The most traditional avenue for a distressed company seeking to reorganize existing debts or maximize company value is through a Chapter 11 bankruptcy. However, due to its complexity, a Chapter 11 bankruptcy can be a lengthy, expensive process that is not always palatable for the distressed company’s secured lenders.

In some situations, appointing an independent director or board of directors to replace the existing directors (consensually or non-consensually) is a quicker, more cost-effective turnaround approach. Independent directors can be beneficial for distressed companies because they (i) offer expertise as to maximizing value in a struggling business and (ii) insulate the company from liability related to any real or perceived conflicts of interest at the director level. For secured lenders, particularly when existing management is acting unreasonably, independent directors can offer fresh and unbiased perspective for the company, allowing for a unified path towards maximizing value. This article explores the mechanisms a secured lender can utilize when seeking to appoint independent directors, and key issues that secured lenders and independent directors alike should consider.

Mechanisms for Appointing Independent Directors

Independent directors can be appointed to take over distressed company consensually or non-consensually.

Consensual path: A distressed company will often seek to alleviate economic stressors by negotiating an amendment to its existing credit facility or entering into a forbearance agreement with its secured lenders. Secured lenders can utilize this opportunity to add a condition precedent to the effectiveness of the applicable agreement that requires appointment of independent directors (who are agreeable both to the secured lenders and to the company) by  certain date. This is the most desirable approach, as it promotes a unified path forward and is generally less risk and less costly.

Non-consensual path: A typical secured financing will include an equity pledge and/or proxy right that allows secured lenders to exercise voting rights on the company’s behalf upon the occurrence of an uncured event o default. When a distressed company has triggered an event of default under the existing loan facility and is no cooperating with its secured lenders, the secured lender can choose to exercise their proxy rights to replace the existing directors with new independent directors who are better suited to act in the best interest of the company’s stakeholders. This is generally considered the riskier approach, as it may result in litigation or disgruntled sponsors and company management that can undermine the new directors’ efforts.

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