Corporate Governance in the Age of a Pandemic

Experience from past crises suggests that companies with robust corporate governance systems and practices are able to weather a storm better than others. Similarly, it is reasonable to hypothesize that, even amid the throes of a crisis such as the COVID-19 pandemic, referred to in corporate speak at an “unknown unknown” that has sparked a systemic risk, well governed companies can more optimally address the interests of various corporate stakeholders.

The Board’s Duties

Situated at the core of governance dynamic is the board of directors of a company. Its role, actions, reactions and omissions are bound to be subjected to microscopic scrutiny in this time of pronounced uncertainty, as compared to normal circumstances. Exacerbating the situation is the fact that social distancing norms limit the ability of directors to meet physically, who must therefore rely on unconventional means of engagement.

Conscious of these limitations, regulators the world over have relaxed various governance measures. For instance, the Ministry of Corporate Affairs in India has temporarily allowed boards to meet virtually to decide all matters of business, and also permitted virtual shareholders’ meetings. The Securities and Exchange Board of India has taken the sting out of stringent filing and reporting requirements by extending several deadlines. As much as such a move could allure boards to be drawn into a state of complacency, the regulatory motivation is far from the truth. These rulings dispense with formal and administrative requirements, but they do not relieve corporate boards of their obligations as fiduciaries. Directors continue to bear the burden of various duties imposed on them under corporate law. They would be hard-pressed to shake off directors’ duties in a crisis, which will instead operate with greater vigour.

This gives rise to a key question. How should boards tread in this unchartered territory when they face constraining factors such as social distancing, and nevertheless discharge their fiduciary obligations? If there is a single strategy that boards must devolve their attention towards during this crisis, it is: communicate, communicate and communicate. The board’s engagement operates at different levels depending upon the constituencies involved. They can be internal to the company, in the form of discussions essentially with management. They can be external, in form of timely disclosures to shareholders, employees, creditors, customers and the government.

Communication with Management

The far-reaching impact of COVID-19 on the corporate sector demands greater focus on the part of directors, especially non-executive directors. At the outset, and notwithstanding various regulatory dispensations, it would be prudent for boards of affected companies to meet more regularly to communicate with management. Given that non-executive directors too are subject to fiduciary duties and responsibilities under company law, it is incumbent upon them to place a stronger oversight on the affairs of the company. They must not only constantly ask questions and seek information to their reasonable satisfaction from management, but they are also required to get to the bottom of issues raised as red flags. The discharge of such duties by the board will require the establishment of open channels of communication and information-flow between the board, especially non-executive directors, and the management. Given that board and committee meetings are likely to be held virtually, governance practices such as advance notice of meetings, sharing of agenda and board papers and the faithful depiction of the proceedings (including objections from specific directors) in the minutes gain utmost importance.

Corporate governance pundits have also debated about the possibility that companies may establish a crisis management committee to help the company steer through the vagaries presented by COVID-19. While the utility of such a committee is understandable, individual companies may embark on such an effort depending on the specifics of their situation. Ultimately, whether or not such a committee is constituted, the board of directors as a whole bears the legal responsibility for decisions taken.

A few specific risks have come to the forefront that boards must consider in their decision-making. The first relates to internal controls, where traditional means are palpably inadequate because employees, including those handling the financial affairs of the company, are working remotely. Companies will have to swiftly implement emergency measures to address financial oversight under the supervision of the audit committee. Failing this, companies could suffer from significant risks, as a crisis tends to create a perfect storm setting for financial chicanery. The second relates to cybersecurity, which is understandable as several corporate functions, including board interactions, are taking place using technology. Cyber threats and vulnerabilities have magnified in the wake of COVID-19, which requires companies that are not yet in a state of preparedness to put in place appropriate measures speedily. Third, during a pandemic the risk that one or more of the key managerial personnel may fall ill cannot be overstated, as is the importance of succession planning.

Stakeholder Engagement

Directors of Indian companies bear a duty, enshrined in section 166 of the Companies Act, 2013, to act in the interests of the company, its shareholders, employees and the community. They must also act with “due and reasonable care, skill and diligence and shall exercise independent judgment”. As the saying goes, “sunshine is the best disinfectant”. A vigorous communications strategy will compel boards to identify and address existing and impending risks that the company and its stakeholders encounter.

To begin with, shareholders bear the financial brunt in crisis settings. As Chairman Jay Clayton and Director William H. Hinman of the US Securities and Exchange Commission noted, shareholders “are thirsting to know where companies stand today and, importantly, how they have adjusted, and expect to adjust in the future, their operational and financial affairs to most effectively work through the COVID-19 health crisis”. This makes constant communication and engagement with shareholders crucial. Here, historical information mandated by legal rules and accounting standards can go only so far. Shareholders would be keen to know the board’s assessment of the risks the current situation presents and, more importantly, the steps it has put in place to address those risks. Directors’ duties tend to operate across time-horizons. Corporate law generally expects directors to adopt a long-term perspective, but existential scenarios such as an imminent insolvency may necessitate a response steeped in the immediacy. Flexibility, adaptability and dynamism are the need of the hour.

While SEBI is yet to mandate specific COVID-19 disclosures, companies would be well-advised to make them regardless in the spirit of disclosures pertaining to material events. Board oversight to ensure the accuracy of these disclosure is ever more critical in these circumstances. Similarly, board’s engagement with large institutional investors too would be meaningful, subject of course to insider trading considerations. Companies with limited or no promoter control, whose shares suffer from undervaluation, could be susceptible to influence from activist investors, or even hostile takeovers, which their boards need to be cognizant of.

As Indian corporate law adopts a stakeholder-oriented tone, the interests of non-shareholder constituencies cannot be ignored. Remote working and the associated physical isolation creates insecurities among employees. In order to assuage their concerns and their health and safety, boards would do well to go above and beyond their established roles and reach out to motivate employees by “setting the tone at the top”. Communication with creditors becomes paramount in companies facing severe financial strain. Complete transparency with key suppliers and customers regarding the company’s strategy to mitigate the risks they may face will enable the continued maintenance of these crucial relationships.

Conclusion

In all, despite several regulatory relaxations, directors continue to be bound by their fiduciary obligations owed to their companies to address the interests of various stakeholders. Apart from discharging these duties in the most uncertain of economic circumstances the world has witnessed in recent times, their task has been made more daunting by limitations to human interaction. The lessons from prolonged social distancing might even call for companies to begin establishing or strengthening “board continuity plans” to safeguard enduring and effective corporate leadership in times of a crisis.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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