Navigating a Company through Troubled Waters: Shifting Fiduciary Duties & Corporate Governance in the Zone of Insolvency

On June 25, the FR&CR Department hosted a well-received webinar addressing some of the most pressing fiduciary and governance issues facing troubled companies, including the shifting duties of care and loyalty, board and management changes, and the importance of D&O insurance. The key takeaways from this virtual program included:

• Discharging Your Fiduciary Duty of Care: Be engaged; inform yourself and understand alternative courses of action; seek and assess relevant information from management; ask questions; show a degree of skepticism when appropriate; devote adequate time to company matters and the issues at hand; pay attention to the process and ensure that good records of decision-making are maintained.
• Discharging Your Fiduciary Duty of Loyalty: You must promote the interests of the corporation over personal interests and avoid conflicts of interest (not merely financial conflicts); you cannot usurp business opportunities of the enterprise.
• As the company enters the “zone of insolvency,” the duties do not change, but there is an expansion of the parties who may enforce such duties for the benefit of the corporation—i.e., duties no longer owed solely to shareholders, but to creditors as well, who may be able to assert derivative claims for breach of fiduciary duties.
• As a company goes down the “continuum” from healthy to distressed, management and directors should pay attention to the warning signs of insolvency: not just liabilities exceeding assets, but also cash flow issues, such as the inability to pay debts as they come due.
• It is critical to bring in experienced restructuring and turnaround professionals at an early stage. These may include independent directors, a chief restructuring officer, lawyers, financial advisors, and investment bankers (if a sale transaction is contemplated). Operating in the zone of insolvency is not “business as usual” and requires a different skill set and understanding of applicable law. A CRO or independent director will bring credibility to the company and be a “neutral” counterparty for lenders to negotiate with.
• Subsidiary companies, if any, should have boards in place to take any necessary actions at the subsidiary level.
• If the interests of the company and the board diverge, then the board should retain its own counsel.
• If duty of loyalty issues arise, such as a contemplated insider transaction, explore the creation of a special committee or sub-committee and/or the appointment of an independent director to review and authorize the transaction.
• DO NOT accept a board position without proper D&O liability insurance coverage! Always conduct appropriate due diligence on existing D&O coverage and, if appropriate, explore obtaining additional coverage.
• Resigning from a management or board position with the company may expose you to greater liability; you will likely still be a target in any lawsuits, but unable to influence events after you depart.
• As financial distress becomes more acute, or as a bankruptcy filing or other major transaction nears, the board may need to meet more frequently. Circumstances will dictate, but the situation could require weekly, or even daily, board meetings to stay informed and properly discharge oversight duties.

For more information about this presentation, please contact Brett S. Theisen.