Tuesday November 10, 2020
Now we have entered the final quarter of 2020, we can begin to reflect on what many will look back on as an extremely difficult year. Eleven months on from the early signs of a ‘Boris bounce’ and the sense of greater certainty returning to the economy, many business leaders now find themselves addressing some of the greatest challenges of their careers in ensuring their company remains both operational and relevant in a rapidly changing landscape.
COVID-19 has brought change to all walks of life; although the true extent of its impact will be more latent for some businesses than others. This is particularly the case in the world of forensic services, where it may take months or years for corporate misdemeanours to come to light before being subsequently investigated or for the parties to corporate disputes to get to court.
Given the turbulent nature of the economy since March, it would be surprising if there has not been an increase in poor conduct amongst a minority of businesses – be that firms trying to keep their heads above water, or employees or external actors looking to use the situation to their commercial advantage. Businesses will be carefully reviewing the agreements they have in place with others and considering whether and how terms can potentially be renegotiated or agreements terminated altogether. Businesses will also be counting the cost of the pandemic and considering whether some or all of the cost can be recovered through their insurance cover. As such, we would expect to see a large increase in forensic investigations and dispute services work during 2021.
The first, perhaps most common, of these disputes may well be an increase in business insurance claims. Notably, the High Court recently ruled in favour of the tens of thousands of small businesses who had business interruption claims rejected or challenged by their insurers on the grounds that their business interruption policies did not provide cover in the circumstances of the COVID-19 pandemic. The ruling is estimated to affect 370,000 businesses and very large sums in potential insurance claims.
The test case was brought, on behalf of policyholders by the Financial Conduct Authority (FCA) to remove the need for policyholders to resolve certain key issues individually with their insurers. However, while helping to expedite the claim process and clarifying that certain types of clauses would likely provide cover, the High Court ruled that each policy would still need to be considered on its own merits against the detailed judgement. The judgement is also in the process of being appealed by the FCA and insurers alike. Fundamentally, the judgement does not determine how much is payable under any given policy, although it provides a basis to do so.
For those considering filing a claim, it may be worth seeking advice on how the claim being filed relates to the specific policy wording in the insurance policy and, in particular, that all types of loss that could be claimed are included and have been calculated appropriately.
Compared to the US, the UK is still a relatively new jurisdiction for multiparty litigation and collective redress claims (the equivalent of ‘class actions’ in the US). It has been reported that numerous class actions have been filed in the US and in Canada in relation to COVID-19. For instance, in the US it has been reported that there have been several class actions brought by passengers against airlines seeking refunds and damages for flights cancelled due to COVID-19.
Although it does not appear that such trends are as prevalent in the UK, there are reports of claimant groups being assembled and evidence from litigation funders anticipating new opportunities in 2021.
Other areas in which collective redress actions may arise, depending on the legal case, include consumer claims as a result of booking cancellations and service disruption. Other cases may revolve around alleged anti-competitive behaviour in the sales of certain PPE products and securities actions arising from false or misleading forecasts made by businesses. Claims relating to data and/or cyber breaches are also likely to be prevalent due to the heightened risk of data security incidents occurring as people increasingly work from home, and of the potential misuse of data gathered in the interests of public health needs.
We can expect transactional disputes to become more prevalent in the next 12-18 months. With M&A activity slowing significantly from the second quarter of the year, many corporates and private equity houses will likely have used the pandemic as an opportunity to review and shore up their existing portfolios and recent deals. In doing so, they will have undoubtedly explored their upcoming outlays in terms of deferred payments to the former owners of their portfolio or acquired businesses and whether the price and deferred payments agreed still represent true market value.
With the benefit of hindsight, we should now see an increase in purchasers and sellers modelling complex pricing or price adjustment clauses during the contractual negotiation phase of any new sale to avoid unintended consequences post-completion.
From a quantum perspective, if transactional disputes do arise as a result of the pandemic, they may well revolve around warranties and indemnities, which are often keenly debated during contractual negotiations prior to sale and are increasingly subject to separate insurance to reduce risk for purchasers and sellers. However, lawyers also expect that rarely triggered contractual clauses and legal doctrines will likely be invoked, including covenants on ‘ordinary course of business’ and ‘material adverse effect clauses’ which can be open to subjective interpretation.
For example, the luxury goods conglomerate, LVMH, was recently in dispute with the jewellery company Tiffany & Co over claims that its trading had been impacted by material adverse effect due to the pandemic. Similarly, Sycamore Partners reached an agreement to terminate its acquisition of a majority stake in Victoria’s Secret with its parent company, L Brands, amidst allegations that COVID-19 brought into play a material adverse effect clause in the parties’ agreement, enabling it to walk away from the deal.
These cases reinforce the fact that good digital housekeeping takes on even greater relevance when selling a business. There is a temptation to think that signing and completing the deal is the end of it, but business owners should be aware of what financial information they hold and what may be needed in case of a potential breach of warranty claim from the purchaser post-completion.
Similarly, contractual disputes are also likely to arise between firms and their clients or supply chains based on whether goods or services have been provided in full, whether contracts may have been unable to be performed for a period of time or terminated without good cause. In terms of the quantification of any claim, the nature of the triggering event, the start and end dates for the claim, additional costs necessarily incurred by businesses, as well as the possibility that the effects of the pandemic continue into the future, will all likely be important factors in determining losses suffered by businesses. Businesses would be advised to examine and test complex financial or payment clauses of any contracts prior to signing to ensure that they are aligned with the commercial reality that the parties intended. This may be all the more important for contracts entered into during the pandemic, given the continuing economic and financial uncertainty for a number of businesses.
We will likely begin to see an uptick in the number of cases brought to court regarding fraudulent activity from company directors and employees, be that opportunistic or to protect livelihoods. The financial impact of COVID-19 may increase the pressure on companies to continue as a going concern, hit financial targets, meet bank covenants and be able to pay employees and creditors, which could lead to manipulation of financial results.
For example, corporate accountants may be tempted to fraudulently overstate earnings or exploit revenue recognition policies, or conversely use the pandemic to create a ‘cookie jar’ of unnecessary provisions to smooth earnings in future periods. Individual employees may be concerned about job security and pay reductions, increasing the risk of misappropriation of assets.
Certain aspects of the pandemic may also assist fraudulent activities. For example, management’s focus may have shifted to cashflow in ‘crisis management’ as opposed to internal controls and remote working and furloughing of staff may lead to reduced or more complicated oversight and issues with separation of duties.
Adding to this anticipated rise in legal activity is the fact that the funding landscape for legal actions has changed significantly in the last 10 years. Following the last recession, we saw a spike in investigations and litigation cases being brought forward. However, this time round, the figures are likely to be higher due to an increase in litigation funders on the market and increased sophistication in the way that cases are funded.
With many businesses facing mounting cashflow problems as a result of the pandemic, litigation funding provides claimants with the opportunity to bring meritorious legal cases earlier than may otherwise be the case, as opposed to waiting for cashflow or balance sheets to recover and stabilise (which could take months or years). Litigation funders are often keen to understand indicatively how much a claim is worth prior to filing, which can involve the input of a forensic accountant at an early stage.
Businesses therefore need to be prepared to put their best foot forward should they be likely to enter into a dispute in the coming months. Companies considering claims should look to review their data management and storage as these disputes typically involve large volumes of data. Ensuring a good understanding of the infrastructure and storage now should help to reduce difficulties down the line. It will also be important to retain, gather and evaluate all relevant financial documentation supporting a claim at the time as this can be difficult to pull together retrospectively should queries be raised during the legal process several months or years after the event.
Businesses need to be prepared to put their best foot forward should they be likely to enter into a dispute in the coming months.Nishad Morjaria Forensic Services