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Funding empowers creditors in bankruptcy claims

Focus on: Litigation Funding
|Written By Judy van Rhijn

Litigation in progress and claims arising out of insolvency can represent an important source of funds in an insolvent estate, but there may not be the funds or the confidence to proceed, especially in view of the risk of adverse costs.

With the availability of third-party funding, monitors and creditors can now feel emboldened to pursue claims that previously would have been allowed to lapse.

“We have never been as aggressive as the U.S. in pursuing claims that arise in insolvency situations,” says Aubrey Kauffman of Fasken Martineau DuMoulin LLP in Toronto.

“I think that now, with this funding, trustees and creditors will be more aggressive in pursuing litigation because there is less risk. Limited resources in the estates will not stop them throwing the dice on litigation.”

Kauffman says that, historically in financing litigation in insolvency cases, other tools have been used, including the sale of the assets of the estate, debt financing, major creditor funding or contingency arrangements where the lawyer takes the risk, coupled with litigation trusts.

“Litigation funding is a relatively new product in Canada. It’s of great interest to the insolvency bar,” he says.

“I’m not aware of any pure third-party litigation agreement in a Canadian insolvency case yet, but I believe it is imminent.”

Tania Sulan, chief investment officer of litigation funder Bentham Canada, confirms that assessment of the situation.

“There have been one or two examples of third parties funding litigation of insolvent entities but not professional litigation funders like Bentham, as far as I am aware,” she says. “We have had a number of enquiries on this front but haven’t funded anything yet.”

In Crystallex (Re), 2012 ONCA 404, the Ontario Court of Appeal upheld the financing arrangements despite strong opposition from most of Crystallex’s creditors, affirming the great flexibility and discretion that s. 11.2 of CCAA gives to a supervising CCAA judge to approve so-called ‘interim’ financing.

“The cost issue has to be weighed,” says Gerry Apostolatos of Langlois Lawyers in Montreal, which often assists law firms across Canada with Quebec-related issues, especially in relation to insolvency in bankruptcy.

“Where there are files with no funding, and without funding there is no lawsuit, it makes perfect sense to seek assistance.”

Ken Rosenberg of Paliare Roland Rosenberg Rothstein LLP of Toronto gives an example of the involvement of third-party funders in the insolvency related class action of The Trustees of the Labourers’ Pension Fund of Central and Eastern Canada v. Sino-Forest Corporation, 2012 ONSC 2937, where one representative had third-party funding.

He also points to the class action related to the Lac-Mégantic disaster as a case suitable for the arrangement.

“There was no third-party funder, but the receiver ended up having a contingency fee because the Canadian state ran out of money,” he said.

“The monitor itself got a bonus $10 million on $10 million fee because it went at its own risk. It could have gone out and got someone to back it instead.”

Kauffman says there are different court officers depending on which insurance regime you are involved with, such as trustees in bankruptcy when the business is not operating anymore, receivers when secured creditors have forced the business into receivership and monitors when the debtor still runs the business under supervision.

In reality, these roles are all undertaken by the same insolvency professionals.

“All three types of court officer could benefit from using third-party insurance,” he says.

Kauffman says in bankruptcy proceedings where there is not enough money in the estate to pursue a claim is a natural situation for a third-party arrangement.

He says this is particularly the case if there have been improper transactions, fraudulent transactions or preferential payments.

“In the case of a receiver, where there is a piece of litigation — a cause of action that a debtor has — and the secured creditor doesn’t want to fight it, that is also a natural situation for the receiver to make a funding arrangement,” he says.

“Similarly, this applies to restructuring under the Companies’ Creditors Arrangement Act where there is a monitor. If there are not sufficient funds and creditors are not willing to take the risk of proceeding, either the debtor company or the monitor could enter into an arrangement.”

Apostolatos says whoever may be legally invested with the claim to sue, whether it is the insolvency professional or the creditor, could seek funding.

“Assuming lawyers can’t be found to take the case on a contingency basis, litigation funding can be very helpful. The lawyer must also manage his or her risk and so may be the one driving the litigation funding,” he says.

“More complex claims that proceed over years, not months, might require a lot more funding. Not every firm is prepared to take them on. They may mix it up and do some files on contingency and some with litigation funding.”

While Kauffman expects this option will make trustees, receivers and monitors more adventurous, he also considers there are balances in place.

“We will not see a tidal wave of frivolous or abusive claims. The funders have got to win the case to get their money back,” he says.

“There will be a larger volume of lawsuits in cases where creditors didn’t want to risk recovery before.”

In situations where creditors wish to take over the lawsuit themselves, Kauffman advises that there are mechanisms that allow that to happen.

“In bankruptcy, there is a method by which a creditor can get assignment of the claim where the trustee in bankruptcy won’t pursue the claim,” he says.

“In restructurings under the CCAA, it’s not uncommon to set up a litigation trust for the causes of action.”

Apostolatos laments that, unfortunately, in certain insolvencies, there are very few assets that are unencumbered.

“When the assets are covered by blanket security, any realization from them goes to the secured creditor,” he says.

“There may be nothing left over for the unsecured creditors except claims. For instance, you might have 20 or 30 claims for preferential payments.”

He says that when a creditor institutes proceedings when a trustee doesn’t want to or can’t, a creditor can, but the money recovered goes to pay that creditor and potentially other creditors if they decide to participate.

“The way the system works now, the creditors have to get involved. If insolvency professionals with lawyers are empowered to do what they do, creditors won’t have to worry,” he says.

“My prediction is that this will ultimately benefit the mass of creditors and not just the one, two or three that decided to participate in litigation.”

A trustee is also permitted to sell the right to a claim.

Kauffman can foresee this becoming more common with the availability of third-party funding.

“I think our judicial system has to be open to these new and creative ways of assisting litigants in seeking justice and getting paid,” says Apostolatos.  

“There is no doubt in my mind that litigation funding in appropriate circumstances is something that we lawyers appreciate. It ultimately increases access to justice.”

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