Posted: 23 May, 2018
TURNING AROUND TITANIC?
RESOLVING CONFLICT IN THE BOARDROOM
Where a turnaround professional has accepted a position on the board of a company in distress, it's all too easy just to focus on the numbers and the turnaround plan. After all, that's usually the reason you were appointed in the first place.
However, in the current trading environment we are seeing more and more cases where a conflict in the boardroom has the potential to undermine, cause damage and disrupt the business. If the conflict isn't handled promptly and effectively, the turnaround director faces the dual risks that not only will the business suffer potentially serious reputational damage, but also that it will derail the successful implementation of the turnaround plan.
This article is based on recent experience of advising boards and their advisors and explores some of the tensions that frequently arise, the problems these cause and the practical steps that turnaround professionals can take to try to prevent boardroom tensions from escalating into something altogether more damaging.
Taking each case as it comes
As everyone working in the turnaround sector knows, no two cases are ever the same and every assignment has its own individual characteristics. The same applies to companies, whilst the basic contractual structure will be common: the articles of association provide the framework and a shareholders' agreement may introduce an additional layer of structure; what terms they contain and how they interact and operate are different for each company.
At the outset of any turnaround assignment, you look to assess the Board and the other key stakeholders within a business, in order to identify where the balance of power lies, who are the leaders and uniters and who are the disrupters. The promotion of differing opinions and the challenging of behaviours within a Board are necessary to drive change and optimise business performance; this is something businesses actively encourage and turnaround professionals rely on to successfully develop new ideas and implement their plan. However, we often see the same positive forces have a negative effect when they highlight more fundamental differences within a company about the direction of travel and which, in our experience, are exacerbated when a business finds itself in a stressed, or even a distressed, financial position.
In recent turnaround and restructuring assignments we have experienced, among other things, all of the following manifest themselves at one stage or another:
- Dissatisfaction from investors or lenders about how some or all of the directors are managing and operating the company and/or its financial performance;
- Lack of engagement or performance from non-executive directors causing tension with the executive directors;
- Deadlock at board level often caused by a fundamental disagreement over long term strategy;
- Conflicts where a director has a number of roles, bringing into question whether he is acting in the best interests of the company and/or breaching statutory duties;
- Exiting directors (and sometimes non-exiting directors) taking valuable know how, data or contacts with them.
The right tools for the job
Experience tells us that turnaround practitioners can resolve or control many of the above issues through effective deployment of their leadership and influencing skills, working alongside directors and key stakeholders to build trust and a consensus which supports the implementation and the evolution of the turnaround plan. However, at the same time, it has to be accepted that emotional intelligence and other complementary interpersonal skills do have limitations and will not be wholly effective in every circumstance.
It is therefore important that in any role taken, the turnaround practitioner understands the legal board room options available to them, the Board and the shareholders and how they can be implemented to best resolve conflicts or obtain leverage.
For example, in situations of Board deadlock, properly drafted articles of association will address how decisions are to be made by the Board, who has the casting vote and whether reference can be made to a third party adjudicator.
In family owned SME businesses operating on model articles, the casting vote will invariably be granted to be the chairman of the meeting, showing the importance of taking that role at any meeting where the aim is to drive change and decision making. Where more complex funding and investment structures are in place the articles will specifically address issues such as:
- the appointment of nominated directors by investors and the need for their attendance at meetings for there to be a quorum and therefore valid decisions; and
- the ability of certain investors or shareholders to be able to effectively control the Board through specific appointments and, potentially, dismissals.
The well advised turnaround practitioner will not only understand the personal dynamics of the Board he is working with but will be able to fit that into the legal framework governing the Board, in order to assess where the balance of power lies, what blockers there might be to effective change and what options he might have to change that position, including by obtaining shareholder approval to update the constitutional documents of the company. The reality being that the turnaround director is likely to have more constitutional freedom in a family run SME than a larger corporate with significant external investment.
One blocker could be a disruptive or non-cooperative director who pulls against the turnaround plan or is subject to significant conflicts of interest through outside interests or other roles or a director who is simply not performing. Working with the director it may be possible to resolve these issues through open dialogue, support and influencing but we have all come across situations where that simply will not work and a divisive influence on the Board needs to be effectively neutered.
One simple option is to terminate their directorship and the articles may grant the Board or a specific Board member this power; as an alternative, the shareholders will always have the constitutional right under statute to remove a director by ordinary resolution. However, whilst termination properly deals with the directorship, an executive director’s employment contract is another matter as this will continue unless and until it is properly terminated in accordance with its terms. The employment law surrounding dismissals are complex and there is no substitute for obtaining legal advice before any action is taken. But even then, the obvious risk is that Board focus, not to mention additional cost, is then diverted to managing a contentious dismissal process.
To avoid that, a more pragmatic solution we have seen adopted could be to leave the director in place but to effectively minimise their influence by appointing additional directors whether through Board or shareholder action, who support the majority view and the turnaround plan. One word of caution here is where the side-lined director is also a minority shareholder as this could result in an unfair prejudice application. A well-publicised example of this is the recent case involving Blackpool Football Club where the minority shareholder successfully claimed that, pursuant to a 'gentleman's agreement' entered into with the majority shareholders, he was entitled to be treated as an equal partner in the management of the company, but that, amongst other things, he had been systematically and deliberately excluded from participating in crucial board decisions about the use of company funds.
Where a director's conduct moves from the merely disruptive to being damaging to the long term interests of the company then more significant legal steps will need to be considered and taken.
In the immediate term the company might need to consider the use of an injunction to prevent a director absconding with, for example, key client information or taking steps which are in clear conflict with his/her duty to act in the best interests of the company.
Where the actions have already been taken by a director then consideration needs to be given to the potential for recovering direct from the director using a breach of duty claim by the company or a derivative claim by the shareholders, typically for negligence or breach of duty.
What if shareholders, not directors are at the centre of the conflict?
If the issue hampering the turnaround plan is not the directors but difficulty with a shareholder or a dispute between minority and majority shareholders, then the articles may contain mutual put and call options allowing each shareholder the right, on notice, to require the other(s) to purchase or sell their shares within a stated period in accordance with an agreed mechanism. Even where the articles do not contain such a right, it may be possible for the shareholders to pass a special resolution in favour of amending them in order to do so or to agree this by mutual consent.
These provisions facilitate the dissenting shareholder's exit from the business by enabling a process by which they can obtain value for their shares; however, in turnaround situations there can be two particular issues which hinder the effective implementation of these provisions.
Firstly, the valuation of the shares is always an area of dispute and challenge even where a clear mechanism is detailed and an expert determination option available; this is something we have seen time and again both in this area and also in relation to shareholder unfair prejudice applications which are often resolved by an order for purchase of shares. The tumult of a turnaround situation only exacerbates these issues.
Secondly, given the nature of turnaround situations there may well not be the capital or liquidity available for existing shareholders to acquire the exiting shareholder's shares.
In order to give a turnaround the best possible chance of success, the turnaround director will want to work alongside a cohesive Board of Directors, shareholder group and investor community throughout the project. However, the reality is that every assignment will bring with it an imperfect group with individual dynamics, personalities and challenges.
In our experience a detailed review of the corporate framework documents to this level does not happen unless and until a specific solution is required to a problem. However, careful review at the outset of a turnaround process can provide the turnaround professional with an enhanced toolkit and a greater ability to influence and effect change when needed.
Whilst leadership and influencing skills will be able to resolve many of the issues and tensions along the turnaround pathway, this article highlights some of the harder, legal options that a turnaround director will need knowledge of and potentially need to implement to maximise their chances of successfully delivering the turnaround.
In the current trading conditions our view is that boardroom tension will continue to increase. The 'winners' will be those professionals who plan for it in advance, identify gaps early on, and then implement effective, practical solutions enabling focus to return to what really matters.
For more information please contact:
Tim Pritchard, Legal Director
T: +44 117 915 4987
Catherine Haugh, Senior Associate
T: +44 117 915 4984
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