Corporate directors and officers and fiduciary duties in the COVID 19 world: Same duties, but much more to do
It seems as if COVID‑19 has changed everything, sometimes in ways that were inconceivable only weeks ago. One thing that hasn’t changed? Directors and officers of corporations still have the same fiduciary duties that they had before the pandemic.
Directors and officers continue to owe the same fiduciary duties of due care to make informed decisions in good faith and loyalty to put the interests of the corporation ahead of their own. What COVID‑19 has changed is what constitutes due care, and the impact of this is likely to be broadened by an enlargement of the parties who should be considered as fiduciary duties are discharged.
In the typical case of a solvent corporation (which now may not be so typical), the duties of directors and officers are to manage the corporation for the benefit of the owners, and their fiduciary obligations are to the corporation. In many states, including Delaware, fiduciary duties have been held to include, in some sense, all stakeholders, including employees, customers, suppliers, and communities. This is not surprising even in the strictest sense because adverse impacts upon these constituencies can adversely impact the corporation.
Corporations are obligated to comply with applicable laws, which requires directors and officers—in their oversight function—to ensure that the corporation complies with laws governing, for example, employee matters, making consideration of actions by the corporation that affect its employees an indirect duty of the directors and officers. COVID‑19, and the fact that it is highly contagious, is now likely to focus scrutiny upon directors and officers and their discharge of duties and will require them to be more proactive than directors and officers have historically been. For example, if applicable return to work rules require corporations to create an employee protection monitoring plan to protect employees and the public (PPE, testing, spacing, etc.), directors and officers should do far more than simply approving and authorizing management to implement a plan that complies with the applicable rules. Because the health of their employees can rapidly affect the health of numerous non-employees, at least one pre- COVID‑19 case suggests that directors and officers should make sure that their corporation put into place a monitoring system that enables the board of directors to remain fully informed about issues with the actual performance of the plan and the impact on the health and safety of employees, as this, in turn, impacts public health and welfare.
Another complication for directors and officers caused by COVID‑19 is that the rapid structural changes in business conditions is causing dramatic short-term and long-term shutdowns, as well as volume reductions, some of which could be permanent. Moreover, the impact on efficiencies and costs that will be required for many businesses to operate (i.e., the cost of delay in shift changes for cleaning, staggered shifts, increased spacing requirements, increased health care costs, etc.) is likely to dramatically impact the profitability, cash flow, and even viability of many heretofore profitable corporations. Where duties of directors and officers shift or expand, in some jurisdictions, from the stockholder to the creditors (sometimes by giving them standing to bring derivative actions, sometimes by imposing duties using trust or other theories) when a corporation becomes insolvent, the post COVID‑19 environment will require directors and officers to proactively monitor the financial condition as a corporation’s financial condition may shift to being insolvent, to balance the potential insolvency risk of “bet the farm” strategies to save the business, and to know when the corporation could or does become insolvent as never before.
Unfortunately, what constitutes “insolvency” is not always clear, and corporations have frequently operated in what has been called “zone of insolvency,” which has become a much bigger zone due to COVID‑19. Although the duties of directors and officers remain to the stockholders while in the zone of insolvency, this is of little help. When a corporation slips from the zone of insolvency into actual insolvency can itself be a matter of opinion, can happen instantly, and varies from state to state. Most jurisdictions use two tests to determine solvency: the balance sheet test and the cash flow test. On its face, the balance sheet test appears simple, are the corporation’s assets greater than its liabilities? However, depending upon the jurisdiction, this is not so clear. For example, are fixed assets valued at book value or some current appraised value. Moreover, the values of assets can change rapidly, especially in the COVID‑19 environment, which has seen the collectability of certain accounts receivable fall and the value of machinery and equipment and of real estate decline rapidly. The cash flow test, which generally is whether the corporation is paying and/or can pay its debts as they come due, is also less than clear, especially in the post COVID‑19 environment when revenue is uncertain and difficult to project, the ability of customers to pay is unclear, and costs and operating conditions remain additional question marks. Finally, while many states use these test, how they are used differs. In some, if a corporation satisfies one of the two tests it is considered solvent and in other states a corporation has to satisfy both tests to be considered solvent.
Given the foregoing, what should directors and officers do in the current rapidly changing environment? Here are few thoughts:
- Ensure that all federal, state, and local requirements for employees returning to work are fully understood, develop plans that comply with the applicable requirements and methods to enforce compliance, make sure that the corporation executes on these plans, and ensure that there’s a process for the directors and officers to monitor compliance actively.
- Develop a plan for management to monitor carefully the return to work status and timing for the business’s facilities and those of its customers and suppliers in real time to enable the corporation to make appropriate decisions about operations and set up a procedure for this to be communicated to the directors and officers frequently for review and, where necessary, approval.
- Require management to prepare a 13‑week cash flow and long‑term projections based upon current knowledge developed as part of the business’s planning—given the paucity of reliable information, this may require best case, middle case, and worst case scenarios—to determine the additional capital required to re‑start operations. Projections should be updated weekly (or daily, where appropriate) with reports including comparisons of budgeted amounts to actual results and shared with directors and officers.
- Based upon the business’s liquidity, projected profit and loss, and the cash requirements for restarting, management should be instructed to have the corporation’s legal team review its loan covenants to determine if defaults exist or are likely. A plan to communicate with lenders should be developed and implemented whether it is to seek additional funding, to address covenant defaults, or to obtain concessions. Also, management should, if appropriate, be instructed to investigate additional sources of capital and keep the directors and officers apprised of those efforts.
- Before implementing any potential financing or acquisition transactions (as well as the decision whether to incur trade debt to continue operations), management should be instructed to evaluate both the financial and legal impacts of these transactions upon the corporation.
Should you desire to discuss these or other issues facing your board of directors and officers, please do not hesitate to contact the attorneys listed below who each have decades of experience in advising corporations and their boards in time of crisis.