Bankruptcy filings have dropped precipitously in the last decade (from more than 60,000 in 2009 to 22,000 last year) — but that trend has reversed as companies deal with the devastating consequences of the pandemic. Law firms are reportedly scrambling to hire bankruptcy attorneys to help with the flood of expected filings. Litigation finance may be a creative and viable option for restructuring attorneys and advisors to consider throughout the bankruptcy process especially as traditional sources of financing by outside lenders, creditors and law firms are constrained by the current environment.
Litigation finance can preserve or increase estate resources for creditors and enable additional recoveries. But its use is not limited to a debtor or potential debtor. Financing can be useful for creditors in intercreditor disputes or other matters and especially useful for a litigation or liquidation trust seeking to prosecute ongoing claims. Here are some examples where litigation finance may be an attractive option (although creative restructuring professionals may find it useful in a host of other circumstances):
Pre-filing. Companies in distress (particularly small- or medium-sized businesses) that have significant litigation or litigation-related claims may look to litigation finance to free up, or even increase, cash reserves through financing the costs of prosecuting a claim or by monetizing some or all of a claim. Litigation finance can provide these companies the necessary runway to see through the recovery of its business and the realization of litigation proceeds.
DIP financing. Many bankruptcy estates have options with respect to debtor-in-possession (“DIP”) financing from traditional lenders. But there may be instances where the estate’s most valuable assets are litigation claims — in that case it may make sense to discuss potential DIP financing with a commercial litigation funder. Crystallex, for example, secured this very type of financing (in its Canadian bankruptcy proceeding) from a litigation funder to prosecute a $3.4 billion claim against Venezuela for expropriation of a gold mine it had developed. The Canadian court approved the funding agreement finding that “there is a single ‘pot of gold’ asset which, if realized, will provide significantly more than required to repay the creditors.”
In the National Events bankruptcy, a “litigation funding DIP” funded by creditors sought to investigate potential claims on behalf of the essentially defunct entity. In that case, the company didn’t need DIP financing to continue operations, but only to pursue potential recovery through litigation. In another instance, a related party provided funding under DIP provisions in the Welded Construction bankruptcy seeking to recover funds from a construction dispute. Styled as a litigation funding agreement, the arrangement also resolved some of the claims the funder had against the debtor due to its existing business relationship. In both of these cases, related parties provided the funding because they presumably had the most to gain from successful litigation; in each, the role of funding could have also been assumed by a litigation funder in coordination with the debtor and the related parties. The involvement of a litigation funder could prove attractive to all parties because (1) related parties and creditors may not be willing or able to provide additional funding and (2) a litigation funder, who specializes in assessing litigation risk, may be able to provide funds at the lowest cost of capital.
Sale of litigation assets in bankruptcy. A bankruptcy estate can sell a stake in its litigation or litigation-related claims much in the same way that it sells other assets in its bankruptcy process.
Many companies hold litigation-related assets, for example, in large class actions, and these can be sold like a traditional asset in a bankruptcy. Numerous companies, for example, have sold claims in the Visa Mastercard class action (In re Payment Card Interchange) through bankruptcy asset sales. (See, for example, Shopko’s motion to sell its claim for $2.2 million during its bankruptcy process last year.)
Bankruptcy estates may also have more traditional litigation claims available for monetization during a bankruptcy process (including claims stemming from the bankruptcy itself). These claims are much harder for the estate to value and their continued prosecution often requires expense and resources of the bankrupt entity or its representatives. A bankruptcy estate may wish to sell some or all of its litigation claims to maximize cash recoveries for the estate, reduce or offset estate expenses (including funding the litigation), and hedge its risk of loss in the litigation. The most significant example of this type of sale was the 2016 sale of litigation claims in the Magcorp bankruptcy pending an appeal of that action following an intensive bidding and auction process. A litigation funder paid $26.2 million to acquire a $50 million interest in the claims, which allowed creditors to off-load some risk of a loss on appeal and to fund the appeals process itself.
Litigation or liquidation trusts. Litigation trusts and liquidation trusts can also be prime candidates for litigation funding. The establishment of these trusts generally allows for the confirmation of a plan of reorganization while litigation claims that may take years to play out continue to progress. The litigation trusts typically benefit unsecured creditors who might otherwise end up with little or nothing from the bankruptcy. These trusts sometimes receive seed funding from the estate or from more typical lenders or rely on contingency arrangements with law firms, but because the assets they hold are litigation-related, and because funds expended on the fees or expenses of litigation might otherwise be returned to creditors if not used for litigation, these trusts make excellent candidates for litigation funding.
The General Motors Avoidance Action presents a prime example of how this funding can be used. The long-running dispute stemmed from the alleged improper repayment of GM’s term lenders during the automaker’s bankruptcy. This intercreditor dispute centered on whether the term lender’s security interest had been terminated prior to repayment and, if so, how much of the funds paid to the term lenders should have gone to other creditors. The action proceeded with $1.6 million in “seed” funding from the estate, but that amount and an additional $13 million were soon exhausted. GM’s reorganization plan was confirmed, but the avoidance action was permitted to proceed as a liquidation trust. As the case progressed, the U.S. Department of Treasury and Export Development Canada provided an additional $15 million to the trust to prosecute the action. Once that amount was exhausted, a private litigation funder provided another $15 million facility, and finally Lake Whillans (through an SPV) provided a $10 million facility. Eventually, the matter settled for $231 million, an amount that would certainly not have been possible without funding for the protracted and costly litigation that took nearly ten years to resolve, and included a two-week representative trial that narrowed the issues between the parties.
The motion for $40 million in additional funding in the Paragon Litigation Trust offers a behind-the-scenes look at the type of process that a litigation trustee might undergo in seeking additional funding after the trust had exhausted its initial $10 million funding for the offshore driller’s claims seeking more than $1 billion against its former parent company. The monthslong process involved soliciting interest from dozens of parties including holders of interests in the litigation trust and commercial litigation funders. Eventually, the trustee and its advisors held an auction that resulted in a number of different funders signing on to provide an additional $40 million in funding for the litigation.
To underscore how valuable this type of funding can be for a standalone litigation trust consider the Tropicana matter. After the casino operator went bankrupt in 2008, the estate eventually formed a litigation trust to pursue claims (backed largely by investor Carl Icahn) in an adversary proceeding against its former CEO. More than a decade later, those claims survived a summary judgment motion, which wouldn’t have been possible without an additional cash infusion from Icahn and other funders in 2016.
The coming wave of bankruptcies will challenge companies seeking to restructure, creditors seeking recovery, and the attorneys and other professionals seeking to advise them. Litigation finance provides a creative tool to help as companies consider their options and plan for what may be (as in the case of GM and Tropicana) matters that live on for the next decade or more.