Washington Mutual Inc. unveiled a new proposed settlement with shareholders who have held up confirmation of its Chapter 11 plan and a $7 billion payday for creditors.

The proposed pact, unveiled Monday, is set for its first test Jan. 11 in the U.S. Bankruptcy Court in Wilmington, Del., where a judge has twice rejected Washington Mutual's Chapter 11 plan. In a release, the company said it hopes to be out of bankruptcy by the end of February.

Much like an earlier settlement attempt that failed in the spring, the new proposal shakes some cash loose from senior creditors for distribution to shareholders who were left with nothing under earlier versions of the plan.

Shareholders agreed to drop accusations of insider trading aimed at major hedge funds that invested in Washington Mutual's debt while the company was bargaining the terms of the Chapter 11 plan. Appaloosa Capital Management, Aurelius Capital Management, Centerbridge Capital Partners and Owl Creek Capital Management, the accused hedge funds, have denied wrongdoing.

In return, shareholders get equity in the reorganized company, which will run a fading insurance operation and attempt to capitalize on tax breaks.

Senior creditors, owed $5.75 billion, are contributing $75 million to get the reorganized company off to a good start, while the accused hedge funds provide a $125 million senior secured loan to the new entity.

The insider-trading charges set off alarms in the distressed-debt industry, where hedge funds buy and sell heavily discounted debt while trying to sway the course of big Chapter 11 cases. All four accused hedge funds appealed the Washington Mutual ruling that said shareholders had sketched out the basics of a case against them.

In the end, however, practicality prevailed, driving a settlement that means a faster payday for most creditors. Each month of delay ate at least $30 million out of the assets available for creditors at the bottom of the rankings in the case, lawyers have estimated.

Payday for Washington Mutual creditors, when it finally arrives, still means huge profits for many investors that gambled on the company's debt when it was selling for pennies on the dollar at the height of anxiety about the strength of the U.S. financial system.

Investors who bought senior debt will get 100 cents on the dollar plus their contract rate of interest under Washington Mutual's plan.

Much of the money Washington Mutual expects to pay out comes from tax refunds triggered by the same event that plunged the company into bankruptcy--the September 2008 regulatory seizure of Washington Mutual Bank, or WaMu.

Stuffed with chancy mortgages, WaMu was grabbed by banking authorities and sold to J.P. Morgan Chase & Co. (JPM) in a hasty deal that sparked a storm of litigation. Among other things, J.P. Morgan claimed the right to hold on to $4 billion the parent company had on deposit with WaMu when it went under in the biggest banking collapse in U.S. history.

WaMu's failure also generated billions of dollars tax breaks for J.P. Morgan and Washington Mutual to fight over. They agreed to split up the tax money, giving some to the Federal Deposit Insurance Corp. The FDIC brokered the sale and is in charge of finding money for creditors of WaMu in a proceeding separate from the parent company's Chapter 11 bankruptcy.

Washington Mutual's core Chapter 11 plan settlement has already passed muster in court. Defects in other areas of the earlier versions of the plan, as well as the accusations that big investors profited from inside knowledge, have kept Washington Mutual and its billions bottled up in bankruptcy court.

In addition to the reorganized company, the new Chapter 11 plan offers future recovery from proceeds of lawsuits that will be pursued by a litigation trust, to be funded with from $50 million to $60 million.

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