The Commercial Litigation Summit 2016: Dangerous territory

In an unusual session, Legal Business united top M&A lawyers and litigators to forecast the next wave of disputes to come when the deal cycle turns

It is a received wisdom of the legal industry that the economic cycle inevitably turns from market excesses and greed of the boom to the recrimination and disputes in the following recession. Yet in detail, the pattern – and corresponding risks – never play out the same way.

To close Legal Business‘s 2016 Commercial Litigation Summit, we called in some of the City’s top M&A veterans, including Freshfields Bruckhaus Deringer heavyweight Mark Rawlinson and Herbert Smith Freehills (HSF) senior partner James Palmer, to gauge how the current wave of corporate activity is storing up risks… and potential disputes down the line.

Rawlinson kicked off by noting that hard-won experience goes a long way in anticipating problems. ‘My dad always used to say wisdom is learned mistakes. I have had clients say: ‘That is a really good point. How did you come across that?’ You say: ‘It is something I nearly made a mistake on in a previous deal.’

‘A public M&A deal is two or three days of executives talking. If it is a bad deal, the shareholders suffer, but in the UK it is bloody difficult for shareholders to sue.’
Mark Rawlinson, Freshfields Bruckhaus Deringer

Noting a formative experience as a young corporate lawyer on the notorious Guinness/Distillers share-trading fraud in the 1980s, Rawlinson added: ‘It gave me a sort of sixth sense. It was like having this garden gnome sitting on your shoulder; when you did things, you looked at it and said: ‘How would that look if a regulator came to analyse it after the event? How am I going to do it differently? How am I going to protect the client?’

Palmer – who argued that ‘the level of latent risk in business is as great as it has ever been’ – began by stressing the need to focus on patterns of corporate behaviour. ‘I am a great believer in going back to first principles. You ask: “Where are the areas that people have taken on legal duties that they have not focused on?” That is the simple core of where you get litigation. I have seen contractual arrangements or practices where someone cannot articulate why the provisions are as they are and will just tell you it is market standard. Those are the areas I always worry about.’

Reworking Rawlinson’s opening remarks, Palmer noted the perennial problem of short memories in the City, asking: ‘How many people here remember the Co-operative Wholesale [Serious Fraud Office (SFO)] investigation? That was one of the biggest scandals of the early 1990s in the City and everyone has forgotten about it.’

Pinsent Masons corporate crime head Barry Vitou highlighted the stark realities of proliferating regulation on the business community. ‘We are in an environment the like of which I cannot remember in terms of the desire to regulate and legislate for everything, probably because the legislators have no money to do much else. What that ends up with is a fairly toxic cocktail.’

Developing the theme, Vitou noted that the widening of the regulatory net was now catching much larger companies, adding: ‘A decade ago, these things were outliers. The Co-op was an outlier. BCCI was an outlier. Now look at the SFO’s top ten cases. It was pretty inconceivable to me that you would have GSK, Rolls-Royce, Barclays – a whole host of big corporates – all under ongoing SFO criminal investigations.’

Noting the dramatic expansion of warranties in corporate transactions over the last 20 years in response to expanding compliance liabilities, Vitou concluded: ‘The regulatory burden will continue to grow. That will have all sorts of consequences, intended and some unintended, which will create difficulty, and parallel civil litigation will flow from that.’

Taylor Wessing disputes head Shane Gleghorn picked up the point, commenting: ‘The sanctions of all the regulators are now being turned very much towards the individual and they are trying to criminalise their conduct. Whereas before it was not criminal conduct, they are trying to re-characterise it.’

Rawlinson argued that the risk from regulation and claims was leading companies to avoid certain markets altogether, even large markets. ‘If you were the GC of an oil company, you would think twice about having assets in North America. I have known lots of discussions on boards where they have North American assets and they are beginning to say: “Is it worth us being here?” Talking about the rule of law in the US, the [Department of Justice] is just arbitrary in terms of how it goes about things. One of my clients said: “Hydrocarbons are essentially unstable.” Things happen and, if you are in the US, you are in a mess.’

If it’s a bad deal

Despite a robust run of deal activity in 2014 and 2015, the panel did not think the market had recently come anywhere near to the excesses seen during the mid-2000s boom. ‘People are more cautious,’ said Palmer. ‘It is blindingly obvious that the banks are being much more cautious; big corporates are on the whole more cautious, because there is still the risk of getting it wrong rather than the risk of missing the opportunity. In 2005, 2006 and 2007 everyone was talking about the risk of missing the opportunity – words that always fill me with nervousness.’

But despite the confidence that regulated lenders are now in better shape than before the credit crunch, Palmer expressed unease that the finance sector is pushing risks into the shadow banking sector of funds and sponsors, with uncertain consequences. He added: ‘The Prudential Regulation Authority, the Bank of England, the Fed and others are really worried in terms of systemic risk and solvency risk, which clearly could drive litigation.’

Turning to the risks from public deals, Rawlinson conceded that big-ticket M&A was sometimes agreed quickly but noted that the English courts have been slow to allow recourse for mis-firing acquisitions. ‘A public M&A deal is probably two or three days of executives talking to each other and getting a feel for what is going on. You can negotiate the agreements over a weekend. There are not loads of reps, warranties and indemnities; if it is a bad deal, the shareholders suffer, but in the UK it is bloody difficult for shareholders to sue boards.’

Nevertheless, some of the panel felt the chances of such derivatives actions or group actions were increasing, with Addleshaw Goddard litigation partner Louisa Caswell arguing: ‘It is getting easier with the funders. That is the big focus of third-party litigation funders: large group-action shareholder disputes. They are looking for opportunities.’

Palmer agreed there would be more scope for such claims.

‘The statutory provisions under English law give much more flexibility for bringing a derivative claim for any breach of duty than the courts have enforced, but we will at some stage get a case on the facts that starts to change that. It is public that The Royal Bank of Scotland and Lloyds have very public shareholder actions that are soaking up huge amounts of our teams and there are a number of others. We certainly think the risk profile around those has changed.’

Reputations in the dock

A theme developed in the discussion was that corporate reputations, once distinct from legal liabilities, are increasingly becoming more vulnerable targets with potentially dramatic consequences for companies, both in business and legal risk.

Vitou cited the recent introduction of the Modern Slavery Act in the context of reputations liable to be quickly damaged by online-driven disclosures. ‘It’s the Act with no teeth, so who cares? [But] you could say it is quite clever, because there is this public mood. Someone will spot that you have a problem in your supply chain and that is going to be networked and blown across the internet very quickly. From having no problem and no knowledge, you are going to be all over the internet and the mainstream media with a massive problem, with some people bringing class actions out in California, if you have a subsidiary out there, costing you a fortune and creating a massive PR crisis. We are increasingly networked. Who had heard of Mossack Fonseca [the Panamanian law firm at the heart of the so-called Panama Papers tax disclosures] until about six or seven weeks ago? No one. The weak link in everyone’s supply chain can suddenly become a problem for lots of people, and it is instant.’

Amid a riskier business environment, the panel agreed that growth in insurance coverage for company officers could end up at the centre of disputes. Caswell observed: ‘We are seeing more companies taking out insurance when they do a deal. Insurers and brokers are pushing warranty and indemnity insurance heavily at the moment and it is seen as a panacea. We are going to see litigation in that area. It is fine when everyone is booming and happy, but as soon as a downturn hits, people will be turning to that insurance and looking at what they can claim.’

Gleghorn cited research from global insurance group American International Group (AIG) on the level of claims against directors and officer liability insurance, which indicated that one in seven of these policies were already generating a claim. He commented: ‘One of the things that seems to be a feature of the AIG report is that you are also starting to see on some of the larger deal assets that have latent regulatory issues, the seller trying to downplay that, the buyer coming in and having an awful mess – oil and gas is a good example – and then suddenly dealing with the Department of Justice and so on, and wanting to make a claim against the seller.’

‘How many people remember the Co-operative Wholesale investigation? That was one of the biggest scandals of the early 1990s in the City and everyone has forgotten it.’
James Palmer, Herbert Smith Freehills

 

 

Rounding up other emerging risks, the panel cited areas as disparate as pensions-related disputes, audit-related claims in the wake of new EU regulation and the increasingly ubiquitous matter of cyber security. Volatile commodity prices, meanwhile, look likely to keep driving disputes over the next two years.

Given the timing of our event in May, inevitably the panel was asked if a victory for controversial Republican candidate Donald Trump in this year’s US election or a vote for the UK to exit the EU would have more risk for the economy. Given that on 23 June the UK narrowly voted to leave the EU, triggering political and market shockwaves, the panel appear to have been proved correct in their prediction that Brexit was the bigger risk.

Palmer concluded: ‘The Brexit issues are the most immediate negative economic impact here. Trump’s election would not be majorly negative, but I think if he pursues some of his very isolationist policies, that will be even more significant globally.’

Rawlinson at least managed to find the upside amid turbulent markets, citing the advice given to him years ago by Herbert Smith’s then senior partner, Edward Walker-Arnott. ‘He said: “Flux is good for lawyers. The worst thing is stagnation.” The run-up to Brexit is awful, because everyone is worried, but either loads of deals are going to start happening and people are going to be happy or all hell is going to break loose. One way or another, I suspect we are going to be busy post-23 June.’

alex.novarese@legalease.co.uk

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