The COVID-19 lockdown in the United States earlier this year brought an end to the halcyon days for start-ups and their attraction from the venture community. Many companies are facing difficult strategic decisions as the first half 2020 draws to a close.
Many businesses are now operating at or near the level of pre-pandemic forecasts and budgets. This has caused them to be in financial distress. Directors are being pressured to take drastic measures to allow their company access capital, or to pursue business strategies that were impossible just a few months back
Directors owe a duty of care and loyalty to the Corporation and its Shareholders
- These duties apply regardless of whether directors are solvent.
- Directors must act in the best interest of shareholders and the corporation. Directors can’t use their trust and confidence to advance their own interests or those of other constituencies at the expense the corporation’s best interest.
- Directors must consider all information available to make business decisions. They should also use the same level of care as a prudent and ordinarily cautious director in similar situations.
- Directors may find their duties extremely difficult in these times. This could prompt them to reconsider whether or not they should resign. Directors are free to resign at any time, but it is not possible to do so in all cases.
- Directors should remember another important constituency when trying to weather the economic storm: Creditors. In certain cases, creditors can sue directors if a Delaware corporation or California corporation is insolvent.
Protecting Director Exposure
Directors of companies that are potentially insolvent should be aware that their duties and obligations will vary depending on the facts and the applicable law. However, they should take the following steps to reduce exposure to creditors and equity holders:
- Get information about the Corporation’s financial performance. Consultation with the CFO or outside accountants is often required. If in doubt about solvency/insolvency it is possible to conclude that the company is insolvent.
- Make informed decisions. This requires active participation in decision-making and the gathering of information. Recognizing transactions that may involve conflicts of interests of interested parties is crucial. A special committee of Board members may also be useful in focusing attention on solvency issues.
- Document the Board’s Decision-Making process. All information should be obtained by the board in writing. Questions, objections, and other communications should also be recorded.
- You might consider obtaining D&O Insurance or Director Indemnification
Agreements. Directors may be able to mitigate their potential liability by purchasing D&O and seeking indemnity from company. However, this is only possible if the insurance and indemnity contracts are in place prior to the board decision that triggers a shareholder claim or creditor claim.
Summarized from an article by Stubbs, Alderton & Markiles, LLP.
