The Business Judgement Rule

The collapses world over shook the trust and reliability of stock holders on the director’s. Obviously leading to the codes, principles making it very strict for the director’s to negate their fiduciary duties in common law or equity. On the other hand it is also desired of the corporate manager to run a corporation profitably i.e. the maximization of share value. The balance between the two areas became important and risk driven. In this light the business judgment rule came as a rescuer for the director’s as a means to protect against the judicial scrutiny against the risk and innovation a director needs to do to run the corporate profitably .

Business judgment rule(BJR) is a means of protection for directors who work for the best interest of the corporation in good faith and honestly, best called as fiduciary duties. directors of a company are said to be the fiduceres or trustees, they are entrusted with the corporation as someone else’s property. Hence it is director’s liability to work for companies best interest. And in turn work for the interest of the shareholders, hence today if a director needs to work for the best interest of all, the areas he needs to handle are large and risk driven if a claim is brought against such director who disposes his duty in good faith for every ones best interest, the protection stands for him from any claims in the form of (BJR). The rule stands best suited for the current business realities where the risk and innovation is desired .the importance of rule lies in the fact that it protects the directors against the derivative claims of shareholders, if certain conditions are met. In the words of Gevurtz [1]

“In black letter, The ‘business judgment’ rule sustains corporate transactions and immunizes management from liability where the transaction is within the powers of the corporation (intra vires) and the authority of management, and involves the exercise of due care and compliance with applicable fiduciary duties.” The essay tries to analyze whether the rule is an effective protective devise and if so what is the reluctance of UK to adopt such a rule. In the first limb of the essay Business judgment rule (BJR) in relation with US is defined, in the second Australian approach of BJR with contrast to UK is brought out. In the last part analysis of the rule and criticism is dealt.

The rule is defined and modeled into two theories the traditional stand and the modern stand. Traditional view belongs to the state of Delaware under Section 141(a) of general corporation law of sate of Delaware.

The rule is progeny of principle enshrined in Sec. 141(a) of General Corporation Law of the State of Delaware, which supposes that corporation is run by management and not shareholders hence the management shall act for the best interest of the corporation, the underlying rationale is board of directors should be lead free from a persistent fear of lawsuits. For the rule presumes an honest, informed and uninterested decision from the director’s. Explained in the landmark judgment of the Delaware Supreme Court

Aronson v Lewis [2] in making business decisions “presumed to have acted independently, on an informed basis and in the good faith belief that the decision is in the best interests of the corporation” the four criteria identified for the protection of the rule, in the United States the business judgment rule consists

a) There should be a business decision if the director fails to enquire or take decision on a certain matter the rule doesn’t afford any protection,

b) Secondly must have informed to the extent he reasonably believes appropriate under the circumstances,

c) The decision should have been taken in good faith and

d) Lastly the director should be uninterested in the matter [3]

The presence of the conditions laid in the case [4] would safely harbor a director against the claims, in case the vexed business decision leads to the loss of the stock holder’s in the corporation. However one should note that the protection shall not be afforded if it is clear from the case that the director is liable-

hence in the a case where the director failed to furnish materials or information before the board meeting, and in the meeting the board failed to ask any questions, hence the conditions laid above in the case are not satisfied and no protection in the form of BJR given.

The modern theory is given by American legal institute. According to the ALI’s Principles of Corporate Governance of the United States, the rule is designed to “stimulate risk taking, innovation and other creative entrepreneurial activities” [5] the main idea behind the rule is, commerce would come to halt if the courts would second- guess every decision of the management the consequential result of such approach by court would lead to fear of taking up directorship by competent person’s. [6]

One of the features of the U.S common law system which supports business judgment rule is the low standard of care from the director of the corporation. Certainly this low-standard is waived off by active shareholder and theirs derivative actions, which forms unease for directors. And it’s the only equitable remedy available with the shareholders which can be seen as the monitoring device in their hands as checks for internal and external wrongdoers. [7] However the Australian perspective and corporations socio-economic background is entirely different from the U.S. the fiduciary duties are treated more strictly in Australia then U.S, hence the fear of director from personnel liability from every risk and decision, supports the incorporation of the rule as a statue.

Incorporation of the rule-

Due to the major collapse and failure of few in Australia in 80’s Australia was going through a development phase. The duties of care and skill i.e. fiduciary duty of the director’s where under examination and these were strengthen by adopting an objective standard.

The objective standards were levied following a case which also stands as the real impetus for the incorporation of the rule.

Daniels vs. Anderson [8] , (NEW SOUTH WALES APPEAL CASE), the court deviated from what if the rule established in Re Equitable Insurance Fire Works [9] by Roomer CJ “partly subjective and partly objective approach. However in the present case the rule which created lot of debate was a “ignorance is not bliss”

Rogers CJ made the position clear “The director of company is expected to have a minimum knowledge and keep himself informed” [10]

The standards set in the case were overwhelming for the directors duties as they fail to consider the personnel liabilities and responsibilities of certain director’s. Which led to the reforms by CLERP, Corporate law and Economic reform programme amendments, the reform was twofold, and first the introduction of BJR and the other the right given to the share-holder’s for derivative action [11] . Australian directors are scrutinized on equity, common law and statue, hence because of so many pressures the need was felt to push US style business rule [12] the much confusion about the duties f director was vanished by the incorporation of BJR.

The incorporation of the rule in Australia took 10 years as it was thought to be developed by the judiciary and it was thought that S1318 and 1317J of the corporations act to be sufficient protection against the personnel liability of the director. hence the judgment of the Justice Roger CJ changed the entire notion on the principle of Fiduciary duties and the directors were now feeling insecure towards there liabilities, hence first Connie Committee in Australia recommended a BJR to be expressly incorporated into Australian company law which was the incorporation of American law institute code on BJR” [13] This was done through the Corporate Law Economic Reform Progress Bill 1998, passed by the Australian Parliament on October 20, 1999 and which came into effect on March 13, 2000.

BJR as a statue is incorporated under Australian Corporations Act 2001 under section 180,

Section 180(1) -speaks about the duty of care and diligence with which a director needs to execute his duty.

Section 180(2)-expressly gives the business judgment rule, makes four conditions mandatory for the application of the rule, the rule reads as

(2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection

(1) And their equivalent duties at common law and in equity, in respect of the judgment if they:

(a) Make the judgment in good faith for a proper purpose; and

(b) Do not have a material personal interest in the subject matter of the judgment; and

(c) Inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and

(d) Rationally believe that the judgment is in the best interests of the corporation.

(3) In this section:

Business judgment means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

The rationale behind the rule is that the person in an intellectual capacity would not want to be caught with law as a barrier to their innovation and responsibility, high demand of responsibility and obliging to the duty of care and diligence would result in less people 5willing to take up director duties .The business judgment rule clearly mandates a better corporate governance. The rule protects, managers or directors who are well informed and who exercise good faith without being interested in the subject matter of the transaction. Clearly the rule is promoting the best governance practice by providing “you follow your duties we will protect you”. The rule seeks to promote responsible risk taking by the manager of the corporation and also a check on their powers.

The advantages of rules are in the words of Greenhow “Providing enrichment and elucidation of the course to be followed to reach a decision with awareness of the duties owed. Encouraging responsible risk taking with the comfort of knowing that decisions will not be second-guessed by the Court if the four requirements are met. Attracting a high caliber of directors and officer to the positions knowing that the duty of care is no higher than that expected of a reasonable person. The benefits to shareholders include the increase of return on their investments resulting from the ‘green-light’ given to directors to engage in responsible risk taking. Shareholders also have the right to apply to the Court for leave to take action against the company and/or directors under the statutory derivative action. Requirements are met. Attracting a high caliber of directors and officer to the positions knowing that the duty of care is no higher than that expected of a reasonable person. The benefits to shareholders include the increase of return on their investments resulting from the ‘green-light’ given to directors to engage in responsible risk taking. Shareholders also have the right to apply to the Court for leave to take action against the company and/or directors under the statutory derivative action.” [14]

The rule is said to be advantageous by Greenhow on one hand for the director and on the other for the investors which every code would want to achieve in the Corporate Governance. It mandates to protect both the parties which stand very essential for a corporate to run.

Business judgment rule is rebuttable, the burden of proof shifts to the plaintiff i.e. directors. The shareholders today have right to bring derivative action on behalf of the company where the court will order reimbursement of costs by the company. However such actions could be challenged by means of business judgment. the rule doesn’t protect every management decision’s For instance if the company violates a competition law as a business policy even though that was in the best interest of the corporation such a decision will not get protection from the rule. [15]

In ASIC V ALDER [16] – the case involved three directors of high insurance group which related to the transaction made to unit trust held by Mr. alder who was a non-executive director of HIH he procured a loan of 10 million. Such payment was first utilized for the purchases on the stock market buying high shares to shore up its share value. Unlisted acquisitions and selling them later which according to Mr. Alder was to raise capital for HIH. And lastly crediting three unsecured loans.

All the three directors invoked business judgment rule,

Lord Santow J held them responsible for the breach of S 18o (1), while evaluating their individual liabilities Honable court said with respect to Mr. alder who was a non-executive director that he had failed in his duty to follow authorized investment practice and also there was a conflict of interest and he used his position to make a gain as a shareholder improperly used his position as a director. Mr. Williams’s director of high was found guilty of not having implemented his mind to the judgment, having neglected it completely and was personally interested in the transaction as a major shareholder of a HIH. Lastly the failure of inaction over the entire matter was held to be the guilt of the last director. The decision brings to the notice the fact that business judgment rule is not a guard against the decision taken in pursuit of self interest or the omission to act as is the case in UK. And also clarifies the application of the rule to larger people in organization, inclusive of NED’S, which obviously means a better governance practice.

If the same kind of duties is expected of both forms of director the rule shall help in a strict supervision of the role and decision taken up by the executive director. The rule clarifying the role of a manager in a corporate also puts in place the mediums to exercise a better control over him either through the strict supervision or the derivative claims and on other hand makes an honest and diligent director do his work safely without being bothered about the risky decision he take for the advancement of corporation to which he is an agent .The Australian corporations act has given a very broad meaning to the business judgment under section 180(3) to any decision to take or not to take action. However the inaction or acting as a rubber stamp for the decision taken by rest of the board shall not save a director from liability, held in the case

Deputy Commissioner of Taxation v Clark [17] -on the persuasion of a husband the wife was made director as the company law mandates for essential two director in board, the decision of the Supreme Court, in the New South Wales Court of Appeal

Hodgson J stated-

“Whether a director knows it or not, he or she has a duty to exercise reasonable care and diligence in the discharge of his or her duties, with the standard of reasonableness being largely an objective one. A director’s non-participation in the management of the company will usually involve a breach of that duty, whether the director is aware of this or not.” Clearly sets out the rule established by Rogers CJ [18] that there is no remedy in law for ignorance of once duties.

The Australian corporate authorities are ready to give that extra benefit to their directors, if that is in the interest of the corporation. However the underlying question is whether really business judgment rule comes as a cover for the directors in Australia are they permitted to breach all their duties with the reliance of one rule. Certainly no, this cover is on the directors who honestly work for the corporation but sometimes there decision lacks precision. A relevant feature of Australian system is collective responsibility of the board the decision could not be reached by just one single executive, a director singularly cannot bind the company .even in other jurisdictions the board takes the decision by majority, depending upon the article and memo the decision could also be taken by simple majority .if the one of the director is not in agreement with the decision taken by the board or vote against such decision. Such directors can too rely on business judgment rule however the duty of care for them would depend on individual’s merits. The rule in Australia also protects officers who are related to management or who implements the policy of the management or is connected with such implementation [19]

Sometimes the decision of a corporation is neither wrong nor right. Another merit of the rule is reducing the burden of court. In the first place rule strikes off those cases where the conditions laid down by the rule are satisfied by the director’s of the corporation. Hence saves the time and cost of the litigation. The courts might lack the expertise on some of the issues in the case the rule also saves the decision which is business oriented to be guessed by the courts as advantageous or vice versa.

The rule stands to be very advantageous for Australia where there is strict stance in relation to director duties however if one analyses UK in comparison, the picture is very different. Firstly in UK the duty of care skill and diligence is not as strict as in Australia and secondly there is an implied rule followed by the courts in UK, not to judge commercial decision with wisdom of hindsight ,the uk courts have shown an unwillingness to second guess every management Decision [20] . The rule might bring an ambiguity to UK company law which is needs clarification at the present situation and possibly that adoption would bring in ambiguity for governance in UK which is in its nascent stage.

In Howard smith ltd, the Lord Wilberforce said “A matter such as the raising of finance is one of management, within the responsibility of the directors. It would be wrong for a court to question the correctness of the management’s decision if bona fide arrived at. But, when a dispute arises whether the directors of a company made a particular decision for one purpose or for another, or whether there being more than one purpose, one or another purpose was the substantial or primary purpose, the court is entitled to look at the situation objectively in order to estimate how critical or pressing or substantial an alleged requirement may have been. If it finds that a particular requirement, though real, was not urgent or critical at the relevant time, it may have reason to doubt or discount the assertions of individuals that they acted solely in order to deal with the matter” [21] which clearly lays the position in uk, That is court does not wants to interfere in any business decision underlying advantage is they lack expertise in such matters and wouldn’t be able to decide what would be best for a company. The rule speaks about a protection in case of a commission i.e. to take or not to take a decision, omission is not covered as protection under the rule, which is the case in with directors mostly omission to their jobs is what the directors are guilty of in most cases [22] .

One must take into notice that the profit maximization is not the only goal for corporations here. The societal concerns although second after profit do consist of a major reason for establishing a corporation .these societal concern or social responsibilities encompass, stakeholders –which consists of environment ,employee, consumers shareholders. .the corporate social responsibility which needs to provide a full disclosure of to the society about the effects of certain corporation is felt necessary as it is presumed to legitimize power and the rule would not apply in case of failure of decision due to above reason [23] .

“There were many references to company stake-holders included in white paper, representing broadening corporate agendas. The review considered to whom director should owe their duties … the basic goal for director should be the success of the company in the collective best interest of shareholders, but the directors should also recognize, as the circumstances require , the company’s need to foster relationship with its employees, customers and suppliers , it needs to maintain its business reputation, and it needs to consider the company’s impact on community and the working environment” [24]

The amendment in 1989 in Companies is one of the big reasons for not adopting US style business judgment rule. The amendment introduced a subsection 3(a) to section 310 –provided company is not prohibited from taking out the liability insurance for directors. the adoption of rule would bring the consequences would be similar to Trans union case in US i.e. following the business judgment the courts adopted stricter stance and due to which the premiums for such insurance went up more than 100% ,in US. Consequentially less people interested and taking up the director job, which led to an amendment in the form of allowing companies to eliminate director’s liability. The adoption of the rule shall give more importance to insurance for director’s liability which would be very hard to procure seeing the above example in US.

Hence the main rational of the rule of taking responsible decision would be eliminated with two fold protection-one the BJR and other insurance. Hence it is wise for the UK governance for the rule to be developed by the means of its judiciary.

As the application of BJR is twofold i.e., directors and shareholders, in UK unlike Australia the shareholder are inactive. In a country where the shareholder lacks activism to attend general meetings such rule would become an incentive for the company’s director to utilize their position for the best interest of themselves with no checks and no fear of litigation.

From the examples of both Australia and US rule appears as the best possible protections however in analysis of business rule one finds lacunas –

Although the rule clearly states of no second guessing the business decisions, however one cannot ignore the fact that in deciding whether the director falls under the protection of the rule court do analyze and second guess rather interfere with the business decision. Trying to find a proper purpose for the decision is not at all within the ideology. Hence it is just as giving a plane to fly with the protection till the time a pilot has a proper purpose to take it above a level or height, however if due to some technical reasons it fails the people who know nothing about the mechanics of flying shall analyze whether the pilot was perfect in taking the plane to such height and if the decision of the pilot is found wise, then he remains innocent. In respect to the above example judiciary are “the people” who know nothing about the mechanics of business and neither have they had the expertise hence one can say that, the application of rule is diametrically opposite to its purpose.

As Elson writes:

“Staged like a good play, such proceedings may evoke a recitation of the required emotions on the part of the actors that, in the final analysis, when the stage lights dim, have only been an illusion. Nothing is gained by such a charade. Entertaining, maybe; shareholder value-enhancing, absolutely not. [25]

The rule is said to bring a respite to the judiciary, however it cannot be overlooked that it also gives powers to the shareholder to bring an action against the directors. Hence even for the successful application of the rule the judiciary needs to validate the four points, which would be time consuming and waste of resources.

. one of the reason of the protection which rationalize the rule is the higher risk taken by the director’s, however Gevurtz [26] argues that the position of the other profession is much the same, for instance law or medical profession, a medical practitioner might face the same consequences for the a bad desicion in tort, he argues company director should not be treated any special. However one must not forget that in this globalised world where the corporations know no boundaries the directors one mistake can hamper thousands of living, hence it would be wrong to argue that the director or the board of a company should not be treated any special

The courts fails to recognize that in a case of conflict of interest the desicion is taken by the board and not an individual person, hence in applying the rule the court needs to see the people who were for and against such a merger. Gevurtz explains that there are board decisions which are not on the either side they are “fuzzy decisions.”

“Sometimes the riskier decision tends to bring more benefits to a company than a less risky one, but if the board is cautioned with the possibility of facing personnel liabilities then it might accept less risky decisions. Thus bold but desirable decisions. Might be avoided.” [27]

It wouldn’t be wrong to say that the director would use this as a safety device for they would have nothing to lose in case of a wrong decision however if this safety valve is taken away the analysis of every decision would certainly be more.

The BJR underlying ideology in being innovative and risk free is profit maximization of a company .however such goal shall undermine the responsibility a corporation holds towards society generally, the stake that a company Owens. The recent governance is molding it in a shape where the factors such as environment, employee, and society are one amongst the several considerations for making a decision. On one hand the policy practices and good governance codes world over would promote the stake-holder cause on the other hand the decision of a corporation if in the best interest-if it maximizes profits shall have protection. Hence it could be said that if the board of a company would give bonuses to the employees in case of profits, the share-holder might bring a claim and because the corporate social responsibility stands as a soft law, the directors would be held liable. [28]

Alternative

The rule doesn’t need any codification the rule could best address to its purpose if it’s implied by the court and the courts follow a lenient approach towards the decision of the company directors. However one may say that this could bring an upheaval in Australian corporations law, however the only argument which could support it is the extra amount of second guessing judiciary does in the application of the rule hence it could be said that rule as it stands is nothing but a superficial security for director, which even without this rule shall protect the director who follow their duties honestly in good faith sand for the best interest of the corporation.

Conclusion

.Australia and UK differ in many way ,ie the Australian legislature is more active hence in time if the rule stands out to kill the very purpose of the adoption, the modification shall be brought about, certainly this is not the case with U.K.

certainly the introduction of rule has evolved and helped Australian director’s to come out of the confusion which they faced in respect of their duties. However clearer the position it is not a safe harbor, the only wise approach is honestly. As in criminal law assertion is ignorance of law is no excuse similarly for directors in relation to their duties it could be said ignorance of duties is no excuse.hence rule aims at eradicating the fear of the personnel liability of director, however thinking of a situation where the action is brought and the judiciary analyzing the details of the decision taken in the light of four conditions doesnot seem to be a viable idea because sometimes the decision are taken by individuals depending upon their nature that might be for the interst of the corporation and might be not and every decision is not wrong or right there are grey areas, hence the rule doesnot speak about those grey areas and generally the protection should be afforded in thoses cases

The nature of duties of director may demand the presence of a business judgment rule however in the light of the above present arguments it would not be wrong to say that the purpose of the rule has been suppressed keeping in mind the extra synthesis of the decision of a corporate by the court. the starting place of the rule U.S has seen over the years that rule creates more problem