Business judgement rule offers better protection to directors
The Institute of Directors in Southern Africa (IoDSA) has welcomed the introduction of the business judgment rule into South African company law, which seeks to protect directors from liability to the company and shareholders as a result of poor decision-making. What this means is that when the business judgment rule applies, it is taken that a court will largely be prohibited from examining the merits of the directors’ decision and that a presumption of due care and good faith will be created regarding that director.
The Companies Act no 71 of 2008 (new Act) introduced the business judgement rule into South African company law for the first time, after being developed in the US in order to:
· Deter a risk-averse culture among directors as their liability increases. It is envisioned that the rule could help prevent directors not taking part in risky activities that could be beneficial to the company;
· Persuade competent individuals to take up the position of director. There exists a limited pool of competent people who could properly serve as directors in SA;
· Avoid ‘judicial second guessing’: The evaluation of business decisions by judges after the event is problematic because judges then have the benefit of hindsight - something the directors did not have when taking decisions; and
· Avoid shareholder management of the company. If certain decisions made by directors are protected by means of the business judgement rule, shareholders will be wary of bringing legal action against directors, owing to the potential of failing in their action and the legal costs involved.
What’s interesting is that the business judgement rule contained in the new Act can be invoked when faced with claims based on breach of a director’s duty of care and skill, as well as claims based on breach of a director’s fiduciary duties.
Seventeen years ago in the first King Report on Corporate Governance for South Africa, the King Commission recommended a statutory limitation on the director’s duty of care. However, this recommendation was criticised by many academics, and in 2002, the second King Report on Corporate Governance for South Africa (King II) considered the content and origin of the business judgment rule. Here, they emphasised that this rule and the duty of care and skill remain two distinct concepts. Therefore, a separate analysis as to a director’s compliance with the duty of care and skill is always necessary because the duty of care and skill applies regardless of whether a business judgement has been made.
When does the business judgment rule apply?
The business judgment rule only applies if a decision has been made on an informed basis, in good faith and without conflicting financial interest. Therefore, this defence will be available only to a director who is found to have:
· taken reasonably diligent steps to become informed about the matter at hand;
· had no material personal financial interest in the matter (and had no reasonable basis to know that any related person had a personal financial interest in the matter), or dealt with those personal financial interest(s) as required by the new Act;
· made or supported a decision of the board or a board committee regarding the matter; and
· had a rational basis for believing, and did believe the decision was in the best interest of the company.
In terms of the new Act, directors will also be allowed to rely on the performance of certain individuals, e.g. competent employees and professionals, as well as information, opinions, recommendations and reports or statements used by these people.
Natasha Bouwman is the Company Secretary and Legal Specialist at the Institute of Directors in Southern Africa (www.iodsa.co.za).