Using litigation finance for intercreditor litigation
Author: Daniela Raz
When stakeholders in a bankruptcy disagree as to how assets should be distributed, the result may be intercreditor litigation that is both expensive and time-consuming. Such litigation can seem antithetical to the purpose of the Bankruptcy Code, which encourages stakeholders to approve a consensual restructuring plan. Nevertheless, many creditors conclude they have no other choice but to litigate.
Litigating an intercreditor dispute may be justifiable when there is a genuine dispute and the consequence of not challenging the proposed treatment of a claim is high. This has played out in several high-profile cases recently involving challenges by unsecured creditor committees (UCCs) to the perfection of liens asserted by secured creditors.
Third-party litigation finance provides a powerful tool for creditors who wish to challenge their proposed treatment under a plan or pursue claims against other creditors of the debtor. Litigation is expensive, resources are limited, and the cost of obtaining financing from existing stakeholders may be prohibitively high. In the absence of funding, creditors may believe they must engage counsel on a contingency basis, giving up much of their upside, or settle early on for less than full value. Third-party litigation finance may permit creditors to engage their first choice of counsel and ensures adequate resources are available to press for a resolution that provides meaningful recoveries.
In bankruptcy, the absolute priority rule governs the order of priority of claims, and there is seldom enough money to pay every creditor in full. Secured claims with collateral are first in line, except when a debtor-in-possession lender (DIP Lender) has obtained a priming lien. Further, restrictive loan documents often leave very little room for creditors (or the debtor) to challenge perfection of a lien. In these circumstances, unsecured creditors can seek standing from the bankruptcy court to challenge claim classification. Other circumstances may also lead to disputes between creditors that are less tied into the estate, for example, disputes over the interpretation of an intercreditor or subordination agreement.
Recent cases demonstrate that unsecured creditors are increasingly willing to challenge their treatment under a proposed plan, especially when their debtors are unable or unwilling to mount these challenges, which is often the case when a DIP Lender has effective control of the case. (See, e.g., In re Hertz Corp. (Bankr. D. Del., No. 20-11218); In re Tailored Brands, Inc. (Bankr. S.D. Tex., No. 20-33900); In re Sanchez Energy Corp. (Bankr. S.D. Tex., No. 19-34508); In re BL Restaurants Holding, LLC (Bar Louie) (Bankr. D. Del., No. 20-10156); and In re Katy Industries, Inc. (Bankr. D. Del., No. 17-11101)). By using litigation finance to support such a challenge, unsecured creditors can gird for battle against secured lenders with reduced cost and risk and can select and use counsel of their choice.
Bankruptcy practitioners are increasingly well-versed in the use of litigation finance to maximize the value of debtors’ claims through litigation trusts that are formed at the end of a bankruptcy – with chapter 11 documents increasingly providing the litigation trust with authority to monetize claims, enter into litigation financing agreements and, ideally, finalize those arrangements without the need for further bankruptcy court approval. However, litigation finance also can be used to support disputes that arise earlier in the bankruptcy proceeding, including intercreditor disputes relating to lien validity.
Litigation funding may serve as an attractive alternative to paying hourly fees or hiring a law firm on a contingency basis. As one financial advisor recently observed during an industry roundtable, consideration of third-party litigation finance for intercreditor disputes has become "de rigueur" and "a clear third option." Why? Because it enables the claimant to engage counsel with the necessary firing power to take on secured creditors in an intercreditor dispute, even if that counsel is otherwise unwilling to work on a full contingency.
Under a typical funding arrangement, counsel is paid all or more commonly, a portion of, its fee budget by the litigation funder rather than by the estate (as in a full hourly fee arrangement). In return, the funder (and the counsel, if they have been paid only a portion of their fees along the way) is entitled to receive a share of any of the proceeds or value recovered. The claimant pays nothing to the funder unless there are recoveries from the underlying litigation, in which case the funder receives a pre-agreed share of those recoveries. Unlike a full contingency arrangement, the claimant has a greater array of options in the selection of counsel, since it may tap counsel who are not comfortable with or are able to offer contingent fee structures.
Creditors seeking to challenge a lien or bring other intercreditor claims should engage with a litigation finance provider early in the bankruptcy process to permit informed decision-making and should ensure that the finance provider has experience in bankruptcy litigation. Bankruptcy investing is one of our core competencies at Omni Bridgeway, and we are uniquely situated to evaluate intercreditor disputes in the early stages of a bankruptcy proceeding and structure transactions that align with creditors’ best interests.
To learn more about using litigation finance for intercreditor litigation, visit our Company Insights. While there, explore our recent podcasts, blog posts, and videos. Or contact us for a consultation to learn more about the ways we can help you pursue meritorious claims.