Restructuring roundtable: Unlocking liquidity with legal assets (Part II)
In May 2020, Burford Managing Director Emily Slater 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
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.
Read more of "Restructuring roundtable: Unlocking liquidity with legal assets."
Part I • Part II
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