An unprecedented crisis has come almost out of nowhere to suddenly hit the Netherlands – and indeed the entire world. In the latter half of January 2020, Dutch public health authority RIVM announced that the risk of COVID-19 – at the time a largely unknown coronavirus – manifesting in the Netherlands was “very low”. The first coronavirus diagnosis in the Netherlands came a little over a month later, on 27 February 2020. Within less than a fortnight, the World Health Organization had declared COVID-19 to be a pandemic, and the alarm bells were ringing loud and clear. On 15 March 2020, the Dutch government announced that hotels, restaurants and bars had 30 minutes to close for business, and that schools and children’s day-care centres were to shut too. Further restrictions followed on 23 March 2020, when an “intelligent lockdown” was imposed. And while this initially prevented the continuing spread of the coronavirus, further lockdown restrictions were imposed in November 2020 to battle the second wave COVID-19. It is safe to say companies in every sector have faced and will be facing unprecedented and uncertain times.
What to expect from executives in times of financial difficulty
Suddenly, the boards of managing directors (in Dutch: het bestuur’ of companies all around the country were scrambling to deal with the unprecedented impact of the COVID-19 outbreak and the intelligent lockdown. They also faced a unique crisis all of their own. The question confronting them was this: how is a board expected to respond to financial difficulties? If a company is struggling as a result of the COVID-19 pandemic, the board of a company are of course not to blame. Yet if a crisis is looming, or indeed has already manifested, should the expectations on a board not be greater? For example, should it be expected to take measures to minimise the harmful impact of the crisis? Should it go all-out to ensure their company’s survival as a going concern?
Except in terms of liability, remarkably little has been written about the mandate and role of the board in struggling companies – despite the numerous problems that members of the board of managing directors, and particularly where they are also major shareholders. Relationships can become strained in these situations. For example, disagreements could occur with the workforce: employees often have long relationships with the company, but now might face an uncertain future. Other issues may arise in dealings with vendors, as their bills go unpaid, and with shareholders, who are at risk of being “out of the money”. The board is caught in the middle of it all.
The need for more positive focus on the position of executives
It is remarkable that so little positive focus has been given to the mandate and role of executives in struggling companies, given how vital their business acumen will be in leading “us” to economic recovery. The economy thrives on a business community that pursues long-term value creation. Companies that maximise long-term value create jobs, contribute more to corporate responsibility, generate more customer satisfaction and keep shareholders with a long-term horizon happy. Entrepreneurial activity is generally acknowledged to be a “strong motor for economic growth and job creation”. An enterprising business community generates innovation and competition, which are both key factors in the global economy. Accordingly, sound business management draws investors and boosts a company’s competitive ability.
Bold and efficient executives
Companies need a board that possesses strong business skills, both in good times and in bad, as do their stakeholders and society as a whole. We all benefit from bold and efficient members of the board who are prepared to take a certain degree of risk and who can handle the tensions that define their scope of activity. The members of the board of directors are also expected to be highly flexible. Particularly in times of financial difficulty, the company’s interests are best served by board members who are capable of continually adapting to ever-evolving circumstances, who are willing to take judicious risks and who understand all the various and frequently unusual rules that govern the world as it changes around them as a result of the financial struggles. All this is expected of board members when times are good; during an economic crisis and the subsequent recovery, these qualities become indispensable.
However, board members can draw little support from legislation or case law. The abstract and open standards of conduct that legislation and case law impose on board members of struggling companies can clip the wings not only of such members, but also of their stakeholders and advisers.
Holding board members liable is an appropriate route to take if their actions are – essentially – self-serving or against the law. However, this ignores the grey area where a board member might carry out his or her mandate in a spirit of enterprise, but at the expense of a stakeholder such as a creditor. And it is in that grey area where those standards of conduct have such an undesirable effect on board members. When the storm clouds gather, it is not uncommon for a company’s board to become paralysed and adopt an unnecessary averseness to risk in light of those standards of conduct, out of fear of “retaliation”. Haunted by the spectre of personal liability, they (and their advisers) start to avoid all risk.
Concrete expectations of executives in times of crisis
It is important for a board to receive more guidance on how to carry out their duties when a crisis hits.
By law, the responsibility of managing a company is entrusted to its board, unless the articles of association dictate otherwise. The board has a collective responsibility for the “general course of business”. Logically, in our view this means that those executives are responsible for i) determining strategy, ii) handling the company’s financial affairs and iii) designing and monitoring a reliable risk management system.
How the mandate of “managing the company” is given shape depends on various factors, including i) the nature and size of the company, and in some cases its positioning within its group, ii) the ever-evolving circumstances in which it operates, iii) the substance of the company’s articles of association and other regulations, including how the company’s objects are defined, and iv) any specific details of the board’s mandate.
Doing business involves taking risks, and always will. How those risks are assessed and weighed is governed by the board’s policies. This means that executives may take risks, as long as they are judicious. Creativity and boldness should not be inhibited. Society does not benefit from rules and regulations that encourage businesses to prefer risk-averse decisions that offer little economic gain over higher-risk decisions that offer the possibility of significantly greater gains. Any other mindset would be diametrically opposed to the pursuit of a vital and innovative economy. As a result, when carrying out the board’s mandate, members of the board should be afforded a large degree of freedom to define policy, particularly on business matters – freedom that is influenced, among other factors, by the nature of the company and the extent to which its results affect stakeholders or even – in some cases – society as a whole.
As such, good members of the board should possess the ability to restructure/reorganise the company as and when necessary without being forced to by third parties.
Another issue here is that “managing the company” is not just a right, but an obligation as well: the board may not ignore its duties, but instead must actively manage the company.
Moreover, its board members must fulfil their duties responsibly. A board member may also be expected to possess an appropriate range of skills and expertise suitable and required for his or her role at the specific company. Board members must be able to handle their duties, and must perform them scrupulously. If a company faces the possibility of difficult times, a board member should ask whether he or she is in fact properly equipped to steer the company through the troubles or, if necessary, should bring in the skills and expertise that the company needs but lacks, by hiring advisers or a “chief restructuring officer”.
A board must carry out its duties in the best interests of the company and its operations. The company’s interests dictate that (and how) the board should consider all visible interests of stakeholders: taking due care, in so far as is possible and depending on the specific circumstances, with regard to the “known legitimate interests” of all parties with a stake in the company, including creditors. This sometimes means that the board must act as the keeper of the interests of the company’s creditors, by ensuring that their interests are not harmed unnecessarily and/or disproportionately.
Continuing a struggling company
The question then is whether the board’s duties change if the company foresees or encounters financial difficulties. Should members of the board be governed by alternative or additional standards of conduct then, and how would this impact their liability in respect of the company’s creditors?
We distinguish two phases here, irrespective of the causes leading up to the financial crisis. The first is the phase when developments are so worrying that the company’s continued existence is at risk, but acting swiftly and appropriately could secure the company’s survival as a going concern. The policy during that phase is focused on the company’s success, and as such on creating value. However, it is impossible to predict with any certainty during this phase that the company will in fact be “rescued”, even if the necessary action is taken. The risks that are inherent in doing business are objectively apparent, and have visibly increased. The company’s survival as a going concern is at risk, and it reorganises/restructures in an attempt to turn the tide. This phase can be described as a “reversible crisis”.
The second phase occurs when the company is revealed to be materially insolvent: the company will not survive, even if measures are taken. In this situation, policy will no longer be geared towards the company’s success in the long term: the short term is now paramount. Insolvency looms, with rescue no longer a realistic likelihood.
It is important to consider here that a crisis does not arise from one day to the next: generally, it will be preceded by the reversible crisis phase.
First and foremost, the board has a duty to take action if the company faces the prospect of, or finds itself in, financial difficulty. In a crisis more than in other situations, all the company’s executives may then be expected to become more involved than usual.
The board must investigate possibilities for securing the company’s survival as a going concern. If any possibility exists, the board must take whatever measures are necessary to achieve it. If the the members of the board do not do this, they are failing in their duties and they could be found culpable of “mismanagement” in inquiry proceedings. If this causes harm to any of the company’s creditors after the “reference date” (see below), the executives may be held liable for that harm.
If the crisis is irreversible, the board’s duty is to set up a process to ensure that the company’s “insolvency” is completed as efficiently as possible, to minimise any loss of value and prevent further harm to third parties, such as vendors and customers, until the actual insolvency proceedings start. However, even this scenario can offer room for longer-term interests, for example if some of the company’s operations could survive the insolvency as a going concern, which might save jobs.
The manner in which the board of directors carries out its mandate should logically be materially different in a crisis than its role in a “strong economy”. Not only will the board face the necessity of taking whatever measures are necessary in the short term to eliminate the symptoms of the financial difficulties (for example a lack of liquid assets), it will also need to give extra consideration to the possibility that those measures will not achieve the desired effect. In this crisis, the focus of the company’s interests (and accordingly the board’s mandate) undergoes a shift: the possibility exists that the company’s capital providers, i.e. its shareholders, will be “out of the money”. The interests of other stakeholders including creditors, vendors and employees gain further relevance. Particularly if a crisis has become irreversible, the creditors become the actual “residual risk bearers”. The board’s options are also limited in a crisis by the fact that the company becomes more reliant on third parties, for example if a bank, banking consortium or group of investors takes control.
Whenever the members of a board are confronted with developments that are so severe that the company faces or encounters financial difficulties, they must take action:
- First, they must ask whether they possess the skills and expertise needed to steer the company through the crisis, whether the relevant stakeholders have confidence in them and whether the relationships between the separate board members are good. This demands critical self-reflection. If a board memberdoes not possess the necessary skills and expertise, he or she must bring them in from “outside”, by hiring advisers with business acumen and/or appointing a “chief restructuring officer” to the board: an executive who has experience with, and understands, financial crisis situations.
- That chief restructuring officer must oversee a series of reliable and thorough analyses, essentially mapping out i) the company’s finances, ii) the causes for the poor or deteriorated finances (including in operational terms) and iii) the known or projected future cash flows/liquidity forecasts in the short and the medium term. Cash is king, particularly in a crisis: the company needs to have control of its liquidity. Those liquidity forecasts must then be prepared, or at least tested, by the people in the actual business, rather than by the accounting department or the controller: a customer-facing member of the sales team is often a better judge of when their customers will make a payment or order new products. Another important factor is that the analyses must be carried out, and at least reviewed, by “independent” outsiders, to ensure greater agreement from the company’s stakeholders and to prevent the positives from being overstated.
- The management information system will also need to be examined: it needs to be made capable, if it is not already, of producing all the information that is needed for managing the company, when it is needed. In a financial crisis, it is vital, if not all-important, to plot the company’s course based on financial parameters, and this is possible only if the management information system is up to standard (and with it the company’s accounts and records).
- The board must then use this analysis to draw up a restructuring plan. It will need to examine the company’s balance sheet, identify its core assets, decide what operations could be considered “non-core” or are generating losses (divestments), how great the liquidity deficit is, what it will be in the near future and whether it will increase, and what possibilities exist for boosting the balance sheet and improving the company’s liquidity position. This will not only involve a financial and tax due diligence, but will also require mapping out the company’s legal position. What actual and empty securities have been granted, and to whom? That is important to know: not only does this information go a long way to determining what assets will actually generate cash for the company (instead of for the party holding the security), this legal position is also one of the factors that decide what is possible, and what is impossible, in terms of restructuring efforts. As such, a restructuring plan should include sections containing strategic, financial/tax and legal information. Particularly with the financial data (such as the liquidity forecast) being focused on the future (even if this is the near future), the board will need to consider multiple scenarios.
- The board must make sure that its risk management is scrupulous and that it has a realistic plan of action. The restructuring plan should cover “management-case” and “bank-case” scenarios, as well as a worst-case scenario. In other words, the board must map out the possible effects on the liquidity forecast or the balance sheet, for example, if the proceeds from a non-core asset are much lower than projected, for instance, or if payment on a debt is not received as expected. It is important to involve the stakeholders that are “essential” to the rescue operation (including the bank) in the plan of action.
- This analysis and the restructuring plan should demonstrate that a rescue operation has a real possibility of succeeding, meaning that the company will be able to fulfil its obligations once again in the future and will offer recourse for all other claims. If that possibility does not exist, or if it ceases to exist while the rescue operation is underway, the board is obliged to set up a process to minimise the harm to the company’s creditors.
- Importantly, the board must carefully and above all critically monitor how the restructuring plan is carried out and take appropriate action, for example if divestments are not yielding, or do not appear to be yielding, the hoped-for outcome. That action could involve increasing the efforts, raising priorities and/or modifying policy/strategy.
- It is also important to be aware that executives, and particularly executives whose companies are struggling, are obliged to ensure a contingency plan, essentially describing the risks of the restructuring plan and explaining what will happen if specific scenarios underlying the restructuring fail to emerge, or do not turn out as expected. This information must be substantiated by financial data. Such a plan will help the board to take swift and appropriate action. It also serves to map out what the various scenarios and risks mean for the company, and perhaps more importantly for its key stakeholders, such as in most cases a bank and important vendors. It should include a breakdown for those stakeholders.
If a company is at risk of finding itself in financial difficulties, or is already in difficulties, this changes the playing field and dynamics for managing the company, which are not the same as they are in times of economic prosperity. Members of the board are expected to carefully and deliberately navigate the tensions arising from what are frequently conflicting interests of the company’s various stakeholders, all the time knowing that the future remains uncertain. This requires boldness and a willingness to take risks. Experience shows that the sooner board members undertake action to restructure a struggling company, the greater the possibility is that they will succeed.