Litigation Finance – a New Tool for Unsecured Creditors

When a bankruptcy proceeding ends, the debtor’s unsecured creditors are often left wondering how to collect on what appear to be worthless claims. In business bankruptcies, a common target is the debtor’s claims that are owned by the bankruptcy trustee. When risk is high and money is scarce, the trustee may not be willing to pursue what may otherwise be valuable claims. How can creditors acquire these claims and then recover what is due the debtor?

The answer is litigation finance. Litigation finance has been a source of money for law firms and clients who are trying to recover money in what appears to be a long and costly lawsuit. In return for financing the litigation, the litigation finance firm receives a portion of the recovery. In effect, the debtor’s claim, now owned by one or more creditors, is used to secure the loan that permits the lawsuit to proceed. Bankruptcy creditors are now turning to litigation financing to help them obtain and recover on claims that the trustee does not wish to pursue.

Litigation finance has a number of potential uses in bankruptcy. As described above, the litigation financier can provide capital to the bankrupt estate by purchasing a claim outright from the trustee. The estate itself can also utilize litigation financing to pursue claims that might otherwise be too risky or whose cost may be beyond the financial capability of the estate. The biggest “if” in litigation financing is having a claim that is sufficiently large to encourage the litigation financier to support efforts to recover on it.

Unsecured creditors almost always finish last in the race to obtain the debtor’s assets in a bankruptcy proceeding. Nevertheless, a knowledgeable bankruptcy attorney may be able to provide useful advice on ways to pull cash out of what may appear to be a worthless claim.