Litigation Funders See Growing Opportunities in Bankruptcy Boom

Litigation finance is working its way into corporate bankruptcy proceedings as Chapter 11 cases pile up, enabling more lawsuits and strengthening plaintiffs’ claims against third parties who may have caused or worsened a bankrupt company’s distress.

The nascent but growing $13.5 billion industry, in which outside investors pool money into lawsuits in exchange for a portion of any award that results, is encountering its first US corporate bankruptcy boom. A wave of new bankruptcies could be rife with opportunities to invest in legal claims.

“I think the level of activity rises and falls with the amount of bankruptcy activity we see,” said Emily Slater, a managing director at litigation finance firm Burford Capital LLC. “And obviously we’re starting to see more bankruptcy activity now.”

Bankruptcy litigation funding arrangements have been publicly disclosed for court approval in about two dozen instances so far, according to attorney Marc Carmel of McDonald Hopkins LLC.

Litigation funding wasn’t prevalent during the last major bankruptcy wave stemming from the 2008 financial crisis, so the current environment is new for most industry players. Litigation finance presents a new tool for bankrupt companies and creditor trusts to pursue claims against other parties or secure bigger payouts.

Third-party litigation funders have been tapped to help creditors pursue claims in some notable bankruptcy cases already, including General Motors Corp. and Sears Holdings Corp.

This year, the trustee for a group of bankrupt rural hospitals across the South and Midwest took on a third-party investment to fund claims accusing the hospitals’ former owners and managers of using the companies to perpetuate a fraudulent insurer billing scheme. Trustee Thomas W. Waldrep Jr. in June won approval from a North Carolina bankruptcy court to bring in Omni Bridgeway Ltd. to finance the suit.

Carmel, who helped Waldrep secure the financing, said he thinks bankruptcy practitioners have become more familiar with litigation funding than they were just a few years ago. Although it’s not the right fit for every bankruptcy case, litigation funding allows trustees “to pursue more litigation that they might not have pursued to begin with,” he said.

In many situations, that outside funding “reduces the pressure of taking an early settlement,” said Carmel.

New Legal Options

Profit-minded funders first approached US corporate litigation less than 20 years ago, finding ways to assist plaintiffs short on cash but armed with evidently viable and valuable claims against deep-pocketed defendants.

Because the practice largely developed during the economically prosperous years that followed the Great Recession, it hasn’t before featured in a wide-scale distress cycle. But with Chapter 11 cases swelling this year at a pace not seen since the aftermath of the financial crisis, it appears the time has come.

“As Chapter 11 filings go up, there’s more awareness in the market of litigation finance as a tool,” said Slater. “I definitely think we’ll see more and we’re hoping to because it’s an active area and an attractive area for us.”

For the most part, bankruptcy funding arrangements have been used to strengthen the legal firepower of creditor trusts. The trusts are often set up under corporate bankruptcy plans to distribute cash and pursue potential legal actions against various parties, like a company’s former executives or owners.

A creditor committee last year asked to borrow $35 million in funding from Bench Walk Advisors LLC to pursue claims that former Sears CEO Eddie Lampert and others stripped the department store chain of valuable assets in the years preceding the company’s collapse. The defendants, without admitting liability, agreed to a $175 million settlement four months later.

Bankruptcy trust lawsuits typically focus on allegations of company mismanagement, insider payments, preferential transfers made in the lead-up to a case, and questionable lender liens.

Trustees historically have had to work with minimal resources to litigate claims, and often hire lawyers on a contingency fee basis to pursue costlier cases.

With litigation funding now more accessible, trustees representing creditors of a bankrupt estate must weigh the investment option against hiring contingency counsel, who often receive about 35% of a case recovery, said Omni Bridgeway investment manager Ken Epstein.

The question to consider is “how do you successfully bring those claims?” said Epstein. “This is just another tool that the industry is using to do that.”

‘Natural Fit’

In the eyes of funders, carefully selected litigation not only provides an opportunity to receive a healthy return on investment, but also helps put plaintiffs on equal footing against well-heeled defendants.

With costs always a concern in bankruptcy proceedings, “it’s kind of a natural fit,” said Epstein.

Litigation can also help bring in money at the outset of a bankruptcy. Century 21 Department Stores LLC in 2020 raised $59 million to disburse to creditors by selling the retailer’s claims against insurers that declined to pay out on business interruption policies in the wake of the pandemic.

Gulf Shore oil producer Cox Operating LLC filed for bankruptcy in May while litigating against the owner of an oil tanker that allegedly struck one of its offshore platforms. The company is now marketing the litigation as an asset that can bring in more money.

Marla Decker, a managing director at litigation finance firm Lake Whillans Capital Partners LLC, believes that of all the spaces for litigation funders to hunt for investment opportunities, bankruptcy could be “the most obvious.”

And as the market for traditional corporate loans tightens due to a capital crunch, litigation funders increasingly make “a perfect pairing” with bankrupt estates, she said.

Enhanced Disclosures

Litigation funders in civil court settings have avoided disclosure of their investments in most cases, prompting concerns that the lack of transparency could mask undue influence. The plaintiffs’ bar and corporate defendants for years have argued over keeping litigation strategies protected. Efforts to regulate the industry at the state and federal level have often fallen flat.

But in bankruptcy, where financial transparency is paramount, funding arrangements are often shared publicly by law or because the parties have agreed to seek court approval.

“We’re well aware of the transparency of the US bankruptcy system,” Burford’s Slater said. “We approach investing in the bankruptcy space knowing that our financing is likely to be disclosed.”

While the importance of disclosure in bankruptcy could discourage some funders, the public nature of third-party financing arrangements may help plaintiffs establish a strong posture at the beginning of a case.

And for funders, disclosure in certain cases can be seen as good for business.

“We love having things that are public,” said Slater. “We’re just educating the market about what can be done.”

—With assistance from Emily Siegel.