In most corporate environments, directors understand that the role of the board is one of oversight. For years, they have heard the governance advice captured by “nose in, fingers out” (NIFO). However, the current COVID-19 pandemic has many directors wondering about how best to discharge their fiduciary duty—to act honestly and in good faith with a view to the best interest of the corporation—and their duty of care—to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
Directors are asking us whether these duties have been heightened during the midst of this unprecedented disruption, and whether the rules of governance and the framework of their respective boards should change to meet these duties because of COVID-19.
In our April 2020 COVID-19 Checklist: 51 Issues for Public Company Directors and Officers to Consider, Blakes set out 51 issues we have been addressing for Canadian public companies concerning the impact of COVID-19 on their financial results, operations and cash flows, as well as the price or value of their securities in public capital markets. In this publication, we seek to complement that information by providing you a view from inside the boardroom.
1. What is the role of the board and its chair in the current circumstances?
At present, directors are concerned about their oversight and risk management responsibilities. Their instincts may prompt them to try and take a more active role and to request additional meetings and information from the Chief Executive Officer (CEO) in order to ensure that they have sufficient oversight over management decisions. However, in a crisis like COVID-19, boards need to find the right balance between oversight and support of management. In the midst of this crisis, we believe that it is best practice for the chair of the board to guard against cumbersome requests for non-essential information from the management team. The chair should act as a leader in managing the directors’ expectations and should focus on having effective and straightforward communication with the CEO on a regular basis. In the past weeks, we have seen chairs becoming much more involved, playing a key role as strong and regular liaisons between the senior executive teams and the board.
As the CEO and the management have their hands full in the day-to-day handling of this crisis, the board should focus on the bigger picture and ensure that the decisions taken by management are in line with the culture and core values of the organization and are viable in the short-, medium- and long-term by providing challenging input and giving critical, independent and constructive insight. It is also the role of the board to be thinking strategically about gradual business resumption and what it means for the organization, specifically accounting for the impact on various stakeholders, including future health and safety measures, the impact of social distancing and travel bans on operations, available technology and financial reporting and compensation implications for the executives, workforce and pensioners.
2. What are the practical aspects of the board’s involvement?
The board needs to maintain close contact with the CEO without crowding him or her. The cadence of this communication is important, as is the scope of the matters to be reported on. For example, if the organization operates in a heavily regulated industry, it is very important that the board and management ensure that all relevant information related to safety—for customers and employees—is effectively reported to the board by management on an ongoing basis, in an easily digestible format. Directors also need to examine management assumptions and provide helpful insight and fresh eyes on any proposed alternatives.
It is paramount that adequate monitoring processes be put in place to allow directors to obtain up-to-date information about COVID-19’s impact on their organization’s operations. Directors must make a good faith effort to oversee their organization's operations by putting in place a reasonable board-level system of monitoring and reporting that goes beyond supervising that the organization nominally complies with the law. Failing to make that good faith effort risks breaching the duty of loyalty and can expose a director to liability. In Marchand v. Barnhill. 212 A.3d 805 (2019), at the time of the listeria outbreak, the directors of one of the Unites States' largest ice cream manufacturers were found to have “[completely] fail[ed] to implement any reporting or information system or controls.” Once such a system or controls are implemented, the board should consciously monitor or oversee their organization’s operations to avoid “disabling themselves from being informed of risks or problems requiring their attention.” In short, to properly discharge their duties, directors must make a good faith effort to ensure implementation of an oversight system and to then monitor it.
Some examples of good practices that would apply to specific areas of concern for an organization include:
Implementing a process or protocols that require management to keep the board apprised of the compliance practices of their organization related to the risk and of all related reports
Scheduling regular meetings to allow the board to consider issues pertaining to such risk on a continuous basis
Specifically allocating time during each board meeting to address the area of concern and maintaining a reliable record of such discussions
We believe that the board should ensure that the management’s contingency plans are transparent throughout the organization and communicated effectively to applicable stakeholders, including employees, shareholders, suppliers, customers, investors, creditors, government and surrounding communities. To this end, the board should ensure that the communication channels—both inside and outside the organization—are well-established and that the message and information provided is clear, internally consistent across channels and target audiences, and consistent with management’s strategy and public disclosures. Communication of the strategy and strong leadership is key.
It is also good practice that boards review their directors and officers (D&O) insurance plan and indemnity or release of liability agreements, as well as any relevant insurance plans of their organization.
Finally, we see some management teams hesitate when it comes to substantially changing the strategic plans of their organization or closing down some parts of it. In this regard, boards shouldn’t hesitate to nudge their organization forward and ask the “what if” questions that may be dictated by the circumstances to surface difficult decisions for appropriate consideration.
3. Over and above their oversight responsibility, do boards ever step in?
In situations where the management team does not provide the necessary leadership or might lack a special skill that is critical to the current context and available at the board level, it may in fact be appropriate for individual members of the board to take a more active hands-on role within the organization. We are seeing some directors—who are senior executives in organizations dealing with similar issues—offer their help as sounding boards to the CEOs of the organizations on whose boards they serve. Typically, those approaches have been well-received as everyone realizes that pooling lessons learned facilitates the acceleration of better decision-making.
We have also seen boards raise their level of intervention when the financial situation of the organization is so critical that it presents a going concern risk.
4. What are some of the matters that directors should be monitoring when management reports on COVID-19?
Among other matters particular to their organization, we suggest that directors should know and be informed of the following:
Updated status of the organization: Where does the organization currently stand? How is it handling the crisis, understanding the high-level risks and actions to minimize and mitigate?
Health, safety and well-being of employees: What is the update on the health and safety of the employees (number of cases and how the organization is dealing with them)? What is the absenteeism rate? What is the impact on operations and what are the mitigation measures? Are employees being laid-off, furloughed or otherwise financially impacted by organizational decisions? How is executive pay being impacted?
Operational overview of the facilities: What are the facilities’ occupancy levels and the back-up plans if certain facilities need to be closed temporarily?
Indebtedness and obligations: What are the organization’s ratios, obligations and covenants under financing arrangements or substantial contractual commitments of the organization?
Capital allocation and liquidity risks: What is the liquidity position of the organization? What are the needs of the organization and the measures taken to preserve cash flow and follow receivables and provisions for bad debts (sensitivity analyses and stress testing)? What are the organization’s available sources of capital and are they expected to be adequate—for how long and in what range of circumstances?
Status of key customers: How is the organization handling its key customers’ requests? Are deliveries or deliverables being delayed? What are the key customers’ financial situations? How can the organization contribute to alleviating commercial concerns of key customers?
Review of the supply chain: Are key suppliers to the organization struggling? Does the organization face border issues? What is the anticipated lag in supplies being provided following reestablishment of semi-regular operations for the organization and its key suppliers?
Help from the government: What steps have been taken to benefit from the various government plans that have been made available to support the economy? What, if any, public disclosures are required of the organization in such context?
Term of strategy: What are the adjustments to be made to the timeline of the organization’s strategic plan? Some boards are resetting their plan to a one-year horizon and some to three months.
Market opportunities: Is the organization prepared to address the opportunities and challenges posed by depressed stock prices? Management talent could become available, markets could open for refinancing credit arrangements, acquisition opportunities could develop, the organization could become vulnerable to unwanted third-party approaches, equity financing could become excessively dilutive, etc.
Communication: Is the messaging and communications—both internal and external, including press releases, messages to employees, communication plan with respect to governments, regulators and key stakeholders—effective and efficient? Is there a consistent “tone from the top,” despite an ever-evolving landscape?
Support: What actions are being taken to support the local community or governmental needs, such as repurposing of some organizational activities or plants?
5. How often should directors meet?
We are seeing the chair of the board and the CEO speak very regularly, sometimes daily. Information flows to the boards in different ways. Depending on the business and other context, we are seeing formal meetings most often being called every second week and being held by teleconference, or more effectively, remotely through virtual platforms. They are brief touchpoints, providing directors with updates on the above matters. Sometimes they are recorded and made available to those directors who missed the meeting—often because they were handling the same issues in their own organizations—so that they can listen to the recording and be kept informed on all matters as if they had been in the room. Any such recordings should be deleted after being listened to or viewed by the absent directors.
Many organizations who still pay board meeting fees have seen their directors choose not to receive their meeting fees for these information sessions, to support the organization and preserve some cash, or to donate a portion of their fees.
In our view, minutes of these meetings should be kept and promptly turned around between meetings for approval by the directors at each succeeding meeting. This discipline will help the directors follow the actions taken by management, the matters reported on and the matters to be followed up on. We suggest as best practice that directors not keep personal notes of the discussions held during those meetings; the minutes should stand on their own.
6. What is the format of the reports to the board?
In our experience, during the week where the board does not hold a formal meeting, most boards receive a short, fact-oriented, written point-form update from the CEO, updating from the last meeting the same topics as above. Some chairs also communicate with their directors through unofficial channels to fill the gaps between the meetings. In the midst of COVID-19, communication by leadership is key.
However, while reports or communication ought to be promptly shared in times of crisis, boards should ensure that minutes of meetings and any ancillary communications reflect their position and the organization’s public disclosures. Directors should also be mindful of cybersecurity and litigation risks associated with any written communication by text, e-mail or other instant means of communication, and should be careful when sharing confidential or sensitive information.
7. Should the board strike a special committee?
Certain boards may consider forming a special COVID-19 committee, thinking that a smaller group of directors can be nimbler at scheduling discussions and acting on quickly evolving matters. However, most boards have taken the approach whereby all the directors deal with the issues and opportunities relating to the outbreak. Such approach may be favoured as it helps directors fulfill their duties and avoids creating information asymmetries between directors. Indeed, even with the best of intentions of making the information available to all, the situation is evolving extremely fast and the consequences are unknown. Striking a special COVID-19 committee may result in the creation of two classes of directors: those with the information and those without. Furthermore, for many organizations, this unprecedented crisis management requires the board to consider and make rapid decisions on high stake issues, which, due to the level of their materiality, cannot be delegated to a committee and benefit from the diverse points of view represented by the full board.
8. Are proper succession plans in place if directors or members of the C-Suite get infected?
The virus doesn’t discriminate. Several public issuers have disclosed that their CEO was or is infected by COVID-19, while others have announced the untimely passing of some of their key employees.
Boards must have organized conversations about revisiting their succession plans in the current context of COVID-19. These start with plans for the chair of the board, the committee chairs and the key management team, with two levels of replacements: 1) immediate successor and 2) replacement for immediate successor. There should be a clear consensus from all involved that the individuals identified in the succession plans be told, where appropriate, that they have been so designated—particularly if they are the immediate successor—and that they should to be prepared to step in on a moment’s notice. There will be no time to ramp-up if and when the incumbent becomes sick. Further, in the current context, an organization’s ability to recruit identified succession candidates from other organizations can be expected to be very limited, putting pressure on the identification and reliance on internal successors.
For those positions where no internal replacement is identified, we recommend identifying an interim replacement with experience who can assume the responsibilities and manage the crisis in the short-term. Such interim replacement could even be a director who retired from a similar position at another organization. We note that Institutional Shareholder Services Inc. stated in its updated Impacts of the COVID-19 Pandemic: ISS Policy Guidance, released on April 8, 2020, that interim management functions assumed by board members due to the disability or incapacity of an existing member of the management team will be tolerated by use of discretion in applying guidelines related to directors’ independence and other attributes.
9. What about public disclosure?
Everyone understands the difficulties of providing accurate and meaningful disclosure at present on how the COVID-19 outbreak is affecting and will impact business operations. However, public issuers need to provide meaningful information and stay away from generic statements copied from another reporting issuer’s public disclosure. Boards need to work with management teams to reinforce this requirement. The language contained in public disclosures such as press releases and annual or quarterly reports should be carefully analyzed and considered.
Canadian securities regulators and stock exchanges have issued recent guidelines in connection with various relief granted to public issuers in the context of COVID-19; for more information please see our April 2020 COVID-19 Checklist: 51 Issues for Public Organization Directors and Officers to Consider. Moreover, helpful guidance may be found in the disclosure guidance published by the US Securities and Exchange Commission on March 25, 2020, which provides a list of questions public issuers should consider when assessing and disclosing COVID-19-related effects.
10. As confinement measures are starting to be relaxed, what are boards considering?
Most of the work so far from management teams and boards has been focused on dealing with and overseeing the daily consequences of COVID-19. Some organizations have started planning their back-to-work protocols, but very few have envisaged how the governments seem to be planning the relaxation of the confinement measures: certain industries before others, certain countries before others, certain provinces or regions thereof before others; certain demographics before others; etc.
In order to reduce the level of concern of their employees for their health as they return to work, we are seeing organizations considering not bringing back all functions at the same time. For example, the return of those head office or corporate functions more suitable to working from home—such as legal, communications, many accounting and tax and most back-office functions—could be delayed even to the end of the year. Others are considering a gradual return to normality (workforce divided by even and odd days, or reduced hours of operation) while, at all times, maintaining any arrangement which would facilitate the continuation of the distancing measures in the workplace. It is also hard to deny that there may be a new norm in this respect as employees get used to not commuting and organizations see the benefits of prior trends in more flexible work arrangements that have now been accelerated. This new reality may not be how boards and CEOs had planned for their organizations to be returning to work when everyone was told to stay home in early March. This can be expected to result in much more conservatism in the boardrooms when cash flow budgets and revenue projections are presented.
As boards try to steer their organizations through these difficult times, we suggest that all decisions be taken through the lens of their corporate values, as articulated in their public documents and on their website. This will go a long way to seeing that the directors discharge their statutory duties.
For further information, please reach out to a member of our Corporate Governance group or your usual Blakes contact at any time.
Please visit our COVID-19 Resource Centre to learn more about how COVID-19 may impact your business.