Let’s Debate: Independent Directors Part II

Part II of our new interactive feature
Where our Contributors delve deeper into timely financial and restructuring topics
We’re joined by Jeffrey Cohen of Lowenstein Sandler, David Feldman of Gibson Dunn, Jim Millar of Faegre Drinker, Paul Silverstein of Hunton Andrews Kurth, and Evan Lederman former Co-Head of Credit & Restructuring at Fir Tree. We want to use this forum to delve deeper into the controversy surrounding independent directors. While we have lots of questions, please don’t hesitate to jump right in. So, Let’s Debate.

Let’s talk about some solutions here. Jeff, how can a Court be more active in policing this process?

– Jeffrey Cohen:
The suggestion you’re referring to is that independent directors would have to get retained under Section 327 and demonstrate they’re disinterested. To me that should be a very easy bar for any professional to overcome, especially if you’re supposed to be “independentâ€. So, to me, subjecting the selection of the director to the scrutiny of the court should be a no brainer. If there’s nothing to hide, then it’s an easy disclosure to the court. And then once you’re in front of the court, just proving that you don’t have connections to parties in interest or advisors that would result in you being unable to perform your duties should also be something pretty easy to prove. So I think that’s a very logical way to try to address the problems we’ve been running into.

– Paul Silverstein:
Independent directors are typically appointed prior to a filing and not appointed post chapter 11. So the court doesn’t get to approve an independent director as being disinterested under Section 327. So I don’t get how this works when an independent director is put in before the filing and what corporate law or corporate rules under exchange rules have to say about that. If an independent director is coming in post-bankruptcy, he’s not really independent in the corporate sense. He’s more a quasi- CRO or a sort of semi-CRO.

– David Feldman:
While I think Jeff’s mind is in the right place trying to correct a problem that sometimes exists. I think there’s a fundamental flaw in his suggestion. I would be concerned with Jeff’s suggestion for the great amount of dislocation which would arise if we had all of the directors in the crosshairs at the moment of filing. Having said that, I do agree that by the time you get to confirmation, it is often too late. You try to preserve your rights, your breach of fiduciary duty claims against the directors during the case but it is often too late. I don’t really have the right solution, but I do think the idea that we basically put everyone on the board up for public scrutiny on day 1 of the case just seems like an overreaction.

– Paul Silverstein:
I think that David’s right. A normal part of the case is not just to immediately, when it’s filed, to go in and scrutinize who the directors are and who’s independent and who put them in. And, don’t forget, it’s still a debtor statute, right? It’s always been a debtor statute. It’s always going to be a debtor statute. And, the judge’s job is to confirm cases, not to get the optimal recovery for creditors in most judges’ views. So, I think that the practical answer is that if you you’re in a situation where the independent director or the people who are supposedly controlling the board are bad and if you think the deck is totally stacked against you, you have to immediately make some kind of aggressive motion.

Jeff, let’s give you the last word here.

– Jeffrey Cohen:
So I understand Paul’s comments with regard to the timing that most independent directors, if not all independent directors are retained or appointed pre-bankruptcy, but so are debtor’s counsel, CROs and debtor’s financial advisors and all of them could be disqualified for conflicts after the filing. So the timing to me is not really that problematic, the timing issue that gives me heartburn is that usually the first time anyone can challenge an independent director’s independence is at a contested confirmation hearing, right? It’s after we’ve gone through discovery, after we’ve run an investigation after we have not reached a deal with the debtors and when the debtors are finally putting that independent director on the stand and they are cross examined, and we find out how many cases they’ve done with debtor’s counsel and that’s too late. So I’m not necessarily insisting it has to be 327 versus 363 (retention of professionals vs. out of the ordinary course transactions) versus something else. But from a timing perspective, I believe it needs to be done at, or shortly after the bankruptcy filing before all the parties and interest put significant amount of time and effort into doing their jobs. We should know whether an independent director is actually independent at the beginning of the case.

Evan, what do you think? Any other solutions out there?

– Evan Lederman:
As part of the filing all directors should have to disclose how many boards they are on and how many are affiliated with debtor’s counsel. I think that’s useful information. To be clear, it doesn’t necessarily mean that that the board member is not qualified or in any way conflicted to do the job, but it’s good information for everyone to have as one of many data points.

– David Feldman:
What’s the best way to move forward? If someone is representing a sponsor and needs to get people on the board, they shouldn’t just call their three closest friends and say, do you want to do this? Really what they should look for is someone who has the correct industry experience and will be in this industry again. In my experience, when you put somebody on the board as an independent director who has experience and been on a bunch of boards in the oil and gas space or the tech space or in the pharma space or the healthcare space, there is a level of credibility that they have to hold themselves up to and keeps people a little more honest.

Given the power dynamics at play, do we need even broader structural changes? Evan?

– Evan Lederman:
The overarching backdrop of our bankruptcy system like Paul said is that the debtor-in-possession has enormous power. And that’s not going to change. I really think the change needs to come from market participants. And it’s very simple. And this is what I did when I was an investor. When I was investing in a distressed company before, you know, before bankruptcy, hoping to avoid a bankruptcy, hoping to bridge the company or whatever it was, but it was a stress situation. I always triggered our ability to appoint or nominate directors when things went bad. And I’m just shocked by how many market participants don’t build that protection into the documents, the ability to add directors when certain events happen and certain triggers occur. Because in my experience, the really good functioning boards where there is diverse opinion and constructive debate often includes a mix of directors chosen by the debtors and those who are put on or nominated in some way or form by creditors. When you have various stakeholders putting people on a board who are not necessarily just there to do the debtor’s work or the previous management’s work there’s a better overall alignment across the capital structure. And so I think the market needs to adjust and have the ability for creditors to put their chosen independent directors into the process versus it always having to go through the debtors. Market participants can and should do more. It’s really that simple.

– David Feldman:
One last suggestion that I would raise as I’ve been listening to this back and forth is to build in some kind of mechanism on the back end, which says “you operate at your own riskâ€. If there’s a pattern of behavior here where you’re not acting independent, the court will apply a higher degree of scrutiny before giving the directors the exculpation that everyone comes to expect.

– Jeffrey Cohen:
I really echo Evan’s comments, the more stakeholders that have a say, the more equitable I think the entire exercise can be. I’m not quite sure whether there’s a single solution to this, but it is a combination of all the suggestions. It’ll be trial and error until we get to the right position. The reality is even the directors you think could be considered “bad apples†are all highly qualified individuals that do this for a living they’re just in business to be in business. Right. And you want to get hired again. So you deliver the result for the person that hired you. And I think that’s the muscle memory that we need to break, and we need to figure out the way to do that.

I think we can start to try and wrap it up here and go around the horn. Paul, you want to start us off?

– Paul Silverstein:
I think it’s an issue of how active people are going to be in a case. Different constituencies have to be sensitive to it, but I can assure you that in the first month or the first two months or five months of a case, you can’t show me a judge who will say: I’ve gotta look at this independent director to see if he’s really independent. That doesn’t happen unless it’s really, really egregious. Unless the guy gets up on the stand and testifies very poorly like the guy did in the Neiman case. And that’s very rare. I don’t think we are going to see independent director rules instituted to protect creditors. And, it’s going to be a case by case sort of thing.

– David Feldman:
What’s the best way to move forward? If someone is representing a sponsor and needs to get people on the board, they shouldn’t just call their three closest friends and say, do you want to do this? Really what they should look for is someone who has the correct industry experience and will be in this industry again. In my experience, when you put somebody on the board as an independent director who has experience and been on a bunch of boards in the oil and gas space or the tech space or in the pharma space or the healthcare space, there is a level of credibility that they have to hold themselves up to and keeps people a little more honest.

– Evan Lederman:
Practically speaking, I don’t think there’s going to be legislative changes to the Code. So creditors are the ones who are going to have to use the market to effectuate change on this issue. Just negotiate ahead of time. Don’t wait until someone comes to you for a forbearance or an extension, and then try and get a director in, negotiate it up front. And there’s easy ways to get around the issue that David said, which is you can’t necessarily pick one person, but usually you could say, here are three nominations Mr. Debtor: You choose 1 or 2. There are ways to make sure that you get good qualified, attentive, independent directors in there ahead of a filing to at least balance the process. I think that’s the best you can hope for and it would be good for the process and better for stakeholders.

– Jim Millar:
I agree with what Evan just said. I would say the corollary to what Evan just said is we need to take away the magic wand from the independent director. They are not there to make some pronouncement on behalf of everybody. They are not a mediator. They are frankly, one voice independent or not. They are the company. And we need to remember that they serve in that role and that other voices need to be heard, whether it’s agreeing on a settlement with insiders or other aspects of the case as well. We want them to do a good job. We want them to run the company properly, but creditors, and that goes for committees and even minority creditors, should get an opportunity to be heard as well, because I think we get to a better result.

Thank you. Jeff, you get the last word.

– Jeffrey Cohen:
The problem I see is that bankruptcy cases used to be about rehabilitation and reorganization and everybody trying to figure that out together during the case, but now it’s become about what David said earlier: strategizing to stack the deck in advance of the filing, many times, to minimize the ability of the committee to do their job. Appointing independent directors is just another chip that the debtors are playing in that effort to stack the deck.

Some responses have been edited from their original content for clarity and style purposes.

Be on the lookout for our next feature on Transparency featuring Guest Contributors Tom Mayer and Nancy Bello of Kramer Levin