From the Recession:
What Directors Need to Know
Helen Mallovy Hicks
There are definitely many positive signs that we are on our way out of the recession. But this is now a changed world. In this episode of Strategy Talks, a panel of guests talk about corporate governance, and the lessons they have learned from the recession.
Voiceover: Welcome to Strategy Talks, the business podcast series from PricewaterhouseCoopers Canada. Hosted by Helen Mallovy Hicks, a partner the Dispute Analysis and Valuations group, this interview series, featuring new topics and guests every episode, is designed to give you valuable insight into some of today's hottest issues affecting your business.
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Helen: There are definitely many positive signs that we are on our way out of the recession. But this is now a changed world. Today we are joined by a panel of guests that will talk about corporate governance and the lessons they have learned from the recession. Joining us today are Bill Braithwaite, Senior Partner, Stikeman Elliott, Warren Seyffert, Deputy Chairman and Lead Director, Teck Resources, and Dave Planques, Leader of PwC’s Corporate Advisory and Restructuring Group. They are just joining us from a Directors’ briefing, held here in Toronto. My co-host today is Kristian Knibutat, National Leader of PwC’s Deals team. Welcome everyone.
Kristian: Thank you very much for coming and joining us. Bill, there’s a business judgment rule which guides a lot of what Directors do, and there have been some recent changes in that. Can you tell us what the status of that rule is and what some of those changes are?
Bill: Well I think the first point to make is that recently, the Supreme Court of Canada in its B.C. decision – B.C. dealt with a number of issues, but in particular, the Supreme Court of Canada in the B.C. decision affirmed quite clearly and unambiguously that the business judgment rule is part of the legal landscape in Canada. Under that rule, as you know, Directors, so long as they act prudently and diligently, so long as they’re reasonably informed, and so long as the decision they reach is in some range of reasonableness, the courts will not second guess Directors on matters of business judgment.
Kristian: Now Warren, I know in the conversation we were having earlier, you certainly got some views with respect to how boards should be looking and acting to make sure that they’ve got that reasonable basis for business judgment. Can you share some of your thoughts with us around that?
Warren: Well basically, the problem that I see today is getting the appropriate information, or the appropriate data that you can rely on. We live in a time when it’s the age of communication, rather than the age of information. There’s so much data and facts and other nonsense out there; it’s white noise. And so boards of directors have to start looking by themselves at how to accumulate the information, how to find out, how to educate themselves, and how to find information which they can base their business judgment on. That means you’ve got to look at stakeholders, what their interests are, they’ll look at shareholders, what their interests are, and they’ve got to find out what markets are doing out there that affect their products or services, etc.
Helen: Bill, you mentioned there are some limitations or considerations with the business judgment rule. Can you tell us about those?
Bill: Sure. They sort of relate a little bit to one of the things Warren just said. I think that Directors have to earn the benefit of business judgment rule. You have to make sure that you follow good process, and that you are properly informed. And if you are being rushed, and you’re not being provided with adequate information as Directors, insist on more time and insist on more information. Because unless the record shows that you did follow good process, you won’t earn the benefit of the business judgment rule. As well, the courts have said that even if you follow good process, if your decision is so off the mark that it’s outside the range of reasonableness, courts won’t give you the benefit of the business judgment rule. Finally, the rule only applies when Boards are actually making business decisions. The Supreme Court of Canada, in a case called Danier Leather, which was a prospectus disclosure case, held that, while a business judgment rule is part of the landscape in Canada, it doesn’t apply when Directors are making decisions with respect to disclosure, whether something is material or not material. Because that is not involved, they exercise their business judgment.
Kristian: Dave, certainly while we’re talking about business judgments, one of the real challenging business judgments that Boards have had to deal with through this economic crisis that we’ve been in is the difficult financing situations that they found themselves in. Can you share with us some of the things that Boards have had to struggle with through that?
Dave: Sure. It’s been a tough time for Directors on companies that thought they would never end up in distress and ended up in distress. There was bond debt coming due, there were significant interest payments coming due, and when we’re in a period where there was very little credit available, Directors had to struggle with the issue of “what are you going to do?” For a number of Boards, I know that they were taking a look at what I would call Plan D, which is “are we going to have to file?”
And some companies actually made that decision: that they would file. It was one option that was being considered amongst others, such as trying to find refinancing, can we sell down some equity? But for some companies, the only solution – and there are some pretty big companies that have filed this year – the only solution ended up being a CCAA filing, to restructure the company and restructure the debt. The impact of that is that there’s significant debt to equity conversions and significant dilution or wiping out of the shareholders.
Kristian: Dave, the threat of filing: how is that used in your negotiations?
Dave: That’s a good question because the threat of a filing actually has been used a number of times. Companies who looked at the option of a CCAA came to the conclusion that they could actually get to the point that they could go out and threaten to certain stakeholder groups or suppliers or landlords - or it was also even useful in discussions with unions and labour – the threat of a CCAA filing was enough to scare a lot of people back to the negotiating table, allowing the formulation of consensual restructurings and avoiding a CCAA filing altogether.
Helen: Bill, there was an interesting question from the floor this morning at the Directors’ briefing about in camera sessions and keeping evidence on business judgment and making a reasonable and informed decision, and what do you do about your minutes from in camera sessions, notes of other Directors – how should all of that be handled?
Bill: Notes generally, and how they figure into the formal record of the meeting, are always an issue that’s discussed when meeting with Directors. Views do vary; the advice that I give is that it’s perfectly legitimate for Directors to take notes during the meeting, but when the formal minutes of the meeting are approved by the Board, then they’ll have their opportunity as a Director to approve the minutes and comment on them. Once the minutes are approved, it’s in their interest not to keep the notes. That the formal record of the meeting is contained in the minutes. With respect to the in camera session of the meeting, again, the only record of the meeting is through the minutes. So while practice varies there as well, I encourage a record to be kept of what is discussed at the in camera session. Whether it’s contained actually in the minutes which are generally circulated, or in a confidential file for the Directors, that’s a different matter, but formal recordings of what happened at an in camera meeting is what I encourage.
Kristian: Certainly when we talk about business judgments, as we all know, you make the best business judgment you can at the time, and not everybody always agrees. There are probably two key areas around that; one is the prevalence of activist shareholders coming to the fore, and maybe challenging some of those business decisions that Boards are making, and maybe a subset of that is a little bit of the whole concept around Say on Pay. Maybe we’ll start with the Say on Pay. Warren, maybe you’ve got some perspectives and thoughts with respect to that that you can share?
Warren: Well Say on Pay is one of the current debates everyone’s having. When you’re talking about it and looking at it from the point of view of the companies of the Boards I sit on, we’re not one of the companies that generated all this interest, that is to say, we’re not a big banking institution or investment house that was paying gazillions of dollars to its CEO. So you have a negative reaction when people talk about Say on Pay.
There’s an argument which I don’t generally accept that says it’s a disincentive – just to pass a resolution – just to have a resolution passed by shareholders which has no effect. That you don’t have to follow, you can ignore. They argue that that’s a disincentive to doing that process because people will just do it and then ignore it. While I don’t accept that, I do look behind what Say on Pay is trying to accomplish. If you’re trying to accomplish more dialogues with shareholders on this specific issue, executive compensation, then I feel there may be better ways that you can do that.
Better ways than having a Say on Pay resolution. Going out there and actually having a dialogue, finding out what shareholders think. And the basis for that, of course, is that initially, it’s full and complete disclosure, and making it understood exactly what your compensation package is based on.
Helen: Warren, any thoughts on ways to deal with activist shareholders?
Warren: Someone has said recently that there is no such thing as long-term shareholders. You get a shareholder looking beyond three to five years, and maybe it’s a pension fund, but other than that, there’s very few. Because things are changing so rapidly. So when you get an activist shareholder who is coming in your meeting and asking questions, I’ve found, strangely enough, that if they’re asking questions, we don’t have any problems. We answer the questions, and people are quite satisfied, and that’s it. If they’re protesting – if activist shareholders take a point of view of protesting, with placards, and blocking people – that’s a separate issue altogether, and that you’ve got to deal with up front, before your meeting.
Helen: Thoughts on how you would deal with it before your meeting?
Warren: Well you’d find out what the group is, and then you’d meet with that group. I don’t know why there’s a resistance in some companies to meet with some of these activist shareholders groups. The worst that can happen is they will voice their concerns, you won’t agree with them, and they may get a little excited about it, but so what? Sometimes they may say something that takes you aback and you do react on it. Or sometimes you can say “well how about if we do this and this? How about if we approach it from this point of view, and try to deal with it?”
Bill: But there are circumstances where the Board and the activist continue to be at odds. We’ve seen examples of activist shareholders taking Boards on and challenging Board decisions. I think the best example of that of late, which shows how far activist shareholders are prepared to go, would be the experience that we saw in the Lundin HudBay transaction, the failed transaction, last year.
Where after HudBay announced its proposed acquisition of Lundin, which was to be done though a shared transaction, the shareholders sprung into action to try to challenge that Board decision. And that involved bringing a court action under the oppression remedy by one hedge fund shareholder, an appeal of a TSX decision before the Ontario ? by another shareholder, a requisition for a special meeting of the shareholders of HudBay to remove the Board – all of those steps were taken by activist shareholders.
Ultimately, they succeeded, in that case, requiring that the HudBay shareholders get a vote in the transaction, which, in effect, killed the deal. Examples like that show how far activist shareholders are prepared to go when they disagree with the Board. Agreed, lots of cases where an agreement can be reached through a good dialogue between the activists and the company. Oftentimes, that involves putting the activist on the Board, but there can be an agreement reached before you get to an all-out knock-out proxy battle, as we saw in HudBay / Lundin.
Warren: I don’t know enough about the Hud Bay circumstance, but I will say this: I think it’s incumbent on any Board, if you’re going to do a major transaction or reorganization, you have to get out there and you have to sell it. You have to explain why you’ve gone this route ahead of time, you have to be proactive. I don’t think you sit back and say “okay, we’re going to put it to shareholders, it’s a good deal, so they’ll automatically think that.” No, I think you’ve got to get out there and market it, just like you do anything else. Say “here’s why we’re doing it, here’s what we’re doing.”
Bill: Frankly, in my view, that’s the best tactic to deal with activist shareholders, because at the end of the day, the activist, if it does take the Board on formally, will only succeed if it can convince other shareholders. If the Board has already spoken to its shareholders and has the shareholders’ support for its strategic view, the activist will not succeed.
Warren: If you’re a public company, you have to do this so-called marketing effect anyway, because you have to get out there and explain so your shareholders don’t get beaten down, so people understand what you’re doing, so people can see that it has some benefit. You have to do that anyway. So if you’ve got any inclination from a group of shareholders that they’re against it, then you should go and deal with it. And you always will have some inclination. Public companies today meet throughout the year with various shareholder interests, and answer questions. You could get a sense ahead of time, surely, that there’s going to be a group out there that are against some action you’re proposing to take. If you know it ahead of time, you should deal with it.
Kristian: Certainly one of the best defenses to some of those things is having some great financial results. Unfortunately, in the economic period we’ve come through, not all companies were in that situation. Dave, a number of companies have had to deal with a restructuring situation or difficult financial situation that they maybe never thought they were going to be in, or had never been in that kind of a situation before. Directors probably struggled with “do I stay with this thing? Should I jump ship?” What kind of views and perspectives can you share with Directors who might be dealing with that particular type of an issue?
Dave: It’s a tough time for a Director when you’re dealing with a company in distress, and you’re asking the question “do we need a formal filing or do we just move on and try and find another resolution?” I would argue that actually going into a CCAA filing significantly reduces the risk for a Director. There is a Director’s charge; it’s not as broad as it used to be. But when you’re in a CCAA filing as a Director, there’s a court-appointed monitor who’s watching pretty much every significant event that takes place. There’s court approval on every significant event.
There are multiple stakeholder advisors, whether they be for the bond holders or the secured creditors, watching over your shoulder. So it’s very difficult to get yourself into a situation where you’re not acting prudently, with some many people analyzing and vetting every single move that the company’s making. I would argue that sticking it out through a CCAA makes sense for a Director; that the risk actually reduces. Having said that, the experience is that Directors who hang in there through to the end of a CCAA often are replaced as the debt is converted to equity and the new equity holders want to put their own Board in place.
Kristian: Warren, any views as to whether it’s a breach of a Director’s duty for a Director to bail out in those circumstances?
Warren: Ahead of time? Well I think technically it is. I think morally it is. I’m also not sure that it happens a lot. I don’t have the same knowledge as David has, but I can tell you, public companies I know, you’re required to own shares in the public company. You’ve got skin in the game. And the last thing you want to do is leave it up to somebody else to make the decision. The skin in the game for most Directors is fairly substantial.
Kristian: As we move into an improving market and economy, changing the mindset of the Management team, or how do you guard against the Management team hanging on to what has now become a little bit of risk aversion, so just a question for everybody – how are you seeing risk dealt with in the current environment with Management, how are Boards dealing with the interplay with Management on risk?
Warren: Well speaking for myself, there’s no question that the Boards I’m involved in risk mitigation, risk management, has come to the fore. It’s been doing that for some years now, and of course after this recession, it’s out there. We deal with it by looking at risk management policies at every single meeting of the Board. We set aside time for that. At the same time, Management have a separate risk management committee set up where they’re looking at a lot of operational risks. That frees the Board to just supervise that but at the same time look at greater risks. The risk of black swans occurring, unanticipated events occurring.
And we focus on that. Sometimes you have to be careful, you can’t have all your Management there when you’re throwing around wild ideas about risk and where possible occurrences could come from. And they walk out of the room stunned and afraid to do anything. You can’t lose the entrepreneurial spirit, but you have to look at all the possibilities that you can think of and put weight to them. What’s the odds of them happening? How do we protect ourselves? Sometimes it’s not a yes or no to do a project. It may be, “this is a project we should have a Partner in. This is a project we should look for governance help in.” They want us to go into this country and accept that risk – they have to help us. If not, we’ll go elsewhere. You have to identify the amount of risk, that you’re willing to take in these situations. And that’s what we’re doing every meeting now. That’s what companies are doing. Doing a good job of it, as far as I can tell.
Bill: I agree. It’s definitely become an important item on the agenda of Board meetings for Canadian public companies. I actually looked to see whether there’s any structural impact as a result of this focus on risk by Boards. I looked at the top 25 companies in the TSX, and found that six of those 25 companies have actually established a risk committee, a standing committee, of the Board. A few Boards have the audit and risk committee, and the others deal with, as Warren said, as the full Board. Of the companies that have actually structurally established a risk committee of the Board, they are primarily in the financial institutions; the banks. Again, OSFI very focused on risk for financial institutions.
Kristian: Anything you’re seeing in the CCAAs around risk, Dave, that’s a little bit different? CROs?
Dave: Yeah, one of the things that is happening is that CROs who are capable of managing a restructuring and who have been there, done that before are brought in, which does reduce your risk, actually – bringing in someone that knows what they’re doing. But for the most part, once you’re in CCAA it’s pretty much a fire fight, so putting capable people in, including advisors, to assist with the restructuring is where it stops. At that point in time it’s about putting the fires out and moving forward with the restructuring plan.
Helen: I think we’re pretty much out of time, but just before we turn off the tapes, any last comments in terms of how the landscape has changed post recession, or advice for Directors in terms of dealing with risks? Anything else that any of you wanted to say?
Warren: The only comment I would make is that I think we have to recognize that more and more Boards deal at every meeting with strategic planning. And I don’t mean actual planning, I mean updates, implementation, possible changes. The more they deal with that, at the same time take on risk management, risk mitigation, and have a real discussion at the meeting, back and forth, about different risks – that means you have to have longer meetings, and the pre-read material’s got to be thicker.
So I think the Boards you’ll see are having not just a one-day meeting, it may be part of one day, and part of the next. That’s what the companies I’m involved with do. And committee work is getting more owners. And I wouldn’t hold a pity party, frankly, for any Directors, because I think they’re all well-paid, they’ve got a stake in the company, they’ve got an interest in seeing it be successful. So I don’t discourage people from being Directors and I certainly don’t accept when I hear whining about how much work they’ve got to do. Doesn’t bother me any.
I’m a Director in a number of companies and I think that’s the approach you have to take. It’s time to work harder. We’ll get through this recession – it’s over in Canada perhaps, not over elsewhere, and there’s more news going to come tomorrow, I’m sure. We’re all involved in this global activity, and the economy is all intertwined. And that’s what Directors do now.
Helen: Thank you very much. I’d like to thank all of you for your insights today, sharing them with us this morning at our DirectorConnect session, and then again this afternoon on our podcast. So thank you very much Bill Braithwaite, Warren Seyffert, and Dave Planques. And thank you very much Kristian for joining us as a co-host today. For more information on corporate governance, please visit our DirectorConnect website at pwc.com/ca/directorconnect.
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