Economic headwinds and the interest rate environment that developed over the course of 2023 increased financial stress on portfolio companies and portend heightened litigation risk in 2024 for portfolio companies and their private fund sponsors. Specifically, interest rate increases that accelerated through 2022 continued in 2023, and compounded existing economic stressors including tight liquidity and inflation coming out of 2020 and 2021, as well as increased cost and other burdens related to ESG and regulatory compliance. These pressures put portfolio companies in often unsustainable financial positions, causing them to prematurely seek liquidity events, violate debt covenants with lenders, and resort to bankruptcy, all of which has led to an increase in disputes and litigation, which we expect to continue in 2024.
As litigation claims against portfolio companies have increased, so have accompanying claims asserted directly against funds (and their sponsors). Plaintiffs’ reasoning for including funds as defendants is no mystery: funds often have greater financial resources than the defendant portfolio company, particularly where the portfolio company is in distress, and thus represent the proverbial “deep pockets.” This is especially true where a liquidity event involving the portfolio company either recently occurred or is on the horizon. Liquidity events, which range from major portfolio company transactions to liquidation or reorganization, often lead to substantial returns for funds.