Defunding the Funders: Bankruptcy Court Voids Post-Confirmation Litigation Funding

A Texas bankruptcy judge has ruled that a post-confirmation litigation trust has no obligations under a litigation funding agreement that had been completely drawn down because the litigation trustee was not authorized to obtain litigation funding. The decision, In re Fresh Acquisitions, LLC, demonstrates the uncertainties in post-confirmation estate administration and serves as a warning for estate administrators and litigation lenders that do not provide advance disclosure of the intended litigation financing or seek court approval.

Background

Fresh Acquisitions filed a chapter 11 petition in 2021 and confirmed a liquidating plan of reorganization that had been proposed by the creditors committee in 2022. The plan established a litigation trust for the benefit of general unsecured creditors to prosecute avoidance actions and seeded the trust with approximately $345,000. The committee projected that litigation costs would be between $100,000 and $350,000 per year. The former financial advisor to the creditors committee was appointed as liquidating trustee, and the former lawyers for the committee were retained as counsel.

The liquidating trustee brought post-confirmation actions against 22 defendants. After over three years of protracted motion practice the cases were still not close to trial. At a June 2025 status conference Judge Jernigan was surprised to learn that the liquidating trustee had, more than a year after confirmation, entered into an agreement to borrow additional funds for litigation expenses. She then on her own motion directed that the litigation funding agreement be filed on the public docket unsealed and unredacted and set an evidentiary hearing regarding whether the litigation trustee had had authority to enter into the agreement.

The record at the hearing showed that neither the trust agreement for the litigation trust nor any of the plan documents contained any provisions expressly referring to potential future litigation funding. The hearing further revealed that the guaranteed funding commitment of $2.325 million had been completely drawn down. The contractual return to the litigation funder, secured by a pledge of the litigation proceeds, was three times the amount of funding plus 12% of any recoveries beyond that amount. In addition to the litigation funding obligations the litigation trust had incurred significant professional costs: litigation counsel was owed more than $2 million over and beyond the more than $2 million that it had already been paid, and the litigation trustee and his firm had been paid over $700,000. This level of litigation cost was massively more than had been estimated in the pre-confirmation disclosure statement, and meant that the majority of the proceeds of any verdict or judgment in favor of the estate would go to paying the litigation funder or professionals rather than unsecured creditors.

Bankruptcy Court Decision

Following the hearing the Bankruptcy Court determined that (1) the litigation trust agreement did not grant the trustee authority to enter into a litigation funding agreement; (2) the confirmation of the plan of reorganization did not constitute approval of litigation funding because the possibility of litigation funding had not been adequately disclosed to creditors pre-confirmation, in connection with voting on the plan nor to the court pre-confirmation or post-confirmation; and (3) the terms of the litigation were so “exorbitantly expensive” that the litigation trustee had not exercised reasonable business judgment and had abused his discretion.

Judge Jernigan then ordered that the litigation trust would have no contractual liability to the litigation funder. She also ordered that the liquidating trustee be replaced with a new trustee to be selected by the United States Trustee. In addition, she ordered an expanded global mediation to include the new replacement liquidating trustee, the defendants in the adversary proceedings, the initial (now discharged) liquidating trustee and his professionals, and the litigation funder. She also suggested that the initial liquidating trustee and his professionals might be subject to disgorgement of fees.

Analysis

Judge Jernigan discounted the uncontroverted expert testimony that the terms of the litigation financing were within the standard market range for such agreements, noting that neither the terms nor the text of most such agreements are made public and that the experts had admitted that they were personally familiar with only a few such agreements.

The financing was styled not as a loan but rather as a prepaid forward purchase agreement for future litigation proceeds, which the litigation funder described was for tax and structural reasons. The court did not consider this to be a significant distinction.

The court rejected the litigation trustee’s position that neither disclosure nor court approval were required for his post-confirmation administrative decisions. The result in Fresh Acquisitions, including the possible disgorgement of substantial fees that had already been paid, illustrates the risks that run with such an absolutist stance.

The litigation funder may argue that it has an equitable claim, especially for the amounts it actually funded. Such claims may be included in the mix to be considered at the mediation that the court ordered. At present, with details of the mediation not public and with the underlying litigations unresolved and vigorously contested, it is unclear how much unsecured creditors will receive and how much, if anything, will be paid to the funder and the professionals.

The opinion cites with approval to pleadings filed in the Sears case, where the analogous liquidating trust agreement expressly stated that the trust was not precluded from seeking additional financing. In Sears, the creditors committee filed a motion seeking court approval of post-confirmation litigation funding. After various parties-in-interest filed objections, the hearing on the motion was adjourned and then cancelled.

It is far from uncommon for plans of reorganization to provide for post-confirmation litigation brought by the professionals who represented the debtors or the creditors committee in the case. The problems discussed in the opinion, including underestimation of the cost, duration and riskiness of the litigation, and the lack of creditor input into post-confirmation administration, are present in many cases.

Professionals that are drafting a plan of reorganization that contemplates significant post-confirmation litigation should consider including provisions for the possibility of litigation funding in the operative documents and providing disclosure to creditors. Plan administrators and trustees should consider seeking court approval of litigation funding. While the process of obtaining court approval may come with cost and delay, and may have the effect of making public details regarding the financing that many parties would prefer to keep private, public notice should at least prevent a catastrophic result for professionals like in Fresh Acquisitions.

Litigation funders should review the authority of plan administrators and trustees to bind post-confirmation estates and trusts to litigation funding agreements and consider requiring court approval and additional public disclosure.