax is automatically remitted to the ATO, there will be no outstanding debt for which directors can be held personally liable under the DPN regime providing of course that a company has sufficient funds to make the automatic payments.

Unfair preference claims: “The computer did it”

Unfair preference claims allow liquidators to claw back certain transactions which have resulted in an unsecured creditor receiving a greater amount from an insolvent company than it would if that company was wound up.

The ATO is the most common defendant to statutory “unfair preference” claims brought by company liquidators. In part, this is because the ATO is an attractive counterparty to litigation: it is solvent and has model litigant obligations.

The most common defence to an unfair preference claim is the “good faith” defence. Under this defence, a creditor argues that:

  • they were party to the transaction in good faith;
  • at the time of the transaction:
    • they did not have reasonable grounds for suspecting the company was insolvent or would become insolvent; and
    • a reasonable person in the creditor’s circumstances would also have had no such grounds for suspecting the company’s insolvency.

It is conceivable that the ATO’s digitalisation strategy may bolster the ATO’s use of the “good faith” defence to an unfair preference claim. for instance, the ATO may seek to deny having the requisite knowledge of a company’s insolvency, having outsourced its debt collection to digitisation. To do so, the ATO would need to argue that a “reasonable person” in the ATO’s circumstances is one with fully digitalised systems.

The Federal Court of Australia has previously considered the impact of ATO automation in the case of Pintarich v DCT (2018) 262 FCR 41, where it found that a taxpayer remained liable for interest charges on a tax liability despite receiving a computer-generated letter from the Deputy Commissioner of Taxation purportedly waiving the general interest charges (GIC). The Court held that the ATO did not make a decision to remit the GIC because a decision required a mental process to reach a conclusion. Perhaps when faced with an unfair preference claim, the ATO will seek to argue that knowledge, like a decision, also requires a mental process which is not present in computer generation. 

Key takeaways

It is unclear how the ATO’s digitalisation strategy will fit with broader reforms the industry may undergo, particularly with respect to the preference regime which may result from the recent inquiry by the Federal Government’s Parliamentary Joint Committee on Corporations and Financial Services into corporate insolvency in Australia.

We are certain, however, that the ATO will continue to have a sizeable and far reaching impact on insolvencies and restructurings in Australia, and that its policy and strategy will continue to influence decision makers in the insolvency space and determine the outcomes of external administrations and turnarounds.


What you need to know:

  • Loan documentation imposing significant restrictions on lenders' ability to transfer or exit loans, including through the use of whitelists, can hinder effective restructuring efforts as credit conditions worsen and more loans become distressed.
  • As tight credit conditions endure, lenders should consider renegotiating transferability restrictions (including whitelists) to allow for more flexibility in restructuring efforts and mitigate risks.
  • The GenesisCare case serves as a reminder of the restructuring challenges that can be associated with whitelists in debt documentation.

Restrictive whitelists in debt documentation, a post-2008 trend, may be hampering restructuring efforts when they are needed most. Has the time come to rethink how they are used?

The rise of whitelists

Benign market conditions post-GFC and pre-COVID saw significant growth in restrictions in loan documentation, including whitelists, on lenders’ ability to transfer or exit out of loans held by them. As credit conditions have worsened and are forecast to continue doing so, whitelists may be hampering effective restructuring efforts when deeper restructuring may be needed most.

Whitelists: what and why

Whitelists in debt documentation are lists of preapproved lenders or classes of lenders with whom existing lenders must trade their debt to exit a loan, unless the lender has obtained prior borrower consent. Generally, the permitted transferees are par lenders who, in the event of a debt restructuring, are perceived as friendly and unlikely to take control of the borrower. Additional language in whitelists may bar lenders from transferring their debt to ‘loan-to-own’ funds. Their United States equivalent, ‘blacklists’, prohibit transfers to certain lenders or classes of lenders, generally distressed investors and funds.

Whitelists will often be accompanied by enhanced borrower consent rights, whereby prior borrower consent to a transfer will only fall away when there has been a payment default or insolvency event. Transfer restrictions may also extend to include sub-participations, so that lenders cannot exit and reduce their exposure even if they remain lender of record.

The design of restrictions like whitelists is to focus par lenders on short-term ‘amend and extend’ and other light-touch solutions when loans become impaired. They also work to prevent distressed funds from buying up debt at deeply discounted prices and seizing control of a distressed company in the event of a restructuring.

Whitelists and other transfer restrictions featuring in loans have grown exponentially since 2008. They have also become more and more restrictive. According to Reorg Debt, 66% of loans sold in 2019 in the European leveraged finance market featured restrictions on sales to distressed funds, compared to 29% in 2017 and fewer than 10% in 2015. While we were unable to obtain current statistics for the APAC region, we assume a similar trend may be occurring.

When these loans become distressed, lenders will generally have two exits available:

  • wait for a material default, in which case a whitelist will cease to apply (although, by this time, the expected recovery by the exiting lender will have dropped dramatically); or
  • wait for a financial covenant breach.

Yet financial covenants – and the early warning system they give lenders of potential borrower liquidity issues – have also been gradually eroded in a simultaneous post-2008 trend towards ‘cov-lite’ debt documentation. In their 2022 European Leveraged Loans Market Wrap, Reorg noted the big question going forward is whether investors will start to undo innovations like whitelists and blacklists:

“The big question in this area is whether investors will seek to roll back innovations that have become more commonplace. The absolute prohibition on transfers to distressed investors, for instance, which are commonly prohibited unless a material (i.e. non-payment or insolvency) event of default is continuing, could be rolled back by easing of the fallaway to any event of default (rather than a material event of default) or by the removal of this absolute prohibition entirely.”

Whitelists, designed to preserve control of a distressed borrower by keeping distressed debt funds away, may be creating distortions in an era of prolonged tight credit when more than short-term, ‘amend and extend’ solutions are needed. By restricting potential distressed debt buyers, whitelists are making debt trading harder, leaving lenders unable to exit deteriorating instruments and inhibiting deeper, longer-term restructuring.


On 1 June 2023, GenesisCare, an Australian-based privately held cancer care provider, entered Chapter 11 bankruptcy in the US as part of a broader restructure of its business and operations. This followed an aggressive debt-laden expansion plan in the US, including the acquisition of 21st Century Oncology in late 2019, and subsequent earnings slump in 2022.

In a statement on 1 June, GenesisCare said it had secured commitments from some existing lenders for US$200 million in restructuring funding via a super-priority, debtor-in-possession term loan facility. The facility would fund GenesisCare’s bankruptcy and its plan to split off its US operations from its rest-of-world operations, including in Australia.

GenesisCare is a cautionary tale of the distortions that restrictive whitelists can create in the pricing and restructuring of loans. They make the trading of these loans more difficult, locking out potential investors at a time of distress and inhibiting turnaround opportunities. By April and May this year, GenesisCare’s loans were trading between 15 cents and 30 cents in the dollar. At least one of those loans – a EUR 500 million loan – contained a restrictive whitelist that excluded early interest from potential investors, including distressed debt funds. The judge overseeing the bankruptcy has since described the debtor-in-possession facility, made available to GenesisCare following the Chapter 11 filing, as ‘incredibly expensive money’, before approving it on 13 June 2023.

It leads to the question: If restrictions like whitelists had not been in play, could GenesisCare’s lenders have exited earlier and traded their debt to investors better positioned to implement a less formal and less expensive turnaround than Chapter 11 bankruptcy?

What should happen next?

The example of GenesisCare is a timely reminder for lenders to consider potential restructuring options when negotiating new or existing loan facilities. Tight credit conditions have been prolonged and are forecast to remain for some time yet. On the one hand, this means a greater proportion of loans might start to enter distressed territory, if they have not already. On the other hand, it is an opportunity for lenders to begin thinking about renegotiating common restrictions on transferability in existing debt instruments, before the merry-go-round of ‘amend and extend’ discussions with borrowers comes around again. In this respect, consideration should be given to loosening transfer restrictions like whitelists so they do not pose risks to syndicate financiers in the future who, in times of distress, must turn to restructuring.


What you need to know:

  • Cryptocurrencies have experienced explosive growth and are now traded on centralised cryptocurrency exchanges, increasing market centralisation.
  • The centralisation of cryptocurrency exchanges introduces greater risk, as these exchanges can become distressed and fail.
  • Lenders and financiers of cryptocurrency investors may mitigate risk by securing crypto assets held by borrowers, and investors may improve their returns by carefully selecting exchanges with favourable terms.
  • The cryptocurrency landscape is still largely unexplored, and participants should proceed cautiously.

The past year has seen numerous high-profile collapses in the cryptocurrency trading universe: an exchange (FTX), a hedge fund (Three Arrows Capital), lenders (BlockFi and Celsius) and a broker (Voyager). Rapid growth, high asset volatility and limited regulatory constraint each contributed to a frenzy of crypto-related insolvency activity.

At the same time, an estimated 99% of cryptocurrency trading occurs on centralised exchanges (like FTX) where investors exchange real currency for cryptocurrencies. In a volatile environment, investors, their lenders, insolvency practitioners and other crypto stakeholders should be aware of the unique challenges that come with cryptocurrency exchange collapses. In this article, we discuss some of those challenges.

What are cryptocurrencies?

Cryptocurrencies are digital assets which can be transferred and used without an intermediary and whose issuance is not under the control of any central administrating authority. While a cryptocurrency has an equivalent notional value in real currencies, such as the Australian dollar, and can be exchanged back-and-forth on cryptocurrency exchanges for real currency, it has no central monitoring or oversight. Cryptocurrencies are stored in digital wallets that involve the generation of a public key (which serves to encrypt the cryptocurrency) and a private key (which allows the holder of the digital wallet to decrypt the cryptocurrency).

In practice, most investors participate in the cryptocurrency universe by way of cryptocurrency exchanges like CoinSpot, Swyftx, Coinbase and eToro. A standard cryptocurrency exchange is a centralised platform on which users can trade cryptocurrencies based on spot prices. Like the ASX, an exchange acts as an intermediary between buyer and seller, and generally charges fees for trades. Testimony in a 2018 US Senate hearing estimated 99% of all cryptocurrency trades occur on cryptocurrency exchanges.

The vast majority of investors using cryptocurrency exchanges choose (or are required by the exchange) to keep their cryptocurrencies in accounts with exchanges which retain control of the private keys required to transfer investors’ crypto assets. Exchanges may describe this arrangement as the provision of ‘wallet services’ to their users. For example, Swyftx’s Terms of Use state:

“While your Crypto Assets remain on Swyftx’s Platform, Swyftx has control of those Crypto Assets. To hold the private keys of your Crypto Assets, you have the option of withdrawing those Crypto Assets to your own wallet.”

In this way, users only ‘hold’ cryptocurrencies in the sense that their holdings are recorded by the exchange operator. But they do not ‘possess’ the cryptocurrencies in the ordinary sense, as a shareholder would possess shares on the ASX.

Implications of using cryptocurrency exchanges

How cryptocurrency exchanges hold cryptocurrencies on behalf of their users becomes significant when considering:

  • whether security can be taken over cryptocurrencies purchased by investors; and
  • how cryptocurrencies are to be treated when an exchange becomes insolvent.

We discuss these issues further below.

Taking security over cryptocurrencies in Australia

The relevant law governing security interests in property other than land – ie ‘personal property’ – is the Personal Property Securities Act 2009 (Cth) (PPSA). In addition to creating a framework that regulates the validity and priority of security interests in personal property, the PPSA also establishes the Personal Property Securities Register (PPSR) as a public register of those interests.

Under the PPSA, a security interest in personal property will only be effective (by being ‘perfected’) if the party that is taking the security (secured party) has possession or control of the personal property, or has registered its interest in the property on the PPSR. In the context of crypto assets, a secured party may be a lender, in circumstances where a borrower has used borrowings to acquire cryptocurrency on an exchange. Given the typical exchange ‘holds’ crypto assets for users by providing a platform for trading, but in reality, possesses the crypto assets itself in its own wallet(s), a secured party will in almost all cases never have possession or control of the cryptocurrency, at least in the sense required by the PPSA. Registration of the interest in the cryptocurrency held by the secured party on the PPSR is therefore necessary.

In registering an interest, definitional issues also arise when it comes to figuring out what ‘collateral class’ cryptocurrency falls within. It may be ‘financial property’, in the sense it is ‘currency’ or an ‘investment instrument’, although we have already discussed how cryptocurrencies differ from fiat or real currencies. Otherwise, it may simply be ‘intangible property’, although this class expressly excludes ‘financial property’, so misclassification as intangible property could render the registration ineffective. The best option for a secured party may be to register their interest in ‘all present and after-acquired property’ of the cryptocurrency investor, a catch-all classification, with exceptions covering the classes of personal property not intended to be covered by the registration.

The laboriousness apparent in the above analysis and registration process reflects the theoretical challenges that crypto assets pose to established legal frameworks, like the PPSR, and the principles underpinning them. Judicial guidance in Australia is also lacking: only the question of whether ‘cryptocurrency mining equipment’ could be the subject of a PPSR-registrable bailment has reached the bench of an Australian superior court (which declined to consider it; see Yimiao Australia Pty Ltd v Cyber Intelligence Tech Pty Ltd [2023] VSCA 21). We await further developments in this space.

Issues relating to cryptocurrency exchanges in insolvency

Given the majority of everyday interactions with crypto assets occurs through crypto exchanges, how crypto assets would be treated if an exchange were to become insolvent also raises novel questions.

The terms and conditions of the cryptocurrency exchange are paramount

The answers to those questions depend heavily on the terms and conditions of the particular exchange, usually found in its user agreement or terms of use. Where the exchange terms indicate the exchange holds the crypto assets on trust for a user, for example, it is more likely that the user could be said to have proprietary rights in the assets. There may be provisions expressly stating that the assets are held on trust on behalf of users, or provisions indicating a custodial arrangement between exchange and user with the user ultimately having ownership.

Alternatively, the terms and conditions may indicate the exchange is holding the crypto assets itself – for example, by offering its own wallets to users in respect of which only the exchange has the private keys – and is offering exchanges between users who all use the same ‘wallet services’. In this case, the user will likely only have contractual rights against the exchange in relation to the crypto assets.

The distinction is significant. If the user has proprietary rights in the crypto assets, in the event of insolvency of the exchange, the user will have priority in relation to those assets over the general body of unsecured creditors. If the user only has contractual rights, they will be treated as an unsecured creditor of the exchange without priority in relation to the crypto assets.

The case of Cryptopia Limited

In Ruscoe v Cryptopia Ltd (in liq) [2020] NZHC 728 (Cryptopia), for example, Cryptopia Limited was an exchange that enabled customers to trade cryptocurrencies among themselves, but which exclusively held the private keys to the wallets containing those crypto assets. Cryptopia had entered into liquidation.

The New Zealand High Court was asked to consider the identity and proprietary character of cryptocurrencies. Finding cryptocurrencies were a form of ‘property’, the Court then considered whether the crypto assets were held on trust by the exchange on behalf of its investors, where the investors could be said to have a proprietary interest in the cryptocurrencies.

Although the Court found that Cryptopia exercised effective control over the coins in users’ wallets and had commingled those coins with its own assets, it also found that the terms and conditions of the exchange gave rise to an express trust. The language throughout the terms and conditions was consistent with the users being beneficial owners of the coins. As a result, the Court held that the users were entitled to the return of their coins rather than a distribution along with the other unsecured creditors of the exchange.

In Australia, the Federal Treasury, in its consultation paper on crypto exchanges, has proposed the application of mandatory obligations on crypto exchanges that maintain custody of crypto assets on behalf of users, including obligations to hold assets on trust for users and appropriately segregating users’ assets. At time of writing, however, the questions raised in Cryptopia have not been judicially tested in Australia and are yet to be resolved, even preliminarily.

Key takeaways

While cryptocurrencies in their true form offer anonymity and decentralisation, their explosive growth as a new class of investment traded on cryptocurrency exchanges has created a market that is in fact highly centralised. With greater centralisation comes greater risk in the event cryptocurrency exchanges become distressed and ultimately fail.

Lenders and financiers of cryptocurrency investors may seek to limit risk by taking security over crypto assets acquired by their borrowers. Returns to investors in the event of an exchange insolvency may also be improved where investors take the time to choose the exchange with the most favourable terms and conditions governing how they hold crypto assets. But much of the cryptocurrency territory remains uncharted and participants exploring it do so at their peril.