HERE is an instructive and timely article by Walker MacLeod of McCarthy Tetrault with respect to the duties of directors and officers of financially troubled companies.

Of particular interest is the observation that financial difficulties often result in diverging interests between creditors and shareholders of a corporation.  As a result, the directors face conflicting pressures that add to the complexity of managing the troubled situation.

The duty of directors is always to direct the affairs of the corporation so as to maximize its value for the benefit of its stakeholders.  When a corporation is solvent, those stakeholders are the corporation’s shareholders.  When the corporation is insolvent, its creditors take the place of the shareholders as the residual beneficiaries of any increase in its value.

While this may seem easy enough to understand in principle, it is difficult for directors in the heat of battle to objectively evaluate where the corporation may be on the continuum from solvent to insolvent and, therefore, to know exactly when the creditors have become the primary beneficiaries.

Adding to the difficulty is the expectation that directors at all times use their best business judgement to increase the value of the corporation.  The result is that directors may be making decisions and incurring risk as if the corporation were a going concern, even if it may be insolvent or in the vicinity thereof.  For example, it often makes good business sense to prioritize certain unsecured supplier payments that are critical to the future value of the business ahead of secured creditors that would benefit from that money in a liquidation.

And if all that isn’t enough, the directors making these difficult decisions are often conflicted with dual roles.  For example:  shareholders are often directors and may be motivated to swing for the fences in hopes of creating some value for themselves; management are often directors and may be motivated to maximize personal compensation; creditors are sometimes directors and maybe motivated to preserve security and liquidity.

Dual role directors are always a hot topic when things are going bad.  For example, our Jay Richardson has been following with interest the activist battle at Taseko Mines.   An activist shareholder, that turns out to be a bondholder as well, wants to oust some of the current directors that benefit from significant related party transactions.  An article on the proxy battle is HERE and responding press release from the company is HERE.  Its an interesting read.

In the end, Walker concludes the article with some good advice for directors, including retaining financial, legal and other professional advisors to provide informed and objective insight on relevant issues.

Posted by Scott Sinclair,  Managing Director, Range Advisors

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