A bankruptcy judge signed off on a $180 million settlement of a
Sears
Holdings Corp. creditor lawsuit against former Chairman Edward S. Lampert and other executives, clearing the final hurdle for the retailer to wrap up its chapter 11 case after four years.

The lawsuit, filed in the spring of 2019 by unsecured creditors, initially sought $2 billion in damages, saying the shareholders and executives drained the retailer of its most valuable assets while losses piled up in the years leading up to bankruptcy. The suit has been the last outstanding issue before Sears’s restructuring plan, which was approved by the bankruptcy court in October 2019, can take effect.

The approval of the settlement on Wednesday by Judge

Robert Drain
of the U.S. Bankruptcy Court in White Plains, N.Y., paves the way for the Sears bankruptcy estate to pay essential bills, including payments to suppliers who have been waiting for their money during years of court fights.

The bulk of the settlement funds—$125 million—will come from insurance policies paid out on behalf of Sears’s directors and officers, court filings show. Defendants in the lawsuit will pay nearly $42 million, including a roughly $3 million contribution from Mr. Lampert’s hedge fund ESL Investments Inc., court filings show. Other Sears shareholders will pay about $7 million, filings show.

A spokesman for ESL declined to comment.

The Hoffman Estates, Illinois-based department-store chain filed for bankruptcy in the fall of 2018 after vendors stopped shipping goods following years of losses. About a year later, Judge Drain had approved Sears’s restructuring plan but he kept the case open because there wasn’t enough money in the estate to pay off the company’s essential bills in full. The Sears estate was at least $100 million short of funds at that time.

In the lawsuit, Sears’s unsecured creditors committee had alleged ESL and other Sears shareholders illegally transferred assets valued at roughly $2 billion, including
Lands’ End Inc.
and some of the retailer’s best real estate, out of the company and into Mr. Lampert’s own hands and to real-estate firm
Seritage Growth Properties.

Mr. Lampert, ESL and Seritage disputed the lawsuit’s allegations.

As of January, the company’s suppliers, who rank among top-tier creditors, were owed $60 million, court filings show. At the time the company and its official unsecured creditors committee had estimated the lawsuit against ESL and other parties would yield $334 million or more.

The final settlement is much smaller than the initial estimates, but it will allow Sears’s foreign vendors, who mounted the most significant opposition to the restructuring plan, to have their bills paid after three years of court fights.

Winners Industry Co., a China-based manufacturer of Christmas trees, will finally get the $3 million it was owed for supplying goods to Sears four years after the case was filed, said Jeffrey Schwartz, a lawyer for Winners.

Ray Schrock, the bankruptcy lawyer representing Sears, said at the hearing on Wednesday the case is expected to officially close in 30 to 60 days.

The settlement proceeds, however, are unlikely to be enough to pay anything to unsecured creditors, who originally brought the lawsuit against Mr. Lampert and others.

Lawyers at Akin Gump Strauss Hauer & Feld LLP representing Sears’s unsecured creditors committee had proposed borrowing $35 million to keep pursuing the lawsuit against ESL after they used up $25 million on the litigation fees.

Akin Gump didn’t immediately respond to calls seeking comment.

A number of Sears creditors opposed taking on the financing, including Wilmington Trust, which represents second-lien creditors and the representative for vendors and other so-called administrative creditors who must be paid in full.

“Knowing for certain after all of this time that an effective date in this case will be coming shortly should be incredible news for many creditors in this case, and particularly the administrative creditors,” Erika Morabito, lawyer for the administrative creditors, said in an emailed statement Wednesday.

The settlement grew out of months of negotiations facilitated by two retired bankruptcy judges and a mediator.

On Wednesday, Sears also reached additional settlements, agreeing to pay $10 million each to Pension Benefit Guaranty Corp., a U.S. retirement insurer, and Cyrus Capital Partners LP, a second-lien debt holder who teamed up with ESL to purchase Sears’s best stores.

Write to Soma Biswas at soma.biswas@wsj.com