Client Alert: COVID-19 and the Need for Directors and Officers to Consider Increased Oversight

Date: April 6, 2020
The current COVID-19 pandemic is wreaking havoc on the balance sheets of many businesses spanning nearly every industry in the United States and challenging their typical corporate governance procedures. As directors and officers of corporations across the country take action in an attempt to steer their companies in a positive direction and mitigate long-lasting impacts, decision-making and the proper exercise of fiduciary duties can require an increased focus on the financial health of a company. These unprecedented times also may uncover or highlight various business and operational risks that must be fully understood and monitored by directors and officers as they guide their companies through this crisis. Understanding fiduciary duties, to whom they are owed, and how to exercise them properly is critical for directors and officers to avoid personal liability.

Traditional Fiduciary Duties
Directors owe fiduciary duties to their companies at all times, but in times of financial distress, the focus of those responsibilities, in most cases, shifts. In good financial times, corporate directors and officers generally owe, among others, fiduciary duties of care, loyalty and good faith to the corporation for the benefit of its shareholders. The duty of care requires directors to act in an informed and deliberate manner prior to making business decisions. The duty of loyalty requires that directors and officers act unselfishly to further the interests of the corporation instead of their personal interests or interests of others. Finally, the duty of good faith dictates that a director and officer act honestly, in the best interests and welfare of the corporation, and not knowingly unlawful or contrary to public policy. Each of these duties is implicated when making decisions for a company in the current pandemic.

Insolvency: When Duties Shift to Include Creditor Interests
When a company becomes insolvent, the focus of the fiduciary duties of directors and officers owed to the corporation shifts to maximizing the corporation’s value for the benefit of all of its residual interest holders, i.e. its shareholders and creditors. At a fundamental level, this shift occurs because the assets of the corporation are insufficient to pay all creditors and also reach its shareholders. Because of this, courts have allowed creditors to sue directors and officers, including on a derivative basis on behalf of the corporation itself. Given the rapidly changing environment caused by the COVID-19 pandemic, it may be difficult for directors and officers to gauge when their company becomes insolvent and when the focus of their decision-making must shift to the interests of the company’s creditors. As a result, it is imperative for directors and officers to maintain regular communication with management, financial professionals, and advisors to ensure that they have up-to-date information relevant to their decision-making.  Regular communication when unable to meet in person presents a novel obstacle, but one that must be addressed early and assessed frequently. The flow of vital communication to the directors and officers must remain uninterrupted.

Identifying and Monitoring COVID-19 Related Risks
In addition to assessing financial risks, directors and officers must fully understand all operating risks—either pre-existing or newly unearthed as a result of the current environment. To comply with their duties, directors and officers must ensure that there is a mechanism to identify company-specific risks and also, through subsequent risk reporting, to monitor those risks by elevating problems to the officers and directors on a regular and as-needed basis. These risks may include employee safety, labor force, financial disclosures, supply-chain and inventory matters, as well as vendor and customer relations. Increased oversight in these areas during the pandemic may give rise to the need for a special committee that can meet and assess the situation more frequently than a full board of directors can. Importantly, efforts to identify and monitor risks and corporate reporting systems should be documented in meeting minutes to memorialize the proper exercise of these duties.

In this uncertain and unprecedented time, business decisions will likely be subject to increased scrutiny. Directors and officers must ensure that they are adequately informed, assess all of the information and reporting provided by managers and advisors, and guide the company in good faith and in a manner that is in the best interest of the enterprise. Taking steps now to fully understand your responsibilities as a director and officer in this unique time, and properly exercising those fiduciary duties, will mitigate both individual and company risk as the nation emerges from the lock down.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.