Board Members and Financially Distressed Companies
If you have made it this far without experiencing the particularly unique ride of being a board member of a financially distressed company, that’s fantastic. Your luck may be running out, however, as coronavirus-related shutdowns continue to affect large swaths of the economy. Whether the current wave of financial distress is your first, or just your latest, there are a number of things you should consider.
For context, I’ve experienced distressed situations from multiple perspectives. As a young professional, I was a financial analyst with a company in Chapter 11. Later on, I was in charge of investor relations for another company that put one of its subsidiaries into a voluntary Chapter 11. Later, I was chief financial officer, and part of a new management team, that took a different company through a successful Chapter 11. Subsequent to that, I was elected as an independent director to the board of another company in Chapter 11 during that company’s proceeding. I was also a partner and managing director in a financial advisory firm that specialized in complex restructurings and recapitalizations and advised boards and companies on restructuring alternatives, both in Chapter 11 and out of court.
What should you do if the company is insolvent or in the so-called “zone of insolvency”? Don’t panic. If ever there was a time for clear, rational thinking, it’s now. As board members, we need to bring value to these situations by providing calm, critical thinking to the process and help facilitate solutions.
Understand your fiduciary obligations. As board members, we owe fiduciary duties of care and loyalty and to act in a manner that is in the best interest of the company. If the company is insolvent or in the zone of insolvency, your fiduciary obligations remain to the company, but the residual beneficiary of those duties may be creditors rather than equity. The best approach is to always exercise your fiduciary obligations in a manner that decisions are made in the best interests of all constituents.
Understand your options. Distressed situations are all about having optionality. One of my favorite restructuring-isms is “If you don’t control the process, the process controls you.” A way to control the process is to understand your options. Are the creditors willing to work with us? Can we get a forbearance (and if so, for how long and at what cost)? Can we refinance the debt? Do we have assets that we can monetize to generate cash? Are there other options we haven’t considered?
Seek help sooner rather than later. Be humble. Be proactive. Companies are often reluctant to add more cost and professionals when liquidity is already a challenge but do not be afraid to insist that the company retain professionals with distressed expertise. The earlier, the better. Most companies wait too long to engage external advisors and, as a result, fail to identify or squander unseen opportunities that otherwise might have been available.
Hire good legal and financial advisors. This is where board members can add tremendous value. Private companies may not have an extensive list of external professionals to turn to in this situation. Board members can assist the company in identifying and vetting external professionals in both fields. Restructuring is sometimes described as being a “play within the play,” and there’s a lot of truth to that. External professionals will help the company understand the landscape of options and provide guidance. Restructuring professionals can also be of great benefit when it comes to negotiating with creditors.
Document. Understand that board decisions made when a company is in or near financial distress may be subject to heightened scrutiny after the fact by creditors or others who find themselves out of the money. Ensure that board meetings, phone calls, ad hoc, and committee meetings are well documented. If you have a fundamental disagreement about a particular issue or vote, go on record, and make sure it’s documented. In a distressed context, documentation is your friend.
Understand the company’s directors' and officers insurance policy. As board members, we operate in a fiduciary capacity which gives us exposure. Understanding how that exposure is covered is critical. Understand the policy, what’s covered (with particular attention to the differences between Side A, B, and C coverage), the amount of coverage, the tail period, and other policy limits.
Resigning from the board can be problematic. Financial distress may not be what you signed up for, and resigning may be a natural instinct, but hang in there and continue to use your best business judgment to act in the best interest of all of the company’s constituents. You don’t want to do anything creditors would argue exacerbated the company’s financial distress, and the last thing you want is to defend your resignation to a bankruptcy judge or trustee. I’ve seen it happen. It’s not pretty. In addition, the bankruptcy code provides a lot of protection for companies, so better to be on the inside than the outside in that situation. That being said, if you believe other board members have violated fiduciary duties or the company is acting improperly, then you should resign and document why you resigned.
Embrace the situation. No one ends up in a distressed situation on purpose. As a board member, management will look to you for guidance and insight. Figuring a path out of the current situation and executing it can be very rewarding and actually make you a better board member and potentially sought out by other distressed companies based on the unique skill set you developed during the crisis.
This is not meant to be an exhaustive list, but rather a primer, as most of these points can be entire topics unto themselves. Financially distressed situations are never easy. Clear, level-headed, critical thinking, and understanding are the options that will win the day.