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As Texas Navigates an Uncertain Future, Funding Is a Resource for Stability and Growth

Article originally printed in Texas Lawyer, September 16, 2020

In early June, we looked at the impact of COVID-19 and collapsed oil prices on Texas businesses. At that time, forecasts indicated continued losses in the energy, health care, legal and other sectors, more layoffs, and an uptick in commercial litigation inside and outside of the bankruptcy courts.

As we close out the third quarter and the economy cautiously reopens, many of these predictions have played out. Businesses continue to struggle with an uncertain future and the need to maximize assets. Bankruptcies and lawsuits are on the rise, while our courts struggle to fully reopen and provide a timely path to resolution. However, there also are signs of stabilization and recovery, and in some instances, losses are fewer than anticipated. Whether and how our precarious recovery continues remains to be seen. In this climate, more than ever, litigation finance is a tool that can ease the financial burdens faced by Texas companies.

Here is where we are today.

Energy

In April, we saw oil futures fall below $0 a barrel, to -$37, an unprecedented event that shook the energy sector. In the weeks and months that followed, unemployment statewide rose to 13%, including more than 39,000 Texans in the oil and gas sector who lost their jobs in the first half of the year. In July, the Texas rig count dropped to 104, down from 454 last year, with the Permian Basin—the most productive shale play in the U.S.—down 316 rigs.

Unsurprisingly, shale oil companies entered bankruptcy at an extraordinary rate. In the second quarter, twelve oil producers filed for bankruptcy, compared to only three in the first quarter, and followed by nine more in July. And it isn’t just the small players that were hit hard. Low oil prices caused Big Oil to dramatically shrink in size. Chevron, Shell, BP, and Total have written off tens of billions in assets and are hesitant to engage in new exploration. And on August 31, ExxonMobil was removed from the Dow Jones Industrial Average, in part because of losses related to the pandemic.

Despite these setbacks, the industry is beginning to experience a recovery, although it is wobbly at best. M&A deals are on the rise across a variety of sectors, energy included. In July, unemployment statewide dropped to 8%. After 20 weeks of straight declines, the rig count appears to be holding steady. The price of oil recently settled at roughly $40 a barrel before dropping into the mid-30s after Labor Day. But while oil prices are certainly up from the April crash, they remain over $20 below the price at the start of the year and more than half of the $90 per barrel average for the period between 2010 and 2014. Importantly, the current price is too low for many U.S. producers to clear a profit, discouraging exploration and development, and the fear remains that prices will stay at this level for a prolonged period as the pandemic persists.

Health Care

Meanwhile, the health care sector remains on unsteady ground. While some elective procedures resumed over the summer, the summer spike in COVID cases caused hospitals to delay many surgical services to create room for COVID patients, cutting significantly into revenues. The pandemic’s impact extended to specialty hospitals, such as the University of Texas MD Anderson Cancer Center, which began taking in COVID patients to ease the burden on the overall hospital system.  While the current COVID hospitalization rate is going down, there is no guarantee against another spike in Texas, especially in the wake of evacuations caused by Hurricane Laura, the Labor Day holiday and the return to in-person school learning, which would continue to cause resource and financial strain.

Bankruptcy

There have been hundreds of bankruptcy filings nationwide since the start of the year, with the total amount of debt declared at over $27 billion. In Texas, more corporations filed for bankruptcy during the first six months of 2020 than in any period in the state’s history. Texas bankruptcy filings were three times higher than the same six-month period in 2019 and 40% more than the first six months of 2009, during some of the darkest days of the Great Recession.

As bankruptcies increase, so do disputes within the bankruptcy context. Many Texas attorneys now find themselves regularly in bankruptcy court. In fact, it has been reported that the majority of Texas practitioners that have worked on bankruptcy cases this year do not even specialize in bankruptcy.

Legal

As anticipated, Texas-based law firms are feeling the effects of the crisis as well, although losses are not as significant as initially thought. According to Citi Private Bank Law Firm Group, during the first half of the year, growth at Texas firms was flat, while in other regions, firm revenue grew by 5.3%. Client demand in Texas fell 4.9% for the first half of the year, while it only fell 0.9% nationally during that same period. This reduced demand for legal services (and corresponding reduction in fee collections) is mitigated some by the significant increase in bankruptcy and restructuring work, but the future remains uncertain in the legal market as well as other sectors.

Law firms also are facing pressure to avoid or unravel pay reductions implemented due to the crisis. Many fear attrition as the lateral recruiting market heats up, and firms that have not readjusted salaries poach talent or look to expand with new talent in high demand specialties.

While the economic forces at play inevitably lead to a rise in disputes, access to our courts is heavily restricted by COVID. While many Texas courts have found ways to conduct hearings and resolve motions remotely, most have postponed jury trials during the pandemic. With some exceptions, Texas jury trials are prohibited until Oct. 1, at which point the Texas Lawbook estimates a backlog of more than 5,000 cases. Many predict that courts will not resume normal activity until the Spring of 2021, when backlogs will have multiplied and cases may see years-long delays from their previously scheduled trial dates.

Funding as a Resource

As Texas businesses and firms continue to navigate the delays, uncertainties, and increased costs associated with litigation in today’s economic and legal climate, litigation finance can serve as a solution to some of their toughest issues. In a litigation finance transaction, a funder provides capital for attorney fees and costs to litigate a case or set of cases, and takes a prenegotiated return from any settlement or damages award. Importantly, the funding is nonrecourse. As such, the funder only recovers a return if the case is successful. If not, the client pays nothing. Thus, not only does funding enable a company to improve its balance sheet by avoiding booking litigation costs as an expense, it also relieves the company from ever paying fees and costs in the event of an unsuccessful litigation. Litigation funding can significantly alleviate a company’s legal risk, improve its bottom line, and provide a path to maximize the value of strong legal claims when budgets are tight.

Likewise, portfolio funding can provide much-needed capital to law firms seeing decreased demand or flat or declining revenues. Collateralized by a group of cases—including defense cases—portfolio funding can provide law firms (and companies as well) a steady stream of capital to be used for any purpose, such as paying and maintaining competitive salaries or hiring laterals, enabling lawyers to offer clients flexible fee arrangements or take more cases on contingency.

Texas is a state known for its comebacks—we’ve bounced back from recessions and crises before—and no doubt, Texans will rebound stronger than ever. But the timing of this economic recovery remains unknown, and during this tumultuous period, the ability for businesses to survive and thrive and achieve justice for their legal disputes, is paramount. When working with a trusted partner, litigation finance can be a tool to help achieve those goals.

Wendie Childress is a portfolio counsel at Validity Finance in Houston.