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Lenders hire litigators before lending
Diligence has changed
Diligence used to ask whether a company could afford to repay its debt, what the upside was if it could not, and how the business should be valued. Now it also asks whether the deal is permitted, and what the consequences are if it is not.
What the Serta ruling showed
The Serta judgment shows why. The judge applied traditional contract principles: breach, a traditional damages model, mitigation, and New York's statutory interest rate. What makes the result unusual is where it came from. The lenders who did the 2020 deal did not expect to owe damages to the lenders they left out, and fights like this often end in a settlement, while this one went to trial and ended with a court finding a remedy.
Pricing in litigation
Years of litigation are a cost too. Some deal makers are now pricing that in and considering cutting other creditors in as second-tier participants who get economy plus treatment while the rest get first class.
Why bring litigators in before the loan is made?
Transactional lawyers draft the terms, while litigators know how judges have read similar language when a dispute reached court. A litigator can test whether a planned maneuver fits within the contract and how a court is likely to react. Seeing that risk early lets a lender decide the price of a loan or whether to lend at all. A clause that looks airtight on paper can read differently once it is argued before a judge.
Why do most lender fights end in settlement?
Trials are expensive, slow, and uncertain, so both sides often prefer a negotiated outcome to a judge's ruling. Statistics from the Administrative Office of the U.S. Courts show that fewer than 2% of federal civil cases are decided at trial. In creditor disputes, each side also weighs the effect of a loss on its other holdings. A case that reaches judgment is therefore the exception.
Why must a harmed party limit its losses?
Contract law includes a duty to mitigate: a party cannot recover damages for losses it could have avoided through reasonable effort. The Restatement (Second) of Contracts states this rule in section 350. The party that breached bears the burden of showing that the loss could have been avoided. A court then reduces the award by the amount that mitigation would have saved.
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