The Role of the Board of Directors in a Turnaround
By Mark W. Sheffert
June 2001
Our firm has worked with over 250 organizations, many of them public companies
in crisis, and oftentimes the actions and attitudes of the board of directors during a
turnaround surprise us. When a company gets into trouble, the first thing many directors
want to do is jump ship --- they want to resign because they feel that with the equity
gone from the company, they are no longer responsible to the shareholders. It’s been
our experience that many directors don’t realize that they have other fiduciary
responsibilities and that the board of directors has an important role to play in a
turnaround.
Rather than jumping ship, directors need to dive in to the company during times
of trouble.
First of all, the board is responsible for protecting and preserving whatever
shareholder value is left, especially when management has been either the direct or
indirect cause of whatever led to the trouble. Managers have to make decisions that
may or may not be compatible with the interests of shareholders. For example, the board
needs to step in to determine where the buck stops for legal infractions, halt a failed
strategy when managers seem to have personal interests in supporting it, address the
poor performance of managers when they are reluctant to do it among themselves, and
acknowledge that employees have lost confidence in management. Even if management is
acting responsibly during a crisis, the board of directors must remain actively involved to
assure shareholders that management is doing so.
Secondly, in certain circumstances, such as in a crisis situation, the fiduciary
responsibilities of a board of directors is broadened to duties beyond the company and
its shareholders. If a company is insolvent or if the board of directors approves a
transaction that might reasonable lead to its insolvency, then the directors have a
fiduciary duty to the company’s creditors plus their duties to the shareholders. In
addition, if a board of directors authorizes a transaction that results in a change of
control, the courts have ruled that directors must receive on behalf of its shareholders
the best value reasonably available. In these instances, courts have examined the
decision of the board of directors and their decision-making process to ensure that this
result is reasonably achieved.
Directors should also possess certain personal qualities that are crucial during a
crisis. At all times, the three main qualities expected of directors are independence from
management, the capacity for objective judgement, and commitment to shareholder
value. However, most companies at some time or another will run into trouble of some
kind, and the ability of directors to utilize these qualities to effectively handle trouble is
especially important. Directors should be so independent of management and capable of
objective judgement, for example, that they are able to make the tough decisions
required when real trouble happens. This is especially important when the crisis requires
dealing with management, as is often the case, and may even be the management team
and / or executive that the director has chosen.
Just as importantly, directors should take their responsibilities seriously, be
committed and engaged in their duties, and take the time and give of the energy
required. Independence, judgement, and attention to detail can mean the difference
between slight trouble and a serious crisis.
The leadership abilities of directors are also important during a turnaround.
Troubled companies have one goal --- to survive --- and directors must possess the
courage and leadership needed to guide their companies through the crisis. In the initial
crisis and then in managing the turnaround plan, time is of the essence and swift action
is imperative. Directors must be able to act quickly and decisively. They must shift their
gears from strategic oversight to focusing on short-term survival. The focus of directors
during a turnaround should be on survival, action, and solving problems; their
decision-making should be quick and decisive; and their involvement must be direct.
For instance, in a severe turnaround my firm will hold weekly meetings with our
client’s board of directors where we give detailed updates as to the progress on the
turnaround plan, any new problems we’ve uncovered, and what we will do next. This
isn’t the level of detail and decision-making that most directors are accustomed to, but it
is required of them during a turnaround.
Directors are also responsible for avoiding situations that can lead the company
down the path into trouble. Managing a turnaround is not easy, and it’s best to not
have to go through it in the first place.
To that end, directors should insist that the company has internal systems in
place to ensure legal compliance, credible and timely financial reporting, and the supply
of necessary information to monitor performance and vital financial trends. Being
disciplined in these areas will not only help companies avoid trouble, but if trouble does
strike, these systems will help directors make decisions more quickly and able to rely
more on facts and less on personal judgement.
The courts are moving toward making the insistence on these internal systems a
requirement. In a recent case in Delaware, the court told directors that they have a duty
not only to monitor the business and affairs of the corporation, but also to assure that
management establishes appropriate information and reporting systems While the
court recognized that the appropriate details should be left to business judgement, it
emphasized that directors have a role in overseeing compliance to laws and regulations
by ensuring that compliance systems exist and function properly.
A frequent source of trouble during a crisis is the proper handling of layoffs, because companies in a financial crisis are often forced to layoff employees. Congress
passed the Worker Adjustment and Retraining Notification Act (the WARN Act) in
1988, but many directors are still unfamiliar with the responsibilities required of them
when planning an employee layoff. The purpose of the WARN Act is to provide
employees and communities a period of time to adjust to mass layoffs and plant closings. If a business employs 100 or more employees (part-time employees are excluded unless
all employees together work at least 4,000 hours per week including overtime), it is
required to provide at least 60 days advance notice to the affected employees of a plant
closing or mass layoff.
A plant closing is defined as the permanent or temporary shutdown of a single
site of employment if the shutdown results in a loss of employment during any 30-day
period for 50 or more employees (excluding part-time employees). A mass layoff is
defined as a reduction in work force resulting in employment loss at a single site of
employment during any 30-day period for (1) at least 33 percent of the employees and
affects 50 or more employees or (2) 500 or more employees.
There are additional WARN Act details that can apply to a company and which
may affect how a company can reorganize during bankruptcy, so if directors find
themselves in that situation they should consult with an experienced bankruptcy
attorney.
In addition, new rules by the Securities and Exchange Commission and the
leading stock exchanges during the past several years emphasize the responsibilities of
directors to oversee the audit process. The rules require that companies adopt and
disclose the audit committee’s charter and that the charter specify that the outside
auditor report to the board, not to management, through the audit committee. Furthermore, the annual proxy statement must include a written report from the audit
committee and a disclosure statement about the independence of the audit committee
members. Following these rules and ensuring the independence of the audit committee
will help directors avoid trouble.
Directors should go beyond the oversight of compliance systems and financial
reporting to also oversee management’s strategies, business plan, and the market
assumptions from which they are built upon. By understanding these key financial
assumptions, competitive factors, and market trends, directors will be in a better position
to effectively judge management’s strategies and business plan and to provide ongoing
measurement of performance. Directors who are actively engaged in their company’s
strategies and business plan are also more likely to spot trouble earlier and deal with
failures when they are in their infancy.
Few companies have been able to avoid life-threatening or near life-threatening
trouble at some point in their history. Trouble seems to be inevitable, for many reasons
including human nature, the pressures to meet the short-term high expectations of Wall
Street, the ever-changing competitive marketplace, and the difficulties of management to
grow with a growing organization. But if the board of directors is properly informed of
their role during a turnaround and takes its responsibilities seriously, that can often
make the difference between long-term success and failure.
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