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COVID-19 and financial distress: How directors can prepare

Author(s): Mary Paterson, Andrew MacDougall, Marc Wasserman, Jessica Habib

April 17, 2020

For further information on this Update, please contact one of the authors or any member of our Insolvency & Restructuring or Corporate Governance Groups.

The COVID-19 crisis has shaken even the most well-grounded organizations. Companies are navigating the uncharted waters of a global pandemic, unprecedented physical distancing and the devastating financial impacts that flow from both.  

Board service entails a personal commitment to support the best interests of the organization – to help it succeed and be a better organization. More than ever, boards should prepare themselves for the governance challenges ahead, and be attuned to their responsibilities during a crisis (Osler has put together a checklist that boards can use and a list of questions to ask in light of the pandemic).

Knowing when a company is heading towards financial distress is the most important factor in avoiding or successfully navigating through that financial distress. To discharge their duties and effectively direct their business, boards require key information to assess potential financial risk and implement a plan to respond efficiently.

Key information and reporting metrics

In discharging its oversight responsibilities, the board should be satisfied that appropriate systems are in place to monitor the key risks of the business, including financial risks and exposures. Such systems should include regular reporting to the board on financial metrics that may highlight the possibility of financial distress before that distress becomes a reality.

Receiving formal and objective reporting metrics allows the board to work more constructively with management before and while the organization is facing potential distress. The board should work with management to develop regular, objective reporting metrics designed to identify potential financial distress early, such as those relating to cash flow, decreases in revenue, decreases in cash reserves, capital commitments, debt maturity dates, discussions with lenders and decreases in profit margins.

Consider strategic alternatives

The board should work with management and draw upon other information to develop expertise in the sources of liquidity available to the organization at any given time. The board must clearly understand what sources of capital the organization is currently using and the potential restrictions that might reduce the availability of such capital. Having a clear understanding of the organization’s liquidity options increases the chance that the organization will be able to resolve its financial distress without a court-based process.

In addition to reviewing the company’s sources of liquidity, the organization needs to consider other options for realizing value to fund its continuing options. For example, an organization may be able to curtail spending, downsize its workforce, reduce commitments where possible, restructure operations, dispose of non-core assets on a timely basis or consider a merger or the sale of the business where appropriate.

Advance planning for financial distress

Regardless of how much notice the board has, it is important to have a clear plan that describes who is responsible for what (including external advisors); how reporting, confidentiality and disclosure will be managed; and what objectives and options are being pursued in the short and long terms.

As a starting point, a financial distress plan should:

  1. Identify who is responsible for what, including a response team that is both technically skilled and able to work seamlessly with internal personnel and external advisors to identify areas of concern and implement solutions efficiently.
  2. Identify and prioritize key stakeholders whose support is needed to implement and execute a strategy to avoid or manage through the financial distress.
  3. Identify a process for reporting, confidentiality and disclosure and delineate responsibility for internal and external reporting and disclosure. Controlling and managing information flow is important to ensuring a successful restructuring.
  4. Identify immediate and long-term objectives and outline the options being pursued to implement those objectives.

More information

A board’s preparation for financial distress can greatly improve an organization’s outcomes, especially as the COVID-19 pandemic continues to challenge businesses in new and unprecedented ways. Osler and the Institute of Corporate Directors prepared a detailed report that expands on the topics covered in this post and provides practical and to-the point counsel on how the board can anticipate, prepare for and respond to financial distress.