Bankruptcy and insolvency proceedings generate a steady stream of litigation, fraudulent transfer claims, preference actions, breach of fiduciary duty suits against former officers and directors, that a trustee or debtor-in-possession often cannot afford to pursue out of a depleted estate. Litigation funding fills that gap: a funder provides non-recourse capital to prosecute the claim, and creditors benefit from the trustee's resulting ability to pursue matters that would otherwise be abandoned or settled at a steep discount purely for lack of funds.
Structurally, these arrangements are set up either as a non-recourse loan against expected proceeds or as an outright purchase of a share of the claim's proceeds, with the funder bearing full downside if the litigation fails. In most cases, the debtor, trustee, or creditors' committee must obtain bankruptcy court approval before entering into the funding arrangement, since it affects the administration of the estate; notably, post-confirmation litigation trusts generally do not need separate court approval to obtain financing.
The practice has grown steadily as bankruptcy practitioners and courts have become more comfortable with it, and it is increasingly treated as a standard tool, alongside traditional contingency-fee arrangements, for maximizing creditor recoveries from estate litigation that would otherwise go unpursued.