Legal finance trends: Bankruptcy
As interest rates increase and amidst economic uncertainty and a potential global slowdown, it is expected that the number of corporate bankruptcies around the world will begin to accelerate in 2019. The retail sector has already been hit hard by high leverage, increasing real estate costs and perhaps most significantly, on-line competition. The recent decline in oil prices could also drive new filings in the oil and gas industry, which has already been through a recent round of restructurings. In Europe, airlines face numerous challenges that have led to some industry-watcher to speculate that there will be additional insolvency filings.
As these and other industries grapple with a rising number of bankruptcies, we anticipate stakeholders seeking innovative solutions to ensure creditors are made whole—including legal finance.
Legal claims held by bankruptcy estates often represent unsecured creditors’ best path to recovery, but how to fund those litigations has been a long-standing issue. Historically, bankruptcy stakeholders have relied upon financing options such as providing releases, obtaining contingency fee arrangements, fee deferrals or further cash contributions from out of the money creditors. But these solutions have their limitations—often resulting in bankruptcy stakeholders settling claims for less than they’re worth or else forgoing them altogether.
Legal finance allows estates to pursue valuable claims that otherwise might have to be abandoned or settled, thus increasing creditor recoveries.
How legal finance will be used in 2019
In the coming year, we anticipate legal finance being used in a range of circumstances:
Companies in reorganization can finance or monetize claims
Companies in reorganization often have several outstanding legal claims with high potential upside. Although restructuring companies may obtain DIP financing, they must reserve that limited and expensive capital for funding operations—not for pursuing litigation that that is non-core to the business. As an alternative, companies can work with a legal finance provider to obtain non-recourse legal financing or to simply monetize claims to preserve DIP cash and limit risk. The finance provider makes an upfront payment to the estate and the estate maintains substantial upside from any recovery in the claim.
Funding a liquidation or litigation trust
A funder can provide non-recourse capital to cash-strapped estates and trusts that have litigation assets, potentially allowing for a faster and larger recovery to the estate and creditors. Creditors may also prefer to seek funding for a litigation trust so that any existing cash can be reserved to guarantee creditor recoveries. With increased resources, an estate can launch a broad litigation strategy that can accelerate the timing of creditor recovery. And, if a trustee has a basket of claims that include claims or counterclaims against the estate, litigation finance can by used to finance the legal fees on both affirmative and defensive claims.
Providing capital to law firms to pursue matters taken on risk
Litigation finance can provide non-recourse capital to law firms that litigate bankruptcy matters on contingency, either on a single-case basis or across a portfolio of cases. The direct injection of capital helps smooth cash flow for the firm and lower its risk exposure. This in turn enables the firm to capitalize the expansion of its contingency business or take on litigation expense risk when a cash-poor estate is unable pay litigation expenses.
Financing inter-creditor disputes
In estates involving with senior and subordinated creditors, disagreements may arise over priority of senior creditors. Creditor groups can use an injection of non-recourse capital to challenge a lien or seek to remove priority, without assuming additional risk to their investments.
A “game-changer”
One bankruptcy trustee described the liquidity that legal finance provides as “a game-changer.” Legal finance allows an early payout and guaranteed minimum recovery to creditors by providing the capital needed to see litigation through. And because capital is typically provided in exchange for a return tied to case outcomes, legal finance is an appealing option to help preserve cash in the estate for operations or the trust for the benefit of creditors.
Legal finance ensures the efficient administration of litigation trusts for the benefit of creditors, and yet it is still an underutilized tool. As its myriad of uses become more widely understood by bankruptcy professionals, however, we anticipate legal finance being used in novel ways to address the needs of bankruptcy estates.
