Can litigation funding play a role in bankruptcy cases?

March 3, 2022

March 3, 2022

Can litigation funding play a role in bankruptcy cases?

Corporate bankruptcies in the U.S. reached a 10-year high in 2020, then decreased to historic lows in 2021. To an extent, the steep hike in 2020 justifies the tame 2021 numbers, as many distressed companies folded quickly under pandemic economic pressures. Trillions of dollars in stimulus funds, debt forbearance, and continued low interest rates likely staved off many bankruptcies last year.

As COVID continues, supply chain issues persist, inflation and oil prices rise, and business stimulus subsidies wane, many sectors, including retail, health care, air and cruise lines remain vulnerable. Companies that wind up in bankruptcy, where traditional financing is often constrained, are likely to find that litigation finance is an emergent and available resource for varied stakeholders.

Litigation financing agreements can aid insolvent companies whose most valuable assets are litigation claims. In late 2020, the Supreme Court of Canada recognized that securing litigation funding for a debtor to pursue a valuable legal claim is a viable way to maximize recovery for creditors of the bankruptcy estate. In April 2021, the Middle District of Florida rejected a challenge to a bankruptcy court’s approval of litigation funding to cover the costs of pursuing the debtor’s claims, worth millions of dollars, against a bank.

Creditors of the estate can also act as litigation funders. In a recent Texas bankruptcy, a creditor agreed to advance up to $200,000 to fund litigation. The court approved a plan for litigation proceeds to first pay the trustee’s commission and expenses, then reimburse the advancing creditor and pay that creditor a 30% return on investment, with only any remainder going to other creditors. Federal District and Circuit courts affirmed the bankruptcy court’s approval of the arrangement. When parties related to the bankruptcy cannot or don’t want to self-fund, third-party funders can step in to coordinate with debtors and creditors.

Distressed companies can also sell their litigation or litigation-related claims to litigation funders to free up or increase cash reserves to invest in recovery of the business.  

Funders may also provide capital to litigation trusts, established for the benefit of unsecured creditors, who otherwise stand to recover little to nothing from the bankruptcy estate. The trusts receive one-time funding from the estate to pursue claims that could take years to develop. Once the initial amount is spent, those claims could falter without a cash infusion.

The many roles that litigation funding can play in bankruptcy cases demonstrates the value and resiliency of legal claims of all kinds. Don’t miss any opportunity to pursue a client’s valuable claim because of high litigation costs. Learn how the cost insurance and financing solutions that LevelEsq offers can get your case into court without you worrying about losing your costs investment.

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