Courage in a turnaround means facing up to people who are very opposed to what you want to do and sometimes requires personal sacrifice. Occasionally, it requires physical courage, as the turnaround leader will need to be present in many tense situations.

A colleague of mine had a difficult experience while engaged as the chief restructuring officer for the U.S. operations of a major European food manufacturer. After conducting a frenzied situational analysis to identify a new strategic focus for the company's domestic subsidiaries, he received a phone call instructing him that he could meet the company's union representative that evening at a famous steakhouse in an outer borough of New York City. Upon arriving—looking forward to starting negotiations—he found himself approached by a large man who ushered him through the kitchen, out the back door, and up a shadowy staircase to a small office upstairs. With two very large gentlemen standing silent guard in the back of the room, the union head lit a cigar and asked to hear the details of the plan. As the CRO began detailing the divisions that would be sold, the plants that would be shuttered, and the union contracts that would require renegotiation, the union head nodded silently before launching his own inquisition.

"And what about my sons? And my cousins? Will they keep their jobs?" he began.

"Well, that depends," the CRO replied, "on what division they are in. What do they do, exactly?"

"They don't do nothin'," the union head responded, glancing none-too-subtly at his two colleagues in the back. "They don't do nothin'. Are they gonna stay on the payroll?" And then he mentioned the names of the wife and children and the home address of the CRO to show that the union knew where they lived.

Telling the story years later, my colleague chuckles at the memory of the smoke-filled room and the implied threat of physical violence that loomed over the meeting. "It was like something out of the Godfather," he laughed. "I said I would look into it, and got the hell out of there as fast as I could. I knew that couldn't intimidate me, however, or I'd never get the place fixed." In the end, the two met a number of times and negotiated major changes both sides could live with, gaining mutual respect for each other.

Situations like this, though somewhat extreme, illustrate the first rule of leadership in a corporate crisis: leaders absolutely must display courage. In times of distress, diverse sets of stakeholders will invariably come into conflict, and they will fight for their goals by using any means necessary, even, as in these cases, the implied threat of violence. It also could take the form of shareholders who threaten lawsuits. It takes courage to bring contentious stakeholders together and convince them all to pull in the same direction.

Courage is always needed to challenge "the way we've always done it" in a large organization, especially if it's an executive who has been there a long time who is now faced with a turnaround situation. Simply put, new people often succeed because they are willing to do things that the old ones can't or won't. I was once involved in a group that had purchased a struggling appliance parts manufacturer that was breaking even but benchmarking terribly against its competitors. In my first meeting with the CEO, I discussed our turnaround plan with him, breaking down all of our intended changes into three lists: strategic, financial, and operational strategies. A month later, I noticed that none of them had been implemented, so I sat down with him a second time to find out why. "Well, I took your lists," he began. "And broke them into two new lists: those I don't know how to do, and those I can't bring myself to do." His proximity to the situation and his commitment to the status quo made it impossible for him to make the changes we needed, so we quickly agreed on his retirement plan and brought in an outsider whose fresh eyes and ears allowed him to implement the plan without reservations.

Courage serves as a bedrock for the next critical requirement for leadership in a turnaround: decisiveness. I regularly explain to my students that the further down the organizational distress curve a company finds itself, the more urgent the need for decisive action. Paradoxically, the level of distress inversely corresponds to the amount of time available for data gathering, debate, and analysis, so turnaround managers often must follow the "Ready, Fire, Aim!" approach to decision making. There simply is not enough time to conduct a rigorous, bottoms-up analysis for the company, so managers have to use an 80/20 rule; if 80 percent of the data to make a decision can be gleaned quickly, one cannot wait for that exhaustive last quintile of information, particularly if a company is already in the faulty action or crisis phases. Sometimes one must ask: How outrageous must the last bit of undetermined data be to make us go in a different direction? If it appears the odds are that a full 100 percent analysis probably won't change what we already know, stop analyzing and take action. Fortunately, if a leader demonstrates the courage necessary to make difficult decisions quickly, employees and lenders will be more likely to respond well should a change in course become necessary down the line. As Steve Miller, CEO of several successful turnarounds (and author of The Turnaround Kid) noted, it is more important to get everyone at a company pulling rapidly in the same new direction, even if it later becomes clear that it was the wrong direction. The willingness to admit error and then change direction yet again based on results is important. Companies often reach that crisis phase because of infighting, misaligned incentives, or differing ideas on how the company should do business, so eradicating those internal conflicts is the necessary first step to returning the company to health. Paralysis by analysis is a deadly situation in an underperforming company. As Miller points out: "Don't study things to death. Most of the choices you need to make are clear, and decisiveness breeds confidence. Listen to you customers because they know more about what's wrong and right with your company than anyone, and listen to your people, from the boiler room at the plant to the executive suite."^[56]

Finally, turnaround managers must project a certain level of credibility in order to inspire their charges to pull together. While incumbent management can on occasion offer that credibility, such as was accomplished when existing Caterpillar management broke down the company's siloed structure, struggling companies are often where they are because of management's failed leadership, so fresh faces can often bring more to the table. Experience is key; a turnaround manager who has been through the process several times before and knows the steps that companies must take in order to right themselves can often convince employees accustomed to riding a rudderless ship that they have what it takes to turn things around. Even a "strong" CEO can create an intolerable situation by refusing to change course. New leadership often provides "fresh eyes" to see things differently and "fresh ears" to listen to everyone in order to determine changes needed. In initial meetings with employees as part of an overall situation analysis, mentioning past engagements or relevant comparable experience—in the same industry or the same type of transaction (a 363 sale, for example, which we explore in Chapter Nine) or the same size of company—can inspire faith that the company is finally in the hands of someone who can help. Sometimes a simple "I've sweated payrolls before" tells people you are experienced and understand their pain.

The most important trait that brings credibility is honesty. Unfortunately, we've reached the point that too many business people believe lying is "just business." In a turnaround situation, it's an unforgivable sin. Turnaround managers face a first test of that credibility and honesty when first meeting with employees, creditors, or incumbent management. As the old saying goes, you only get one chance to make a first impression, so it is important to project confidence and competence in these initial meetings, where a manager probably has not had a chance to formulate a strategic plan for the turnaround but must nonetheless inspire confidence among those key stakeholders. The second test for credibility comes after the plan has been implemented and the first data become available to test whether the plan is meeting its targets. As explained in the next chapter, the thirteen-week cash flow model is a critical diagnostic and forecasting tool that can help ensure that managers formulate rational expectations, communicate them throughout the organization, and meet the expectations they have created. For example, the model will clarify whether a supplier can be paid on time, and if it cannot, the manager must use it to determine and communicate when the supplier can be paid, and then must meet that target date or risk losing credibility both inside and outside of the organization. Meeting targets for lenders—such as returning to compliance on covenants—is especially important, as those key stakeholders are typically fatigued by an extended track record of broken promises and underperformance. Winning their confidence by hitting the promised targets will buy the company the time needed to implement the chosen turnaround plan.

In succeeding John Akers as the CEO of IBM in 1993, Louis Gerstner exemplified these traits by demonstrating a willingness to make difficult decisions to unite a fragmented company. In the early 1990s, IBM's seemingly unlimited resources made it better-positioned than any competitor to take advantage of the growing computing revolution in client/server architectures and the Internet, but the organization's silo structure and reward system incentivized managers to protect their own fiefdoms rather than support a cohesive go-to-market strategy. As a result, they refused to cannibalize the sales of mainframe computers—long IBM's core strength—by introducing more technologically-advanced replacements, with one manager labeling the Internet "a university thing; we're doing serious business here."^[57] Meanwhile, several product lines remained incompatible with each other, particularly those legacy mainframe products, thus aggravating customers and destroying the company's gross margins and market share.

With IBM losing money for the first time in 1991, discussions about a potential spinoff of the PC division led to the CEO talking about completely breaking up the company into thirteen pieces. The uncertainty created an atmosphere of suspicion and empire-building, as management became distracted from fixing the company's underlying problems and worried instead about retaining control of the largest possible piece of any post-breakup entity. Most of the turnaround attempts involved downsizing of employees and plant closings, without looking at the strategy that customers would require. Upon taking control, Gerstner found a culture of bureaucracy and groupthink, where decisions were made by committee and meetings were largely ceremonial. In an astonishing example of this bureaucratic inefficiency, executives frequently held lengthy "pre-meetings" of their own before actual meetings, to ensure that the data presented was in accordance with each department's expectations so that no one would lose face or present contradictory opinions. (I have personally found that executives whose strongest skill is to make great presentations are more suited to be good TV newscasters than good decision makers.)

As the first CEO ever hired from outside the company, Gerstner faced a great deal of resistance in attempting to change IBM's culture of complacency and conformity. He shocked managers simply by attending an annual IBM conference for their largest customers and making personal contact with customers' CIOs. Rather than skirting issues facing the company as his predecessors had, he addressed problems head-on, such as finding out what those important customers really wanted. His open and engaging communication style made his strategic priorities clear to employees, frequently through notes sent to the entire company. Upon discovering that European country heads were rewriting his notes to make them less critical, Gerstner attacked this resistance to change, firing the head of European operations and making it clear that anyone committed to preserving the status quo would be shown the door.

Ultimately, Gerstner's courageous decision to cut through IBM's red tape and restore accountability to managers gave him the credibility necessary to invigorate the company, a feat made doubly impressive by IBM's sheer size and scope. Particularly in such massive companies, inertia is a powerful force, so once an enormous firm starts sliding down the organizational distress curve, it is more difficult to change direction than it might be for a smaller, more nimble organization.

By changing IBM's culture, departments were able to implement his strategy of meeting customers' needs by going to market as "one IBM," finally with cross-department cooperation. The operational changes required to do this also included reengineering key processes, a last round of downsizing done all at once, benchmarking to eliminate $7 billion in costs, and simplifying the organizational structure to speed up customer responses and new product development.

Communication plays a critical role in uncovering the true problems causing distress and addressing them. Because companies typically slide through the blinded and inaction phases of the distress curve before realizing the scope of their problems, information flow in troubled companies is often very poor, and employees may be afraid to bring bad news to management for fear of being blamed. One first critical step for turnaround managers is to make themselves visible in the company and interact with employees across the organizational hierarchy. As mentioned in the previous chapter, my meetings with employees at a tape manufacturer allowed me to identify poor production methods that caused frequent down time when the tape would thin to the point of tearing. Such interactions need not take place in the context of formal meetings; simply making oneself accessible to employees by eating lunch in the plant cafeteria, for example, can make them more comfortable in bringing problems or new information to the manager's attention. Steve Miller, when he was CEO of Delphi, personally answered all his e-mails from employees. Free flow of information is absolutely critical in a turnaround; it is hard enough to solve problems you know about, but you absolutely cannot solve problems that you have yet to identify.

The turnaround manager should not limit his communications to those inside the company, but should also meet with stakeholders both upstream and downstream from the company in the supply chain. Suppliers will likely be frustrated with extended payment periods, and may be threatening to put the company on Cash in Advance (CIA) or Cash on Delivery (COD). A turnaround manager who can meet with such suppliers and placate them by convincing them that the turnaround plan will allow them to be paid on time once again will prove very successful. Meeting with customers is also critical; if cash flow is the lifeblood of any business, then the customers who provide it are the company's heart, so meeting with customers should take a high priority to learn what they want (and are willing to pay for). Managers should also contact players even further downstream, such as end users of the product that includes a component made by the company, in order to get a clear picture of how the company is perceived by the marketplace, unclouded by the myopia or denial of incumbent management and employees.

Having met with these stakeholders, the turnaround manager should focus on building support within the company. Early efforts should focus on individuals and small groups rather than on companywide meetings, as this allows the turnaround manager to receive feedback in private, learn the company's cultural norms, and see what will and will not work. Sometimes one has no choice but to deliver news to a large group, but it should be done in a way that the executive sticks around to answer all questions honestly.

Another colleague of mine in Florida decided to take his senior executive staff and representatives of his unhappy bankers and his bondholders out for golf. He chose the famous "Blue Monster" course at the Doral Country Club, hoping everyone would bond and get to know each other better. He warned them several times beforehand that "this is a very tough course." They all gathered at the first tee to watch the first foursome tee off. As the host, my friend took the honor of being the first to tee off. After several practice swings he carefully took his stance. A good backswing, a mighty swing and follow through—and he whiffed, completely missing the ball. With that, he turned to the assembled executives and creditors and said, "I told you this was a tough course." They were laughing so hard they could barely tee off themselves. The group did bond, but to this day my friend won't admit whether or not he missed the swing intentionally as an icebreaker. They went on to work well together as a group, making tough compromises in the best interests of the company.

Most turnaround plans are likely to involve some difficult decisions that may not immediately enjoy popularity in a company that has grown accustomed to the status quo, so early efforts should focus on identifying key employees and winning their support in person. Every company has "thought leaders" who for whatever reason—be it longevity at the company, technical expertise, or simply charisma—hold disproportionate sway among their coworkers; and they are not necessarily C-level executives. In one turnaround effort, one of my colleagues quickly identified the CEO's secretary as precisely such a power broker whose loyalty to the company allowed her to see the situation clearly. This secretary had recognized that the CEO's profligate spending and the refusal to share information with the bank-recommended chief restructuring officer had led the company to ruin; the CEO even refused to allow the CRO to visit any plants. Using her connections within the organization, the secretary filled out the paperwork to have the CRO hired as a temporary in one of the company's manufacturing facilities. With this cover story, line-level employees felt comfortable communicating with him honestly, and he was able to identify several basic operating weaknesses that they might otherwise have been reluctant to bring to management.

Just as important as identifying the key stakeholders and winning their support is identifying those who will oppose it and isolating or outmaneuvering them. In this same turnaround, the CRO discovered that the main plant's shop steward steadfastly refused to discuss any changes in manpower in the plant. Somehow, however, the CRO convinced the steward that the banks and the company's CEO were demanding performance evaluations of each employee, which was allowed under the contract. Inexplicably, the steward produced those evaluations, and the CRO promptly fired the bottom 10 percent. Identifying the steward as someone who would oppose the implementation of the turnaround plan and outmaneuvering him allowed the CRO to act before the steward could foment internal strife and resistance to the plan.

As an interim CEO, I have attempted to overcome such objections by listening to every viewpoint, even those that I believe to be incorrect or overly committed to the status quo, and only explain our plan of action after I have heard and evaluated all of these viewpoints. Often, employees will reveal themselves as obstacles when they then voice their objections a second time, perhaps more vociferously. I listen again, but then explain a bit more firmly that this is not a democracy, and there will be no recounts or second votes. Management by consensus may work in some settings, but a turnaround is not one of them. This may lead to a situation described by Professor John Whitney at Columbia, one of the first professors to teach a dedicated turnaround course to MBAs, when he suggested that turnaround CEOs often have to make examples of people in order to get rid of the naysayers, as Gerstner did with the rewriters of European memos at IBM. After determining the course of action, a manager may need to eliminate someone who persists in undermining that plan, particularly if he or she is very senior. As stated, this requires courage: not a huge ego, per se, but confidence and a willingness to stick with a decision.

It is very important to understand each stakeholder's incentives as well; for example, this shop steward clearly wanted to retain as high a level of employment as possible, so the CRO's recognition that he would block any attempts to pare payroll dictated his strategy. On other engagements, I have also seen executives who seem far less risk-averse than one might expect, until I see a capitalization table showing that they own a potentially valuable equity position and are therefore willing to throw the proverbial hail mary in the hopes of preserving some value for equity holders or even their jobs. In another famous bankruptcy case, the CEO of a large food manufacturing company was a significant equity holder, but also began purchasing the company's subordinated notes at a discount, eventually amassing a position that gave him some leverage in driving the reorganization plan (and making it less important from his standpoint that the equity class recover any value). It is critical to understand the motivations of each stakeholder in order to address and encourage them properly.

Let us be very clear here, leadership is required by more than the CEO. Many national union officers are just as self-interested as CEOs who are only driven to protect their jobs, a nasty trait also seen in most politicians. Meetings with lenders can take a negative turn, even when just one of them won't cooperate, if they think they have to look tough to keep their job even if it means the bank loses more money because of it and the company goes out of business. The best turnaround people are great mediators, effectively secretaries of state who have the ability to persuade even warring stakeholders to agree on a course of action.

Only once key stakeholders have been won over and the ideal messaging approach determined should one then proceed with mass communications, such as "town hall" meetings and companywide missives. The support of these key employees will ensure that the message is communicated clearly and coherently throughout the organization, and will make employees' acceptance and buy-in far more attainable. Once again, it is imperative that it not be an e-mail or any other cowardly way to deliver bad news without being there to answer questions. Turnaround managers should also recognize that most employees will have limited familiarity with the turnaround process, and that they must therefore act as a teacher and counselor in these times of crisis. The more a manager communicates with all stakeholders, initiating contact rather than waiting for problems to be brought to her, the more likely she can eliminate surprises, calm jittery employees and lenders, and produce a superior outcome.

I have found that employees often respond best to these communications when they include military or medical metaphors. The concepts of war or medicine seem to connote the urgency of the company's situation and the "win-at-all-costs" nature of the necessary response. In turnarounds, managers often refer to "stopping the bleeding" or "conducting triage," and talk of being "in the trenches" or needing to "take that hill." It may seem overly simple, but these metaphors resonate immediately with employees, who find themselves in a highly emotional situation with uncertainty and fear swirling around them. They want someone to lead, and by invoking easily-accessible stories, a manager can help employees understand the situation quickly and thoroughly.

Culture plays an important role in implementing any turnaround plan, but some executives can't seem to understand that. Tom Ridge was an invited guest at a Turnaround Management Association conference shortly after he was named the first Secretary of Homeland Security. Considering that dozens of completely different federal departments, in administrative, protective, and investigative branches, were joined with hundreds of thousands of employees, he was asked what culture he would try to create there. We expected him to say something about efficiency, willingness to share critical information, cooperation—something. Instead, he seemed shocked at the idea, saying "culture is something grown in a Petri dish," informing us he had no intention of trying to create anything other than more bureaucratic layers. Without that needed change in culture, years have gone by without many necessary changes in the federal government.

There are those that say "culture eats strategy for breakfast." Does that mean everyone can take whatever hill they want because it's a culture of change? Do you just ricochet from one strategy to another? Absolutely not. Fostering a culture that will survive the present and the future means creating an environment where everyone is listening to new ideas from within as well as from customers and has a willingness to change. It means that each department head will quickly make whatever changes are required to get the strategy implemented, particularly all needed operations and financial changes. The right culture has everyone in the organization feeling free to make suggestions for improvements, whether small or massive, and moving quickly to implement those improvements.

Market observers saw two sides of Albert Dunlap and the turnaround he engineered at Scott Paper. On one side, Dunlap—and a Harvard Business School case on his exploits—argued that he led "one of the most successful, quickest turnarounds ever." His critics claimed instead that Dunlap gutted Scott Paper's long-term prospects in order to pretty the company up for a sale, which he eventually engineered to Kimberly Clark for $9.4 billion in late 1995, pocketing more than $100 million in the process.

Scott's board hired Dunlap after he had earned the nickname "Chainsaw Al" for his work slashing payroll at Crown Zellerbach. Labeling Scott a "beached whale," Dunlap took less than two months before announcing his slash-and-burn restructuring plan, which would eliminate 35 percent of the employee base, divest noncore units, and cut R&D. Many of the details of the turnaround are subject to strenuous debate; with his typical braggadocio, the abrasive former West Point cadet claims credit for all of them, while company insiders claim that many of the operational measures were already in the works well before Dunlap was hired. Of note, however, is that the greatest disagreement on Dunlap's behavior seems to stem entirely from what the witness's relationship was to Scott Paper.

Scott shareholders adored Dunlap. During his tenure at Scott, the company's stock price rose by 225 percent, creating some $6.3 in shareholder value that was realized upon the sale to Kimberly-Clark. To hear them talk about Dunlap is to hear the exalted reviews of a turnaround maestro, a legend in his own time.

Nearly every other stakeholder in Scott Paper feels differently. In fact, in his memoir written immediately following the Scott sale, Dunlap referred to the very concept of "stakeholders" as "the most ridiculous term heard in boardrooms these days," asking how much those stakeholders had paid for their stake. He went on to belittle companies like Ben & Jerry's and the Body Shop for their employee programs and for supporting social causes, arguing that "the notion of other interests and other constituencies becomes an excuse for flaccid management and poor results."^[58] Those spurned stakeholders took note. Downsized employees lament not only his decision to enact mass layoffs, but the hostile attitude with which he did so. Upon hearing that one of the workers leading him on a tour of a Scott plant had been at the company for three decades, he reportedly sneered, "Why would you stay with a company for 30 years?"^[59] He also antagonized the company's community, discontinuing all of the company's corporate gifts and going so far as to renege on the final $50,000 installment of a $250,000 pledge to the Philadelphia Museum of Art. Nonshareholders' descriptions of Dunlap always took on a very different tone, one that accused him of gussying the company up for a fast sale that essentially represented a transfer of wealth to Scott's shareholders from its other stakeholders, particularly the pain he proudly caused employees.

I use the case of Chainsaw Al in my class to ask the question: To whom does a management team owe duties? While some more compassionate students will argue that the company owed a duty to its other stakeholders, others know that management only owes duties to equity holders, with a few specific exceptions.

Before we examine those duties, however, the Chainsaw Al story has an unhappy postscript. After the sale of Scott, he was hired to enact a similar turnaround at home appliance manufacturer Sunbeam, and the stock market soon rewarded the company with a stock price at an all-time high. In the meantime, he penned a blustery memoir entitled Mean Business: How I Save Bad Companies and Make Good Companies Great, a wildly self-promoting tome filled with hyperbolic braggadocio. It has not aged well, and in light of subsequent events, reads a bit like a pre-Watergate autobiography of Richard Nixon.

Forensic accounting by analysts covering Sunbeam soon revealed questionable revenue bookings, in which the sales of seasonal items like backyard barbecue grills somehow magically spiked during the winter season to cover anticipated revenue shortfalls. In addition to this channel stuffing, a massive SEC investigation revealed that Dunlap had counseled the company's controller to be as aggressive as possible in his accounting interpretations, exaggerating the company's loss (an example of the "big bath" financial shenanigan) in 1996 to make the 1997 recovery look all the more impressive. The board fired a disgraced Dunlap, and Sunbeam soon filed for bankruptcy. In his settlement with the SEC, Chainsaw Al paid $500,000 in fines and was forbidden from ever serving as an officer of a public company, and later settled a suit with Sunbeam shareholders for $15 million. In 2009, Portfolio.com named him the sixth-worst executive of all time, noting that the obvious glee he took in antagonizing his critics and embracing his reputation for cold-heartedness made him "the middle finger of the free market's invisible hand."^[60]

History will not be kind to Chainsaw Al, but until he ran afoul of the SEC at Sunbeam, he did nothing wrong from a legal perspective at Scott Paper. As an officer of Scott Paper, his only duties were to the company and thus shareholders, and Scott's directors had those very same duties, so they were right to support anything that maximized shareholder value.

Directors are not always so aligned with a CEO in turnaround situations, when they must decide whether to support incumbent management or clean house with someone who can return the company to health. The decision of whether or not to replace a CEO is the most difficult decision a board ever has to deal with, and not surprisingly, one that comes up frequently when companies are in crisis. Naturally, after years of working with a particular CEO, directors can grow reluctant to replace him or her even as a company slides into insolvency; they may live in the same town, play golf at the same country club, or otherwise have personal connections that unduly influence their professional interactions, particularly in the case of closely held family businesses. In my work on several boards, I am often called upon to explain to other directors exactly what duties we owe to the company, to management, to shareholders, to employees, and to creditors.

A gentle reminder that the author is not giving legal advice but summarizing legal concepts and answers given general situations. The general answer is that under U.S. corporate law—which is a function of the state of a company's incorporation but generally follows Delaware corporate law—directors owe primarily two duties to the companies they serve. The first is a duty of care, which essentially requires that directors and officers act in good faith, in an informed and deliberate matter. That means doing one's homework. Potential violations of the duty of care could include waste, such as engaging in a transaction so obviously one-sided that no reasonable person could decide that the company received adequate consideration for whatever it exchanged. A famous case^[61] involving a company that executed a leveraged buyout also established that the board of directors was grossly negligent for failing to make reasonable efforts to remain informed regarding the company's situation, making a rapid decision to agree with the CEO, and doing nothing to be sure they weren't accepting an offer to sell the company well below fair market value. (Because the Delaware Supreme Court's holding explained that merely consulting with a financial advisor or valuation expert would have constituted reasonable effort, the case has become jokingly known as the "investment banker full employment act.")

However, violations of this duty of care are difficult to prove in court, because most courts have accepted the Business Judgment Rule (BJR), a blanket protection that presumes that directors performed their duties in good faith, with the level of care that an ordinary person would exercise under similar circumstances, in a manner they reasonably believe to be in the best interests of the corporation. In effect, the BJR places a high burden of proof on the plaintiff to prove that a director or officer has violated this duty; even a stupid decision can be protected by the BJR if directors can show they took time to study the issue, hired and relied on outside experts, and used their business judgment to make the call. Only gross negligence overcomes the protections it offers, and the standard for meeting such a blatant dereliction of duty is so difficult to prove that plaintiffs (typically the shareholders of a company) rarely meet it. It is interesting that when shareholders sue the company in what is called a derivative suit, management is responsible for defending the corporation; any damages are usually paid by the corporation itself, thus limiting their effectiveness because the shareholders ostensibly already owned any assets used to pay damages.

The second major duty directors and officers owe the companies they oversee is the duty of loyalty, which requires that they prioritize the company's well-being over their own personal gain from company decisions. Although transactions between the company and the director or officer are permitted, they must be transparent and considered reasonably fair to the company; a director cannot engage in a transaction with the company that is profitable to her personally but not to the company. Situations that violate this duty include flagrant diversion, where an official essentially steals corporate assets for her own benefit, engagement in a transaction on her own with a third party that the company could have profitably engaged in (the "corporate opportunity doctrine"), insider information, or failure to disclose information in a timely manner to shareholders. Note that the BJR will not apply if there is a breach of the duty of loyalty. In general, the duties are owed to shareholders. Normally, creditors are only owed whatever duties are spelled out contractually.

These duties to the corporation exist at all times, but additional duties have been interpreted to arise when companies approach what is known as the "zone of insolvency."^[62] Different courts use various legal tests to determine after the fact whether a company was in this zone, such as a balance sheet test that determines whether the company's liabilities exceed the market value of its assets, a cash flow test that determines whether the company has the necessary cash flow to meet its financial obligations, or a capital test to determine whether the company has the capital necessary to obtain or support financing for its operations. A company that trips covenants with its lenders, is overdrawn on its revolver, faces chronic liquidity problems, or knows it's impossible to pay its looming bondholder payment, is likely in the zone of insolvency. From a practical standpoint, any time a company may be approaching the zone of insolvency, directors should protect themselves by contacting an experienced restructuring attorney, assuming that these additional duties have arisen, and acting accordingly. As a result, boards are generally very careful to note in their meeting minutes that any difficult decisions were made "after a great deal of study and advice from professionals" and "keeping in mind any potential duties we may owe to creditors" and "after considering the motives of various stakeholders." The key is that you may not yet be declared insolvent, but it's coming.

When in the zone of insolvency, directors' duties expand to include not only the company and its shareholders but perhaps its creditors. Courts have compared directors in such situations to trustees administering the company's assets for the benefit of creditors as well as shareholders, such that they must maximize the value of assets that may be needed to pay the debts of the company. Generally, maximizing a company's enterprise value meets this duty, but in so doing directors may not unfairly favor the equity holders over creditors, who according to the absolute priority rule that we discuss in Chapter Six have a first claim to the company's assets before the equity holders receive any consideration. To be clear, the directors do not have to take orders now from creditors, other than contract or loan negotiations. The duty is to maximize the value of the entity.

Some courts have also considered a "deepening insolvency" theory, where directors may be held liable for negligently prolonging the life of a corporation by taking on high-risk projects that increase the likelihood of there being some value left over for shareholders while decreasing the amount that creditors could be paid. For example, if a company is producing sufficient cash flow to justify a $400 million pre-debt valuation but has $450 million in outstanding debt, the company is insolvent and equity holders are "out of the money" by $50 million. A negligent board might approve a risky new product launch that costs $100 million and has a 10 percent chance of producing an extra $500 million in valuation. While equity holders would support such a product launch—as its unlikely success would be the only way their shares would be worth anything—creditors would recognize that with 90 percent certainty, it would reduce the amount distributed to them from $400 million to $300 million. Courts have recognized such deepening insolvency generally in situations in which there were more egregious acts, such as when directors falsified financial statements to obtain additional financing, or concealed a company's insolvency from creditors to prevent them from seizing their collateral. However, thus far, no court has found liability exclusively under a theory of deepening insolvency, but rather only in situations where the deepening insolvency liability occurred in conjunction with violations of the duty of care or duty of loyalty.^[63] Shrewd directors and officers—and even turnaround consultants hired by the board—should maintain rigorous documentation of the care taken in all material decision-making processes in order to avoid such allegations of liability.

Revisiting Chainsaw Al for the moment: Despite the company's struggles, Scott Paper was probably not in the zone of insolvency when Al began stripping out assets. Even if the company was found to be in that zone, however, its sale to Kimberly-Clark made all of its creditors whole, so there would probably be no reason for them to file a lawsuit based upon some breached duty. One might argue that things would have been significantly worse for Chainsaw had the sale failed to go through and the company been left insolvent, but this was not the case. It might also have been a different situation in one of the states that allows a corporation to declare that it owes duties to whatever stakeholders it chooses. Some of these states establish that the company's articles of incorporation may lay out exactly what order of priorities the company wants to follow. Barring any state statute requiring that other stakeholders be considered, however, no such duties will arise unless the company has entered the zone of insolvency.

One other exception can arise where a director or officer may owe duties to someone other than the company's shareholders or creditors, and that is in the case of various whistleblower statutes. In the event that a subordinate reports wrongdoing within the company, a CEO cannot use his or her duty of loyalty as an excuse for illegal activity, such as suppressing a whistle-blower or interfering with the whistleblower's attempt to support an investigation.

With regard to examples we have already considered, one can pose legitimate questions as to why the boards at EDS overseeing Dick Brown or at Sara Lee under John Bryan waited so long to replace clearly ineffective managers. If anyone sued them for breach of fiduciary duty, they would probably escape punishment by pleading the Business Judgment Rule; they simply made poor decisions in a situation with leaders exhibiting a great deal of hubris that they refused to replace until substantial outside pressure mounted. Boards should learn from these mistakes, and act more aggressively when a number of the early warning signs discussed in Chapter One suggest that a regime change is in order.

There are unlimited examples of leadership, many of which are briefly described in this book. Two of my favorite extremes are the CEOs of Schwinn and J. Crew. Apple is a good addition to show how entrepreneurship can trump bureaucracy.

In December of 2000, the board of directors of diversified food equipment manufacturer Middleby Corporation had finally grown tired of CEO David Riley's underperformance. Middleby developed and manufactured equipment for cooking and food preparation in restaurants, including fast food chains and other institutional food processing operations. The company had spent almost a decade expanding its product line without regard for margin attractiveness or strategic fit. They had a staggering 10,000 product lines, thinking they had to be a one-stop shop for commercial kitchen equipment. An ill-timed two million share repurchase during an industrywide slowdown in sales, expensive failures in enterprise resource planning (ERP) system implementations, and an oil-less fryer that didn't work after four years of R&D efforts had left the company with a share price at an all-time low and in violation of covenants on its $20 million, multicurrency, revolving credit line and $15 million senior unsecured note.

Rather than sit idly by, however, the board acted swiftly and decisively, dismissing Riley and promoting Selim Bassoul, the president of the company's Southbend division, to lead Middleby's restructuring as its COO and later as CEO. As a show of good faith to all the stakeholders, Bassoul mortgaged his house to buy the company's stock.^[69]

Bassoul had demonstrated a capacity for crisis leadership at Southbend, where he became legendary for charismatic displays and unorthodox motivational techniques, such as the time he persuaded ten employees to volunteer their free time on nights and weekends to paint the 130,000 square-foot factory in exchange for an extravagant dinner and night on the town with him. At Middleby headquarters, Bassoul resorted to outlandish employee appreciation tactics such as dropping bonus checks from airplanes or distributing sales executives' bonuses from a rented armored truck, and organizing impromptu staff dinners. These personal connections with the employees he was trying to lead through a turnaround helped him clarify changing individual roles and improve company morale.

Bassoul met with Middleby's customers, as well as customers of his competitors. He learned what they didn't like about Middleby's products, quality, and customer service and learned what they wanted. He met with lenders to sell his ideas and buy time.

While winning over the key stakeholders in the organization, Bassoul conducted the analysis necessary to determine the appropriate turnaround strategy, which he called a five-point strategic plan focused on

Bassoul's overwhelming success at Middleby stems directly from his display of the three critical traits of turnaround managers. He demonstrated courage throughout the process by facing up to many stockholders who didn't want change, expecting the markets would improve; he showed decisiveness in his many rapid decisions, such as his discontinuation of 5,000 products that shrank top-line sales but restored the company to profitability. It was his credibility and honesty that got lenders, customers, suppliers, and employees to be willing to follow and support his many changes.

Perhaps his most courageous move came in the midst of the turnaround, when he convinced the board to bid for and purchase Blodgett, the market leader in convection ovens and char broilers. The Maytag subsidiary had 25 percent greater annual revenues than all of Middleby, making post-merger integration a daunting task, but Bassoul's due diligence convinced him that Middleby could cut costs through scale efficiencies to justify the acquisition.

Although impressed with Bassoul's early leadership, shareholders and the board did not expect such an aggressive proposal from their new CEO, having only just grown comfortable with the new, leaner Middleby. The company's credit ratings had yet to recover fully, and many felt that the company should simply weather the economic downturn and strengthen its balance sheet. Memories of a time before Bassoul's tenure also resurfaced. In 1989, Middleby had acquired Hussman Corp.'s foodservice equipment business, a disastrous purchase that had caused four years of litigation and management distraction. With the new millennium came hope that the company would avoid similar mistakes; many thought that acquiring a company with greater annual revenues than Middleby would represent a significant risk to those hopes.

Armed with meticulous due diligence research, Bassoul swayed the board to his point of view on Blodgett by leveraging the credibility with the board that he had developed both at Southbend and in leading the first steps of the Middleby turnaround. "I felt hesitant at first," admitted board member John Miller III, "but this was the guy, if anybody, that could make it happen." Impressed with Bassoul's courage and tenacity, the board voted unanimously to approve the merger, and that summer Middleby agreed to acquire Blodgett for $74 million in cash and $21 million in high-yield subordinated notes. Even after credit markets softened in the wake of September 11, 2001, Bassoul persisted, finally persuading Bank of America (the lead lender on the deal) of the transaction's merits, thus allowing the merger to close in December.

The purchase of Blodgett not only diversified Middleby's product portfolio but also allowed it to forge relationships with important new client accounts such as Yum! Brands, owner of Pizza Hut, Kentucky Fried Chicken, Long John Silver's, and Taco Bell. Customers had historically rated the Blodgett equipment as outstanding but lacking in customer service, so Bassoul paid customers personal visits and extended them Middleby's "no-quibble" warranty protection and reputation for service. Diligent post-merger integration efforts proved successful, with increased customer retention and repeat orders allowing the company to achieve almost all of the cost savings and streamlining opportunities it had identified during due diligence within just nine months.

Bassoul deserves praise for the courage, decisiveness, and credibility he displayed in leading Middleby through a crisis, but the company's board deserves credit as well for recognizing and responding to a crisis before it deepened further. Middleby's prior CEO had led them to the brink of the crisis phase, but the board made the difficult decision to change the company's leadership before it could slide further. It is no coincidence that Bassoul's plan then proved so successful, for had the company slid further down the organizational distress curve, it doubtlessly would have proven more difficult for Bassoul to hire and retain high-potential employees, provide a clear mandate for change, and inspire confidence in employees that his plan would work. His efforts show that the "ready-fire-aim" approach can unite employees behind a strong strategic vision to start and maintain the turnaround. It is often best to get everyone aligned behind a common goal even if that vision later changes in the face of new information such as an acquisition or other opportunity. Bassoul's efforts to flatten Middleby's organizational structure, tie compensation to performance, and unite employees behind common cause improved morale and enabled the company's impressive operational improvements. Under Bassoul's leadership, Middleby's stock rose 1,600 percent from its low when he took over, and the company was recognized by BusinessWeek as one of the 100 Hot Growth Companies of 2007 and by Forbes as one of America's Best Small Companies. Bassoul's purchase of Middleby stock was a great investment, as was Middleby's investment in him.

Leadership is the critical ingredient that makes it possible to execute a well-conceived turnaround plan. Even the most cleverly designed plan will fail if managers lack the credibility to convince their charges to pull together, the courage to make unpopular decisions, the decisiveness needed to forge ahead in times of uncertainty and rapidly approaching deadlines, and the willingness to communicate both good and bad information. In the next chapter, we examine the thirteen-week cash flow model, which serves as the backbone for financial decision making in a turnaround.