Bankruptcy Litigation Funding

Bankruptcy litigation funding, also known as debtor-in-possession (DIP) financing for litigation or bankruptcy litigation financing, is a specialized form of financing used to fund legal claims and other aspects of litigation by companies or individuals who are in bankruptcy proceedings. It can be a lifeline for debtors seeking to maximize the value of their estate and repay creditors.

Here's a breakdown of key aspects:

How it Works:

• The Debtor's Need: A bankrupt company or individual (the debtor) often has valuable legal claims (e.g., breach of contract, fraud, preference claims, avoidance actions) that could generate significant recovery. However, they may lack the resources to pursue these claims due to being in bankruptcy.


• The Funder's Role: A litigation funder provides capital to the debtor specifically for the purpose of pursuing these legal claims. The funding is typically non-recourse, meaning the funder only gets repaid if the case is successful and generates a recovery.


• The Agreement: The litigation funding agreement outlines the terms of the funding, including:


• The specific claims covered by the funding.


• The amount of funding provided.


• The funder's share of the recovery (typically a percentage or multiple of the investment).


• The funder's level of control over the litigation (often limited to strategic advice and approval of major decisions).


• Repayment priority (often paid out of any recovery before other parties, including the debtor and its attorneys).


• Bankruptcy Court Approval: Crucially, the litigation funding agreement usually requires approval from the bankruptcy court. The court will assess whether the funding is in the best interests of the bankruptcy estate and its creditors. Factors considered often include:


• The likelihood of success of the litigation.


• The reasonableness of the funder's share of the recovery.


• Whether the funding agreement impairs the rights of other creditors.


• Whether the funding agreement creates conflicts of interest.

• Avoidance Actions/Preference Claims: Recovering payments made to creditors shortly before bankruptcy, which could be deemed unfair to other creditors.


• Fraudulent Transfer Claims: Recovering assets transferred by the debtor to avoid creditors.


• Breach of Contract: Claims against parties who breached contracts with the debtor.


• Intellectual Property Litigation: Claims involving patents, trademarks, or copyrights.


• Antitrust Claims: Claims of anticompetitive behavior.


• Directors & Officers (D&O) Liability Claims: Claims against former company executives.

• Access to Justice: Allows debtors to pursue valuable claims they couldn't afford to litigate otherwise.


• Maximizing Estate Value: Increases the potential recovery for creditors and the debtor.


• Risk Mitigation: The funder bears the risk of loss if the litigation is unsuccessful.


• Specialized Expertise: Funders often have legal and financial expertise to evaluate and manage complex litigation.


• Leveling the Playing Field: Allows debtors to compete with better-resourced adversaries.

• Cost of Capital: Litigation funding is generally more expensive than traditional financing, reflecting the higher risk.


• Loss of Control: While funders typically don't control the day-to-day litigation, they may have significant influence over strategy.


• Disclosure: The terms of the funding agreement must be disclosed to the bankruptcy court and other parties.


• Potential Conflicts of Interest: Conflicts may arise between the debtor, the funder, and other creditors.


• Court Approval Uncertainty: There's no guarantee that the bankruptcy court will approve the funding agreement.


• Ethical Concerns: Some argue that litigation funding can encourage frivolous lawsuits.

• Champerty and Maintenance: These historical doctrines, which prohibit third parties from improperly interfering in litigation, are less relevant in modern litigation funding. However, courts still scrutinize funding agreements to ensure they are fair and do not encourage frivolous litigation.


• Attorney-Client Privilege: Protecting the attorney-client privilege when sharing information with the funder is crucial. Confidentiality agreements are essential.


• Disclosure Obligations: Disclosure of the funding agreement to the court and other parties is usually required.

• Increased Use: Bankruptcy litigation funding is becoming increasingly common as more companies and individuals seek bankruptcy protection.


• Larger Investments: Funders are investing in larger and more complex cases.


• Specialized Funds: More funds are specializing in bankruptcy litigation funding.


• Greater Sophistication: The market is becoming more sophisticated, with more standardized terms and due diligence processes.