As industries grapple with a rising number of bankruptcies, stakeholders should seek innovative solutions like legal finance to ensure creditors are made whole.
Recession fears are back in full force with 97 percent of US CFOs surveyed by Deloitte in the fourth quarter of 2019 expecting an economic downturn in 2020. It is clear that we should expect ongoing turbulent economic conditions, given not only such CFO jitters but also Brexit uncertainty, a potential pandemic, tensions in Iran, and China—the world’s second largest economy—expanding at its slowest pace since the early 1990s. We at Burford expect an increase in active bankruptcy and restructuring in the coming year, and we anticipate this will result in a rise in demand for legal finance. Below, we explain some of the key trends in the bankruptcy space.
Insolvency in Asia will increase
As the Chinese economy has slowed, there has been a sharp increase in insolvency activity in the region, particularly in Hong Kong where businesses are so closely connected to the mainland Chinese economy. As a result of deteriorating economic conditions, Chinese parent companies are failing to meet obligations to (or otherwise support) subsidiaries based in Hong Kong and elsewhere. When these subsidiaries fail, liquidators are appointed and fraud and mismanagement are exposed, and this activity is driving requests for legal finance. The redress sought is often in Hong Kong and elsewhere in Asia, as well as Cayman, BVI and other offshore jurisdictions frequently used to structure international transactions. As the number of insolvencies has increased, so too have requests for legal finance throughout Asia. While litigation and enforcement in China itself present significant challenges to funding, Burford takes seriously the clear demand for outside capital and intends to explore potential opportunities; we have a presence in Asia primarily through our Singapore office, and we have Mandarin language capability.
Legal finance will enter new markets via insolvency
Many jurisdictions severely restrict or prevent law firms from acting on risk, which can prevent resource-constrained parties from pursuing meritorious legal claims. This is especially problematic in bankruptcy situations, where there often are limited funds available in the estate to pursue litigation—even if high-value claims represent the estate’s most valuable asset and creditors’ best path to recovery. For this reason, insolvency is often one of the first ways in which legal finance is used in new jurisdictions. And as the success of legal finance has been borne out in the largest and most established legal markets, bankruptcy professionals and local courts are seeking to allow and enshrine its use in less established jurisdictions, as has recently been the case in the Channel Islands.
Use of portfolio finance will continue to grow
We anticipate that portfolio finance arrangements, where capital for multiple claims is provided under a single funding agreement, will become more commonplace in the bankruptcy context. Because matters in a portfolio are “cross-collateralized” (meaning the funder can take its full entitlement from any case that wins), clients gain access to greater flexibility: They have an opportunity to potentially finance a mix of affirmative and defense cases or to pursue cases where the economics would not support funding on a stand alone basis (e.g., small or more speculative claims). Cross-collateralization also allows for more competitive pricing of funds given the reduced risk to the funder. Given these advantages, portfolio finance will prove to be even more attractive to bankruptcy professionals and their lawyers as they increasingly pursue complex international cases across jurisdictions.
Geopolitical uncertainty will impact the economic climate
Political influences, including ongoing US-China trade tensions, Brexit uncertainty, international sanctions and disruption to international oil shipments involving Iran mean that the global economy is likely to remain volatile in the coming year. These factors threaten organizational structures built for an age of open trade. This geopolitical uncertainty will exacerbate any weakness in economic conditions and may push organizations into bankruptcy.
Potential recession will drive use of legal finance in bankruptcy context
The buzz around the inevitability of the next recession continues, and in 2020 we expect it to build momentum. Indeed, as reported in The Wall Street Journal, according to the Duke University/CFO Global Business Outlook, there is a clear consensus that a downturn is coming, with the majority predicting the US economy will enter a recession by the third quarter of 2020.1Should a recession occur, we anticipate that legal finance will play a significant role in the bankruptcy context—simply because it is more widely available and better understood now compared to the global financial crisis in 2008. Not only have more jurisdictions sanctioned the use of outside capital, but the amount of legal capital available has grown exponentially over the past decade. As just one point of reference, Burford launched in 2009 with a $130 million IPO; In 2018, we reported a $3.2 billion investment portfolio.2 Additionally, as the legal finance market has matured, bankruptcy professionals have grown to better understand how legal finance can enhance returns to creditors. Some practitioners have even explored selling their claims outright, which can in turn enable them to investigate and seed further claims that can be financed and litigated. Combined, these factors will undoubtedly lead to more litigation, as claims that in recessions past could not have been brought, are brought.
The specific triggers of the next global recession or regional downturns and the types of claims that will result from them are unknown. What is for sure is that, with the growing availability of legal finance, professionals are more comprehensively equipped to secure redress for creditors and wronged parties than ever before.
Robin Ganguly is Counsel with responsibility for assessing and underwriting legal risk, focusing on contentious insolvencies. Previously, he spent almost a decade at Magic Circle firm Linklaters before moving to Silver Circle firm Berwin Leighton Paisner (now Bryan Cave Leighton Paisner), where he developed and led the contentious insolvency practice.
Jessica Woodhouse is a Vice President with responsibility for developing and executing strategic business development initiatives, as well as building and expanding Burford’s relationships with third parties and alliance partners. Prior to joining Burford, Jessica was Vice President of Business Development for LicenseLogix, where she built and ran a national alliances program. Previously she was an associate at Latham & Watkins.