Business Judgment Rule:Navigating Jurisprudential Diversity

Introduction

The Business Judgment Rule (hereinafter, BJR) finds its historical roots in corporate law of United States of America (hereinafter, USA), with its earliest mention in the Louisiana Supreme Court’s judgment in Percy v. Millaudon.[1] It initially established that directors, as long as they fulfilled their duties diligently and acted in good faith, would not be personally liable for the consequences of their business decisions. These early rulings also underscored the importance of directors exercising reasonable care and diligence while carrying out their responsibilities.[2] The BJR was not formulated with the intent to be employed as an absolute defence to shield directors from judicial scrutiny of their decision-making processes.[3] Instead, it served as aprima facie presumption that directors, in making business decisions, acted with the requisite information, good faith, and a genuine belief that their actions were in furtherance of the best interests of the company, as described in the contemporary position of law established by Delaware courts.[4]

The position crystallized by Delaware Courts states that directors are expected to approach their duties with independence and impartiality concerning the subject at hand. Their actions should demonstrate the exercise of due care and good faith. The assessment of due care is process-focused and sets the bar at a level of gross negligence. Importantly, the responsibility of proof lies with the party contesting the directors’ decision, requiring them to present compelling evidence that contradicts the presumption of due care.[5]The primary justifications behind the existence of BJR could be enlisted as follows:firstly, to incentivize active engagement of directors to serve their roles and make decisions involving risks; secondly, to forestall undue intrusion by the judiciary into the realm of business choices made by directors; and lastly, to maintain the position of board of directors as the central decision-making authority in matters related to corporate governance.[6]

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Jurisprudence

The significance of the existence of BJR in terms of corporate governance has been acknowledged by multiple countries by incorporating the principle in their jurisdictions. However, closer examination of the BJR in these jurisdictionsreveal that now multiple versions of the BJR exist with the fundamental principles remaining intact.In the course of this piece, the author will first delve into why the existence of multiple versions of the BJR justified by making reference to the dissimilarities of the versions of different countries from the position of USA. Further, the author will primarily focus on the Indian version of the BJR and attempt to decode the justification behind the existence of the same in its current form. Moreover, the piece will explore the viability of the Indian version of the BJR in terms of its aptness and assess whether the BJR as a protective shield compromises the accountability on the part of the directors.

Rationale Behind The Multiplicity Of Meaning Attached To The Principle

This segment of the piece posits that the fundamental interpretationassociated with transplanted legal principles or doctrines is not universally conveyed alongside the literal text of the norm; rather, this meaning remains context-dependent and influenced by a myriad of considerations that are not of legal nature, such as a specific perception of the advantages and risks associated with different socio-economic systems prevailing within an economy. This assertion builds upon prior research revealing that even well-defined norms can exhibit open-endedness, allowing for a “multiplicity of meaning” to be attached to a single norm. The cultural context plays a crucial role in ascertaining this multiplicity, often rooted in “narrative traditions.”The judiciary of the respective jurisdictions, as key influencers in this regard, hold the power to control and shape these narratives. In simple words, local narratives can significantly impact the understanding of transplanted legal institutions, to the extent that two similarly formulated rules may produce contrasting outcomes in comparable cases.[7]

In order to illustrate the same, this segment focuses on a comparative analysis of the Delaware business judgment rule and its German version. Delaware and Germany represent examples of distinct legal traditions and models of market economies, aligning with different categories proposed by the varieties of capitalism literature. This categorization is closely linked to the ways in which market actors coordinate their activities, which, in turn, are shaped by shared experiences and prevalent cultural norms in a society. In the context of this segment, the concept of narratives is closely intertwined with these cultural determinants, as differing narratives across types of market economies are likely to mold legal institutions in distinct ways.[8]

The potential divergence in interpretation inherent in similarly structured legal institutions becomes evident when examining cases related to the BJR in the aftermath of the global financial crisis, as witnessed in the aforementioned jurisdictions. In this regard, a case appropriate in the context of Delaware wasIn re Citigroup Inc. Shareholder Derivative Litigation, whereinthe plaintiffs alleged breaches of fiduciary duties by Citigroup’s directors and officers, who had exposed themselves to excessive risks associated with the subprime mortgage market by investing in Collateralized Debt Obligations (CDOs), resulting in substantial losses.The court, applying the “Caremark standard” for directorial neglect and referenced “hindsight bias” to justify judicial restraint and employed a risk assessment framework inspired by finance theory, albeit in a non-technical manner. Furthermore, it underscored the protective strength of the BJR. Under this rule, which entails a lack of bad faith in the case of a Caremark claim, no liability attaches to directors’ decisions, even when those decisions result in “catastrophic losses.” Consequently, in theaforementioned case, allthe allegations levelled against the directors concerning the CDO transactions were dismissed.[9]

The methodology employed by the Delaware Court stand in stark contrast to the approach employed byGermany Courts while dealing with the issue of excessive risk-taking. One of the German cases that could be utilized in this context is the one concerning the financial instability ofa German financial institution, namely,IKB Deutsche Industriebank.Herein, the court held members ofboth the boards(management as well as supervisory) to be liable for breaching their duty of care, thereby depriving them of the protection under the BJR. In its judgment, the court relied on the uninformed decision of the board of investing in such securitized products and non-compliance with the requisite level of reasonableness in exercising duty of care leading to taking excessive risks of detrimental nature. This implied inapplicability of the BJR owing to the directors’ unreasonable decisions tainted by bad faith and detrimental to the company’s interests.[10]

As the directors were not shielded by the BJR, the court proceeded to evaluate whether their investment decisions aligned with those of a “prudent and conscientious manager.” The court’s conclusion was that they did not, as the board did not adhere to fundamental principles of prudent banking, such as managing associated banking risks.[11]The divergent results observed in the aforementioned cases cannot be solely ascribed to the legal disparities in the articulation of the BJR in Germany and Delaware. Rather, they find their roots in shared principles present in both jurisdictions, affirming that the BJR does not provide a shield for actions that contravene legal statutes, corporate articles, or those tainted by bad faith.It is imperative to recognize that the judgment aligns with a narrative typified by skepticism and apprehension towards finance capitalism. This narrative, when warranted, provides a rationale for a judicial examination of business decisions that may have adverse societal implications.

It could be inferred from the above analysis that the BJR is grounded in the principles of economic theory, and other encompassing concepts like utility maximization, and risk aversion, among others.[12] Hence, different jurisdictions while incorporating the BJR has given birth to different versions with fundamental principles remaining intact.

Indian Position On Business Judgment Rule

The Indian Companies Act of 2013 (hereinafter, the Act) does not explicitly incorporate the principle of BJR. However, certain provisions of the Act reflect the fundamental norms on which BJR is grounded. For instance, Section 463(1) provides that “an individual facing a proceeding for negligence, default, breach of duty, misfeasance or breach of trust may be relieved of liability wholly or partly if the court finds that the person acted honestly and reasonably with due regard to the circumstances.”[13]Though, this immunity is contingent solely upon the discretion of the courts and does not constitute an inherent right or legal entitlement.Further, Section 166 elaborates on the duties of the directors and encapsulates the elements of good faith, reasonable care, conflict of interest and undue gain.[14]Moreover, Section 184 also elaborates on the duty on the part of the directors to reveal their “interest” (if any) associated with any company.[15]

The principle has found implicit recognition by Indian courts. For instance, in the case of Miheer H Mafatlal v Mafatlal Industries,[16] the court held that judicial intervention would be unwarranted when a director’s conduct aligns with the principles of fairness and reasonableness, akin to a prudent businessperson making a commercially advantageous decision for the company.However, it’s crucial to note that certain aspects of the doctrine have undergone a transformation over time. Previously, the 1956 Act did not mandate the exclusion of interested directors from meetings, akin to the legal framework in the USA. Presently, the mere presence of self-interest of one of the directors deprives that director from participating in a meeting. The Indian courts exercise heightened scrutiny in cases involving share valuations, specifically evaluating whether such valuations primarily serve the interests of the company’s promoters. The judiciary has exhibited a proclivity for upholding the rights and concerns of minority shareholders, thus granting them the privilege to meticulously scrutinize the determinations of the directors. As a consequence, the burden lies with the board of directors to substantiate that their actions were rooted in the paramount interests of the corporation and did not unfairly discriminate against any of its shareholders.[17]

In USA, the business judgment rule establishes a robust presumption in favor of the board’s determinations. This presumption is particularly fortified when the decisions are made by directors who exhibit loyalty and are well-informed. Consequently, on prima facie grounds, the burden primarily rests on the plaintiff contesting a decision (taken by the board) to rebut the presumption enshrined by the rule. In the absence of compelling evidence demonstrating a breach of any of the fiduciary duties, encompassing “good faith”,“loyalty”, or “due care”, a plaintiff’s challenge will be repelled by the protective shield of the BJR, sparing directors and their actions from further judicial review.[18]

The stark difference between the Indian and USA position could be attributed to the differences in the shareholding structures of these countries. In the United States, there has been a notable dispersion of stock ownership and shareholding in major corporations.[19]The primary shareholders typically possess less than 1% of the total shares. This suggests that individual or wealthy business families seldom have the capacity to exert dominance in electing the board of directors and subsequently influencing the company’s management. On the other hand, among India’s leading public corporations, a significant concentration of majority shareholding is held by affluent and influential business families.[20]

Take, for instance, “Reliance Industries Ltd.,” where promoters maintain ownership of around 40% of shares, dispersed among a mere 47 entities. While this shareholding may appear dispersed at first glance, these entities predominantly comprise relatives and proxies of the promoters, signifying a consolidation of power within the family.[21] Given the circumstances prevalent in such situations, wherein a substantial segment of the board may have a personal stake in a transaction or align with the principal shareholder’s interests, the imperative necessity arises for a prescriptive legal framework that mandates an interested director’s abstention from participating in board meetings following the disclosure of their vested interests. This serves as a pivotal measure to ensure the collective decision-making of the board remains untainted.As discussed under Part II of the piece, multiple non-legal considerations are at play in formulation of any legal structure.

Conclusion

The Business Judgment Rule is a concept that has traversed boundaries, has evolved and found application in various countries, each adapting it to their specific legal systems and corporate landscapes. The rationale behind the multiplicity of meanings attributed to the BJR is multifaceted. It is essential to recognize that the core tenets of the BJR, such as promoting directors’ confidence, avoiding judicial overreach in business decisions, and upholding the centrality of the board of directors in corporate governance, continue to be relevant.The Indian context, as the author has explored, has seen an interesting evolution in its interpretation of the BJR. Indian courts have demonstrated a growing commitment to safeguarding the rights and interests of minority shareholders. This diversion in position has placed greater onus on scrutinizing directors’ actions and decisions, requiring boards to demonstrate that their conduct genuinely serves the company’s best interests and is equitable towards all shareholders. The Indian courts have not frequently resorted to the application of the BJR but when applied, the current form (or version) of the principle could be said to fit in Indian context.

Author: Harsh Choubey, in case of any queries please contact/write back to us via email chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.

[1]Percy v. Millaudon, 8 Mart. (n.s.) 68, 78 (La. 1829).

[2]Flom, Joseph H., and Rodman Ward. The Business Lawyer, vol. 42, no. 3, 1987, pp. 995–97. JSTOR, http://www.jstor.org/stable/40686882. Accessed 31 Oct. 2023.

[3]Manning, Bayless. “The Business Judgment Rule and the Director’s Duty of Attention: Time for Reality.” The Business Lawyer, vol. 39, no. 4, 1984, pp. 1477–501. JSTOR, http://www.jstor.org/stable/40686581. Accessed 31 Oct. 2023.

[4]“The Business Judgement Rule as a Mechanism to Protect Directors from Liability When Making Business Decisions.” Osborne Clarke, 23 Jan. 2020, www.osborneclarke.com/insights/business-judgement-rule-mechanism-protect-directors-liability-making-business-decisions#:~:text=The%20business%20judgement%20rule%20is,best%20interests%20of%20the%20company. Accessed 31 Oct. 2023.

[5]Giraldo, Carlos Andrés Laguado and M. D. Canon. “Modern conception of business judgment rule: A case study on Delaware jurisprudence.” (2005).

[6]Ibid.

[7]Supra note 3.

[8]Roth, Markus. “Business Judgment Rule.” Max, max-eup2012.mpipriv.de/index.php/Business_Judgment_Rule#b.29_The_German_business_judgment_rule.

[9]In re Citigroup Inc Shareholder Derivative Litigation, 964 A 2d 106 (Del Ch 2009).

[10]Oberlandesgericht [Higher Regional Court] Dusseldorf, decision of 9 December 2009, 6 W 45/09, BeckRS

2010, 532.

[11]Ibid.

[12]Sharfman, Bernard S., The Importance of the Business Judgment Rule (December 29, 2017). 14 New York University Journal of Law and Business 27 (Fall 2017), Available at SSRN: https://ssrn.com/abstract=2888052 or http://dx.doi.org/10.2139/ssrn.2888052.

[13]The Companies Act, 2013, Section 463(1).

[14]The Companies Act, 2013, Section 166.

[15]The Companies Act, 2013, Section 184.

[16](1997) 1 SCC 579.

[17]Mookherjee, Ishani. “Shareholding Patterns and Director’s Duty of Loyalty: Comparative Analysis of India and the US.” IndiaCorpLaw, 28 July 2019, indiacorplaw.in/2019/07/shareholding-patterns-directors-duty-loyalty-comparative-analysis-india-us.html.

[18]Ibid.

[19]Ibid.

[20] Ajay Garg and Vinit Chauhan, Family-controlled businesses in India: a shareholding pattern-based definition, International Journal of Indian Culture and Business Management 20(1):60, January 2020, DOI:10.1504/IJICBM.2020.105568.

[21]Ibid.

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