A BUSINESS JUDGMENT RULE FOR INCORPORATING JURISDICTIONS IN ASIA?

AuthorDouglas M BRANSON BA (University of Notre Dame), JD (Northwestern University), LLM (University of Virginia); W Edward Sell Chair in Business Law, University of Pittsburgh, Pennsylvania, USA; Permanent Senior Fellow, School of Law, University of Melbourne, Australia.
Published date01 December 2011
Date01 December 2011

Australia, Malaysia, South Africa, several US states, and other jurisdictions have adopted statutory codifications of the common law business judgment rule. The rule protects directors from liability for errors in judgment or lapses of ordinary care. As an incorporation jurisdiction, whether Singapore should adopt a codification is the issue running throughout this article. To answer that question, parties must develop a feel for the rule: what it is, the policies behind it, how it might operate in practice, and the cons of statutory adoption.

I. Introduction

1 The much misunderstood business judgment rule is not a rule at all. It has no mandatory content. It involves no substantive “dos” or “don'ts” for officers or directors of corporations. Instead, the business judgment rule is a standard of judicial review, entailing only slight review of business decisions. Alternatively, the rule could be called a standard of non-review, entailing no review of the merits of a business decision if directors have not been somnambulant.1

2 Where it exists, the business judgment rule generally remains uncodified. Authoritative, indeed official, commentary to the widely adopted US Model Business Corporation Act confirms this.2 Nonetheless, judges and litigants both frequently mistake the statutory statement of the standard of care, “the care … of an ordinarily prudent

person in a like position under similar circumstances”, as the business judgment rule.3 One expression of the difference is that the former is the standard of conduct while the latter is the standard of review.

3 Recent years have witnessed a few codifications, in Australia, Malaysia, South Africa and Germany, as well as in the US state of Nevada.4 Scholarly articles have called for a statutory formulation elsewhere, evidently to no avail.5 Why more jurisdictions have not considered a statutory rule is imponderable.

4 This article is about the tangible and the concrete rather than the imponderable, leaving aside speculation as to why more jurisdictions, especially pro-business jurisdictions such as Singapore,6 have not adopted a statutory provision. The article backs into treatment of the subject, first discussing what the business judgment rule is not, some of the uses to which the rule may be put, and certain of the policy bases which underlie a business judgment rule.

5 Second, the article sets forth common formulations of the rule, at least in US jurisdictions.

6 Third, the article sets forth further policy bases for the rule.

7 Fourth, the relationship between the standard of conduct and the rule is illustrated further with an example of how the two might work in tandem.

8 Fifth, the treatment pages through the elements of the rule in greater detail, noting certain of the criticisms levelled at modern versions of the business judgment rule.

9 Sixth, and seventh, two sections of the article explain in greater detail how the rule operates in particularised contexts, namely, the dismissal of shareholders derivative litigation and the adoption of takeover defences, at least in jurisdictions in which directors have some latitude for adoption of defences.

10 Eighth, and finally, the article sets forth and parses the few codifications that have entered modern company law codes.

II. What the business judgment rule is not

11 As seen above, under the Model Business Corporation Act a director is to discharge her duties “with the care an ordinarily prudent person in like position would exercise under similar circumstances”.7 Australia's statute is similar.8 The standard of conduct is not “slight care” or “gross negligence” or anything other than due care. The standard of review, however, which becomes a defence if the directors have made a decision or judgment, is the business judgment rule.

12 The rule is multi-faceted, pervading all aspects of business decision-making.9 Most generally, the business judgment rule acts as a presumption in favour of corporate managers' actions. Stronger still, the rule provides a safe harbour that makes both directors' and officers' actions unassailable if certain prerequisites have been met. In litigation, the rule is a means of conserving judicial resources, thereby permitting courts to avoid being mired down in business decisions that are inherently subjective and ill suited for judges, as opposed to business men and women. Last of all, the rule is the law's implementation of broad economic policy, built upon economic freedom and the encouragement of informed risk taking.10

13 Newer uses to which the business judgment rule may be put include the means by which boards of directors adopt takeover defences, at least in those jurisdictions which give play to directors rather than shareholders, to adopt defence measures. After the fact, using the

business judgment rule, courts review the adoption of those defences at the behest of disgruntled shareholders who have pursued litigation. Another use is as a means whereby corporate directors and their attorneys evaluate and, based upon that evaluation, recommend that courts dismiss derivative litigation.

14 One last curiosity to be noted before delving into the rule itself is that despite the vastly increased number of invocations of the rule in the modern era, at least in the US,11 with one exception, the US business judgment rule remains uncodified. On an international basis, however, the picture is different. In 1999, Australia, based upon a well-known US “soft law” codification,12 enacted a statutory version of the business judgment rule.13 Malaysia, South Africa and Germany have all recently followed Australia's footsteps.14 Whether this incipient trickle will morph into a waterfall, a cascade, or a torrent, remains to be seen.

III. Common formulations of the rule

15 Courts are major perpetrators of the error of stating policy bases of the rule for the rule itself. “Courts”, one venerable court stated, will not review “an honest mistake of business judgment”.15 This economium is a statement of the effect of the rule, not the rule itself.

16 Similar is the statement that “[d]irectors of a commercial corporation may take chances, the same kind of chances that a man would take in his own business”.16 Yet another court recited that “[o]rdinarily neither the directors nor the other officers of a corporation are liable for mere mistakes or errors of judgment”.17 Again, the statement is a summary of the effect of the rule and also a hint at the policy behind the rule, rather than the rule stated in any analytical way.

17 Courts persist in talking about the rule's effect rather than the rule itself: “The rule prevents a judge or jury from second guessing

director decisions.”18 The same court speaks of how the rule works and the strong policies behind it: “The business judgment rule is process oriented and informed by a deep respect for all good faith board decisions.”19

18 There are really only two formulations of the rule in wide currency: the Delaware business judgment rule and the American Law Institute (“ALI”) formulation.20

19 Although not without its critics,21 the ALI formulation, promulgated in final form in 1994, has been adopted by the highest courts of several US states.22 The ALI section states:23

(c) A director or officer who makes a business judgment in good faith fulfills [the duty of care] if the director or officer:

(1) is not interested in the subject of his business judgment;

(2) is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and

(3) rationally believes that the business judgment is in the best interests of the corporation.

20 In more understandable terms, a director and her decision are shielded from legal review if: first, she and her colleagues made a judgment or decision; second, the decision makers were free of disabling conflicts of interest in the matter; third, they exercised some (not necessarily reasonable) care in informing themselves about the matter decided; and, fourth, they had a rational (not necessarily reasonable) basis for the decision they made.

21 One principal function of the rule is as a conservator of judicial resources. If the rule required reasonable care or a reasonable basis for the decision made, courts would have to hold plenary hearings (trials) because it is in those fora in which questions of reasonableness are determined. Instead, under the ALI rule, once other prerequisites are demonstrated to have been present (proactive directors making decisions, free of conflicts of interest, and so on), the defending directors need only demonstrate some care and only a rational (plausible) basis for the decision made. Defending directors can make these showings in a pre-trial application for summary treatment, what a US lawyer would term a motion for summary judgment.

22 Delaware courts state the business judgment rule more succinctly and do so using the language of presumption. Thus the business judgment rule is a “presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company”.24

23 Delaware courts look for the same elements as do courts applying an ALI type safe harbour rule: a judgment or decision (including the decision to make no decision), some care, good faith (absence of conflicts of interest or of base motives). A principal difference is because of the use of presumption, a plaintiff shareholder has the burden of going forward, attempting to upset the presumed facts. The challenging shareholder must demonstrate that the collegial body (the board) was infected by conflicts of interest on the part of a critical group (perhaps less than a majority) of directors.25 Or the shareholder might offer credible proof that the directors...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT