Because board members have a financial duty to their shareholders, the time may come when an insolvent organization must consider the option of bankruptcy in order to protect those investors’ interests. In many states, creditors are also designated as stakeholders and must be considered, too. Depending on the type of bankruptcy that is filed, board members may continue to operate in their directorial positions.
As an organization approaches the position of insolvency, board members must consider the options in front of them. According to the Houston Chronicle, “Conducting a thorough financial review and seeking professional help are now the primary concerns. Directors should avoid resigning because those who quit rather than engage themselves in the bankruptcy proceedings are generally viewed as being in derogation of duty.” In other words, board members shouldn’t jump ship during the company’s moment of greatest need.
Under Chapter 11 style bankruptcies, the board is still intimately involved in what comes after filing. Chapter 11 allows companies to “reorganize” in order to try to help the company recover and become profitable again. According to the U.S. Securities and Exchange Commission’s website, “Most publicly-held companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process. Chapter 11 provides a process for rehabilitating the company’s faltering business. Sometimes the company successfully works out a plan to return to profitability; sometimes, in the end, it liquidates.” However, a bankruptcy court must also approve all important business decisions.
Under Chapter 7 bankruptcy, the worst occurs. The company halts all business operations, and a trustee is appointed to liquidate all of its assets. The profits from that liquidation are then used to pay debts to creditors as well as to investors. Secured creditors are paid first and followed by unsecured creditors. Stockholders are last on the list and may not receive remuneration of any kind if the creditors are not fully repaid.
Simply put, corporate governance exists to help protect stockholders from losing their investments to a Chapter 7 bankruptcy. That’s why it is vitally important for directors to have a deep understanding of the current state of their organization’s financial wellbeing. When difficulties are spotted early, companies often have a chance at reviving their operations. If bad audits are ignored, however, the outlook is grim.