RWA Bankruptcy & Investor Rights: Legal Protection Guide

While RWA tokenization offers tremendous potential for democratizing access to traditionally illiquid assets, sophisticated investors must understand what happens in a worst-case scenario. When an issuer faces financial distress or declares bankruptcy, the legal structures protecting tokenized assets become paramount. This article examines the protective mechanisms—from bankruptcy-remote SPVs to perfected security interests—that are designed to safeguard investor rights when things go wrong.

The reality is that not all RWA deals are created equal. The difference between recovering your investment and losing everything typically comes down to how well the deal was structured from the beginning. Understanding these structures isn't just academic—it's essential due diligence for anyone considering an RWA investment.

We'll break down the legal protections that separate well-structured deals from risky ones, explain how assets flow through the priority waterfall in a liquidation, and provide a practical checklist for evaluating the bankruptcy protections in any RWA offering. This knowledge empowers investors to ask the right questions before committing capital, not after problems arise.

The SPV & Perfected Security Interests

The bankruptcy-remote Special Purpose Vehicle (SPV) stands as the investor's single most important protection in an RWA deal. An SPV is a legal entity created solely to hold title to the underlying asset—whether that's real estate, art, commodities, or other tangible property. This entity exists for one purpose: to own and manage that specific asset on behalf of its stakeholders.

The "bankruptcy-remote" designation is crucial. It means the SPV is legally structured to isolate its assets from the financial distress of its parent company or sponsor. If the company that created the SPV declares bankruptcy, its creditors cannot reach into the SPV to seize the assets held there. The SPV's assets remain ring-fenced, protected for the benefit of the SPV's own stakeholders—namely, the token holders.

This protection isn't automatic. Creating a truly bankruptcy-remote SPV requires careful legal structuring, including restrictions on the SPV's ability to incur debt, merge with other entities, or engage in activities beyond holding the specific asset. The SPV typically has independent directors who must approve any bankruptcy filing, providing an additional layer of protection against voluntary bankruptcy.

The legal doctrine of "true sale" is fundamental to this protection. For the asset transfer to the SPV to be considered a true sale rather than a secured loan, the originator must relinquish meaningful control over the assets. This requires demonstrating legal separateness between the SPV and sponsor through independent governance, separate books and records, arm's-length transactions, and adequate capitalization. For cross-border RWA structures, the UNCITRAL Model Law on Cross-Border Insolvency provides a framework for recognizing foreign insolvency proceedings and protecting assets held internationally, though implementation varies by jurisdiction.

Perfected Security Interests

Beyond the SPV structure itself, a perfected security interest provides another critical layer of protection. A perfected security interest is a publicly filed legal claim that establishes the SPV's priority rights to the asset. In the United States, this typically involves filing a UCC-1 financing statement with the appropriate state authority under UCC §9-310, which requires perfection for security interests to have priority over other claimants ^[1]. For digital assets, the 2022 amendments to UCC Article 12 establish specific rules for controllable electronic records (CERs), providing clearer perfection standards for tokenized securities.

This public filing serves multiple purposes. First, it puts the world on notice that the SPV has a claim on the asset. Second, it establishes the priority date for that claim—earlier filings generally have priority over later ones. Third, it creates a legal record that can be relied upon in court if disputes arise about who owns or has rights to the asset.

The perfection process varies by asset type and jurisdiction. Real estate typically requires recording a deed or mortgage with the local land records office. Personal property might require possession or control in addition to filing. Intellectual property often involves registration with the relevant government office. Each type of asset has its own perfection requirements, and missing these steps can leave investors vulnerable.

Without proper perfection, the SPV's interest in the asset might be treated as unsecured in a bankruptcy proceeding. This could subordinate token holders' claims to those of secured creditors, dramatically reducing recovery prospects. The difference between a perfected and unperfected security interest can often mean the difference between recovering most of your investment and recovering very little.

This hierarchy of claims leads us to one of the most critical concepts in RWA investing: understanding exactly where you stand in the waterfall of payments.

The Priority of Claims (The Waterfall)

When an SPV must liquidate its assets, the proceeds don't simply get divided equally among all stakeholders. Instead, they flow through a legally defined hierarchy known as the "waterfall" or priority of claims. Understanding where token holders sit in this waterfall is essential for assessing investment risk.

The waterfall concept is simple: money from the asset sale flows from top to bottom, with each tier being paid in full before any money flows to the next tier. Once the money runs out, lower tiers generally receive nothing. This harsh reality makes the priority structure one of the most important aspects of any RWA investment.

In most RWA structures, secured creditors sit at the top of the waterfall. If the SPV took out a mortgage to purchase real estate, that mortgage lender gets paid first from any sale proceeds. These senior creditors negotiated their priority position when they provided financing, and their claims must be satisfied before junior stakeholders see any recovery.

Next come the administrative expenses of the liquidation itself, which under Bankruptcy Code §503(b) include legal fees, accounting costs, taxes, and other expenses necessary to wind down the SPV and sell the asset. These costs receive priority treatment under §507(a)(2) and must be paid before general unsecured claims. Administrative expenses can be substantial, especially in complex liquidations involving litigation or disputed claims, and in some cases can consume a significant portion of the asset value.

Token holders typically sit near the bottom of the waterfall, treated either as equity holders or subordinated debt holders depending on the structure. They receive distributions only after all senior claims have been satisfied in full. This subordinated position is the trade-off for the potentially higher returns that equity-like instruments can provide.

However, even the most carefully structured waterfall can be complicated by custody arrangements and the unique challenges they present.

Custody & Fungibility Issues

Even with a bankruptcy-remote SPV and perfected security interests, custody arrangements can create additional risks for token holders. The failure of a custodian—the entity physically or legally holding the asset—introduces another layer of complexity to bankruptcy scenarios.

The importance of using a qualified, regulated custodian cannot be overstated. A qualified custodian segregates client assets from its own assets, maintaining them in separate accounts that are clearly identified as belonging to clients. Under SEC Rule 15c3-3 (the Customer Protection Rule), broker-dealers must segregate fully-paid customer securities in special accounts, providing additional protection in bankruptcy scenarios. Similarly, NYDFS custody regulations require state-chartered banks and trust companies to maintain strict asset segregation for digital asset custody services. This segregation is crucial: if the custodian fails, client assets should not be part of the custodian's bankruptcy estate.

However, not all custody arrangements provide equal protection. Some custodians use omnibus accounts that pool assets from multiple clients or SPVs. While operationally efficient, these pooled arrangements can complicate matters in a bankruptcy. Proving which specific assets belong to which SPV becomes more difficult, potentially delaying recovery and increasing legal costs.

The Fungibility Challenge

Fungibility presents a particular challenge for certain types of RWA investments. When assets are fungible—meaning one unit is interchangeable with another—custodians might not segregate specific units for specific clients. For example, consider a tokenized precious metals fund holding 1,000 ounces of gold bars. Rather than designating specific serial-numbered bars to specific token holders, the custodian maintains a pool of gold and tracks each investor's proportional ownership (e.g., "Investor A owns 2.5% of the total gold holdings") through bookkeeping entries.

This arrangement works well under normal circumstances but can create problems in bankruptcy. If the custodian's records are incomplete or disputed, proving ownership becomes more complex. Additionally, if the custodian has improperly used client assets—a form of fraud that, while illegal, does occasionally occur—the pooled nature of fungible assets can make it harder to trace and recover specific property.

Some jurisdictions have addressed these concerns through legislation providing special protections for securities held in custody. However, these protections don't always extend to all types of tokenized assets, particularly those involving physical commodities or real estate. Understanding the specific custody arrangements and applicable legal protections is essential due diligence.

Digital asset custody adds another layer of complexity. The private keys controlling tokenized assets must be secured, and the loss or compromise of these keys could result in permanent loss of the investment. Many RWA structures use multi-signature arrangements or qualified digital asset custodians to mitigate this risk, but the technology and regulatory framework are still evolving.

For tokenized securities that trade on Alternative Trading Systems (ATS), additional FINRA regulations apply to ensure investor protection and market integrity. These platforms must register as ATS under Regulation ATS and comply with various operational requirements. Additionally, resales of privately-placed tokenized securities are typically subject to Rule 144 holding periods and volume limitations—generally requiring a minimum six-month holding period for securities of reporting companies and one year for non-reporting companies—which can affect liquidity during distress scenarios.

Understanding these custody complexities becomes especially important when an RWA investment faces financial difficulties, as the path forward depends heavily on the available options and stakeholder rights.

Workout & Liquidation Paths

When an RWA investment encounters distress, two primary paths emerge: workout or liquidation. Understanding these scenarios helps investors assess potential outcomes and their role in the process.

Workout Scenario

A workout occurs when the underlying asset underperforms but retains enough value to potentially recover. Perhaps a real estate property has declining rental income, or a commodity investment faces temporary market headwinds. Rather than immediately liquidating at a loss, stakeholders might agree to restructure the investment terms.

In a workout, the asset manager typically leads negotiations with creditors and token holders to modify the deal structure. This might involve extending maturity dates, reducing distribution rates, or injecting additional capital. The goal is to give the asset time to recover value while avoiding the costs and losses associated with forced liquidation.

Token holders' rights in a workout depend entirely on the governance provisions in the original offering documents. Some structures give token holders voting rights on major decisions, including workout proposals. Others vest all decision-making authority in the manager or a designated party. Understanding these governance rights before investing is crucial, as they determine whether investors have any say in workout negotiations.

Successful workouts can preserve significant value for all stakeholders. By avoiding forced sale in a distressed market, the asset may recover and ultimately deliver returns closer to original projections. However, workouts also involve risks, including the possibility that delays simply postpone inevitable losses while consuming additional resources.

Liquidation Scenario

When workout isn't viable or stakeholders cannot agree on restructuring terms, liquidation becomes necessary. In a liquidation, the SPV sells the underlying asset and distributes proceeds according to the priority waterfall. This process can be voluntary, initiated by the manager or token holders, or involuntary, forced by creditors or regulatory requirements.

The liquidation process typically begins with the appointment of a liquidation agent or trustee. In a bankruptcy proceeding, the court appoints this party. In a voluntary liquidation, the SPV's governing documents usually specify who serves this role. The liquidator's job is to maximize value for all stakeholders while following the legal requirements for asset disposition.

Liquidation isn't always a fire sale. A skilled liquidator with adequate time can run a competitive sale process, potentially achieving reasonable value even in difficult circumstances. However, forced liquidations under time pressure typically result in lower recoveries. Market conditions, asset type, and the presence of ready buyers all influence liquidation outcomes.

The liquidation timeline can vary dramatically. Simple assets in liquid markets might be sold within months. Complex assets, especially those involving litigation or regulatory approvals, can take years to fully liquidate. During this time, the asset continues to incur costs—property taxes, maintenance, legal fees—all of which reduce the amount available for distribution to stakeholders.

Throughout the liquidation process, communication with token holders varies by structure. Some liquidators provide regular updates on progress and expected timelines. Others maintain minimal communication, leaving investors uncertain about status and recovery prospects. The offering documents should specify reporting requirements during liquidation, though enforcement can be challenging once a structure enters distress. For deeper insights into how these scenarios fit within the broader tokenization lifecycle, see our guide on the RWA lifecycle including wind-down phases.

Given the complexity of these scenarios and their potential impact on token holder recovery, conducting thorough due diligence before investing becomes paramount.

The Investor Due Diligence Checklist

Before investing in any RWA offering, sophisticated investors should systematically evaluate the bankruptcy protections and structural safeguards. This checklist provides a practical framework for assessing whether a deal has adequate protections for worst-case scenarios.

• Verify Bankruptcy-Remote SPV Does the Private Placement Memorandum (PPM) explicitly state that the SPV is structured to be bankruptcy-remote? Look for specific provisions including: restrictions on additional debt, limitations on merger or consolidation, independent director requirements, and separateness covenants. Without clear documentation of bankruptcy-remote features, the SPV's assets could be consolidated with a bankrupt sponsor's estate.
• Review the Waterfall Does the PPM clearly define the priority of claims in a liquidation scenario? The document should specify exactly where token holders rank relative to other stakeholders. Pay particular attention to any senior debt, as it will be paid before token holders receive anything. Calculate potential recovery under different asset value scenarios to understand downside risk.
• Confirm Custodian Quality Is a regulated, insured custodian used for the off-chain asset? Verify the custodian's regulatory status, insurance coverage, and asset segregation practices. For digital assets, confirm the security measures for private key management. Understand whether assets are held in segregated or omnibus accounts and what protections apply if the custodian fails.
• Understand Governance Rights What rights, if any, do token holders have in a distress scenario? Review provisions for voting on workout proposals, replacing the manager, or initiating liquidation. Understand whether token holders can act collectively and what percentage is required for various actions. Limited governance rights may leave investors powerless if problems arise.
• Check for Security Interest Filings Has the SPV's interest in the asset been publicly filed and perfected? For US deals, verify UCC-1 filings through the appropriate state databases. For real estate, confirm proper recording of deeds or mortgages. For other jurisdictions, understand local perfection requirements. An unperfected security interest dramatically increases risk in bankruptcy scenarios.

Beyond these fundamental checks, investors should also evaluate the track record and reputation of the sponsor and manager. Have they successfully managed similar assets through full cycles, including distressed situations? Do they have the operational expertise and financial resources to handle problems if they arise? Past performance in difficult markets often predicts future behavior in crisis situations.

Legal documentation quality matters enormously. Well-drafted documents anticipate problems and provide clear procedures for addressing them. Poorly drafted documents create ambiguity that leads to disputes, delays, and additional costs in bankruptcy scenarios. Having experienced legal counsel review offering documents before investing can identify potential structural weaknesses.

Finally, understand the specific risks associated with the underlying asset type. Real estate, commodities, intellectual property, and other asset classes each have unique bankruptcy considerations. Local laws where the asset is located may provide additional protections or create unexpected vulnerabilities. For a comprehensive guide on evaluating RWA investments, see our article on investing in RWAs.

While risks always exist in any investment, a well-structured RWA deal uses bankruptcy-remote SPVs and perfected security interests to legally separate the asset from the issuer, providing investors with a direct claim designed to survive even a sponsor's failure. The key is understanding these protections before investing, not after problems emerge.

The difference between sophisticated and unsophisticated RWA investors often comes down to their appreciation of structural protections. While yields and growth potential attract attention, the boring details of bankruptcy remoteness, security interest perfection, and custody arrangements determine outcomes when things go wrong. Investors who understand these concepts can better evaluate opportunities and avoid structures that leave them vulnerable.

As the RWA market matures, we're likely to see continued evolution in structural protections and standardization of best practices. Regulatory frameworks are developing to provide greater clarity and protection for token holders. However, the fundamental principles discussed here—proper legal structuring, clear priority of claims, and robust custody arrangements—will remain the bedrock of investor protection in tokenized assets. Understanding the broader regulatory landscape is essential, as covered in our guide to RWA regulation and compliance.

References (as of August 2025)

[1] Uniform Commercial Code Article 9: Security Interests and Perfection Requirements

[2] American Bankruptcy Institute: Bankruptcy Remote Entities and Structured Finance

[3] SEC Investor Bulletin: Custody of Digital Asset Securities

[4] Moody's Investors Service: SPV Structures and Bankruptcy Remoteness Criteria

[5] International Association of Restructuring Professionals: Cross-Border Insolvency and Asset Recovery

[6] Federal Reserve Bank: Special Purpose Vehicles in Structured Finance

[7] Harvard Law School Bankruptcy Roundtable: Digital Assets in Bankruptcy Proceedings

[8] Journal of Structured Finance: Perfection of Security Interests in Tokenized Assets

This content is for educational purposes only and does not constitute financial, legal, or tax advice.