Revitalizing Distressed Businesses: The Role of Independent Directors
Highlights from a panel discussion titled “The Challenges and Evolving Demands Facing Independent Directors.”
During the most recent Distressed Investing Conference hosted by Beard Group, Inc., a panel featuring restructuring experts discussed the current role of independent directors, private equity firms, and creditors. The panel discussion, moderated by Didier Siffer, a managing director at Riveron, featured diverse viewpoints and a healthy debate that offered a robust look at the role and challenges independent directors face in today’s market.
The role of independent directors
An independent director is neither sponsor, management, nor auditor. Typically added to a team in the event of a conflict, an independent director receives a sitting fee, and does not derive revenue or income from the company itself. While much of the role is defined by federal securities laws and SEC listing requirements, it is highly valuable to have an autonomous, experienced perspective asking questions. A good independent director quickly understands and translates their expert competency into working well with the rest of the board and helps to move the resolution process along. For example, if a company is entering into a period of stress or distress, adding the experience of an independent director to the board lends operational proficiency at a critical time.
An independent director’s role is to also help uphold the integrity of the process. This often begins with assessing whether a conflict actually exists. Their role is to walk in without predisposition of how they will vote, and to gather information from all directions.
When to hire independent advisors
A good independent director needs to be impartial not only in appearance but in actuality. Independent directors perform the role of a special committee, and to do this effectively, they practically and legally need to have access to their own advisors.
Opinions vary for when these advisors should be brought on board. Some restructuring experts consider that both the effective and operational independence protect the directors as well as the rest of the board. For these reasons, hiring independent counsel and financial advisors is considered a default during the course of business. Others consider that the primary role of the independent director is to help preserve and create momentum. In not seeking additional advisors unless necessary, they are able to help keep costs down. With either school of thought, independent directors are expected to be proactive, while remaining reflective and neutral.
Removing roadblocks in negotiations
Independent directors bring with them relationships across broad spectrums. Their network and wide-ranging experience equip them with skills to know what questions to ask. It also enables them to better contextualize issues that the company may be facing. Their relationships with sponsors, law firms, advisors, various creditor constituencies, secured bondholders, other independent directors, and management teams all contribute to their ability to offer consequential and objective insight.
Creditors and signaling bias
The market is experiencing an era of unprecedented levels of liquidity. A somewhat unspoken bias is that when a private company hires an independent, it can be perceived as a signal that they are approaching a period of restructuring or filing for Chapter 11 Bankruptcy. Chapter 11 represents the US legal system’s way of allowing restructuring to happen, offering companies an opportunity to reorganize rather than turn themselves over to creditors at the first sign of distress. Even if a company engages an independent director because it is experiencing financial distress, the optics preferably indicate that the company is receiving proper advisory.
At the same time, this scenario can trigger a bias, signaling possible risk to creditors and causing them to look for exposure. In the United States, restructuring is currently a shareholder- and board-led process. Traditionally, creditors have had an opportunity to draft covenants in their documents so that they get early warning signs. A newer, though debatably unnecessary trend sees lenders pursuing credit agreements that allow them to pick board members and list additional consents for bankruptcy.
Historically, loans were structured so that payment to creditors was the priority. With the increase in private credit and direct lending, control has been diluted. Negotiations with various providers of capital outside of traditional lenders have in many ways democratized the process, with syndicated creditors looking to revisit means by which they might assume proxy rights and share pledges while drafting the loan.
Choosing independents and the optics of power, control, and credibility
An effective independent director comes in with a strong moral and ethical compass, an availability of time to devote to the process, and a posture of challenging assumptions. At the same time, much of an independent’s job extends beyond their upholding the integrity of lending their expertise with autonomy.
During restructuring, independents may face scrutiny from skeptics claiming structuring bias. Even if they are as informed as possible, the optics of who is in control is important to maintain. Independents must seek to run a transparent process so that advisors are confident that they are negotiating in good faith. In standing upright, being persistent by asking the right questions, and offering visibility into all activity, independents can help eliminate the majority of concerns.
There has been a recent shift in creditors wanting to bring in their own independent directors or having a choice in proposing law firms. While working with both the company and creditor’s perspectives are critical in a successful restructuring deal, those in favor of the way the process is currently run believe that the shift would dilute the objectivity of the independent director.
The selection of an independent must be a careful choice, as the job requires not only a filter for experience, but also one of moral character. As a result, sourcing a director is naturally based on relationships. To combat the unspoken “roster” of independents, skeptics of the process have initiated discussions to try and update the process for being able to also impact how directors are chosen. In the long run, experts agree that the nuance and agility required to do the work well would be at risk.
State law offers several avenues through which an appointed director may be challenged. On the other hand, legislating the selection and monitoring of an independent director creates a premature emphasis that is unable to be streamlined. Experts agree that the process of elimination for a directors’ potential bias or incompetence must come through a natural flushing out from the market.
The future of independent directors
Based on the momentum of restructuring deals, some experts suggest that creditors will continue to exert more influence in how independents are selected. In addition, some companies are working with creditors to try and improve trust and communication in an ever-changing landscape. In response to the fast-paced deals that are happening, much is being pre-arranged and pre-negotiated.
Experts also believe that there is an increasing trend of negotiations playing out in court. At the same time, those who have been around restructuring deals for decades believe that the United States bankruptcy process is a world-class, effective solution, and not a broken approach to turn distressed companies around. Room for improvement comes down to solidifying and clarifying relationships on all sides of the process.