"When the going gets tough, the tough get going!"
The times we face are trying, unprecedented and marked by absolute uncertainty. The situation at hand is extraordinary. The speed with which the pandemic is spreading and its gigantic proportions have impacted every aspect of human civilization and left us not just speechless but also motionless. This is one event that has a fundamental and far reaching impact on the way the businesses conduct themselves. Newer models of doing business had to be evolved such as prescriptive work from home, curfews and lockdowns across cities, nations and continents.
While the economy has taken a plunge, the bears are pulling down the stock markets deeper by the hour and even continuity of business is threatened, the real mantra for any corporate would be to stand by its conviction of purpose and sustainability. It is for the board of directors of a company to lead from the front in such a crisis and provide leadership with utmost optimism and self-confidence to survive these tough times.
In this update we focus on corporate governance best practices the board could adopt to ensure continuity of business, crisis management and sustainability.
1. Dynamic Risk Identification, Assessment and Management
- The Board must be in close contact with the CEO and CFO work with the management to ensure safety, security and well-being of the Company's workforce and other stakeholders.
- The Board must frequently monitor with the executive management the emerging risks of the pandemic and strategizing for minimizing the adverse consequences and mitigating the risks and ensure viability.
- The Board may consider a two-pronged approach of risk analysis:
(a) Firstly, the Board along with the management consider effect on supply chains manufacturing operations (including quality, quantity and overall productivity), intermediary processes, pricing and costs, liquidity, and so on; and
(b) Secondly, companies must continuously examine and consider the legal impact of disruption in the above e.g. probability of violation of local sourcing requirement under foreign direct investment approvals due to short supply of locally sourced material.
2. Financial Continuity and Going Concern
- The Board must seek frequent briefing on the company's indebtedness, the bank financing, lines of credit, liquidity risks in short term and work with the management to proactively secure the liquidity needs.
- 2019-20 has not been a great year for many companies. The last quarter will close soon but with a shadow of an overall gloom and doom. The year-end audits at a fairly advanced stage. The Board must constantly watch out for any early warning signals that may put their going concern belief to the most stringent test. The Board must work with the management to prepare and update business forecasts on a real time basis.
3. Communicate, communicate, communicate
- The Board must often be in proactive mode for communicating with the sectoral regulators and governmental agencies. Procuring timely guidance from these authorities can facilitate the company to navigate better through choppy waters.
- The Board must look out for opportunities in every adverse situation and strategize to encash them at the soonest. For successful implementation of the Board's vision in adversity, the CEO and the management team will have to shore up the resources keeping in mind the strict limitations on physical movement of people. The mentorship of the Board members coupled with the diversity and depth of experience can positively impact the fortunes for the company in worst of the situations.
- The Board must be fully engaged with major shareholders and other stakeholders to share their vision and strategy to rise out like a phoenix.
- The challenging economic conditions are also getting complicated with multitude of regulators bringing in several regulatory changes at the same time. The Board must be vigilant about the prospective change in law and must be quick to respond and reflect and even staunchly resist any deviations from conventional wisdom.
4. Disclosures – mandatory and otherwise
- One of the most successful strategies of risk mitigation is a prompt and measured disclosure. In light of existing and emerging uncertainties, it would be the most appropriate to take a more conservative approach about the prompt disclosure of all risk factors and reservations that intimidate the business models.
- No Board is blessed with magic a wand to resolve all issues at all times. However, the stakeholders are more than likely to appreciate and respect an honest approach of disclosure of the efforts being taken by the Board to address the problem or mitigate the risk.
- The Boards of listed companies have to be mindful of the mandatory disclosure requirements. E.g. prompt and comprehensive disclosure of occurrence of all material events under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 20151 or the unpublished price sensitive information that would impact price discovery of its securities, under the SEBI (Prohibition of Insider Trading) Regulations 20152.
- In order to determine price sensitivity and materiality, the Boards must seek timely legal counsel for a thorough commercial and legal risk analysis to discern actual risk from potential risk and craft the disclosure statement under expert guidance.
- Most Boards prefer to follow the precedents. However, the Board must ensure that the form does not obscure the substance of the disclosure.
- The Boards must guard themselves against the temptation of limited or selective disclosure. Companies must not indulge in such a practice and must provide full and fair disclosure to ensure protection of investors' interest.
5. Supply chain disruption
- With economies affected globally, there is an obvious crunch in the supply of raw materials and components whereas the demand remains constant, if not inflated by the perceived fear of absolute breakdown of the economic cycle. The security of the supply has been compromised due to various reasons like source of supply being a COVID-19 affected area and apprehension of spread of the fatal virus in transit. This has impacted the supply chain and more crucially the life cycle of product manufacturing. The disruption at the first rung of supply, say for instance raw material, has a domino effect – impacting each step - work in progress, finished goods, further value addition to finished goods, if any, packing material inventory and lastly the ultimate use of product whether as a commodity for end use as a component for other OEMs.
- The board and management need to respond to the crunch in supply chain and the dynamic circumstances.
(a) Contractual issues
It would not be uncommon for COVID-19 situation to be construed or claimed as a force majeure event or even leading to impossibility of performance i.e. frustration of contract, depending on the contractual terms. However, what would be key for the Board of Directors would be to find alternatives for sustainability and negotiate support, in case such events are triggered under the contract. The Board should not assume or adopt adversarial attitude or strategy to ensure continuity of fair and long-term relations with operational stakeholders.
In hindsight, this episode will certainly lead to careful crafting of the commercial contracts reducing the dependency on the boiler plate clauses.
(b) Effective planning
In line with the national motto to deal with disasters – Mitigate, Prepare and Respond, the Board in consultation with the management must assess the supply chain and logistical risks in order to come up with a mitigation strategy and plan to effectively tackle the such risks, set milestones to ensure preparedness and plan for response in case of adversity.
(c) Resetting the goals
The Board should reconsider its financial and operational capabilities as well as key performance indicators, by taking into account its market demand and budget. It may be helpful to decentralize non-essential decision making with respect to supply chain relation functions as well as cross-training personnel to fill for originally responsible person's absence.
(d) Long term sustainability
From a forward looking perspective, the current times offer a golden opportunity to the boards and management to spend some time on making their supply chain ecologically resilient.
(e) Be the Leader
From an altruistic perspective, the Boards may also encourage their companies to share their best practices for disaster management in public domain for others to emulate.
6. Data Privacy considerations
- Unscrupulous dissemination of sensitive company data can have fatal repercussions. However, under remote working circumstances, maintaining control over data, especially unpublished price sensitive information, might pose certain barriers. The Boards may consider implementation of the following practices:
(a) Use company protocol for sharing data
It is suggested to ensure compliance with company protocol on data sharing. In case the company does not have any such policy in place, the Board along with management inputs could develop the policy pointers for ensuring safety of data, such as restricted use of WhatsApp or other social media or communication platforms for sharing sensitive data.
(b) Updating information technology and communications system
Information technology plays a crucial role in the day to day operations in the current tech-savvy commercial operations. It is recommended for the companies to ensure that the employees have adequate IT support and have the bare minimum facilities like anti-virus, VPN (virtual private network), etc. to ensure the integrity of confidentiality and reasonably pawn off cyber attacks and data phishing.
7. Facilitating and undertaking year end audits
The financial statements and auditor's report are the crucial investor report cards which have a bearing on the fate of the company. Given the proximity of current events to the end of financial year, the companies must not only prepare for the annual statutory audit exercise as usual, albeit this time round also consider the eventuality of the audit being conducted in a hybrid manner, which could mean a part of audit being done remotely with documents uploaded in the cloud. This exposes the company to potential data breach and compromised audits. The Boards may consider some of the following measures to mitigate these issues:
(a) Execution of a robust non-disclosure agreements with auditors including indemnity and personal liability clauses for breach.
(b) Keep up with ICAI advisory
The Institute of Chartered Accountants of India (ICAI) is expected to release advisory on dealing with coronavirus and impact on conduct of audit assignments. The Audit Committee as well as the Board should familiarize themselves with these new procedures and associated risks so that the audits can be planned accordingly.
(c) CARO, 2020
The Companies (Auditor's Report) Order, 2020 notified recently by MCA entails more than 25 new checks to be carried out by the statutory auditors. The ICAI's guidance note on CARO 2020 will be soon released. In spite of Work-From-Home regime enforced on all organisations, the management teams will have to quickly adapt to this new challenge and meet the auditor's expectations.
8. Avoiding Ethical Traps
- The primary purpose of the Board Leadership is to create, preserve and grow shareholder value and contribute to the nation's wealth legally and ethically.
- The Boards must remind themselves that when crisis hits, Milton Friedman can often overpower the Guidelines for Responsible Business Conduct. The survival instincts are likely to cause ethical blind spots and result in serious erosion of the moral values on which the business once flourished. Before the economics of innocent fraud become the rule of the game, the Boards are required to nudge the CEO and the management of the core values and sustainability.
- In extreme situations such as the Covid-19 pandemic, the Boards should ensure re-dedication of the management to simple principles of behavioural ethics – moral awareness of the company coupled with moral intent lead to moral decision making, the foundation of a moral action and ESG compliant company.
1 More specifically Para B of Part A of Schedule III and Annexure I of SEBI circular dated 9 September 2015 (https://www1.nseindia.com/content/equities/SEBI_Circ_09092015.pdf)
2 Regulation 8 read with Schedule A.
The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at email@example.com