Predictions 2023: Macro influences giving rise to disputes

We predict that 2023 will begin to see the results of a significant increase in financial sanctions enforcement action and related litigation in the UK, connected to the consequences from the war in Ukraine and Western sanctions on Russia. Given the typically extended periods of time taken for investigations and litigation to conclude, this will continue to play out over the next 5-10 years.

Why?

• Compared to the position in the US, there has historically been only limited sanctions enforcement in the UK (or indeed elsewhere). Financial sanctions enforcement by OFSI has, however, been on an upward trend since Brexit. Most of OFSI’s enforcement action is not publicised, but 8 enforcement notices have been issued since January 2019. This trend was expected to continue, even prior to the war in Ukraine.
• Following the implementation of sanctions on Russia, the total scale of UK sanctions has dramatically increased; frozen Russian assets reported to OFSI increased from £44.5 million to £18.39 billion (between September 2021 and October 2022), representing an approximate 250% increase in the total level of frozen assets across all jurisdictions.
• Given the scale of the Russian economy - as compared to previous sanctioned jurisdictions - and the proliferation of financial and trade sanctions other than asset freezes, the above figures materially understate the degree of the change.
• Since February 2022, the number of breaches reported to OFSI has significantly increased; sanctions circumvention and illicit wealth is now an enforcement priority across the UK law enforcement and regulatory space.
• OFSI has enhanced its enforcement capabilities over the past year. This includes:

1. imposing strict liability for civil enforcement of financial sanctions breaches;

2. powers to publicise details of financial sanctions breaches, even if no monetary penalty has been imposed (which may lead to a significant increase in reported enforcement);

3. enhanced information sharing powers;

4. doubling OFSI’s staffing levels; and

5. engaging in extensive cooperation with foreign authorities on enforcement, in particular OFAC.

• OFSI has stated that it has a significant number of investigations underway (including joint UK/US investigations), and that it will take on more enforcement cases, and more complex ones, in 2023 to match its increased resourcing and capabilities.
• We also expect to see:
  • significant increases in enforcement from other sources: the NCA is the enforcer for breaches deemed by OFSI to meet the criminal threshold; the FCA and other regulators are very likely to pursue regulated persons in relation to sanctions systems and controls failures; and given the vastly increased volume of sanctioned trade activity, it is inevitable that there will be an uptick in HMRC trade and export controls enforcement;
  • growing focus on the links between sanctions breaches, particularly circumvention activities, and efforts to crack down on illicit wealth and money laundering; and
  • significant high court litigation connected to OFSI’s licencing activity, in particular where time lags in obtaining (or having confirmation of a rejection) licence applications has led to disputes between commercial counterparties in transactions containing a sanctioned component.

Prediction authors: Cherie Spinks, Tom Bowen

In 2023 we will see innovative use of insolvency procedures to deal with cross-border insolvencies and corporate vehicles used for fraud.

Why?

• The changing macro-economic climate - with international supply chains disrupted by the war in Ukraine, the withdrawal of Covid-19 support measures, and the exposure of issues masked by the pandemic - will present a difficult landscape for companies in 2023.
• This, coupled with years of covenant light lending practices, a decrease in forbearance, and a de-risking of portfolios by financial institutions, will result in an increased number of defaults and enforcement action.
• We expect to see four key developments:

1. The second and third quarters of 2023 will see a marked uptick in the number of companies entering insolvency procedures. Businesses will need to monitor the solvency of their contractual counterparties with a view to acting early if there are warning signs, using tools such as tighter management of credit, the use of retention of title clauses where goods are being provided and the potential use of court proceedings.

2. Attempts to use the provisions of the UK’s Insolvency Act to create moratoria for, or wind up, overseas companies; effectively forum-shopping to take advantage of the UK’s very flexible insolvency processes. Under the Insolvency Act, a foreign company can be wound up by its creditors as an “unregistered company” where there is a sufficient connection with Great Britain. This offers real opportunities for creditors of insolvent Russian entities. Despite Brexit, the definition of a “company” in relation to which an administration order can be made by the courts still includes companies incorporated or having their centre of main interests (COMI) in an EEA state (with the exception of Denmark in respect of the COMI gateway).

3. There is increasing awareness at banks that distressed assets can be realised and judgments monetised without exposure to the risk of legal costs that would once have led debts to be written off. Funders are keen to buy books of business, but greater returns can flow from alternative fee arrangements and the innovative use of insurance products.

4. Economic contraction always reveals fraud. Covid-19 related business fraud is only now starting to be investigated and the House of Lords Fraud Act 2006 and Digital Fraud Committee has named fraud as “the UK’s biggest crime” that should be at the forefront of the national agenda. As an alternative to freezing injunctions, which can be costly to obtain and take time to enforce, we predict an increase in creditor-led applications to appoint administrators. This process has the immediate effect of taking control of a company away from directors thereby removing the risk of dissipation of assets and facilitating an investigation by the administrators using the extensive statutory powers available to them.

Prediction authors: Kirsten Kitt, Tina Lockwood

We predict that in 2023 there will be a significant increase in disputes arising from M&A activity.

Why?

• The economic cycle follows a familiar pattern:
  • first buoyant markets, awash with cheap money, lead to a 'risk on' mindset and too little risk aversion;
  • this causes increased M&A at stretched valuations;
  • then economic conditions get more challenging (external shocks, inflation, interest rates, recession);
  • finally, those who have lost money look to their avenues for recovery.

We are entering the last of those stages as 2022 draws to a close.

• The categories of claim can be varied; from breach of warranty, to diversion of business opportunities, joint venture disputes, issues over financing and even fraud.
• These claims arise between companies across industry sectors; the 'new' factor this time is the increased role of private equity (in asset ownership) and private credit (in financing the economy). This is likely to alter the pattern of disputes that we see, with greater involvement of asset managers on both sides of those disputes.

Prediction author: Adam Brown

We predict that in 2023 tax authorities worldwide will litigate more frequently and more aggressively.

Why?

• The global economic situation is placing acute pressures on government, business, and individual finances. Many governments are being asked to do more to support families and businesses at a time when state financing costs are moving up, and what dry powder there may have been has already been spent during the pandemic.
• Finance ministers will therefore be looking to maximise their recovery of tax. Unlike rate increases or the introduction of new taxes, collecting taxes that are already 'on the books' is politically uncontroversial. Indeed, administrations that are not perceived to be 'tough enough' on those who do not pay their 'fair share' of tax open themselves to criticism.
• While there will always be more to do to collect taxes lost to fraud or evasion, it’s typically far easier to seek to recover tax from large businesses and high net worth individuals.
• Additionally, the years since the global financial crisis have seen tax authorities worldwide become much more effective: they are generally reasonably well resourced, proficient users of data, and intelligently led. At the same time, they have access to far stronger legislation, both domestic and international.
• Tax authorities are therefore likely to have greater political incentives to use their increasingly broad legal powers to seek to collect tax from businesses and high net worth individuals.

Prediction author: Craig Kirkham-Wilson

We predict that the consequences from the war in Ukraine will give rise to increased litigation and arbitration in 2023, and related insurance issues.

Why?

• The damage, disruption and expropriation of assets resulting from the Russian invasion of Crimea in 2014 triggered a slew of disputes. We predict this pattern will be repeated with increased intensity following the ongoing war in Ukraine.
• On the commercial side, disputes are likely to relate chiefly to contracts that have been affected by the war - not only directly in Ukraine and Russia (where Western sanctions and Russian counter-sanctions are biting) – but throughout the world, as markets react to the economic, commodity and energy impacts of the conflict.
• Claims for force majeure protection are likely to be a common theme, as illustrated by the recent decision in MUR Shipping v RTI (see here).
• There is also widespread consensus that we will see a slew of new investment treaty claims against the Russian State in relation to investments that have been damaged or expropriated during the war, or resulting from measures introduced by the Russian state to shore up its economy and counter Western sanctions (see our articles on this here and here). These claims will build on those brought against Russia following the invasion of Crimea in 2014.
• Insured parties will look to their insurers for some recompense for expropriated, lost or damaged foreign assets in Ukraine, which we expect to give rise to a number of insurance disputes.
• In March 2022, after Russia permitted its airlines to seize and use foreign-owned planes grounded in Russia when the war broke out, an Irish aircraft leasing company issued a claim against its insurers after its $3.5 billion insurance claim was declined (AIG v Aercap). We expect a number of similar disputes, as parties seek to recover losses caused by the war and/or the expropriation of assets from their insurers.
• As during the Covid-19 pandemic, we also expect close scrutiny of, and claims under, the business interruption element of insurance cover across a number of lines. Although the FCA Test case resolved a number of disputes between insurers and insureds over BI wordings, there may well be further litigation.
• Increased cyber risk - particularly the risk of malicious attacks from Russian state actors and its supporters - has widely been recognised as a potential effect of the war in Ukraine and Western sanctions. Some have attributed a November 2022 attack on the European Parliament to a pro-Russia group. There are likely to be disputes over the extent to which insurance policies in place will cover the consequences of such events. In the context of a malicious (state-sponsored) cyber-attack the scope of political risk and terrorism cover may be unclear, and as we saw in the US following the 2017 NotPetya attack (*Merck & Co., Inc., et al. v. ACE Amer. Ins. Co., et al.*) we are likely to see disputes over the application of any exclusion of cover for acts of war.

Prediction authors: Stuart Dutson, Felix Zimmermann, Basil Woodd-Walker, William Dunning