Client Advisory: Best practices for litigation funding in bankruptcy matters following recent bankruptcy court decision
A recent bankruptcy court decision in the Northern District of Texas voided a $2.3 million litigation funding agreement between a liquidating trustee and litigation funder. This ruling has prompted renewed attention to the structuring, documentation, and approval of litigation funding arrangements in bankruptcy cases. Funders, trustees, and other stakeholders should take proactive steps to ensure that future agreements are enforceable and aligned with the interests of the estate and its creditors.
Below are best practices for parties considering entering into litigation funding arrangements in bankruptcy matters.
Confirm Authority in Plan and Trust Documents
Before entering into any litigation funding arrangement, review the relevant bankruptcy plan, trust agreement, and related documents to confirm that the trustee or estate representative has clear authority to enter into such agreements. If the plan has not yet been confirmed, consider including express language authorizing litigation funding in the plan, disclosure statement, and trust or liquidation agreements. This reduces the risk of later challenges and provides a solid foundation for the transaction.
Seek Bankruptcy Court Approval
Even if the plan documents provide authority, it is prudent to consider explicit bankruptcy court approval for any litigation funding agreement. Specific court approval of an arrangement increases certainty, protects against later challenges, and increases the likelihood that the arrangement is binding on all parties in interest. When seeking approval, be prepared to demonstrate that the terms are fair, reasonable, and in the best interest of the estate and its creditors.
Ensure Transparency and Proper Disclosure
Assume that the funding agreement and all related documents may be subject to public disclosure in the bankruptcy process. Draft every document, including term sheets, letters of intent, and definitive agreements, with this expectation in mind. Include robust provisions that request redaction of sensitive commercial terms such as pricing, proprietary methodologies, and return formulas, and be prepared to justify any such request for redaction under the applicable bankruptcy rules and standards.
Structure Agreements to Protect the Estate and Funders
Debtors or trusts seeking litigation funding should make sure to follow proper notice procedures and a fair process for selecting the funder. The terms of the agreement should be commercially reasonable and market-tested where possible. Ensure that the estate retains a meaningful share of any recovery and that the funding arrangement does not unduly burden creditor recoveries.
Preserve Causes of Action, Privileges, and Protections
Litigation funders should confirm that the claims or causes of action to be funded are properly preserved in the bankruptcy schedules and plan documents. They should not be subject to releases, waivers, or exculpation provisions that could undermine the value of the litigation or the funder’s rights. All parties should consider how claims and causes of action are treated to maximize the likelihood that the privileges and protections of the debtors are preserved to the greatest extent possible.
Prepare for Judicial and Stakeholder Scrutiny
Bankruptcy judges and other parties in interest may closely examine the economics of and process for obtaining litigation funding arrangements. Be ready to demonstrate the fairness of the terms, the benefit to the estate, and the appropriateness of the selection process.
Monitor Evolving Case Law and Local Practices
Stay informed about developments in bankruptcy case law and local court practices regarding litigation funding. Maintain flexibility in documentation to address potential objections from creditors, the U.S. Trustee, or other parties.
Guidance for Funders with Existing Agreements
If you are a funder with a litigation funding agreement already in place in a bankruptcy matter, consider the following steps: first, review the underlying plan and trust documents to confirm authority for the agreement; second, assess whether the agreement was properly disclosed and approved by the court. If not, consider whether there is anything you should do to maximize the enforceability of your arrangement. And third, if you haven’t done so already, be prepared to demonstrate that your agreement is commercially reasonable and in the best interest of the estate. Going forward, you will want to monitor the case for any objections or developments that could affect your rights; maintain open communication with the funded party and respond promptly to any court or stakeholder inquiries; if there is a risk of a challenge, evaluate options such as negotiating a revised agreement or seeking ratification from court; keep detailed records of all communications and payments related to funding agreement. Consult with experienced bankruptcy counsel to assess your specific situation and develop a tailored strategy.
Conclusion
The bankruptcy court decision underscores the importance of careful planning, documentation, and transparency in litigation funding arrangements in bankruptcy. By following these best practices, funders and estate representatives can maximize the likelihood of court approval, protect the interests of creditors, and ensure the enforceability of their agreements. For further guidance or to discuss specific funding opportunities, please contact a member of our Litigation Finance Group or Strategic Advisory and Restructuring Department.
