While the Covid-19 pandemic is more than simply an economic disaster, it is increasingly clear that March 2020 will come to occupy a notorious place in financial history, potentially eclipsing the dark days of September 2008. As with the global financial crisis, the darkening economic landscape is likely to give rise to an increase in disputes. From prehistory to the digital age, existential crises have engaged the basic instincts of fight or flight. Many will choose the former. Venture capital firms are liable to find themselves at the sharp end of this unfortunate truth. Notwithstanding the UK government’s recent assistance to the sector, many start-ups are in desperate need of liquidity, many investors continue to want to reallocate capital away from risk, and many contractual counterparties everywhere are walking away from their obligations. Such circumstances have significant potential to cause disputes.
With that said, as of now Covid-19 has had a negative impact on disputes activity, with the number of claims filed in the Commercial Court falling by around 65% in March. That may remain the case in the short term, while the focus remains on weathering the storm. However, in the medium term, it is likely that there will be a significant increase in the volume of disputes, as businesses seek to recoup losses, renegotiate existing agreements or seek redress for exploitative commercial behaviour. As Burford Capital, a major litigation funder, noted in a recent London Stock Exchange update, “as the global financial crisis of 2008-09 was followed by a large amount of litigation […] what is likely to be a time of economic pressure will result in a significant increase in the volume of large dollar litigation.”
Commercial disputes are usually regarded by VC firms (and many other businesses) as something to be avoided where possible. There are good reasons for this. Hourly partner rates at leading City law firms are typically in the £500 – £1,000 range. Civil litigation in England operates under a system where the losing party is generally responsible for paying most or all of the winning party’s costs. Disputes can often cause significant business interruption risk, trigger automatic defaults under finance agreements and risk personal liability for senior individuals. Many of these risks are, at best, only partially addressed via insurance. However, there are at least two reasons not to simply ignore commercial disputes issues unless and until that is no longer an option.
First, problems left to fester tend to get worse, which is as true of disputes as it is of a great deal of other things (other time-honoured platitudes like ‘a stitch in time saves nine’ also apply more often than not). Second, a good disputes strategy can add more value than simply aiming for the least worst outcome. For example, Burford Capital’s recent LSE update noted that “as businesses face liquidity challenges, [we] anticipate an increase in corporate monetisations of litigation positions” (i.e. claimants selling a portion of potential damages in exchange for litigation funding). The fact is that there is real money to be made, as well as lost, in this area, and now more than ever. In this series of three articles we seek to outline and analyse some of the key disputes issues for VC firms in the context of the fallout from Covid-19, focusing on (i) co-investor disputes, (ii) LP disputes and (ii) disputes at the portfolio company level. If further information on any of the issues in these articles would be helpful, please get in contact.