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February 27, 2023

What directors need to consider during financial distress

By Curtis Cusinato, Marshall Eidinger and Ashley White, Bennett Jones LLP

It is widely expected that Canadian companies will face more financial distress in 2023. This distress could happen in volatile or emerging industries, or traditional ones whose trajectories have become uncertain.
If a company finds itself in this situation, there are a number of important things for its directors to consider. There are also practical ways to plan ahead.
Director duties and liabilities
Director duties
A director’s fiduciary duty is at all times owed solely to the company, not to any particular stakeholder or creditor. Recent case law in Canada has clarified this. Directors can consider stakeholders’ interests during financial distress, but do not owe them a duty of loyalty.
If approaching insolvency, directors may choose from various remedial options, so long as:
  • They have considered the interests of affected stakeholders.
  • The decision is within a range of reasonable alternatives.
  • The board has determined the selected option is in the company’s best interest.
It is not uncommon, however, for the interests of a company and its creditors to align in trying financial circumstances.
Director liability and mitigation of risk
Directors should consider their personal exposure to a company’s debts when it is in financial distress. There are three main areas where directors could have personal liability – source deductions, wages and statutory liability.
Directors should familiarize themselves with the terms of the company’s directors and officers (D&O) insurance policy and the indemnification provided through corporate statute, the company’s constating documents and standalone indemnity agreements.
Liquidity and strategic alternatives
Understand sources of liquidity
The board should fully understand the company’s existing and potential sources of liquidity and how likely these sources will remain available. This understanding makes it easier to manage financial distress.
Understand the strategic alternatives available
Boards need to consider – with input and plans from management – strategic alternatives in the event of financial distress. These could include moves to:
  • curtail spending
  • downsize the workforce
  • restructure operations
  • dispose of non-core assets
  • consider a merger or the sale of the business
Understanding these options includes knowing whether the alternative will solve the problem, or merely buy time to implement another solution.
Developing a plan
Boards should create a clear financial distress plan, or instruct and oversee management‘s development of a plan. The plan should describe:
  • Who is responsible for what (including external advisors, if necessary).
  • How reporting, confidentiality and disclosure will be managed.
  • What objectives and options are pursued in the short and long term.
Developing a plan allows the board and management to better understand their depth of experience in sourcing liquidity and managing financial distress. If the necessary expertise is lacking, steps should be taken to acquire or grow it.
Identify team members
Navigating financial distress requires experience and skill in financial analysis and industry and financial market intelligence. It should be considered early on whether directors and management possess these skills. Otherwise, external advisors can be sought out to assist the company, including lawyers, investment bankers, financial advisors or public relations specialists.
Identify key stakeholders
A financial distress plan should identify the key stakeholders whose support is needed to implement and execute the strategy. Stakeholder needs should be assessed based on their ability to help or hinder the execution of the plan – and how they will be affected in a formal restructuring process under insolvency law.
Key stakeholders include shareholders, employees, creditors, suppliers, customers and governments.
Confidentiality and disclosure
Controlling and managing the flow of internal and external information is a must in financial distress situations. A plan should clearly define responsibility for this. Creating a plan in advance helps a company maintain control over its message and minimize the chance of potentially damaging off-message statements.
Documenting deliberations and decisions
Careful documentation is a necessary protection for the board when financial distress is imminent or worsening. Documenting decisions and the entire process means there is no confusion about the plan or why it is being pursued. This requisite shows directors have met the required standard – and are seen to have done so.
Looking ahead
Continued market uncertainty and other variables create a higher likelihood of financial distress in corporate Canada in 2023. Directors should be thinking now about what this might mean for their company and what they can do to get ahead of any potential financial distress.