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John Healy
Co-head, Americas M&A Practice
Clifford Chance

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

In this environment, as a director, should I be performing my management oversight role differently?

You should pay particular attention to your duty of management oversight, and to internal control systems. Directors also should pay heightened attention to risk management. Every company’s situation is different, so there is no single, one-size-fits-all approach to managing risk. In the present environment, though, the approach for almost every company should include carefully monitoring and maximizing liquidity, and contingency planning that addresses what to do in case of further business deterioration. In addition to monitoring and controlling operating expenses and capital expenditures, this also requires careful consideration of cash outlays that in normal times frequently are applauded by shareholders – for example dividends and share repurchases.

How should boards discharge their oversight responsibilities?

Board members should receive monthly detailed cash/liquidity position projections covering the next 12 months, together with sensitivity analyses showing the pro forma impact of adverse developments. They also should receive regular risk assessment reports from management, detailing types and scope of risks considered material. Depending on the company’s business, in the current environment, the risks covered by the assessment may include declines in sales volumes, margin deterioration, non-renewal of lines of credit or other financing arrangements, exposure to fluctuations in prices of commodities, raw materials or components, and exposure under swap or other derivatives positions entered into for hedging or other purposes. Finally, board members should receive regular briefings on contingency plans designed to address adverse outcomes identified in the risk analysis.

Should I behave differently if my company is facing insolvency?

When facing insolvency, many directors ask themselves the thorny question of whether or not they should alter their behavior in any way. Recently decided court cases make clear that, at least for directors of Delaware corporations, the rules in this area are as follows:

First, the primary duties of the board are owed to the corporation, and in all cases they require the board, acting in a prudent and fully-informed manner, to seek to maximize the value of the corporate enterprise. Second, while a corporation is insolvent, including when it operates close to (or “in the zone of”) insolvency, directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners. Third, after the corporation becomes insolvent, the directors’ obligations continue to be to the corporation, but those obligations can be enforced derivately by the corporation’s creditors. Fourth, after the corporation becomes insolvent, the corporation’s directors remain entitled (and in many instances will be required) to engage in vigorous, good faith negotiations with creditors for the benefit of the corporation. Fifth, its directors retain the freedom to implement strategies that involve the incurrence of incremental debt or risk (i.e., that may if unsuccessful reduce the ultimate recovery by creditors), so long as the directors believe in good faith that the chosen course of action is in the best interests of the corporation, and the directors’ decisions will have the benefit of the business judgment rule.

Notwithstanding the flexibility afforded directors by Delaware law, directors of a financially-troubled company obviously will in most cases act differently than they do when the company is profitable and free of difficulty. Appetite for risk is likely to be lower. And in reality, the risk that the creditors are likely to sue if things go badly also will tend to make directors more cautious. So long as the directors remain focused on protecting the interests of the company, a relatively conservative approach is permissible and in many cases desirable.

How should I communicate with the public if my company is in financial difficulties?

A company’s board should continue seeking to maximize shareholder value even as the company nears insolvency. There can be significant tension in a close-to-insolvency situation between seeking to maximize shareholder value by expressing optimism about the future on the one hand, and on the other hand, complying with the securities laws. It is appropriate to express optimism where there is a reasonable basis for it, but the company’s directors should insist that the company’s public statements must be accurate and not misleading.

What actions should I be considering when faced with unsolicited takeover proposals?

A board is under no obligation to entertain unsolicited offers. If an unsolicited offer is specific and credible though, the board should carefully review and consider it. Appearing to reject a proposal as a reflexive “knee jerk” reaction will play poorly in the courtroom and with shareholders.

If the board concludes in good faith that its shareholders are best served by the company continuing to execute its business plan as an independent entity, the board should recommend against the unsolicited offer and can actively oppose it. Of course, if the company lacks effective takeover or “shark repellant” defenses (so that the “just say no” defense won’t work,) the board should be prepared to deal with an unsolicited offer addressed directly to the shareholders by seeking out alternatives and by clearly communicating its position to shareholders. For Delaware corporations, the question of whether a corporation with effective takeover defenses (a properly-designed staggered board and a poison pill rights plan) can “just say no” indefinitely has not been definitively answered. Regardless of the legal niceties, asserting a just say no defense over an extended period against a determined, well-funded bidder is rarely practical.

Boards receive the greatest criticism (from courts and shareholders) when they fail to take the time to carefully analyze unsolicited proposals and the available alternatives. Conversely, courts are typically deferential to decisions taken by boards that have acted carefully and in good faith and have appropriately addressed any conflicts of interest. Regardless of how the board responds to an unsolicited proposal, it is important to show that the directors acted thoughtfully and carefully and that their chosen course of action is logically related to the best interests of shareholders.

Recent court decisions and commentary suggest a board that wishes to actively oppose an unsolicited offer may have difficulty relying solely on “substantive coercion” – the idea that the shareholders may accept an inadequate offer because they lack sufficient information about the company’s prospects, and therefore must be protected from their own folly. While substantive coercion concerns will justify a board’s attempts to delay a hostile bidder while the board communicates its position to shareholders and seeks out alternatives, those same concerns may not justify holding out for very long.

To help deal with this unwanted attention, directors should review their company’s anti-takeover “shark repellant”, make sure they understand what level of protection it provides, and obtain advice regarding how defenses might be improved.

John A. Healy is the Co-Head of Clifford Chance’s US M&A practice. Mr. Healy routinely advises participants in all types of M&A and change-of-control transactions. A significant portion of his practice is dedicated to cross-border M&A transactions. He can be reached at john.healy@cliffordchance.com.