Photo of Paul B. HaskelPhoto of Frederick (Rick) Hyman

The financing of commercial litigation has grown enormously since it first appeared on the scene in the US, about 15 years ago.  While still small relative to the overall US financial market, it is estimated that more than $11 billion has been invested in litigation finance in the US last year alone.  In essence, lenders (often referred to as “funders”) provide commercial claimants and contingency law firms with the capital needed to prosecute legal claims which the funders believe have a strong likelihood of success.  Funders receive a return based upon, and typically conditioned upon, a successful conclusion of the litigation.  The use of litigation funding by bankruptcy practitioners is a growing phenomenon and one that we see as an increasingly important element in how bankruptcy-related litigation is managed.

Claims in the bankruptcy context can arise in a number of different ways.  In some cases, the bankruptcy estate will already have outstanding claims against third-parties on the petition date.  The debtor or trustee may want to access third-party funding to avoid having to use either its own resources or the expensive capital provided by DIP lenders in order to pay the ongoing expenses of this litigation.  It may also want to use third-party funding to pay the expenses associated with pursuing claims that arise in the course of the bankruptcy case, such as third-party preference or fraudulent transfer claims, or claims against officers, directors or advisors in connection with their prepetition conduct.  Alternatively, creditors (including official creditor committees) may want to use funding to pay the expenses associated with bringing claims against other classes of creditors or equity holders, particularly in instances where they are not entitled to reimbursement from the estate due to restrictions in DIP financing or cash collateral orders.  Litigation trusts, which allow for the confirmation of the plan of reorganization while preserving litigation that may take years to play out, are a prime customer for financing.  And finally, we have seen an increasing trend whereby bankruptcy estates raise funds by conducting, through a court approved auction process, the outright sale (or “monetization”) of third-party claims, typically of a class-action nature.

In each of these cases, having available capital to pay expenses allows the claimant to maximize value and eliminates the pressure to settle for a low figure that may result from a lack of capital.  Importantly, litigation funding allows the claimholder to select its counsel of choice instead of having to rely solely on counsel that will agree to work on a contingency basis.  And of course, the non-recourse nature of the funding allows the claimant to push off much of the risk of loss to the funder – the claimant pays nothing if the litigation goes south.

In most cases, the debtor, trustee or creditors’ committee will need court approval to enter into the proposed litigation financing.  These funding arrangements are structured in different ways – sometimes as a non-recourse loan and other times as a purchase of a share of the proceeds – and care must be taken to seek the appropriate approvals.  This is not the case for post-confirmation litigation trusts which do not need court approval to obtain financing or sell assets.

Bankruptcy courts are increasingly aware of the ability of this form of financing to maximize value for the estate, benefitting creditors as a whole.  And as bankruptcy professionals become more familiar with litigation finance, it will become an increasingly common tool for bankrupt companies and litigation trusts to use in the course of insolvency proceedings.