Banking and financial litigation amid and after the pandemic

The new coronavirus outbreak has led to a health, human, social and economic crisis, the real impact of which may yet be still to come. Financial institutions have become accustomed to cyclical turbulence and this has helped shaping their resilience to challenging events. But this time, we face new questions: is the financial sector prepared to cope with the litigation risk that has arisen during the pandemic? What should it look out for? And can anything good come of it?

We are living uncertain times, and uncertainty breeds litigation. Financial institutions face internal operational issues such as staff shortages or geographic dispersion, and the need to comply with different emergency legislation in different countries, which range from rules on over-the-counter customer service to regulatory compliance. However, these institutions will also face a broad spectrum of COVID-19-related lawsuits.

Although the content of these disputes is still unfolding, financial institutions will soon face customer litigation, or at least endure the effects of the latter’s disruption and difficulties. One can easily recall foreclosures and debt collection proceedings, and even anticipate a wave of bankruptcies. Yet, now there is an additional layer of different restrictions, standstills, moratoriums on loans, restructuring arrangements, procedural rules, court recesses and litigation dynamics across the globe. Extended moratoriums on loans are in the interest and a demand of all parties. However, in certain cases, the focus on debtor protection (albeit understandable) will have distressing consequences for financial institutions – not least when they are often secured creditors and usually the most solvent of the parties, which makes them preferred litigation targets – but also for other customers and for society at large.

Litigation risk will also stem from the attempt by some parties to exit, rewrite, or at least renegotiate certain transactions because the agreed contractual terms prove to be no longer adequate for the current times and those to come. This will inevitably result in different understandings, breaches of rights and obligations, and the invocation of contractual clauses or statutory provisions which are seldom relied upon (force majeure, material adverse change, acts of god, exclusion and limitation clauses). There is a further need to consider different legal systems and legislations, doctrines, and court responses. On top of this, there is the concern to screen potential abusive behaviour and ensure there is consistency in this unprecedented, across-the-board situation. An assessment of the other party’s solvency is also key in the decision-making process on whether to proceed to litigation or not.

Then there’ is the risk of regulatory litigation, which requires increased knowledge of local and sector-specific measures taken to address the pandemic, and potentially some more hands-on approaches taken by central banks. Awareness of the political landscape in each jurisdiction might also be a useful addition.

Claims will also be brought in connection with product mis-selling, investment, insurance or risk, mostly aimed at assessing coverage, allocation of risk or loss and damage arising from adverse events caused by the market turmoil resulting from COVID-19.

Finally, litigation may derive from the very technologically innovative solutions that financial institutions were developing before, and that were hurried along by the pandemic, due to the call to stay at home at first and, subsequently, for the foreseeable long-lasting need for social distancing. This includes Fintech, cashless and contactless payments, new remote cash recirculation methods (virtual ATMs, digital banking) and other solutions necessary to enable individuals, businesses and institutions to ensure their financial and banking operations digitally. This introduces new challenges: the need to observe data protection, compliance and other industry-specific requirements, avoid unfair competition and prevent fraudulent transactions – especially fraudulent wire transfers.

Can anything good come out of the above? The late US President John F. Kennedy once said that: When written in Chinese, the word “crisis” is composed of two characters – one represents danger and one represents opportunity. And so it is: Along with danger, crisis is represented by opportunity.

It may still be too early to know which effects of the pandemic will be temporary and which will not, but there are lessons and conclusions that can already be drawn from recent experience.

The first lesson is the need for international or regional cooperation and the search for consistent legal solutions so that societies can return to normal as before, or at least live in the ‘post-corona normal’.

An upside is greater foreseeability and legal awareness: parties entering into contracts will now be more conscious of what to include in contractual agreements. In the case of financial institutions, we can expect a higher level of self-protection, with heavily negotiated material adverse change clauses, a demand for posting of additional collaterals vis-à-vis rates and margins, a more careful prioritisation or choice of loan applicants, thoughtful coverage and carefully selected risk provisions.

Bankruptcies, foreclosures and leveraged technologies will certainly boost business opportunities, entrepreneurship and employment.

In the legal sector, there is great room for improvement. Increased banking and financial disputes will constitute a window for certain countries to create specialised courts. Portugal did this in the aftermath of the 2008 financial crisis with the establishment of the Competition, Regulation and Supervision Court, and in the increasing the expertise of Portuguese judges in banking and financial matters after the BES Resolution in 2014. These will also be an opportunity to set up arbitral institutions and dispute resolution mechanisms for complex banking and financial matters.

Moreover, countries could consider adopting streamlined procedures and specific class action mechanisms for customers, investors and stakeholders. This would also serve as a reason for the “go to” law firms for litigation against financial institutions to grow, third party funding to be encouraged, and even foreign investment be attracted. All of the foregoing will, of course, depend on whether, along with danger, the opportunity is well taken.

From a litigation lawyer’s standpoint, old advice too remains valid today: find out about and assess the impact and risks of any new legal measures on your contracts and/or business, which may be or become significantly altered. Negotiate thoroughly. If you succeed in negotiation, ensure you have a binding and enforceable agreement in all relevant jurisdictions. Finally, choose wisely which disputes are worth it and, if possible, the jurisdictions in which to start litigation – court proceedings are long-drawn-out, stressful and in some countries often entail a heavy financial cost. These precautions may not prevent what is to come, but will certainly soften the impact.