Independent Directors: What Private Credit Lenders Need To Know

• Published date: 10 March 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Financial Restructuring, Compliance, Corporate and Company Law, Directors and Officers, Insolvency/Bankruptcy
• Law Firm: Proskauer Rose LLP
• Author: Charles A. Dale, David Hillman, Vincent Indelicato and Matthew A. Skrzynski

The appointment of an independent director is a powerful tool for private credit lenders. The tool, however, must be skillfully deployed because it can boomerang into lender liability when deployed improperly. In this article we discuss: (1) the value of the tool, (2) when to use it, (3) the risks of using it, and (4) practical guidance.

Why Should a Lender Consider Appointing an Independent Director? Independent directors serve as a means to neutralize a board's allegiance to the controlling shareholder. In the private credit market, the board is typically controlled by sponsor-designated directors and the organizational documents often eliminate (or materially limit) their fiduciary duties. This can be a dangerous combination for lenders in a restructuring scenario. Consider the following hypothetical: secured creditors with a defaulted loan to an underperforming business are pushing for the borrower to commence a sale process that could lead to a par recovery. The board, however, knows an immediate sale would wipe out equity, perhaps prematurely. So the board opts to pursue an alternative with a low chance of success to grow into optimistic projections, but with a chance of an equity recovery. This hypothetical is real, especially for troubled borrowers with sufficient liquidity to play out options, with the lender owning all the downside risk and often still funding the process. The appointment of an independent director is designed to introduce a voice of neutrality and fairness into the board's decision-making process with the hope and expectation that independence from the controlling shareholder enables the board to drive toward viable value-maximizing strategies.

When Should a Lender Consider Appointing an Independent Director? Independent directors are most commonly used at two phases of a private credit restructuring. First, director appointments arise in the context of forbearance or amendment negotiations. Put differently, when a borrower needs the lender's waiver or new money, the lender has leverage to require the appointment of one or more independent directors. In this context, an independent director is typically added to the board by consent and provides a voice to advocate for strategies that might not be attractive for the controlling shareholder. Independent directors are also used in the late stages of a restructuring where the parties reach impasse at the negotiating table. At that point, a lender may consider exercising remedies...