Corporate insolvencies are on the rise globally, with many countries seeing more than a 30% increase. This is due to rising economic pressures: Cheaper debt that was available over the last 10 years is now gone. Companies took on high levels of borrowing during the pandemic, and rising interest rates have made it difficult to service that debt. Companies face difficulties refinancing, particularly given the large number of bonds maturing in the second quarter. Further, it’s likely that global headwinds will continue into the new year, with some brief respite over the festive season, leading to the rising insolvencies into 2024 as costs increase, demand for higher wages increase and consumer spend tightens.
We recently held a webcast with Rob Armstrong of Kroll and Paul Quinn of Kirkland & Ellis to discuss the trends they see in the insolvency space in EMEA and APAC and the role of legal finance. Below are the key takeaways from this discussion.
Global insolvency trends
Insolvencies have become increasingly common in the technology sector as pre-revenue start-ups with large cash burns continue to trade, typically using money from alternative lenders or Private Equity funds. With lenders becoming more circumspect with respect to their investment portfolios and drawdowns continuing, the next tranche of investment is becoming more difficult for these types of tech companies.
Other sectors with high levels of insolvency activity include Chinese property and real estate development, cryptocurrency platforms and operations, as well as businesses with high-cost bases, such as manufacturing.
Dealing with disputes within insolvent estates
Disputes arising from insolvency scenarios have remained consistent over the last 10 to 20 years. Fraud, breach of fiduciary duty claims against directors, professional negligence claims against advisors, unjust enrichment and dishonest assistance claims against banks or others that have benefited from the wrongdoing or the collapse in one way or another, remain common.
The main challenge for insolvency practitioners (IPs) with limited funds dealing with disputes against sophisticated parties (e.g., claims against banks, lawyers, accountants and auditors), is that defendants commonly employ tactics to drag out the litigation and make it even more expensive. Increasingly, those accused of engaging in fraudulent conduct are responding with allegations directly against the IPs [QP1] of dishonesty or other misconduct—these underhanded maneuvers are onerous to deal with and lead to further cost, delay and distraction from the estate’s claims. IPs should stand firm on these issues and show that they won’t be intimidated away from pursuing meritorious claims.
It is also important for IPs and their lawyers to prioritize which claims to pursue, especially when faced with limited resources and several potential disputes. Clearly, there is no point litigating a claim where the economics don’t make sense to do so, for example if the defendant has limited resources. Secondly, the merits must be strong, and the claim must be in the best interest of the estate as a whole. Often creditors feel wronged by a situation in which they have lost money and will be the loud voice within the liquidation. It is important for an IP to remain dispassionate and take a commercial view of the claim.
Indeed, as Paul Quinn notes, “Emotions can run high, and lawyers have a tendency to get overly attached to clever arguments or the merits of the case that they're really keen to run to trial. And this is where [IPs] are so valuable to provide a bit of a reality check, so that you don’t lose sight of the economics, what you're doing this for and the end goal.”
Finally, IPs should be prepared for the long haul. This means having funding arrangements in place (whether this is though contingency fee arrangements, creditor funding or third party funding) having the support of the stakeholders within the insolvency estate and ensuring the right professionals are involved.
Use of legal finance to recover value for creditors
IPs have a duty to try to realize assets, including potential claims within the estate. A lack of initial funds shouldn't be a bar to an IP pursuing potential claims that would return value to the creditors.
There are a few different ways to fund claims in the insolvency context. Creditors who have a direct financial interest in the insolvent estate can be willing to fund. However, the risk with creditors is when they realize they are in a long and expensive litigation they did not anticipate. A few years down the line they may start to lose their appetite for further litigation expense.
Additionally, subject to local law restrictions, some lawyers will take claims on conditional fee (CFA) or damages-based agreements (DBA). However, bringing claims against banks, auditors and solicitors, which require expert reports and other significant disbursements, presents law firms with significant risk. For the larger, more complex insolvency disputes, a different funded approach may be warranted.
As insolvencies rise globally, legal finance is an increasingly relevant solution. Legal finance providers have long had experience in litigating the types of claims that arise in an insolvency context. They not only provide immediate cashflow for IPs and their advisors to prosecute claims but can also provide a degree of objectivity to help stress test some of the thinking around strategy, merits and budget. While legal finance providers do not control matters, they can be a good resource for IPs to use a sounding board, particularly given the focus funders naturally have on the economics of potential claims.
Watch the webcast in full