Trust In Resilience: A Director’s Response to Troubled Times
In recent months, business leaders have placed their most delicate bets to date. With the ongoing pandemic and the resulting lockdowns to varying degrees, businesses have been challenged to plan for the future, conserve cash to stay liquid, and avoid disruption to operations. Burdened by the uncertain global and domestic economic climate, business leaders, especially directors, face difficult questions, including what to do when the business faces inevitable distress.
Warning signs and interpretation of information
As the landscape changes, it is crucial to identify potential signs of distress early. Think of it as personal health. Early diagnosis usually gives doctors a wider range of potential treatments. Ignoring the symptoms until his condition worsens will result in more limited and possibly more drastic treatment options.
Here are some common warning signs administrators should recognize:
- Profit not convertible into operating cash flow
- Frequent (and unplanned) fundraising activities
- Declining income and profits or recurring losses
- High and increasing interest payments
- Downgraded credit rating and high debt
- Extended debit and credit days
- Sharp drop in the share price
- Sudden departure of key executives in a short period of time
But how can directors best diagnose such symptoms, especially when they are not in the company every day? For starters, they can critically review the information on company performance provided by management at each meeting. A good indicator that things are in order is to observe how information is presented and assess whether it is being communicated consistently and what trends are visible.
Administrators should determine if the information is consistent with information from other sources about the state of the industry and the business. If one or more of the above warning signs appear, the correct thing to do is to press for more details or explanation.
Directors should be firm in seeking answers while bearing in mind that management may be concerned about day-to-day operations and may not be as sensitive to systemic threats to the business. This is in line with the responsibilities of the board of directors set out in the recently released Malaysian Code of Corporate Governance 2021, which states that the board shall govern and set the strategic direction of the company while exercising oversight over management.
Despite their vigilance, it is important for directors to accept that distress is sometimes inevitable, especially in an economy weakened by Covid-19. It makes business sense to address distress early on, as proactive actions preserve options, gain employee and investor confidence, and provide the company with greater bargaining power from a position of strength. . In response to the distress, directors could take the route of corporate restructuring.
Restructuring as a solution
When considering a restructuring, directors should first be aware of the options available to them. A restructuring plan may involve a renegotiation of terms or a rearrangement of the nature of the company’s financing (a financial restructuring) or a change in the way a company operates (an operational restructuring), or a combination of the two.
When evaluating restructuring plans, it is important that directors understand that there is no “one size fits all” approach. Each plan is unique to the circumstances of the company being restructured. Administrators must therefore have access to all relevant information and have the right tools to analyze and interpret this information. This is crucial to help them make informed decisions on the most appropriate restructuring plan for the company in light of their fiduciary obligations to the company and its stakeholders.
Once a restructuring plan is developed and approved, directors will need to actively monitor the implementation of the plan to ensure its success. To facilitate this complex process, it is common to have a dedicated restructuring / transformation committee with a direct link to the board of directors. Where specialized skills may not be available in-house, the board may consider engaging qualified advisors to help it develop, implement and monitor a restructuring plan.
However, restructuring plans are not foolproof. Despite the best efforts of all stakeholders involved, a restructuring exercise can fail. In the face of tight liquidity and credit, a business can be considered insolvent. What does this mean for directors?
Role of directors in insolvency
Dealing with insolvency comes with its share of challenges. The main issues that directors need to be aware of are directors’ liability in insolvency and how their fiduciary duties may change when the company is insolvent.
Very simply, when a company is insolvent, there is a change in priority of the fiduciary duties of the directors, that is to say that the best interests of the creditors become paramount. Incurring additional debt when a business is insolvent could result in the personal liability of the debt administrators. This is called insolvent trading.
Therefore, in the pre-insolvency period, the actions of directors and the approval of transactions may be subject to scrutiny from stakeholders. Directors should be careful not to approve transactions that might be privileged for a group of stakeholders or that might be seen as undervalued if they believe the business is going into insolvency. Such operations risk being canceled if a liquidator or a receiver is appointed at the head of the company.
Finally, it is the power of the liquidator to investigate the acts of the directors that led to the insolvency in order to determine whether there is a need to take legal action against the directors. Defending such claims can be time consuming and costly in addition to irreparable reputational damage.
This area is complex and potentially subject to litigation from various stakeholders who will attempt to maximize their collections. Directors would do well to seek legal and professional advice when navigating the insolvency area to ensure that they are effectively discharging their fiduciary duties.
In conclusion, directors must be vigilant to navigate these uncertain times. They need to keep an eye out for warning signs, act on them, and accept that in some cases restructuring may be appropriate. At all times, they should be aware that dealing with distress can be a complex and nuanced matter – and they should seek help when needed – before it is too late.
Lee Chui Sum is Deal Partner and Ganesh Gunaratnam is Deal Manager at PwC Malaysia