Bankruptcy and Your Board: 6 Rules to Remember
BY Ralph Ward
As a result of the slump that's hit tech and dotcom stocks over the past year, combined with a general economic slowdown, many companies once swimming in capital are now wondering who to lay off first. And for some corporate boards, this brings the hard choices and soul searching surrounding the declaration of bankruptcy. Bankruptcy is a major trauma for everyone involved in a business -- but for the board, the demands are particularly harsh. You may end up viewing laid-off workers as the lucky ones. So how do you, as a director, survive the dangers of bankruptcy?
Realize that your legal duties will shift. Boards have a well-established fiduciary duty to shareholders, but when a company goes bankrupt (indeed, before it goes bankrupt), your legal duty "shifts to include creditors," says Myron Sheinfeld, an attorney with the Houston law firm of Sheinfeld Maley & Kay, and an expert on board duties. "Once a company enters the vicinity of bankruptcy, you gain a new legal duty to see that nothing is done that could be unfair to creditors," he continues. "Also, all board actions must treat the creditors equally." No preference can be given to easing the shock for certain vendors or classes of creditors. But when do directors of the troubled company face this new mandate? That's the tricky part. It varies by state, by type of business, by financial situation, and by the creditor structure, so?
Get good guidance early. "The board needs to talk with counsel, auditors, and outside experts immediately. Be willing to hire outside expertise," says Sheinfeld. The company may need to pinch every penny, but legal second-guessing is far more likely to cause problems than spending the money on seeking sound outside counsel.
Stay in close, constant contact with management. "Ask management lots of questions: what are they doing to develop business plans to keep the company solvent? What is the current status of tax payments, receivables, payables, collections and cash? Where are we on payroll, insurance coverage, and any lawsuits? The CEO has to be able to answer this to the satisfaction of the board,"advises Sheinfeld.
Prepare to put your life on hold. "Assume you're going to be completely immersed no matter how things work out. Spend a lot of time on the phone with management and other board members," Sheinfeld says. Also, bankruptcy is the moment when you as a director must put your Rolodex to work for the company. "If I'm a director, I'm going to be working my contacts and keeping intimately involved." This can mean getting on the phone with banks, creditors, suppliers? anyone who can make a difference.
Build a strong paper trail. The bankruptcy or workout period spawns endless legal dangers for directors, so "create a very careful record of what you've actually done," counsels Richard Swanson of the New York law firm Thelen Reid. "Take careful notes, show how you evaluated and picked alternatives, and keep good agendas and minutes," he continues. Even busy, quick telephone conferences should be minuted to keep your paper trail solid.
Avoid the temptation to bail out. Legally, a director may actually be in more danger if he or she quits while the bankruptcy battle is underway. "The director can't just walk away with impunity," notes Sheinfeld. "The best protection for the directors is to go into bankruptcy with the board intact."