In May 2020, Burford Managing Director Emily Slater and Counsel Robin Ganguly directed questions concerning the impact of Covid-19 and the downturn to a respected group of experts on bankruptcy and insolvency litigation, and their perspectives are gathered below.
The economic impact caused by Covid-19 has put the financial condition of companies in the spotlight, and we have already seen the failure of companies in some of the hardest-hit sectors, including Whiting Petroleum, Carluccio’s, Virgin Australia, J. Crew, Neiman Marcus and Hertz. How do you expect the bankruptcy litigation arena to unfold, and what types of claims do you predict will be most prevalent?
Derek Lai: Given the continuing economic environment, most companies will face a lot of business uncertainty. I believe that there will be increased demand for restructuring services and an increase in the number of liquidations. At the same time there may be an increase in fraudulent behavior as some companies try improper means to replace lost revenue in the marketplace. All of this will result in a rise in litigation arising from bankruptcy, including claims for breaches of fiduciary duties by directors. I believe litigation and the market for legal finance will continue to grow in the downturn as businesses are hit by the financial repercussions of the Covid-19 virus and the enforced lockdown, particularly in sectors like retail, automotive, travel and hospitality.
Margot MacInnis: The economic and political focus is to support companies as they navigate the challenges and financial strain of declining or suppressed revenue, and disruption to supply chains, workforce and cashflow. Despite the introduction of legislation by many countries to dampen the impact of these challenges, and to provide some temporary relief, we will undoubtedly see a number of restructurings and trading administrations in the coming months as insolvency and restructuring practitioners are called upon to find solutions.
Novel claims may arise against insurance companies, where there is disagreement over whether an entity’s business continuity policy should have covered its losses during the pandemic. In addition, in circumstances where suppliers and/or customers used force majeure principles to avoid contractual commitments, once the pandemic mist clears recourse to the courts over the use of these principles could be widespread.
Where significant restructurings have taken place, entities may also be on the defensive; a trend may appear where former or current employees bringing class action suits against companies who terminated or altered working arrangements with little employee consultation.
Jason Yardley: While the speed and intensity of the drop-off would have been difficult to predict, it has been clear for a long time that many of the underlying problems behind the 2008 crisis never went away: debt levels still sit at levels only sustainable while interests rates remain close to zero, covenant-lite lending is back with a vengeance, the inter-connected nature of the market makes the risk of economic contagion difficult to understand and predict (e.g., “Are CLOs the new CDOs?”), and so on.
Many companies have been operating on a basis that would not have survived a modest uptick in interest rates, let alone a global pandemic. In that context, as company failures increase, people will look for someone to blame. Fingers will be pointed at those responsible for the over-leveraging of companies, including the directors, sponsors and advisors who arranged and mis-sold debt. Audit negligence claims have been enjoying something of a renaissance recently, and auditors will face scrutiny.
Banks panicked by the wave of potential defaults and looking to shrink their loan books risk serious exposure. Overzealous behavior, including triggering events of default or using flex provisions to impose dramatically tougher terms, may tip over a company that might otherwise have soldiered on.
Certainly, there will be litigation over the valuation of assets, including under the archaic and impenetrable ISDA close-out provisions, and the meaning and operation of insolvency waterfalls. Presumably, there will also be claims related to MAC/MAE clauses, force majeure and frustration. The sheer number of corporate failures is likely to lead to more challenges to the fairness of some pre-pack administrations and schemes.
It’s also inevitable that the spotlight shone by insolvency will unearth many and substantial instances of fraud, including misstatements of assets or earnings that may have gone undetected, and the stripping of assets by shareholders and directors, including transfers at an undervalue, as it became clear the end was nigh.
Thomas Janover: Many US oil producers and the energy sector’s supporting companies will struggle to stay in business amid the worst crude market crash in history and the effects of the Covid-19 pandemic which has significantly suppressed demand for oil. The current collapse of the energy sector, coming on the heels of a period of robust M&A activity, will likely spawn significant fraudulent transfer litigations. These cases will focus on valuation testimony as to whether a debtor received reasonably equivalent value. Of course, the determination of reasonably equivalent value can be vexing, and it’s a costly fight among lawyers and experts.
The recent broader economic collapse has already triggered several breach of contract lawsuits, most notably, the effort by Sycamore Partners to challenge its agreement to take control of Victoria’s Secret that was made in February. I fully expect to see more of these litigations. That said, the turbulent economy may make settlements harder to achieve (as the spread between the bid and the ask gets wider), and puts pressure on the ability of winning parties to recover judgments.
Law firms and insolvency practitioners are reallocating and ramping up resources to handle a rush of business from companies in financial distress. What other measures can practitioners take to address the needs of distressed clients?
Thomas Janover: To serve distressed clients, sophisticated law firms will be able to make quick pivots of talent. Finance lawyers will focus on “amend and extend” transactions and DIP loans, and attorneys will seek out creative financing solutions for companies including, for example, bespoke securitizations. I believe that bankruptcy departments will undoubtedly expand, not necessarily by hiring laterally, but by repurposing under-utilized attorneys. Sophisticated advice on distressed investing advice and claims trading for creditors that may be required to trade distressed debt or distressed investors will be a premium.
Jason Yardley: At Jenner & Block we focus on disputes, including contentious insolvency, so it’s not so much a question of reallocating resources as it is bracing ourselves for the litigation wave that is surely coming. Already, we have been advising clients whose bank lenders have acted aggressively and precipitously to shrink their loan portfolios, ignoring legal fetters on their contractual discretions in a rush to manufacture events of default where none existed.
Any practitioners advising distressed clients facing aggressive and/or panicked lenders should be going back and looking closely at the various (often conflicting) cases on contractual discretions, including those on good faith, the Braganza duty, and so on.
Margot MacInnis: Now more than ever insolvency practitioners should be talking to clients about cash management measures, the need for financing, and the options available for temporary relief from creditor repayments. Informed decisions can only be made where a company fully understands its cash requirements in the short and medium term, and on a worst case basis for both scenarios. Stakeholders contemplating providing financial assistance to companies will not be able to support everyone to the same level.
Having a robust plan underpinned by credible financial forecasts will give comfort and clarity to a stakeholder and maximize the opportunity to access any necessary funding or relief. Insolvency practitioners can play two pivotal roles with respect to this: The first, providing the skills and experience to assist a business in preparing its cash analyses so they are credible when put before financiers; the second, where trust between the entity and financier is strained, by taking a seat on the board as an independent director.
Derek Lai: Restructuring, insolvency and forensic practices frequently consist of relatively small teams of people. At Deloitte we have a combined total of 500 people in our China restructuring and forensic teams. Although it’s quite a large outfit compared to other firms, it still represents only a small part of the China firm’s total workforce. So, we will be launching additional training workshops to expand training to other departments and harness additional resources so as to spread out the workload and ensure maximum efficiency.
We are actively encouraging our partners to reach out to their clients to assess their needs. As the adage goes, a friend in need is a friend indeed. By doing this, partners can better understand our clients, develop relationships, and not just bring in business in the short term. We are also working with various governments in the Asia Pacific region to help them deal with specific challenges, such as working with airlines on restructuring options.
Streamlining our risk management process is a priority so that we can assist our clients more quickly in a distressed market situation. We also need to put more effort into technology enabling solutions to facilitate efficiency and effectiveness in our work such as virtual meeting software, online response software, and enhanced digital deal rooms.
Do you expect to see an uptick in the number of bankruptcy-related actions being taken against directors, officers and advisors or sponsors and what are the respective challenges? Do you see the measures implemented by some governments to relax insolvency laws (such as the suspension of creditor rights and director wrongful trading provisions) limiting the number of actions available?
Margot MacInnis: To the extent some countries have introduced temporary measures and legislative changes designed to bring a reprieve to directors facing difficult decisions it is unlikely such measures will limit the potential actions. While director wrongful trading actions can be quite difficult to bring and particularly in the current environment, where the evidential hurdles will be challenging. It is more likely that insolvency practitioners will need to bring their experience and skill in the areas of lender negotiation, contingency planning, and stakeholder management to navigate the issues and deliver a solution that is fair and equitable to the parties.
Jason Yardley: I think it’s inevitable that such claims will increase as more companies fail. The temporary suspension of wrongful trading provisions and the imposition of a moratorium may be sensible and necessary in the current situation and may limit some types of claims. However, they will not absolve directors, sponsors and advisors from claims for negligence, mis-selling of shares or debt, fraudulent trading or asset stripping. The number of claims brought under s.423 of the Insolvency Act (“Transactions defrauding creditors”), for example, is bound to grow.
In terms of other challenges, social distancing may continue to make the gathering of evidence slower than it would otherwise have been (particularly for urgent, interim applications), and it remains to be seen how the courts’ move to remote hearings will cope with a significant uptick in cases. Whether we see any mega/systemic collapses, such as that of Lehman Brothers, with all the extraordinary challenges such events bring, remains to be seen.
Thomas Janover: Although there will be claims against directors and officers for alleged failures to anticipate the impact of a pandemic (or to mitigate the harm once news of its spread became public), courts in Delaware have made it increasingly difficult to sue directors and officers, by endorsing the terms of LLC operating agreements that have broad indemnity and exculpation provisions and by significantly limiting the direct duties of directors and officers to creditors.
Derek Lai: There will be an uptick in terms of bankruptcy-related actions against directors, officers and even auditors. Difficulties may be faced when attempting to purse such claims because there are still major restrictions on traveling, with a limited number of flights available. This will exacerbate previously encountered problems in accessing books and records and other documents which may be crucial for any contemplated legal action. Some distressed companies have reduced operations, laid-off staff and their information is often unstructured. Data deficiencies could cause a lot of difficulties in pursuing litigation.
In Hong Kong, the courts closed for two months or more, and litigation without courts is impossible. There is a backlog of cases which has accumulated in the courts, meaning even urgent applications may meet delays.
Hong Kong has been considering a formal corporate rescue procedure, similar to Chapter 11 in the US, for more than 15 years, but I understand that the government is now actively looking again at this.
With bankruptcies on the rise, do you expect an uptick in the use of legal finance in the insolvency context? Do you see the greater availability of legal finance now changing the dynamics compared with the 2008 financial crisis?
Derek Lai: I would expect an uptick in the use of legal finance but there may be a time gap. Once liquidators are appointed, they may not necessarily take immediate legal action. Getting access to the relevant books and records can take time, as does performing the necessary detailed analysis to prove there has been a misappropriation or dissipation of assets before liquidation. I think that we will see more and more, but probably in around half a year's time.
Generally there is a lot of support in the market nowadays for the use of legal finance as it offers support for liquidators in situations where a company’s funds have been exhausted or where its creditors do not want to risk their own, or the remaining funds in the liquidation, to pursue litigation. In those situations, liquidators will reach out to financiers like Burford to see if they would be interested in funding the proposed litigation.
Margot MacInnis: Legal finance will feature prominently in the coming wave of restructurings and insolvency and, unlike 2008, there is a greater availability of players in the market who are more sophisticated and experienced. Insolvency practitioners and judicial systems have also become increasingly familiar with legal finance through the tail of the 2008 financial crisis. Historically, the lack of available cash in an estate was a challenge for insolvency practitioners who found themselves with a strong case but few financial options. Legal finance provides real prospects of success for unlocking value through litigation action and recovery against third parties.
Thomas Janover: Legal finance permits creditors and estates to pursue valuable claims that otherwise may have been abandoned or otherwise cannot be settled quickly. I believe that with a dramatic increase in the number of Chapter 11 filings (particularly in the retail, energy and travel sectors), there will be significant opportunities for funders to provide non-recourse capital to estates and trusts that have litigation assets.
Jason Yardley: Two areas provide obviously fertile ground: Investment treaty arbitrations and insolvency claims. Both often involve very substantial and strong claims in the hands of claimants who have substantially reduced (if any) cash to fund the claims themselves, and we’ve seen an increased use of funding in both areas. Of the two, insolvency claims are the most straightforward. With the inevitable rise in corporate failures, coupled with increasingly sophisticated, tailored and competitive offerings from funders, I have no doubt that we will see more IPs and distressed companies turning to funders to bring their claims.
How can distressed companies or insolvency practitioners acting for companies in bankruptcy proceedings recover value for creditors by pursuing claims using legal finance?
Margot MacInnis: Where there is benefit and value to be unlocked for creditors in an insolvent or distressed estate by pursuing claims such as a breach of duty, wrongful trading, misrepresentation, negligence or even fraud, it requires an upfront investment of time and money to engage the advisors necessary to successfully pursue the claims. Sophisticated and financially strong finance providers can provide preliminary funding for the upfront costs associated with assessing the merits and viability of the claims, and they bring a wealth of experience to the assessment of high stakes commercial disputes. It is likely many insolvent estates won’t have the necessary funding or operational capital to take the initial steps to consider the type of claims and recoveries to return value to creditors.
Jason Yardley: Whether it’s distressed companies suing their over-aggressive lenders, IPs suing directors and auditors or creditors suing sponsors, we expect to see a significant increase in stakeholders looking to recoup their losses from those they hold responsible and consider to have deep enough pockets. Given the dire financial position in which Covid-19 will leave many of those stakeholders, legal finance will inevitably play a significant role in funding many of those claims.
Thomas Janover: Legal finance can be a valuable tool in a bankruptcy. The structure helps creditors and insolvency practitioners by bearing some of the risk of the ultimate recovery, and sophisticated creditors typically explore the opportunity to pursue claims on a contingency. As a cautionary note, in the largest restructuring cases, if there is outsized demand for straight pay bankruptcy attorneys at the top firms, there may be less incentive for those practitioners to seek financing.
Derek Lai: Liquidators or receivers can use legal finance to recover money if they have a solid claim and only need funding to bring a successful case. Although proceeds from successful litigation need to be shared with the legal financier who has provided the funding, there will still be a portion that will be distributed to the unsecured creditors. Without a litigation financier, in many cases litigation would not be possible and there would be no return at all, even though there might have been a strong case against the directors or auditors.
Thomas Janover Leads Kramer Levin’s Claims Trading and Investment Advice practice, a team of lawyers widely regarded by peers and clients as one of the finest in this area. For more than 25 years, he has represented hedge funds, investment banks and commercial banks in claims against companies undergoing financial restructuring, in bankruptcy or in other distressed circumstances.
Derek Lai Vice Chair of Deloitte China as well the leader of its Global Belt & Road program and its Value Creation & Crisis Group. He has specialized in corporate restructuring and insolvency in Hong Kong and mainland China for over 30 years.
Margot MacInnis Partner and the Managing Director of Grant Thornton Specialist Services leading their restructuring and insolvency practice in the Cayman Islands. She has been actively engaged in restructuring, insolvency and asset tracing cases for nearly 25 years and has been appointed liquidator on a number of high-profile cross border engagements. Margot is a board member of the Restructuring and Insolvency Association (RISA) in the Cayman Islands and a named thought leader by WWL.
Jason Yardley Partner and co-chair of Jenner & Block’s complex commercial litigation practice. Based in London, he has been recognized by Legal 500 UK and Chambers UK for his dispute resolution practice and 25 years of international litigation and arbitration experience handling complex commercial disputes.
Counsel with responsibility for assessing and underwriting legal risk, focusing on contentious insolvencies. Prior to joining Burford, 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.
Emily Slater | +1 212 235 6820 | firstname.lastname@example.org
Managing Director with responsibility for assessing and underwriting legal risk across a broad range of practice areas. Prior to joining Burford, she was a litigator at Debevoise & Plimpton, where she specialized in complex securities and other bet-the-company litigation and regulatory investigations involving billions in damages.