On January 28, 2016 Newport Board Group partner and Southern California Managing Director Richard Munro took part in a national Expert Webcast, Duties of Officers and Directors of a Distressed Company. Other participants included experts from distinguished firms such as investment bank DelMorgan & Co. and law firm Sullivan & Cromwell.
The subject is timely because there are signs that credit is tightening, possibly the start of a credit crunch.
Richard and the other webinar presenters made a number of important points about how board directors and CEOs should respond when their companies become distressed.
Review of Some Board Governance Basics
The webinar reinforced some important points about the role of a corporate board:
- Among the most important responsibilities of a board director is what is called a duty of loyalty, which includes a prohibition on self-dealing.
- Directors are obligated to serve in good faith and make rational decisions that are in the best interests of the organization.
- Under what is called the “business judgment rule,” the courts typically won’t second guess business decisions made by boards--if the members of the board can show that they acted in a disinterested manner, i.e. without conflict of interest and were properly informed and reasonably diligent in performing their duties.
- Directors are considered to be fiduciaries to shareholders as well as for the company itself. They generally do not have a fiduciary obligation to creditors. Their overriding objective should be to maximize the value of the corporation for shareholders.
Points Made by Richard Munro and Other Participants
Richard has extensive experience with distressed companies including having served as a receiver on several occasions and CEO and Board member of a public company through a Chapter 11 reorganization to a confirmed plan. He and the other presenters made a number of points about the role of officers and directors in distressed situations.
- An experienced director should be able to recognize early signs of distress. In these situations, liquidity gets tighter, accounts receivable take longer to collect and the company starts to stretch out its accounts payable.
- A main risk in distressed situations is that company officers and the board may be in denial —or even in delusion -- about the state of the company’s finances and won’t respond quickly enough. In Richard’s experience, this happens particularly when the board lacks granular analysis and understanding of the underlying dynamics of the business.
- Directors should always ask to see a short term cash flow projection. Richard has seen instances where companies have invested the time to create a 5 Year Plan but had no plan for cash in the next 13 weeks. They must know what is happening with margins and customers; have a fix on what caused the company’s downturn; and require more detailed financial reporting.
- Directors must focus on the balance sheet--to understand the level of current liquidity and how the company can generate additional cash quickly.
- Directors must resist the tendency of CEOs to believe that they can trade out of trouble and that the company can overcome its problems simply with more liquidity (such as from expansion of its bank credit).
- In a distressed situation, the board needs to create a “zone of safety” in which it can be confident about making decisions in the best interests of the company without undue fear of being sued after the fact.
- The board should consider meeting more often. It must make sure that stakeholders understand the company’s financial position and the headwinds it is facing. They should also review the company’s Directors and Officers (D & O) insurance to make sure that its terms will adequately protect them in the event of lawsuits.
- In a distressed situation, directors should generally not bail from the Board – this sends the wrong message to shareholders and other stakeholders.
- On the other hand, distressed companies can benefit by adding directors, such as industry experts who can help to right size the company, and particularly directors with experience navigating distress.
Bringing in Outsiders
Richard put forward the view that, if a company seems headed toward insolvency, there is often a case to bring in outside experts to evaluate financial trends and strategy — and do so quickly. Boards won’t be criticized for bringing in world class experts. Bringing in experts to scrutinize management helps make the board feel more comfortable about making the bold decisions for survival, countering a tendency for boards to be overly cautious in these situations.
Outside advisors are unencumbered by association with the company’s past and therefore will be more objective, able to ask the right questions, restore credibility with creditors and lenders and look at options to restructure the business model. If Chapter 11 is an option, they should have experience with bankruptcy but not have a bias to it. Experts in investor relations and crisis communications are very important to help the board shape strategy and have a communications plan ready to launch at a moment’s notice. Directors should be alert to a tendency for company executives to “hunker down,” convinced that they can work their way out of the problem with only incremental changes in strategy. This never works.
Other Director Responsibilities
- If the company is in the public eye or one that the media covers, the lead director or chairman should have media training and be counseled how to deal with media inquiries.
- Directors must keep a focus on risk adjusted returns, weighing the risk that the company will be able to pull itself out of crisis and earn positive returns--versus landing the company in some form of bankruptcy.
- When there are disagreements between directors, they should remember that a consensus “middle ground” approach is not always the right answer.
- The board must ensure that the company’s executives understand all details of the covenants that are part of their credit facilities.
- Dissident board members should generally not be asked to resign.
The Restructuring Option
Richard, who has extensive experience in restructuring, made the point that different skills are required to get through a restructuring. A project management mentality is needed. The time horizon for making a key decision to pull a company out of distress may be as little as 3 to 5 days not the usual 3-5 year mindset of executives. The world of insolvency and distress is foreign to most executives and they generally don’t have the judgment and confidence to respond as quickly as required. Experienced insolvency advisors and directors can be indispensable to guiding the Board and management to get up to speed quickly, maximizing the odds for recovery.
Overall the webinar suggested that there are best practices for boards and officers to follow as they navigate the difficult challenges of a company in financial distress.
About the Author
Richard has 30 years of experience bringing leadership to growth and underperforming businesses and improving their performance. He has held senior executive positions as a CEO, CFO, COO, CRO, Court appointed Receiver and strategic advisor, as well as serving as a director on public and private company boards. Richard’s experience spans the food, energy, consumer products, healthcare, and specialty retail industry sectors. Click here to learn more about Richard Munro or contact him.
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