Risk & Economy » How will a recession affect the insolvency and litigation landscapes?

How will a recession affect the insolvency and litigation landscapes?

Tim Symes and Jack Barlow of litigation specialists Stewarts reflect on how the recession will impact the litigation landscape amid rising inflation and interest rates, and the types of claims that we’re likely to see more of

How will a recession affect the insolvency and litigation landscapes?

UK businesses are facing unprecedented challenges. Many of those that survived the hardship and headwinds of the pandemic did so, in part, because of government support and bars on creditors winding them up. Then, just as the measures are lifted and businesses try to get back on their feet, bigger issues threaten their existence.

The perfect storm

The cost of living is increasing at almost its quickest rate in 40 years. The Office for National Statistics has indicated that prices in August were 9.9% higher than they were 12 months earlier. Predictions are that inflation will continue to rise.

Russia’s invasion of Ukraine has impacted businesses globally. Ukraine is one of the world’s largest exporters of grains and oilseeds. The war has resulted in a massive decline in the supply of major staple foods, leading to a rise in food prices and unprecedented increases in energy prices.

Interest rate rises are a serious problem for businesses. During the pandemic, many took on debt when they were not generating income and have only survived due to low interest rates. They now face higher borrowing and energy costs, as well as a drop in consumer spending and inflation. Lenders will become more cautious as they start to experience failures in their existing book, stifling growth in viable companies wishing to borrow and the ability for others to restructure their debt to survive.

Chancellor Kwasi Kwarteng’s mini-Budget on September 23 caused shockwaves through the financial markets, a slump in the pound and a potential acceleration in interest rate rises and inflation. This is burdening businesses yet further with higher debt costs and more expensive raw materials exports.

These multiple threats have set the UK on a path of economic turmoil and pain. The consequences are likely to be a significant uptick in insolvencies and an increase in legal disputes.

Insolvency-related litigation

The insolvency figures for this calendar year are alarming. The end of the Covid-19 fiscal support and creditor protections, led to 5,629 registered company insolvencies between April 1, 2022, and June 30, 2022 – representing a twelve-year high. The number of businesses entering insolvency is likely to increase dramatically in the coming months.

Insolvency officeholders (i.e. liquidators and administrators) will play a vital role in helping businesses survive where possible or otherwise achieving maximum returns to creditors.

As well as selling off tangible assets, insolvency officeholders will look to monetise legal claims to bring money into the company. Those might be insolvency-specific claims that only they have the power to bring, such as unwinding questionable transactions with connected parties where money or assets have been siphoned out. Or they could be any number of ordinary commercial litigation claims, some of which we look at below.

History tells us that economic downturns lead to an upturn in fraud. When a company is insolvent or on the verge of insolvency, its directors must have regard to the creditors of the company, not just the shareholders. This is often a difficult shift in mind-set for directors, which can get them into legal hot water.

Wrongdoing is often only uncovered once an officeholder has ‘lifted the bonnet’ of a company by deploying the extensive investigatory powers statute gives them.

In the coming months and years, we can expect to see claims against directors for wrongful trading, fraudulent trading and misfeasance increase significantly.

General litigation:

General litigation claims are likely to increase across the board, but we see two key categories where claims will rise.

Negligence

In the aftermath of the financial crisis of 2008/2009, the number of claims for professional negligence rose considerably. Lenders were at the vanguard, targeting solicitors and surveyors to counter the increasing levels of defaults causing them loss. The pattern will likely repeat itself as interest rates rise, with claims focusing on the integrity of professional advice and valuations relied on to lend.

Auditors will face growing legal challenges to their audits where they can be held responsible for causing a company loss. In recent times, they have been publicly criticised for failing to identify issues with failing companies that would have minimised or prevented losses to stakeholders had they been flagged.

Banks will increasingly be targeted for negligence-based claims, particularly where the bank has been used in a fraud. Banks must reasonably follow their clients’ instructions but will also be expected to protect their customers in certain circumstances where a fraud may be at play. This is known as the Quincecare duty. As fraud rises, the potential for instances of liability by banks to Quincecare claims may track that rise.

Greenwashing

Environmental, social and corporate governance (ESG) litigation has become a hot topic this year. A recession will likely increase the scope of potential actions against businesses in the ESG sphere.

Companies will be desperate to attract investment and build customers during the downturn. One potential way to do that is to emphasise their green credentials. If listed companies over-represent or even falsify their achievements in this regard and shareholders suffer a loss as a result, they could be vulnerable to large claims by shareholders either individually or as a group under financial services and markets legislation.

Monetise disputes

A recession means more insolvencies, which means more litigation. Surviving companies will look to monetise their disputes as they seek ways to raise revenue. Liquidators will do the same for creditors of failed entities. The modern marketplace of insurers and funders stand ready to de-risk and fund large-scale litigation. This will enable companies to pursue claims as a viable means of bringing money into the business, but this in itself will contribute to the rise in litigation.

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