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 perspective is excerpted and gathered below.
Thomas Janover, Partner, Kramer Levin
Derek Lai, Vice Chair, Deloitte China
Margot MacInnis, Managing Director, Grant Thornton
Jason Yardley, Partner & Co-Chair of Complex Commercial Litigation practice, Jenner & Block
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.
Read more of "Restructuring roundtable: Unlocking liquidity with legal assets."
Part I • Part II
To read the article in full, download the Issue 3 Burford Quarterly 2020