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Mar 15, 2023

Governance reminders for a period of uncertainty

Amid concerns about a financial crisis, Jennifer Carlson, Lawrence Cunningham and Anna Pinedo offer timely advice on board oversight during times of stress

Companies will be affected in a variety of ways by the receivership of Signature Bank, Silicon Valley Bank and any financial institution faced with a similar crisis. Companies may face both liquidity and solvency challenges, and the resulting constraints may lead to difficult decisions, including prioritizing the uses of limited cash.

Board oversight of resulting decision-making will be implicated in many cases. Senior executives are advised to maintain a regular dialogue with boards, particularly independent chairs or lead independent directors, as well as audit committee members. Boards and officers should coordinate with inside counsel and outside counsel as needed to assure compliance with applicable laws, including those concerning director and officer duties. A very brief rundown follows (and our fuller account is available here).

Duties of directors
When a company operates amid heightened uncertainty, stakeholders may second-guess decisions the company makes. Decisions to raise capital or pursue other strategic alternatives – or other significant decisions – or a failure to take action or even consider certain alternatives, could all be challenged (with the bias of hindsight) as a breach of fiduciary duties.

Duty of care
The duty of care requires that the actions and conduct of directors be informed and that decisions be made with ‘requisite care’. In satisfying their duty of care, directors should: (1) inform themselves of all material information reasonably available; (2) carefully consider that information and all reasonable alternatives; and (3) act with requisite care in discharging their duties.

In discharging their duty of care, directors may reasonably rely on the advice of the company’s officers and advisers but should independently evaluate the assumptions and information presented.

Duty of loyalty
The duty of loyalty requires that directors act in good faith and in a manner they reasonably believe to be in the best interests of the company. Directors must exercise disinterested and independent judgment. They cannot act for a personal or non-corporate purpose, such as to preserve their positions or compensation, and should promptly disclose any conflicts – or potential conflicts – so that the board can evaluate and ‘neutralize’ those conflicts, if necessary.

Business judgment rule
If directors satisfy the duties of care and loyalty, they are afforded the protection of the business judgment rule if a transaction they authorize is challenged. The business judgment rule is a highly deferential, protective standard that shields directors in their decision-making process if they satisfy their fiduciary duties when making that decision.

Entire fairness standard
In cases of conflicts of interest, self-dealing, lack of good faith, fraud, failure to act reasonably or exercise reasonable judgment or abdication of responsibilities, the less deferential entire fairness standard applies. Given the potential for future challenges, directors acting amid heightened uncertainty should act as if this higher level of scrutiny will apply to their actions. The entire fairness standard shifts the burden to directors to prove that the decision or transaction was both procedurally and substantively fair.

Potential claimants
When a company is solvent, only equity holders may obtain standing to bring a derivative action on behalf of the company for breach of fiduciary duties. When a company is insolvent, creditors may obtain standing to bring a derivative action on behalf of the company for breach of fiduciary duties.

Although the fiduciary duties of care and loyalty to the company remain the same, the beneficiaries of those duties shift during insolvency. As it can be hard to tell in real time when a company becomes insolvent, directors of a company in the vicinity of insolvency should view their duties through the lens of the different beneficiaries of those fiduciary duties.

Oversight duties
A board’s risk oversight responsibility derives primarily from state law fiduciary duties. To be clear, the board is not required to be involved in day-to-day risk management. IIts responsibilities are limited to oversight. Generally, directors can be liable for a failure of board oversight only where there is ‘sustained or systemic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists.’

Duties of officers
Officers’ duties and scope of authority are usually outlined in a company’s bylaws and detailed in employment agreements. In addition, officers are generally understood to owe their companies the same duties as directors. In a recent case, the Delaware Chancery Court held that officers owe their companies a duty of oversight, fitted to the context of their scope of authority. When officers operate in challenging environments posing extraordinary decisions, it is advisable to consult with senior officers or the board of directors.

Securities law disclosure duties
Compliance with US securities laws is particularly important in times of heightened uncertainty. Every public disclosure, including SEC filings, press releases and investor presentations must be presented in a manner that does not contain an untrue statement of material fact or omit to state a material fact necessary in order to make the disclosure – in light of the circumstances under which it is presented – not misleading.

Public companies are subject to detailed requirements regarding the public disclosures they must make. Every effort should be made to ensure information required to be disclosed is disclosed in a timely manner, including on all aspects of risk and risk management as well as financial reporting consequences.

Maintain perspective
As federal and state authorities and private institutions work to maintain the stability of the financial system, it is important for corporate leaders to maintain perspective. The duties of officers and directors of public companies are unchanged but the context in which they are applied may differ for some companies.

Jennifer Carlson and Anna Pinedo are partners and Lawrence Cunningham is special counsel with Mayer Brown