Liquidity without leverage: the benefits of exit financing through litigation funding
We recently covered the growing trend of debtors using litigation funding as a source of DIP financing to maximize value during the pendency of their bankruptcy. In this post, we focus on another crucial role that litigation funding can play in a bankruptcy reorganization: as a source of exit financing. Unlike DIP financing—which is generally used to fund operations during the chapter 11 process—exit financing is used for post-emergence purposes, such as supporting a debtor’s post-exit business plan, funding plan distributions, or paying off indebtedness.
Historically, emergent debtors have secured exit financing through term loans or revolving credit lines, often from preexisting lenders or other traditional financial institutions. Alternatively, some debtors have generated exit financing through rights offerings of debt or equity securities in the reorganized entity. Unfortunately, these sources of liquidity usually come with strings attached—for example, lenders often require all-asset liens and a rollup of prepetition indebtedness, and parties backstopping rights offerings may demand significant premiums and breakup fees. Also, traditional sources of financing are recourse, meaning a debtor remains obligated to repay its lender, regardless of the value of the collateral securing the obligation.
Sometimes, burdensome exit financing obligations can leave a debtor in a strained financial position post-emergence. As a result, debtors often walk a fine line when assessing their exit financing options: while they strive to secure sufficient financing to sustain their post-emergence business, they also strive to keep their exit obligations financially feasible in light of their overall reorganization plan. An over-leveraged debtor runs the risk of a so-called Chapter 22 bankruptcy—a Chapter 11 followed by another Chapter 11.
Litigation funding can be the key to supplying a debtor with the post-exit liquidity needed to carry out its plan without saddling it with the burdensome obligations that are characteristic of traditional exit financing.
Unlike traditional financing, litigation funding is non-recourse, meaning a debtor owes nothing if the lender’s collateral (in this case, the subject litigation) turns out to be valueless. Moreover, litigation funders like Bentham IMF traditionally do not take liens on any other property of the debtor, such as cash, receivables, or real estate in the ordinary course. Accordingly, a reorganized debtor maintains full discretion to use its post-exit income to sustain continued growth and operations, rather than to satisfy debt service obligations. And it remains free to use its unencumbered assets to raise additional capital if necessary down the line. Intuitively, a debtor hoping to obtain litigation exit funding must own valuable litigation assets, and accordingly, should draft its plan to re-vest the debtor’s litigation in the reorganized debtor, rather than assigning it to a liquidating trust or other vehicle separate from the reorganized entity.
For debtors that qualify, litigation funding can also be the key to resolving plan feasibility challenges based on section 1129 of the Bankruptcy Code. Section 1129’s feasibility requirement is designed to help avoid the “chapter 22” scenario discussed above, and provides that a bankruptcy court may only confirm a plan of reorganization if “[c]onfirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan.” See 11 U.S.C. 1129(a)(11).
Like with any type of financing, debtors need to consider the reputation and experience of their financier when considering teaming with a litigation funder. Bentham is a well-qualified partner, offering a longstanding industry track-record, reliable financial backing, and a sophisticated team of attorneys who are experienced in the restructuring space.
To learn more about how Bentham can help bankruptcy professionals maximize the likelihood of a successful reorganization for their clients, download our bankruptcy funding brochure or contact us.