Extreme times, Extreme Measures: Pandemic-Resistant Corporate Law

Extreme times, Extreme Measures: Pandemic-Resistant Corporate Law

Luca Enriques

April 22 2020

GCGC/ECGI Global Webinar Series

This article was first published on the Oxford Business Law Blog on 22 April 2020

By Prof. Luca Enriques (Oxford University, Faculty of Law)


It's a pandemic. There are no rules (Seth Meyers)

These are exceptional times. Almost everywhere, policymakers are taking exceptional measures. Most of these measures are in the domains of public health, public finance and public law. Among the latter, of great relevance to corporate governance are the rules broadening governments’ powers to authorize large share block purchases (eg, in Germany and Italy). Even stronger proposals are being aired, and in some cases already adopted, in the direction of injecting public funds into companies in exchange for equity (Germany), if not of nationalising businesses altogether (France).

But some incursions into private law have also been made. This is especially true with regard to insolvency (or bankruptcy) law, as documented by Aurelio Gurrea Martinez. Some of the bankruptcy law-related measures intervene to change rules that ordinarily apply in the vicinity of insolvency and are therefore at the boundary between insolvency and corporate law. For instance, a number of countries are discussing whether to review directors’ duties in the proximity of insolvency (eg, the UK and New Zealand: see Licht) or have already done so (eg, AustraliaSpain and Germany). 

Similarly, some of the jurisdictions still providing for the ‘recapitalize or liquidate’ rule (which requires directors to promote a recapitalization of the company, convert it into an unlimited liability partnership or liquidate it, if net assets fall below a given threshold), such as SpainItaly and Ecuador, have chosen to suspend its application during the crisis. Finally, in Italy rules on the subordination of shareholders loans have also been suspended.

This post asks the question of whether company law rules not specifically dealing with companies in the twilight zone should also be tweaked to face the emergency. One obvious focus are rules dealing with how general meetings must be held (see eg the UK and Italy). Such rules may be at odds with social distancing provisions wherever they don’t allow for virtual meetings or forms of collective representation of the shareholders. But one can think more broadly about how corporate law should be amended in order to avoid economic rather than viral contagion and keep companies afloat in these exceptional times. Below are some general considerations to guide policymakers’ choices in this area, followed by examples of temporary corporate law interventions for the emergency. This post concludes with some thoughts about how to prepare for a similar emergency in the future.

1. Tackling the current crisis: a framework for tweaking corporate law 

What kind of interventions should be made in the area of corporate law? First of all, the case can be made in favour of adopting, wherever feasible, the simplest form of intervention, consisting in either the suspension of existing rules or in temporarily applying a set of already existing laxer rules to facts otherwise falling under stricter ones. 

The alternative to these very basic forms of intervention would be the crafting of new special temporary rules. While in some cases that may be necessary (as some of the examples below will illustrate), caution is warranted with the idea of designing new rules: experimenting with new (corporate law) rules in exceptional times carries the risk that the new rules will not have been properly pondered, let alone gone through a consultation process or a cost-benefit analysis (as Iris Chiu and her co-authors point out here with reference to financial regulation). In addition, in exceptional times such as these, it is likelier that extreme solutions leaning on the side of excessive state interventionism and ‘stealth protectionism’ (Pargendler) will be approved. Finally, novel off-the-cuff measures could be taken as a response to the political pressure to ‘do something’ for the sake of it rather than because something needs to be done (Romano). While lawmakers and governments may have plenty else to do to show that they are facing the crisis, securities regulators may find themselves in the more awkward position of being seen on the side lines and therefore be strongly tempted to just come up with something within their power (as I argued here with specific regard to the 2008 short-selling bans). For this reason, the granting of new emergency powers to regulators other than in the form of the authority to relax or suspend existing rules should be resisted.

All such measures should have a clear and reasonably short end date, so that the need to extend their validity will be duly pondered and the risk that they stay in force more than needed is reduced. 

Needless to say, they should also be proportionate, which means that deviations from the corporate law that applies in normal conditions should be as narrow as possible. One way for the intervention to be proportionate is by suspending normal-times rules in the way that is most deferential to individual companies’ autonomy. In a time of extreme uncertainty, it is safer to let individual companies decide on whether to move away from normal-times corporate law rules. Unless, that is, a clear case can be made for the proposition that individual companies would make choices contrary to the interests of society as a whole.

Deference to individual companies’ choices can take many forms, which policymakers should consider when assessing rules for proportionality. First of all, rather than themselves suspending rules, policymakers may just enable companies to deviate from them (subject to the point made immediately above about overarching public interests, if any can be identified). They may do so by leaving the opt-in decision to the shareholder meeting or, favouring a leaner decision-making process, the board. Second, and more effectively but also more intrusively, lawmakers may introduce new ‘majoritarian defaults’ (Easterbrook and Fischel, p. 15), based on the argument that, at the time of starting up the company or going public, shareholders had not focused their attention on a pandemic scenario such as the current one [1] and that, had they done so, at most companies they would have chosen a leaner decision-making process. Hence, instead of suspending a given mandatory rule, policymakers may provide for a new, more lenient rule that companies would remain free to opt out of, thereby moving back into the normal-times corporate law rule. And again, the ‘opt-back’ decision could be left with the shareholders, with the board, or both. 

Finally, what rules should policymakers tamper with, content-wise? Normal-times corporate law rules exist to make sure that, throughout their life, companies are managed in the interests of their shareholders and other stakeholders, so long as contractual protections are insufficient to protect the latter. Lawmakers enact those rules because they believe their benefits for investors, other stakeholders and society more generally are greater than the costs. Things can change dramatically in extreme times. With economies worldwide so heavily disrupted, most companies are in survival mode and corporate law constraints, justified as they are in normal times, may simply prove fatal to them. Hence, the main focus should be on those rules that may affect a company’s very survival

In addition, lawmakers write rules based on the assumption that uncertainty may, of course, vary across time but, arguably, not to the point that we presently observe. This raises the question of whether any corporate law rules may become ineffective, if not counterproductive, once the level of uncertainty reaches unprecedented peaks.

Extreme uncertainty also hits share prices. Again, share prices may plummet to the point when rules implicitly relying on prices providing a good-enough estimate of future cash flows may no longer rest on secure ground. Of course, there is no way to tell whether the market has over-reacted in recent weeks. At the same time, the market currently discounts a level of uncertainty that will soon disappear as more is known about the health and economic consequences of the pandemic.  

2. Tackling the current crisis: what tweaks?

So, which rules should be suspended or relaxed? Every jurisdiction is, of course, different and may require different interventions, but here are some areas that policymakers may consider, with a special focus on EU countries. The suggestions are made having publicly traded companies in mind, although most of them would be appropriate also for closely held companies.

2.1. Survival: how to facilitate equity and debt capital injections. When it comes to following a ‘Survival first’ imperative, attention should be given to rules that hamper quick decisions on matters on which the life of the company may depend. 

While most of the attention of policymakers is currently focused on whether companies can borrow to ensure their survival, it is already clear that quickly raising equity could be a lifeline for many companies. Governments in many countries are not helping by tightening public law rules on foreign investments. But they could also do something supportive by making equity capital raising easier. 

Wherever the law grants shareholders a pre-emption right on newly issued shares, they could relax (if not outright suspend) that requirement, and hence considerably shorten the time it takes to execute a capital increase resolution (within the EU, by at least 14 days: article 72(3), Directive (EU) 2017/1132). That should make it easier to find one or more investors willing to prop up the company via an equity capital injection. [2]  

Because timing can be existentially important in securing new funding, another requirement that may be suspended or narrowed down in scope is that shareholders approve new issues of shares or delegate that power to the directors within the boundaries set, for EU countries, by article 68, Directive (EU) 2017/1132. [3]

Granted, measures such as these will increase the risk that existing shareholders lose out to buyers of newly issued shares who may obtain a bargain price even with no discount on current market prices, given their low level. But if there is self-dealing or other abuse, this can be dealt with by ex post review, including liability suits for breach of directors’ duty of loyalty, and this seems preferable to chilling all transactions ex ante[4] 

One way for a company to find new equity may be by having the incumbent controlling shareholder cede control to a new one. A mandatory bid, under normal circumstances, would follow, which may, at the margin, rule out not only inefficient control transfers but also efficient ones (see eg Bebchuk). Many European jurisdictions allow for exemptions in special situations such as financial distress (see Clerc et al). Others provide for a general exemption power in the hands of the regulator, like in the UK (id). Where the latter does not exist, by analogy with the case of financially distressed companies, the current situation may justify a (temporary and default) exemption from the mandatory bid rule: in ‘survival first’ mode, an imperfect tool for the protection of minority shareholders may well have to be sacrificed. For countries that provide for a general exemption power such as the UK, a general policy could be announced that spells out under which conditions, if any, the regulator will still require mandatory bids to be launched in case of control transfers taking place during the emergency. 

Finally, EU rules on capital increases that aim to ensure that a company’s legal capital provides a reliable measure of funds that cannot be easily distributed to shareholders should be suspended. Doubtful as it is that such rules serve any purpose in normal times, they certainly reduce companies’ range of action when their survival may depend on raising new equity.

With regard to debt financing, it is well-known that there can be situations in which the dominant shareholder even of a listed company may be in the position to provide cheap debt finance to an ailing company. In times when the need for cash may be urgent and the avoidance of bankruptcies is in the public interest (given the risk of clogged courts), restrictions on such cash infusions may have to be eased even at the cost of, again, increasing the risk of abuse. The suspension or relaxation of rules on related party transactions, especially when they considerably lengthen the decision-making process by, for example, requiring shareholder majority of the minority approval, should be considered. That, incidentally, should also be the case for new shares issues reserved to related parties. [5]  

All these measures should be merely default ones: well capitalized companies may want to signal their good shape by opting back to normal-times rules; thereby, they can also reassure their institutional shareholder base that the risk of abuse will not increase. If the risk of abuse is considered high, lawmakers could facilitate companies’ opting-back to normal-times protections by requiring a simple majority to do so or even allowing a qualified minority (say, one third of the shares represented at the meeting) to force the opt-back. And because it can be a company’s board that may want to signal the company’s good shape, the board itself may be given the opt-back power.

2.2. Dealing with extreme uncertainty. Two areas where rules can be tweaked to deal with extreme uncertainty are director liability and control transactions.

2.2a. Directors liability. Companies do not have to be close to insolvency for their managers to get things terribly wrong given the circumstances. Liability regimes giving rise to significant liability risks for directors’ violations of the duty of care may reveal themselves to be too harsh in a business environment characterized by extreme uncertainty (see generally Hill and Pacces). For instance, Germany’s version of the business judgement rule requires the defendant director to prove that they complied with their duty to make informed decisions. 

At present, we are all aware of the extreme uncertainty businesspeople are making decisions under. However, uncertainty will eventually recede in the not too distant future and we (and judges and regulators in at least some jurisdictions) may be too quick to conclude that harmful choices made during the crisis (harmful as a consequence of the fact that negative circumstances, whether anticipated or not, then materialized) could and should have been avoided if directors had given due weight to information signalling the likelihood of a bad outcome. Of course, judges are not supposed to use their ex post knowledge to judge directors’ behaviour. They are indeed expected to put themselves in their shoes at the point in time when a given harmful decision was made. And yet, hindsight bias is inevitable and, therefore, could make managers excessively risk averse.
Hence, more lenient standards, if not, preferably, a blanket exemption from liability for negligent conduct could be temporarily introduced. Reputation concerns, the risk of losing their jobs and the generous compensation package that usually comes with it and of finding no other as well-paid job in the future should act as more powerful incentives for diligent decision-making than liability standards. Hence, concerns about the increased likelihood of bad decisions being taken by directors appear to be less pressing than those about inhibiting risk-taking in an extremely uncertain business environment.

Any change in this area should take the form of a default rule, granting companies the power to opt back into the ordinary regime whenever they wish. [6] This opting-back resolution should be made available to boards themselves: while it is most unlikely that turkeys will vote for an early Christmas, there is no reason for preventing them from doing so.

2.2b. Hostile acquisitions. Extreme uncertainty also implies low share prices and low share prices may attract hostile bids. In the US, poison pills are experiencing a revival of sorts. Where, such as within the EU (other than in the Netherlands), poison pill-style defences are unavailable, companies may have to heavily rely on Governments to fend off hostile bids. That gives them an incomplete and potentially costly defence: the target may not hold ‘strategic assets’ that trigger government vetting powers. In addition, the bidder may better connected with the Government than the incumbent: geopolitics may even get in the way and lead the Government to acquiesce to a hostile bid from a foreign company to maintain good relations with a foreign government. In addition, political capital may have to be spent in order to secure the Government’s veto, which may then come with formal or informal strings attached. 

With low valuations reflecting the extreme uncertainty that dominates in today’s business environment, shareholders themselves may prefer managers to focus on their business at such difficult times, rather than having to face the distraction of mounting a defence in the face of a low-ball hostile bid. Hence, leaving aside the question of whether mandatory rules preventing takeover defences are justified in normal times, there may be something to say in favour of the idea of allowing more contractual freedom in defending against potential hostile acquisitions until the crisis is over.

How can that be done? One possibility is to introduce a temporary default rule granting boards the right to approve purchases of share blocks above a given threshold. In addition, one could think of a temporary default rule requiring a supermajority for the removal of directors if a bid is on the table. Finally, temporary tenured voting shares could be facilitated through a default rule doubling the voting rights of shares held for a certain time, but only until a pre-set date or the date when the Government declares the emergency over. Again, the stickiness of the default could vary and opting-back could be made more or less difficult. But there would seem to be no reason to require anything more than a simple majority of the shareholders (or a board resolution) to opt-back to one-share-one-vote before tenured voting becomes effective.

3. Being prepared for future crises

The current crisis will teach us many lessons. A minor and hopefully inconsequential one may be that, if ever, God forbid, another crisis such as this strikes, we will do better if a framework is in place that allows us to adapt corporate law quickly to the emergency. 
One way to do that would be to have regulatory governance mechanisms in place to facilitate adaptation of normal-times corporate law to emergency times. That would have two main advantages: first, if a new crisis as serious as the present one hits, adaptation would be faster and, hopefully, better thought-through. Second, we could reduce the risk that solutions that are disproportionate for normal times are adopted (or retained from the current crisis) with the justification or excuse that another crisis may hit in the future and we’d better be prepared.
Corporate law legislation should thus include delegations of powers to the government (executive branch) so that a pre-determined set of rules can be suspended (or replaced by leaner one) in an emergency. To identify which rules should be tweaked, the experience of emergency-based deviations from normal-times law in the current crisis will help. Of course, Parliament could always re-appropriate those powers or restrict them and corporate law may also provide that suspension of the relevant rules will follow ipso jure a declaration of emergency, without giving the government any discretion on whether deviations from normal-times law should take place.

4. Summary

Under the extreme circumstances we are living through lawmakers should enact corporate law rules deviating from normal-times corporate law in recognition of the exceptional risk that companies are running of going under and the extreme uncertainty under which companies are operating. These tweaks should take the form of temporary default rules. Areas where it would make most sense to enact such rules include equity issuances, shareholder loans, control transfers, director liability and hostile takeovers.

While some of the temporary default rules may be justified even in normal times, this post has only suggested their adoption for the purpose of allowing companies better to weather the crisis. Once the crisis is over, the discussion can be resumed about their merits. But, more importantly, the mechanisms should be put in place for such temporary rules swiftly to kick in again where necessary.

Luca Enriques is Professor of Corporate Law at the University of Oxford.

I wish to thank Kristin Van Zwieten for the excellent comments and suggestions. The usual disclaimer applies.


[1] Arguably, the pandemic was a known unknown, in the sense that it was highly likely to strike at some point but no one could know exactly when. But given that very few people have memory of previous pandemics and governments reactions to pandemics themselves change over time, it is almost impossible to anticipate how best to deal with an exceptional event such as one of this kind. In addition, human beings, both individually and collectively, may be biased against planning for such an event, as Tim Harford explains here.

[2] In the UK, self-regulatory constraints on share issues, which practically limited issuances of shares without granting existing shareholders a pre-emption rights to five percent of the company’s capital have been relaxed: the limit is now 20 percent.

[3] In the US, where it is stock exchange rules that vest shareholders with voting rights on new issues of shares, the New York Stock Exchange has relaxed, through June 30, 2020, certain requirements of its shareholder approval rules.

[4] In any case, the rules allocating issuance powers to shareholders and granting existing shareholders pre-emption rights can already be avoided, albeit with a certain amount of legal risk, which a rule suspension would avoid. That can be done by issuing mandatory convertible bonds with a clause that provides for restitution of capital and interest if the shareholder meeting, to be convened after the issuance is executed, rejects the proposal to raise capital for conversion purposes. For an example of such a transaction see here.

[5] The UK Financial Conduct Authority has done that for recapitalization transactions with related parties requiring majority of minority approval (until further notice).

[6] In jurisdictions, such as the UK, where directors liability vis-à-vis creditors is (also) based on the doctrine according to which, in the vicinity of insolvency, directors’ duties shift from being owed to the company to being owed to its creditors (the West Mercia rule: see BTI 2004 LLC v Sequana SA), a suspension of director duties would imply that creditors would lose the protection that comes from that doctrine. Hence, leaving the decision of whether to opt back to normal times director liability standards to shareholders would allow them also to decide on whether that doctrine should apply. Lawmakers in those jurisdictions could therefore reflect upon whether to leave the West Mercia rule in place, carving out an exception from the general suspension rule, or whether to say nothing, which would have the effect of freezing the same rule as regards duty of care violations. The former solution would be in line with the recent trend towards suspending the application of wrongful trading liability rules. For a discussion, see Van Zwieten.