Howard Brod Brownstein
President, The Brownstein Corporation

For quite some time, I have been “beating the drum” that lenders should pay attention to a borrower’s corporate governance, both at the loan underwriting stage — and on the back-end when considering an extension, waiver or a forbearance agreement. I have been singularly unsuccessful in persuading lenders to do this, but I haven’t given up.

Corporate governance refers to a company’s board of directors, including its make-up and activities. Properly executed, corporate governance can reduce risk and increase enterprise value, but only if it is taken seriously and not treated as a “check-the-box” means of maintaining corporate existence. A corporate board of directors are fiduciaries, as a group, for the shareholders, as a group; and when a company is insolvent or in the zone of insolvency, the board’s fiduciary duties may extend to creditors — including secured lenders.

Better Governance Makes a Difference

As a turnaround professional for nearly 30 years, I have seen first-hand instances where better corporate governance could have made a real difference. Time and again, had there been a truly independent board member — not a relative or golfing buddy of the owners — I’m convinced that he or she would have stood up and said, “Wait! We can’t do this! Let’s consider alternatives, or perhaps get some expert advice!” and the ultimate outcome might have been much better.

While strong corporate governance isn’t a cure-all, nor will it bullet-proof a company, it can certainly act as a necessary brake on management that may be misguided, as well as a positive force for realizing a company’s potential. A truly independent board member is one who will speak truth to power — which many “go-along, get-along” board members will not do.

Unfortunately, for the most part, lenders completely ignore a borrower’s corporate governance. Beyond confirming that the borrower is correctly named and is registered as a corporation in good standing — all necessary for proper perfection of a lender’s liens — lenders seem unaware of the potential value of paying attention to the borrower’s corporate governance.

During the loan underwriting process, a lender can presumably look at anything it desires about the company, and this would include inquiring whether a company has a real board of directors, rather than a board in name only, as well as whether it has regular meetings and creates minutes of those meetings. However, it is relatively rare to find lenders who pay any attention to these aspects of the company during the underwriting stage.

I believe the likely reason is simply that corporate governance matters are not on the lender’s radar, and in today’s fiercely competitive lending environment, lenders avoid asking any questions that might lead the prospective borrower to go elsewhere. And yet, since the underwriting process is all about identifying risk and gauging how it is being managed and monitored, lenders miss a real opportunity in ignoring this important factor.

Even more surprising, when a lender is dealing with a borrower that is in need of an extension or waiver — or especially a forbearance agreement — and is detailing requirements needed before agreeing to provide any of those, I have never encountered a lender that includes “strengthening corporate governance” among those requirements.

Again, there are likely reasons for this. The borrower’s corporate governance is just not on lender’s radar. There is also a fear that such a requirement might step “over the line” with respect to avoiding lender liability or equitable subordination.

In reality, considering that lenders typically specify other requirements relating to the borrower improving its business practices, such as expediting collections or reducing slow-moving inventory what would be so dangerous about a lender similarly telling the borrower to improve its corporate governance. The lenders could advise the borrowers to add one or two truly independent board members. They would not tell the borrowers who these board members should be, and certainly aren’t suggesting themselves. The directors would just need to meet the SEC definition of “independence,” even if this is a privately-owned company.

Benefits of Strong Governance

My friends in academia report that companies with strong corporate governance perform better financially. Although they hasten to add that this may not be cause-and-effect, but just a correlation; businesses that are enlightened about corporate governance may also be enlightened in other areas.

Occasionally I have asked lenders whether, if they were considering a loan to two identical prospective privately-owned borrowers, and one had a real board of directors, with board and committee minutes that the lender could review during underwriting and monitor in the future, wouldn’t they prefer to lend to the “enlightened” borrower? They universally agree.

The conclusion is inescapable. By overlooking a borrower’s corporate governance, lenders are missing an opportunity to utilize a potentially valuable tool for evaluating and monitoring the borrower’s risk and its ability to increase enterprise value.

So, what should lenders do to correct this apparent oversight?

  • Educate lenders about how corporate governance works. Explain the fiduciary duties of board members, board and committee leadership and structure, and corporate governance best practices.
  •  Identify the borrower’s corporate governance as a potential area of risk to be evaluated and monitored.
  • Consider strengthening corporate governance for possible inclusion as a requirement when providing an extension, waiver or forbearance agreement.

Lenders should Include information about the borrower’s corporate governance in their standard underwriting checklists. This should include

  • Who’s on the board?
  • How were they chosen, and for how long have they been serving?
  • How independent are they? What relationship — economic or otherwise — do they have with the owners?
  • How are they compensated?
  • Are board and committee minutes available for review?

Lenders have an opportunity to strengthen their underwriting and credit management by paying attention to their borrower’s corporate governance. I hope they will take the opportunity, but until they do, I’ll keep beating the drum! •