Is There a Ticking Timebomb on Your Balance Sheet?
With so much uncertainty in the world, now is the time to take definite action and address those troublesome contingent liabilities that drag down performance and put your company at financial and reputational risk.
The year 2020 has been filled with so much uncertainty that it often seems as if the world is turned upside down. That has left businesses on edge, with unforeseen tactical challenges requiring constant attention at the board level.
In view of this, taking action that can reduce uncertainty, vulnerability, and/or costs is prudent. One proactive — and often overlooked — strategic step is worth serious consideration to that end:
Deal with your contingent liabilities.
Contingent liabilities, especially those related to legal claims, are like ticking time bombs on a balance sheet. They are potential losses that may arise in the future, depending on the outcome of a certain event or situation. Examples include historical exposures — such as asbestos liability — that can trigger litigation. Other examples include pending environmental investigations or liability arising out of legacy products.
Companies across all sectors have contingent liabilities. They can be troublesome not only because they expose a company to financial and reputational risk, but also because they can divert attention from core business operations and drag down performance. These complications can be especially disruptive when organizations are considering mergers, acquisitions and divestitures, as well as restructuring or borrowing capital.
There are several ways to address contingent liabilities (see infographic below). One is to ensure that they are adequately reflected in disclosures and valuation estimates. Doing so can help soften surprises when they occur and/or mitigate scrutiny by the Securities and Exchange Commission.
Other long-standing remedies are insurance options and Chapter 11 bankruptcy to mitigate or eliminate contingent liability. But more and more companies today are looking into the option of shedding contingent liabilities outright by divesting them to a third party, which can be quicker and less costly than the traditional options.
Besides eliminating uncertainty, divestiture provides other advantages at the operational level, such as removing the need to devote management time (and costs) to overseeing the resolution of the contingent liability. Management can then focus more time on the core business.
Strange Times Indeed
If current uncertainty is not reason enough to address contingent liabilities, consider other risks that may affect these line items rising out of ongoing global events.
The COVID-19 pandemic and the associated economic downturn, for one, have disrupted court hearings and other litigation activities, offering a (potentially) false hope that there will be a downturn in claims. Courts across the United States have already developed their response for handling litigation amid the pandemic, which differs across jurisdictions and includes barring nonessential claims, and a temporary stay on statutes of limitations.
For liabilities where there may be multiple defendants involved to possibly offset liability, the continued wave of bankruptcies may in fact increase the portion of damages to remaining solvent defendants.
Meanwhile, the recent outcome of the 2020 U.S. election signals a change in direction related to tax law and regulation, with timing and scope still uncertain.
Adding to this, social inflation — the increase in an individual’s propensity to sue, more sympathetic juries and higher jury awards — has become more prevalent in recent years and could very well continue given the impact of COVID-19 on the global economy and society.1
With all this turmoil, it may be said that the one sure thing in the near future is more uncertainty. Now is not the time to simply let the unknown take its course. Now is the time to take action and control what you can. Why not start with contingent liabilities.
Disclaimer: FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm.
© Copyright 2020. The views expressed herein are those of the authors and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals.