Fifth circuit rejects a challenge to litigation funding agreement for lack of standing

A recent Fifth Circuit decision released on December 7 sends a clear message to those seeking to challenge a trustee’s litigation funding agreement: you’d better be on solid ground when it comes to “standing.”

In the five-page opinion authored by Judge Jacques L. Weiner, Jr., the court found that the appellant-debtor in In re Dean^[1] lacked standing to challenge a funding agreement approved by a Texas Bankruptcy Court. The Fifth Circuit found that the debtor was not “directly, adversely, and financially impacted” by the funding agreement or the bankruptcy court’s order.

The court relied upon the “person-aggrieved test,” to determine whether the creditor had standing to appeal a bankruptcy court order. “This test,” the decision noted, “is an even more exacting standard than traditional constitutional standing.”

“Standing to appeal a bankruptcy court order is, of necessity, quite limited,” Weiner wrote. “Such standing must be connected to the exact order being appealed as opposed to the proceedings more generally. We have explained ‘that the order of the bankruptcy court must directly and adversely affect the appellant pecuniarily.’”

Weiner was joined in the unanimous opinion by Judges James E. Graves, Jr. and James C. Ho.

The Underlying Bankruptcy Case and Funding Agreement

The opinion stemmed from the 2019 voluntary Chapter 7 filing of William Berry Dean III in the United States Bankruptcy Court for the Northern District of Texas. The bankruptcy court appointed Scott Seidel as Chapter 7 trustee, who quickly realized that he lacked sufficient funds to adequately pursue the estate’s litigation claims for the benefit of creditors.

To solve the estate’s liquidity problem, Seidel reached a litigation funding agreement with one of the creditors, Reticulum Management LLC, to help pay for the estate’s litigation. Under the agreement, Reticulum agreed to advance up to $200,000 to prosecute claims against third parties. In exchange, Reticulum was entitled to reimbursement plus a 30 percent “investment return” from any recoveries collected by the trustee.

Dean challenged the funding agreement. At a contested hearing before the bankruptcy court, Seidel testified that funding was necessary because multiple law firms had rejected pursuing claims for the estate on a contingency-fee basis. The bankruptcy court ultimately approved the funding agreement over the debtor’s objection.

Dean then appealed the order to the U.S. District for the Northern District of Texas.  On appeal, Dean argued that the waterfall proposed in the funding agreement violated the priority scheme of Section 507 and the equality of distribution requirements of Section 726 because it allowed the funder to move ahead of other creditors in the order of payment. In April 2021, Judge Brantley Starr affirmed the bankruptcy court’s order, finding that it had not committed clear error. Dean appealed to the U.S. Court of Appeals for the Fifth Circuit.

Stuck on Standing

The Fifth Circuit did not address Dean’s substantive arguments against the funding agreement, focusing instead on the standing issue. The court noted that in Chapter 7 bankruptcy, the trustee, “not the debtor or the debtor’s principal, has the capacity to represent the estate and to sue and be sued.” Debtors may retain standing if they show that the defeat of an order on appeal “would affect their bankruptcy discharge.”

“Appellants cannot demonstrate bankruptcy standing when the court order to which they are objecting does not directly affect their wallets,” the court said. The case, the court said, was in line with similar decisions, including one rejecting objections by debtors to the hiring of a special counsel by an estate, and another involving a creditor who wished to halt an order approving the sale of assets. In both cases, the court said, the appellants were not directly affected.

The Right Result

The result in In re Dean lends support to the continued growth of litigation funding in bankruptcy. Dispute financing is particularly well-suited for the distressed world because of the frequent existence of meritorious claims without a corresponding financial ability to prosecute them. Ligation funding can be used to help pursue any number of common disputes in the bankruptcy space, including avoidance actions, breach of fiduciary duty claims, insurance coverage disputes, turnover and tax recoveries, recoupment and setoff issues, equitable subordination, and other contested matters (e.g., 9019 motions or contested plan and sale processes).

Litigation funding can also be used to pay general administrative fees and other case expenses, or to provide a liquidity event that allows an estate to make early distributions to creditors. It can serve as a source for debtor-in-possession or exit financing. Finally, litigation funding is frequently utilized to monetize claims and judgments through a 363 sale, which helps de-risk creditors and creates an immediate recovery event for the estate. 

To learn more about Omni Bridgeway’s litigation funding capabilities, 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.