Ch. 7 debtor can't block novel litigation funding deal, says appeals court

(Reuters) - An appeals court on Tuesday shut down a Chapter 7 debtor’s challenge to a litigation funding agreement between his trustee and a creditor, finding that the agreement had no financial impact on the debtor himself.

A three-judge panel of the 5th U.S. Circuit Court of Appeals held in a five-page decision that William Berry Dean III had no standing to appeal a lower court’s approval of the funding agreement because he did not show that he would suffer any financial harm from the deal.

“Appellants cannot demonstrate bankruptcy standing when the court order to which they are objecting does not directly affect their wallets,” Circuit Judge Jacques Wiener Jr wrote. He was joined by Circuit Judges James Graves Jr and James Ho.

The dispute stems from Dean’s 2019 Chapter 7 bankruptcy in Texas, where the trustee assigned to Dean's estate, Scott Seidel, struck a deal with one of Dean’s creditors, Reticulum Management LLC, to fund litigation aimed at collecting money that could be used to pay off Dean’s debts. Reticulum agreed to put forward $200,000 in exchange for 30% of any litigation proceeds the trustee managed to collect.

Seidel said the litigation funding was necessary because other firms refused to do the work on a contingency-fee basis. U.S. Bankruptcy Judge Stacey Jernigan approved the agreement in June 2020. In April, U.S. District Judge Brantley Starr said there are “legitimate ethical concerns” surrounding litigation funding agreements but affirmed Jernigan’s decision.

Dean appealed, arguing that the litigation funding arrangement improperly allowed Reticulum to jump ahead of other creditors and potentially collect more than it would otherwise receive in the case. The appeals court did not address that argument.

Dean’s lawyer, John Lewis Jr of Hayward, told Reuters on Tuesday that allowing litigation funding arrangements like this one to stand will set a “very bad precedent” and “cause creditors that are financially well-heeled to figure out how to manipulate the bankruptcy system, especially in Chapter 7, to actually receive a greater recovery than they normally would by just using their ability to fund litigation.”

The case is Dean v. Seidel, 5th U.S. Circuit Court of Appeals, No. 21-10468.

For Dean: John Lewis Jr of Hayward

For Seidel: Kristian Gluck and Ryan Manns of Norton Rose Fulbright; and Julie Pettit and David Urteago of The Pettit Law Firm

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Maria Chutchian reports on corporate bankruptcies and restructurings. She can be reached at maria.chutchian@thomsonreuters.com.