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Apr 15, 2020

Enhancing leadership resilience during Covid-19

Boards have options to ensure continuity when regular notice and quorum requirements cannot be met due to an emergency

Business continuity planning during the Covid-19 pandemic requires boards of directors and senior management teams to confront the unthinkable: how will the business continue to function if key leaders and decision-makers are incapacitated?

Boards, senior management and corporate counsel should therefore consider whether the company has in place appropriate leadership resilience plans, both with respect to senior executive emergency succession and board emergency procedures.

It has been a common practice for at least the past decade for boards of large public companies to have an emergency CEO plan in place. But our recent review of the bylaws of Fortune 100 companies reveals that only 20 percent have adopted specific emergency bylaw provisions to support board decision-making should a number of directors become incapacitated. Such planning is prudent given that most directors are of an age associated with increased susceptibility to complications from Covid-19.

Here we look at options and considerations for bolstering leadership resilience and discuss related disclosures that may be required or advisable.

Action by a board of directors requires either a vote to be held at a duly noticed meeting at which a quorum is present or unanimous written consent. As the pandemic continues, boards face some risk that it may be difficult to meet notice and quorum requirements – for example, if directors are locked down in a location without connectivity or become incapacitated. But boards have several options to ensure continuity when regular notice and quorum requirements cannot be met due to an emergency.

Default emergency provisions under state law
Depending on the law of the state of incorporation, a pathway for board action in catastrophic circumstances may be available through default emergency provisions. Most importantly, both the Delaware General Corporation Law (DGCL) and the Model Business Corporation Act (MBCA), upon which many state corporation statutes are based, provide emergency default notice and quorum mechanisms:

  • Notice: Default provisions may allow for notice of a board meeting during an emergency to be given only to the directors whom it may be practical to reach and may also allow for notice to be given by such means as may be feasible at the time. See, for example, DGCL Section 110(f) and MBCA Section 3.03(b)
  • Quorum: Default provisions may also provide a mechanism for substituting officers to serve as directors for quorum purposes. For example, the Delaware default provision provides that officers of the corporation, in order of rank and within rank in order of seniority, who are present at a board meeting are deemed to be directors to the extent required to constitute a quorum. See also MBCA Section 3.03(b)
  • Depending on the laws of the particular state of incorporation, these or similar default provisions may apply in an emergency unless the company has adopted more tailored emergency bylaws
  • Note that the MBCA Section 3.03 also provides that the board may use certain emergency powers in anticipation of as well as during an emergency.

Definition of emergency
The Delaware statute currently provides that default emergency powers are effective to the extent required to constitute a quorum in ‘any emergency resulting from an attack on the [US] or on a locality in which the corporation conducts its business or customarily holds meetings of its board of directors or its stockholders, or during any nuclear or atomic disaster, or during the existence of any catastrophe, or other similar emergency condition, as a result of which a quorum of the board of directors or a standing committee thereof cannot readily be convened for action’ (emphasis added). This section was adopted in 1953 and includes emergency conditions that are illustrative of the concerns of the day.

The MBCA defines an emergency as existing if a quorum of the board cannot be readily assembled because of some catastrophic event. Based on the particular facts and circumstances at issue, the Covid-19 pandemic could constitute a situation sufficient to bring such default provisions into play.

Potential action item
At companies that do not have tailored emergency bylaws and intend to rely on available state law default emergency provisions as to notice and quorum should the need arise, boards should consider reviewing their officer list and specifying each officer’s rank and seniority.

Tailored emergency bylaws
Both the Delaware statute and the MBCA allow for bylaws to include tailored provisions for use in an emergency (as defined by the applicable statute) rather than rely on default provisions. Such tailored emergency bylaws are fairly common among financial services companies – in part as a response to the 2008 financial crisis – but less prevalent in other industries.

Tailored emergency bylaws may be subject to repeal or change by shareholders but afford boards significant flexibility to determine in advance how best to prepare for an emergency situation.

Under the DGCL, tailored emergency bylaws may include any provision that may be practical and necessary for the circumstances of the emergency, including provisions that:

  • Permit any officer or director to call a meeting of the board or board committee in such manner and under such conditions as prescribed in the emergency bylaws
  • Provide that a quorum may be deemed to be constituted by the director or directors in attendance at the meeting, or any greater number fixed by the emergency bylaws
  • Permit the board to approve, before the emergency, a list of officers or other persons in order of priority and subject to such conditions and for such period of time (not longer than reasonably necessary after the emergency terminates) as may be provided in the emergency bylaws or in the resolution approving the list, who will be deemed directors to the extent required to provide a quorum at any board meeting; an emergency bylaw as to quorum will override the default emergency power discussed above.

Similar to the DGCL, the MBCA permits emergency bylaws that include all provisions necessary for managing the corporation during an emergency including procedures for calling a board meeting, quorum requirements and designating additional or substitute directors.

Official commentary to the MBCA notes that emergency bylaws may authorize the board to designate the officers or other persons, in order of seniority and subject to various conditions, who may be deemed directors during the emergency. Emergency bylaws under the MBCA are subject to amendment or repeal by shareholders.

Tailored emergency bylaws may, and should, also address notice requirements.

Note that under Delaware law, officers, directors and employees are not liable for acting in accordance with any emergency bylaws except for willful misconduct. The MBCA provides that corporate action taken in good faith in accordance with emergency bylaws may not be used to impose liability on a director, officer, employee or agent of the company.

Potential action item
Boards of companies that do not have tailored emergency bylaws should consider whether to adopt them so as to benefit from the flexibility provided by a bespoke approach.

Implement a two-tier quorum requirement
Although most companies require a majority of the total number of directors to constitute a quorum (and that is the typical default provision outside of an emergency under state law), boards may be able to amend the bylaws to provide for a lower quorum standard to be triggered under defined circumstances.

The DGCL permits a minimum quorum of one third of directors, unless the certificate of incorporation provides otherwise. Similarly, the MBCA provides for a minimum quorum of one third of directors.

A defined event that triggers a lower quorum requirement could include the inability of a majority of directors to constitute a quorum due to incapacity or unavailability in a pandemic or similar catastrophic circumstances.

Potential action item
Boards should consider whether to adopt a lower quorum requirement that would be triggered by certain conditions more broadly and specifically defined than provided under the statutory definition of emergency.

Delegation to executive or other committee
Boards generally have the power to establish and delegate significant, but not all, activities to committees, and a committee may comprise one person. But the delegation of actions to a committee cannot wholly mitigate, in two important respects, the concern that multiple members of the board may be unable to participate in board decisions, such that the board is hampered in its ability to act.

First, certain board decisions cannot be delegated, including bylaw amendments and most recommendations to shareholders. Second, the same circumstances that pose risks that a board quorum requirement will not be satisfied due to a pandemic or other catastrophic event also pose risks to a committee quorum.

Note that director incapacity could also impact the functioning of the three core independent committees – audit, compensation and nominating/governance – at listed companies, and non-compliance triggers notice requirements and the potential for delisting in certain circumstances.

NYSE and Nasdaq rules require the audit committee to comprise at least three members who are financially literate – including at least one member who is financially sophisticated such as someone who qualifies as an audit committee financial expert – and who meet heightened independence requirements.

In addition, Nasdaq rules require the compensation committee to comprise at least two members. Note that Nasdaq (but not NYSE) rules include a cure period if the audit or compensation committee has one vacancy that would trigger non-compliance with the listing rules due to lack of members, and a company relying on the cure period would need to notify Nasdaq of the event causing non-compliance.

NYSE and Nasdaq rules provide for a cure period in the event an audit or compensation committee member ceases to be independent for reasons outside of the member’s control.

Potential action item
Boards should consider whether board resilience would be improved by delegating increased power to an executive or other committee or committees in circumstances such as that posed by the pandemic. Committee charters could be amended to lower quorum requirements based on a trigger event as described above and to provide for self-executing changes in composition and leadership through the designation of alternates or by providing the committee with the ability to set its own composition and leadership under a trigger event.

Disclosure and related considerations
Adopting emergency bylaws and/or amending bylaws to impose a two-tier quorum requirement would require a Form 8K filing within four business days.

Other considerations will apply in the event a company relies on an emergency bylaw or emergency power. For example, a listed company that holds a board meeting with officers stepping into board positions in reliance on the default emergency power or emergency bylaw should consult with the relevant stock exchange whether a majority of ‘directors’ present at that meeting are not independent.

The company should seek guidance about what notifications are required as to the temporary directors and whether the situation constitutes non-compliance with listing rules such that a formal notification is required. The company would also need to consider whether any listing rule non-compliance is material such that Form 8K disclosure is required. These considerations also apply if a key committee takes action with one or more non-independent committee members.

Like directors, key members of senior management are at risk of incapacitation during a pandemic. Preparedness can help ensure the company has sufficient senior managers to implement business continuity plans and keep the company operational.

Potential action items
Boards should review emergency succession plans to ensure they are up to date as regards the CEO and other key officers. The board should understand who is positioned to immediately step into those roles should an executive become incapacitated.

Disclosure and related considerations
Appointing an interim CEO, CFO, COO, principal accounting officer or person performing similar functions requires Form 8K disclosure within four business days, as would the incapacity of any of those officers or other named executive officer in performing his or her functions.

In the event an executive officer contracts Covid-19 but continues to perform his or her duties such that a Form 8K filing is not required, consider whether to disclose the illness voluntarily – with the consent of the affected individual. Although the information may not be considered material and Form 8K does not require disclosure, the company may prefer to manage the narrative in case any information is leaked to the press.

Holly Gregory, John Kelsh and Thomas Kim are partners at Sidley Austin LLP. Rebecca Grapsas is counsel with the firm.

Rebecca Grapsas, Holly Gregory, John Kelsh and Thomas Kim

Sidley Austin