Protect Yourself: Houston Downturn Means More Litigation

Andrew Pearce, Chris Hanslik

April 30, 2015

In the face of a downturn in the city’s economy driven by crude oil trading below $60, Houston has had cautious optimism because of the quick recovery seen in 2009 – but this down cycle may be different.

Crude oil has already dropped farther than it did in 2009, and it may hover in the $60 range for two more years. Houston is already feeling the collateral damage, with 74,000 jobs already lost and more predicted. Beyond jobs, the real estate market in Houston will also be impacted, given that about 58 percent of office space in Houston is directly or indirectly related to the energy sector.

The effect of the downturn in oil and its impact on the oilfield services industry, employment, and real estate, will likely be an increase in litigation.

When the economy is strong, the desire to incur litigation costs and dedicate time to collection efforts can take a backseat to a company’s focus on the growth of its business through new customers, projects and opportunities. But as those opportunities begin to diminish, the focus turns back to outstanding account receivables. We have already seen a number of lawsuits that arose out of demand letters sent months earlier – cases in which the parties did not reach a resolution, but left the matter for another day. Now, that day has come.

Similarly, we also see the domino effect of customers who purchase product on a spec market with the goal of flipping the product for a profit. Yet markets in the energy sector can disappear quickly – and when they do, customers may refuse to take delivery of what they previously ordered. The seller is now faced with mitigating its damages by selling product into a depressed market, if it can sell the product at all. This issue is compounded when the seller, in turn, is unable to pay its own suppliers given the default of the buyer. The terms of the parties’ agreements – whether by contract, purchase order, or some other arrangement – then become critically important.

We are already seeing the front-end impact of reductions-in-force, defaults on contractual agreements, and other disputes arising out of this downturn. Law360 reported in April 2015 that the “steep drop in oil prices over the past year will spur an increase in wage-and-hour suits against companies in the energy sector, as laid-off workers turn to attorneys who are on the lookout for soft spots – like questionable classifications of workers as overtime-exempt or independent contractors – that could be the basis of lucrative collective action claims.”

As we move deeper into this downturn, one important note to consider is whether companies may avoid litigation as part of their effort to reduce their operating costs. The recent reduction in forces are clear signs that companies are already seeking to reduce costs, and the uncertain nature  and expense of litigation may dissuade companies from filing suits in smaller matters.

The factors contributing to this down cycle are estimated to take six quarters to fix, and a more favorable level of economic activity could take two to three years. In the meantime, it will be a tough environment, with the industry under a lot of pressure.

Until turnaround takes place and Houston begins to recover, properly reducing workforces, knowing your contractual termination rights, and fully exploring work-out options become increasingly important.