The role of the conflict director provides independent expertise and timely skills for the Board to navigate difficult situations. As the fallout from the COVID-19 pandemic continues to hit businesses large and small, it can be a particularly worrying time for directors and business owners. There is increased exposure to litigation – whether by business counterparties such as suppliers, lenders or shareholders – heightened fraud risks, and business distress requiring advice and proactive remedial action. That’s where the benefit of a conflict director comes in. What is a conflict director, when might you recommend or encounter one, and what difference could it make to how your client survives a crisis?
Nearly a full year into the pandemic, many companies have thankfully been able to adapt to the growing crisis. But not every company or business has been so lucky, with many businesses experiencing cashflow or operational difficulties arising from the inability to trade normally or as a result of disruptions to the movement of people and goods. Companies are also facing increased exposed to litigation, for example by business counterparties seeking to escape contractual agreements, or investors dissatisfied with the company’s performance. These difficulties have stretched management’s time and resources and require skills that directors and business owners typically do not have. It may have even caused division and disputes within the board itself resulting in deadlocks. The same confluence of factors has also created a perfect storm enabling some individuals to take advantage of the situation to do things they otherwise would not do such as entering into questionable transactions, and going as far as misappropriating assets or creating other fraudulent schemes.
What Is a Conflict Director?
In these challenging situations, bringing in an independent, experienced, turnaround professional enables a clear-eyed assessment of the situation from a fresh perspective to help maintain control, avoid a crisis and, potentially, prevent a company going into insolvency. This clearly benefits the company and its stakeholders, but is also of considerable value to the incumbent directors, as it provides them with a board member highly experienced in dealing with distressed circumstances and can help them minimise their exposure to allegations of breach of fiduciary duty and, depending on the jurisdiction whether the company is located, breach of insolvent trading laws.
The professionals who come into companies in this situation are ‘conflict directors’ (or ‘crisis directors’ as they are also known) and while they have been around for some time, they are becoming more common in recent times due to the increasing complex commercial and regulatory risks that businesses now operate in.
The role and function of a crisis director is to both advise and to assist the board to implement the course of action they advocate, so by its nature it is a very active engagement and differs greatly from a passive nominee directorship. As a result, these roles are normally taken up by partner-level accountants or other such senior professionals from boutique firms or as individual contractors, so as to reduce potential for conflicts and avoid issues with obtaining the blessing of other partners to take up such work.
When Can a Conflict Director Help Unlock Value?
In a recent example of how conflict directors can be used to come in and unlock value in the context of wider disputes that have caused a deadlock among the board and shareholder groups, a conflict director was appointed to a company to complete the time-sensitive sale of a subsidiary. That sale had stalled due to the disputes among the management and ownership groups – which continued to erupt throughout the process of engaging and negotiating with potential bidders. Recognising that this put the sales process at risk and that it needed to complete without interruption, a conflict director was appointed to help complete the sale. That eventual completion process involved the coordinated efforts of law firms in several jurisdictions, over seven months and required the conflict director’s forensic accounting team to calculate and assist in negotiating contentious elements such as the subsidiary’s full employee stock option plan. In this way, the conflict director was able to take control and complete a transaction in an orderly fashion to unlock value for stakeholders, even though they remained locked in heated dispute.
Aside from being able to take decisive informed action where stakeholders are in the midst of a dispute or otherwise lack the skills to handle a situation, the benefit of a conflict director in a crisis situation stems from being able to draw on teams of capable staff and other specialists with specific skillsets such as forensic accounting to undertake financial investigations or to handle corporate secretarial matters, compliance, and statutory filings in order to keep operations running smoothly.
Working with Conflict Directors
The major “operational risk” of a conflict directorship has less to do with company operations, and more the manner in which the conflict director must operate. Stepping into a contentious situation and dealing with parties that may feel aggrieved by nearly anything that the director does, will inevitably be either thoroughly engaging or very stressful, depending on your risk appetite. In this context, a lone conflict director acting without advice or support is risky and uncommon. While it is important that the appointment taker is broadly experienced in contentious matters, it is equally important that they are surrounded by capable and flexible lawyers. This can begin right at the outset with advice on appointment risks and the director’s engagement.
It is highly advisable that before a conflict director starts, they (with their legal advisors) should conduct a general appraisal of the immediate and medium-term risks, mitigation strategies, and litigation strategy as a priority.
Then in taking up the role, the appointment documents or service agreement should cover key matters aside from the normal matters like tenure and fees, it should specifically address any key issues or risks identified and cover insurance and any indemnities - subject to what is in the articles of association.
On this point, it should be stressed that lawyers should be careful to clarify the identity and interests of who the client is – that is the individual conflict director and not the company or the existing Board given the potential for competing interests. This issue arose in Newcastle International Airport Ltd v Eversheds LLP  EWCA Civ 1514, where the English Court of Appeal found that the solicitors had breached their duty of care to the company by taking instructions from an executive director to draft a new service contract with the company without taking reasonable steps to ensure that their client, the company, was aware of this conflict and properly understood the effect of it.
Once appointed, it is typical that the conflict director will retain legal counsel in each relevant jurisdiction and the conflict director and their team acts as the clearing house for all legal advice. Managing and co-ordinating a multitude of lawyers and other service providers can itself be a substantial task, and the conflict director brings their practical experience to bear in considering the advice, raising questions, and probing the strategies proposed and determining (or recommending to the Board) the steps the company should take.
There is little doubt that for many 2020 has been one of the most turbulent years in living memory, and the ramifications for businesses continue to be felt this year as the business environment remains rough. Accordingly, the need for and prevalence of conflict directorships will only increase as management is faced with a multitude of issues that arise from distressed circumstances such as the increase in litigation risk, operational risks, and higher incidences of opportunistic white-collar crime. This provides both opportunities for lawyers in advising conflict directors, as it is a decidedly underserved market in Hong Kong.