Statutory business judgment rule

The following post is by student contributor, Leigh Howard.

The statutory business judgment rule was implanted into the Corporations Act in 1999 by the instigation of the ‘CLERP’ reform, and has been the subject of both controversy and accolade ever since.  It’s present-day form derives from the United States, where it was developed as a common law doctrine and had considerable influence, particularly in the State of Delaware (for a history of the rule, see Redmond, “Safe Harbours or Sleepy Hollows: Does Australia Need a Statutory Business Judgment Rule?” in Ramsay (ed.) Corporate Governance and the Duties of Company Directors, 1997 p. 185). The Australian manifestation sits alongside the duty to discharge powers with the care and diligence of a reasonable person under s 180. It operates as a defence to any business judgment that that is made in good faith and for a proper purpose, so long as the director has no material personal interest and a belief the judgement is in the best interests of the corporation (see s 180(2) of the Act). Adversaries to the rule fear that the rule could operate as a safe harbour for negligent directors otherwise deserving of scrutiny under the duty of care and diligence. However, law makers on both sides of the Parliament believe that the rule in its present form does not go far enough.

I.        Government proposal to extend the business judgment rule

In a Treasury report dated April 2006 (‘Corporate and Financial Services: Regulation Review, Department of Treasury, April 2006), The Howard government put forward a proposal to extend the business judgment rule beyond its present scope. Instead of limiting the defence to that duty, the Howard Government proposal extends broader protection for directors under the rule, excusing them from liability under the Corporations Act so long as directors act:

o        In a bona fide manner;

o        Within the scope of the corporations business;

o        Reasonably and incidentally to the corporations business; and

o        For the corporation's benefit.

Despite the change of government, this proposal seemingly is still on foot. As early as May 19, 2008 Finance Minister Lindsay Tanner and Small Business Minister Craig Emerson flagged such reforms when advising the Coalition of Australian Governments Meeting that the Government wanted to reduce and streamline the obligations imposed on company directors, including those obligations under the Corporations Act (Lenore Taylore, ‘Directors Win Relaxed Personal Liability’, Australian Financial Review, May 19 2008).

II.      The rationale of reform

The rationale for reform is made simple upon considering that the Corporations Act itself rivals the Income Tax Assessment Act 1996 as the most dense and detailed Acts of the legislature of Australia (Robson, Annotated Corporations Law, 2000, p. iii). Quite simply, it is feared that the extensive and sometimes unintelligible duties contained in the Act and general law are preventing risk-taking, hampering enterprise and are in effect anti business (Michael Kirby, “Corporate Governance, Corporate Law and Global Forces”, p.54). Small Business Minister Craig Emerson put it quite cogently:

“We want to pull [the Act] back to where it seems sensible, so that company directors can spend more time making good business decisions and less time trying to understand highly complex legal obligations” (quoted in Lenore Taylor, ‘Directors Win Relaxed Personal Liability’, Australian Financial Review, May 19 2008)

Parliament is not the alone in thinking that overregulation could be chilling entrepreneurialism. In the most famous AWA Case (Daniels v Anderson), the majority of the NSW Supreme Court of Appeal stressed:

“The courts have recognised that directors must be allowed to make business judgments and business decisions in the spirit of enterprise untrammelled by the concerns of [conservatism]; any entrepreneur will rely upon a variety of talents in deciding whether to invest in the business venture … Great risks will be taken in the hope of commensurate rewards. If such ventures fail, how is the undertaking of it to be judged against an allegation of negligence by the entrepreneur?”’ (1995) 13 ACLC at pages 662-663.

If the business judgment rule was to stand alone and promote more general expectations of officers and certainty of decision making, it could be used as the vehicle to simplify core duties and to better educate officers and boards alike. In light of a recent survey conducted by the Chartered Secretaries of Australia, which found that more than half of their members “believed that excessive penalties were discouraging suitably qualified people from accepting board positions” (Chartered Securities Australia, “CSA Rapid Response Survey No. 23”, Sept 2008), it can be said with surety that some sort of leveller is needed. The question is, exactly, how should the Government go about it without dismantling the already intricate balance in place.

III.    Is the proposed amendment the best way to reduce and streamline obligations?

The extended business judgment rule must include appropriate measures that not only removes the fear of “presentation imperatives (of data, evidence and process)” but promotes informed, rigorous decision making (Clarke, ‘This Business Judgment Rule – Good Corporate Governance or not?, Australian Journal of Corporate Law, 2000). The question is therefore posed: what is it about the new proposal that goes to successfully achieve this aim?

Mark Bryne (‘Directors to hide from a sea of liabilities in a new safe harbour’, Australian Journal of Corporate Law, 2008) is one jurist that has taken the lead as one of the first to provide an analysis of the 2006 Treasury recommendations. His contention is that its proposed form is weak and is likely to create a number of new unforseen risks. Central to his critique is the shortcomings of the ‘bona fide’ requirement within the Howard proposal, which he construes under the general law definition in relation to the duty to act in the interests of a company (ibid., 261; relying on Chew v R (1991) 5 ACSR 473, 499). He notes that defining ‘bona fide’ requires an assessment of honesty, which is a subjective criterion  and against the objective notions of the duties that aim not to second guess the decisions of officers and directors (ibid, 261-262). He believes that Courts will have crippling difficulty with this and will lead to uncertain application. With respect, and even if bona fide is at present an uncertain criterion, this may not be a sufficient ground for total dismissal of the proposal. Bona fide will be interpreted with implicit regard to the intentions of the legislature, which we are yet to see. Nonetheless, Bryne’s analysis does reaffirm the need for thoroughness when setting the scope for what will be a very controversial safe harbour.

What is most compelling, however, is Bryne’s discussion regarding whether the rule should apply to the duty to prevent insolvent trading. This is the most controversial proposed extension, but again has been rationalised by proponents as a necessary protection that ensures directors be given every opportunity to take “necessary risks that are commensurate with the existence of a entrepreneurial spirit” (Robert Baxt, ‘The Business Judgment Rule: Have we reached a safe and sensible landing?’, (2006) 2(2) Baxt Report 3 at 3). Directors facing insolvency have even more reason to take risk, and must have the benefit of additional protection in order to encourage “trading out of trouble” (ibid, 12). However, and as Bryne correctly points out, risk when nearing insolvency is a very different consideration to risk when trading in good condition:

“Any potential venture, even the very risky, that may turn a profit could be all that lies between them and the failure of the company. Given that their own benefits and utility is so closely linked to the company, the element of risk may almost become irrelevant…What is the likelihood of the directors finding another such position when the company fails?” (‘Directors to hide from a sea of liabilities in a new safe harbour’, Australian Journal of Corporate Law, 2008, 265)

As directors own stake in the company changes, so does risk. Therefore, it is inappropriate for to apply the same defence to different contexts and “to suggest a general safe harbour could be and should be applied in the same way” (ibid).

Bryne has not proposed an alternative to the Treasury formulation, preferring to argue that existing protection under the common law is sufficient protection. Unfortunately, Bryne will be ignored. The pressure to simplify core duties, which has resulted in bipartisan support, surely allows one to conclude that the extension is a reality, albeit periodically shelved by the Rudd government.

IV.    Beyond the Treasury proposal

To suggest where discussion should be directed beyond the Treasury proposal requires one to first identify the concerns that all stakeholders have raised. Bryne goes some way in evidencing these concerns. Distilling all scholastic material to this debate results in three key considerations that ought to be carefully considered:

1.       The intention to better facilitate risk taking as a necessary element to entrepreneurialism;

2.       The reluctance of Courts to ‘second-guess’ business judgments in retrospect, or to “exercise a supervisory function over the business judgments of directors” (Idamenco (No 123) Pty Ltd v Symbion Health Ltd (2007) 165 FCR 19)

3.       The desire to promote ‘self-regulation’ instead of ‘deregulation’ (see Angus Corbet, ‘Self Regulation, CLERP and Financial Markets: A Missed Opportunity for Innovative Regulatory Reform’, UNSWLJ, Vol 5,  1999); and

4.       In regards to the form it will take, the need for simplicity and cogency in streamlining obligations.

Measuring these concerns against the Treasury proposal makes the Treasury proposal seem naive and almost innocent. It is submitted that current debate is stifled with semantic arguments, which has obviously influenced the Treasury proposal and has served little use. Why not legislate for a statutory business judgment rule that expressly addresses the above mentioned concerns? Such a rule could include a test of appropriate risk, and could identify several ‘levels’ of risk that could help Courts in construing what was required by the director in question. This could eliminate the concerns Bryne raises in regards to the duty to prevent insolvent trading. Such a proposal could expressly limit the Courts power to apply their powers retrospectively, while outlining a way to approach the defence that preserves the requisite ‘teeth’. Further, it could outline a non-exhaustive number of considerations that could assist Courts in construing evidence and limit deregulation, which could in turn be used to help companies self regulate. If this is at the expense of simplicity – then so be it – at least the rule will be hardened by statute and continue with the trend of departing from the common law when it comes to corporate governance.

V.      Conclusion

Nonetheless, despite initial positive indications we are still yet to see whether the Rudd government will tackle these proposed reforms, or in fact any other reforms that were on the table when the Howard government was in power (see R Nickless, ‘Corporate Law Reform at Standstill’, Australian Financial Review, 25 March 2008, p. 6). This analysis is therefore premature, but we are likely to see much attention in this area in light of ASIC’s prosecution of Australia’s richest man, Andrew Forrest. Forrest is being litigated after announcing falsified deals with Chinese mining companies to the ASX, allegedly for the purpose of attracting creditors to invest in his expanding business (see R Le May, ‘FMG’s CREC deal would’ve influenced investors: ASIC tells court’, Australian Financial Review, 6 May 2009, p.3). Counsel’s defence of Forrest relied wholly on the business judgment rule. While we won’t see the judgment for some time, it is likely to thrust the reform debate back on the public agenda and result in much more scholastic innovation – and hopefully action by government.

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