The new tool investment bankers are suggesting to financially distressed corporate clients
By: Ken Epstein and Amy Geise
Recently at Bentham IMF, we have seen investment bankers, especially those who specialize in serving distressed companies, express growing interest in litigation funding. As they’re realizing how funding serves to leverage affirmative legal claims, which are commonly overlooked assets, investment bankers are seeking opportunities to connect their distressed clients with opportunities to transform the claims into vehicles for immediate income and substantial future recoveries. Such opportunities can be impactful for distressed clients because they help to improve a company’s cash position and profitability.
Funders like Bentham play a critical role in this process by evaluating litigation assets and identifying claims likely to yield large recoveries. They determine whether companies can monetize a single case or a portfolio of cases, depending on the number of pending or prospective litigations it has that are suitable for funding. They also determine whether the company can obtain working capital secured by the recoveries it could potentially earn from the litigation. Assuming funders find claims suitable for monetization, they will typically propose non-recourse funding in an amount proportionate to the potential recoveries.
Following are a few common scenarios that distressed investment banking clients may face, and an explanation of how litigation funding can provide unique solutions for these specific challenges.
Scenario 1: The Financially Distressed Company with Ongoing Litigation
A mid-market company is embroiled in an expensive and protracted litigation battle with one of its competitors. During the last three years, in fact, it has spent $10 million on the fight, and it believes it will take another three years and several million dollars more to complete the case. However, the battle is worth it: a successful outcome could mean hundreds of millions in recoveries for the company.
The problem is that the company is also experiencing financial distress. With the help of its investment banker, it is evaluating strategic alternatives, including a debt refinancing and/or restructuring of its balance sheet. The company is also exploring ways to improve its liquidity and profitability in preparation for a potential merger, acquisition, or other transaction.
One way the company could accomplish its goals, at least in part, is by partnering with a litigation funder like Bentham. Bentham could fund the legal fees and expenses associated with the company’s dispute, allowing it to “externalize” these costs and preserve its critical cash. Reducing volatile litigation expenses would also improve the accuracy of the company’s financial projections, making it a more attractive acquisition target.
The company would only owe Bentham its money back and a return in the event of a successful outcome in the litigation. Thus, the company could unlock the value of its litigation now without continuing to put its cash or other assets at risk. By partnering with a funder, the company could afford the best possible legal counsel, consultants and experts, maximizing the likelihood of a favorable outcome in the case to the benefit of all company stakeholders.
Scenario 2: The Bankrupt Company with Existing or Future Litigation
Like the company above, this company is a plaintiff in long-running, costly litigation that is likely to return significant sums in a settlement or judgment. In this case, however, the company has filed for Chapter 11 bankruptcy or a similar procedure.
A stay in the litigation would clearly help the defendant and hurt the company. Yet, the company is considering a stay because it is struggling to devote the necessary resources to rigorously pursue the litigation. For instance, the company has been forced to divert its time, energy, and litigation budget from the case to focus on various efforts associated with its Chapter 11 process. And the litigation is distracting the company from key aspects of its reorganization, including developing a plan of reorganization and making the requisite financial preparations to successfully emerge from bankruptcy. The company also may be forced to lay off several key employees with important knowledge about the case.
Bentham can help the company pursue its pending claims without sacrificing scarce resources during the chapter 11 process. As above, a funder like Bentham could provide the company with cash up-front, which could be used for any number of purposes, including to hire counsel, pay case expenses, or to retain valuable employees. In addition, the non-recourse nature of litigation finance allows the estate to better predict its expenses and provide a more accurate picture for the bankruptcy court and creditors.
The company and its stakeholders would also benefit by dispersing the risk associated with a valuable contingent asset and relieving pressure to settle for a sub-optimal amount. Should it look to sell its assets in a section 363 sale, the company will have improved its ability to accurately predict operating income and expenses, thereby reducing risks for a potential buyer.
Scenario 3: The Secured Lender Facing Additional Out-of-Pocket Expense and Risk
In this scenario, let’s imagine a mid-market company that is preparing to file for Chapter 11 bankruptcy. Post-petition, the company seeks $20 million in DIP (or debtor-in-possession) financing to be secured by $15 million of the prepetition senior secured lender’s cash collateral. The pre-petition lender does not want to extend DIP financing beyond the value of the cash collateral; however, it also wants to prevent another DIP lender from stepping in and priming its pre-petition liens. In other words, the lender wants to preserve its priority position as the senior secured creditor without having to put new money at risk.
Litigation finance may be available to solve this problem for the lender and the prospective debtor by providing the additional $5 million in DIP financing sought beyond the value of the company’s cash collateral. Unlike a traditional loan, the funder’s investment would constitute a non-recourse cash advance, and would be backed exclusively by litigation recoveries. Thus, it would be non-priming for the pre-petition secured lender.
This arrangement is also beneficial for the company. As in the above scenarios, the capital deployed by a litigation funder could be used for more than just litigation costs, such as to cover bankruptcy expenses or operating costs.
Scenario 4: The Secured Lender Engaged in Disputes with Other Creditors or the Debtor
Here, another creditor of the debtor has challenged the lien or the priority of a claim a secured lender has on the assets of a company in Chapter 11 bankruptcy. The secured creditor would like to fight, but is hesitant to expend additional resources when it may already be facing a substantial economic loss. Thus, the secured lender would prefer to share some of the risk involved in the dispute over the validity and priority of its lien.
In this scenario, litigation financing can provide the money to pay all or a portion of the legal fees and costs associated with the secured creditor’s efforts to protect its recoveries in the case. Sharing risk with a funder would allow the lender to rigorously defend the priority of its lien and the validity of its claim without incurring hefty legal expenses. In addition, the lender can guarantee that it will fight any challenge on equal footing with its litigation opponent—reducing the risk of an unfavorable settlement or judgment. Under these circumstances, the funder’s return could come from payment of the secured lender’s allowed claims in the underlying Chapter 11 case.
The recurring themes in these scenarios – capital infusions, empowerment, flexibility and risk mitigation – are all benefits that investment bankers strive to deliver to their clients. Litigation funding makes them possible. If you are interested in learning more about how litigation finance can help you or your clients, contact us for a consultation.