The COVID-19 pandemic has sent massive shockwaves throughout the global economy. This crises requires business leaders to confront a host of deleterious effects on an emergency basis – the likes of which many companies have never experienced. Boards of directors must remain cognizant of their oversight responsibilities in these trying times. This post offers guidance to directors of Delaware companies for addressing emergency circumstances occasioned by the COVID-19 pandemic.
Board Oversight – Lessons from Marchand V. Barnhill
Directors should consider the lessons learned from the recent Delaware Supreme Court case Marchand v. Barnhill, a ruling we addressed in a previous blog post, when considering board oversight during the COVID-19 pandemic. Marchand centered on a lawsuit brought by shareholders in an ice cream manufacturing company against the company’s board of directors. The shareholders claimed that the directors violated their duty of loyalty to the company when they failed to provide sufficient oversight and compliance-monitoring during a listeria outbreak that led the company to recall all products, temporarily cease product production at all plants and lay off more than one-third of the company’s workforce.
Companies can work to ensure that their boards are meeting their duties of loyalty and care in addressing the COVID-19 outbreak by pursuing actions that the Marchand board neglected when facing the listeria outbreak. Directors of companies in any industry should, at a minimum:
- gather information from sources regarding the impact of the COVID-19 pandemic on the company and the short-term and long-term plans in development to address these impacts;
- schedule a special board meeting if a regularly-scheduled meeting is not planned for the near future;
- create a special committee to specifically analyze the effects of COVID-19 on the company and to oversee management’s response;
- keep a detailed report of board actions; and
- make sure that monitoring and reporting mechanisms are in place to gather and provide the board with relevant and up-to-date information in any business area affected by the crisis.
Board Oversight in the Zone of Insolvency – When Is a Fiduciary Duty Owed to Creditors?
The business disruptions resulting from the COVID-19 pandemic are financially stressing even the most robust of companies. Many companies may be in the zone of insolvency, while others may in fact be insolvent due to these disruptions to their business. This delineation can be difficult to ascertain, as “zone of insolvency” does not have a bright-line definition. Legal scholars have described it as including “a financially distressed company with deteriorating fiscal conditions such as minimal cash reserves, only marginal surpluses, increasing debt, and an inability to invest in future operations,” but not insolvent under the bankruptcy code or case law.
Whether the company is insolvent or in the zone of insolvency has significant import for the board’s obligations to creditors. Where the company is merely in the zone of insolvency, directors’ fiduciary duties continue to flow only to the corporation and its shareholders pursuant to the Delaware Supreme Court’s holding in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla. Should the company become insolvent, the fiduciary obligations of directors run “to the corporation for the benefit of all of its residual claimants,” including creditors, as explained by the Delaware Court of Chancery in Quadrant Structured Products Co. Ltd. v. Vertin. Directors must be cognizant of the company’s solvency to recognize when duties may run to shareholders and creditors alike.
Proposed Amendments to the Delaware General Corporation Law for Emergency Actions
Section 110 of the Delaware General Corporation Law (DGCL) allows for boards of directors to create and adopt emergency bylaws. In response to the current COVID-19 pandemic and resulting need for companies to be able to have flexibility to adapt to the rapidly changing issues facing their management and operations, a pending proposed revision to section 110 will clarify that circumstances for the use of such emergency bylaws include “an epidemic or pandemic, and a declaration of a national emergency by the United States government.” Further proposed revision to section 110 would permit a majority of the directors present to adopt the emergency bylaws if a quorum cannot be readily convened. Lastly, a proposed new subsection (i) to section 110 would allow directors to postpone stockholder meetings and payment of dividends while the emergency circumstances persist, subject to certain notice obligations.
Boards of directors are facing unprecedented risk management and financial concerns from the COVID-19 pandemic. D&O insurance is an important component of board liability exposure mitigation. Our Financial Lines Group recently published a post identifying the types of questions D&O policyholders can expect to encounter at their next D&O insurance renewal.
Additionally, many tools are available for directors to address these concerns as faithful fiduciaries, as discussed in our recent post. The proposed amendments to the DGCL presage an expansion of the directors’ toolbox to confront emergency circumstances.
Nevertheless, the severity of the COVID-19 crises can understandably be overwhelming for even an experienced board. Unique challenges require innovative solutions, and we are here to help. Please contact Marc Casarino (firstname.lastname@example.org; 302.467.4520), Lori Smith (email@example.com; 212.714.3075), Gwenn Barney (firstname.lastname@example.org; 215.864.7063) or another member of the Corporate and Securities Group or Financial Lines Group with any concerns or questions regarding board and corporate governance matters.
 Challenges to directors’ oversight responsibility vis-à-vis the duty of loyalty are labeled as a Caremark claim in reference to the landmark Delaware Supreme Court case outlining the contours of such claims – In re Caremark International Inc. Derivative Litigation.
 See John A. Pearce II and Ilya A. Lipin, The Duties of Directors and Officers within the Fuzzy Zone of Insolvency, 19 Am. Bankr. Inst. L. Rev. 361 (2011) citing Rutheford B. Campbell, Jr. & Christopher W. Frost, Managers’ Fiduciary Duties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere), 32 J. CORP. L. 491, 493 (2007)