Board meetings are about decision making on a variety of matters. The supervisory and monitoring duties dominate. However a corporation is a wealth creation entity and major business transactions are placed before boards that demand deliberation and judgment.
When a business judgment is mistaken or proven wrong leading to severe losses and damages, how are directors accountable under their burdensome duties of care and skill? In recognition of the risk dimension of a business judgment and the burgeoning duties, legislature has passed safe haven protection for directors.
Judicial acceptance of business judgment
In an Australian decision which captured the pragmatism of common law, Rogers J observed:
"The courts have recognised that directors must be allowed to make business judgments and business decisions untrammeled by the concerns of a conservative investment trustee.
"Any entrepreneur will rely upon a variety of talents in deciding whether to invest in a business venture. These may include legitimate but ephemeral, political insights, a feel for economic trends, trust in the capacity of other human beings. Great risks may be taken in the hope to commensurate rewards. If such ventures fail, how is the undertaking of it to be judged against allegations of negligence by the entrepreneur?" [Daniels v Andersen (1995) NSW Supreme Court.]
The business judgment' defence under Companies Act
The Malaysian Companies (Amendment) Act, 2007 which came into force on 15 Aug 2007 which is now encapsulated in Section 132(1B) provides a "safe harbour" defence for a director who makes a business judgment:
A director who makes a business judgment is deemed to meet the [duty of care, skill and diligence] and the equivalent duties under the common law and in equity if the director
(a) makes the business judgment in good faith for a proper purpose;
(b) does not have a material personal interest in the subject matter of the business judgment;
(c) is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and
(d) reasonably believes that the business judgment is in the best interest of the company.
Section 132 (6) sets out to define "business judgment" to mean "any decision on whether or not to take any action in respect of a matter relevant to the business of the company."
Four conditions
All four conditions must be satisfied before this defence is available.
The first is that the rule protects only decisions that have been consciously made, and where positive evidence of a judgment has been taken on the matter. Passive rubber stamping of a decision and negligent omission by way of serious failure of oversight and monitoring on part of a director does not constitute an exercise of judgment.
Secondly, the decision must not be lacking good faith or have improper purpose.
Thirdly, disinterestedness in the decision making is crucial. If there is any evidence of self-dealing or material personal interest the application of this defense will not be available.
The final element is that any belief that a transaction is in the business judgment be grounded on reasonable ground that it is for the best interest of the company.
Informed decision making
The significance of an informed decision is a cardinal element. The American Law Institute (ALI) acknowledges that there may not be a precise way in which to measure what information is appropriate for sound and informed decision making. Much of governance lapses come from what economists characterise as asymmetrical information that leads to misjudgments by Boards.
The ALI lists the following as matters which are appropriate for sound decision making:
(i)importance of the transaction;
(ii)time availability;
(iii)costs for obtaining information;
(iv) director's confidence in exploring the matter;
(v)state of company's business and nature of competing demands for the board's attention.
In one interesting Delaware decision, the court held that the Board of Trans Union Corporation was not adequately informed when they approved the cash out merger for the corporation [Smith v Van Gorkom (Del 1985)].
The main defects which persuaded the court to disentitle the directors of the protection under the rule and have their conduct castigated as grossly negligent were that the directors:
did not adequately inform themselves as to the role of Van Gorkom in forcing the merger and establishing the cash out price;
were uniformed about the intrinsic value of the company; and
approved the merger after only two hours deliberations without prior notice.
Further, it appeared that the Board did not seek any further valuation or justification for the sale price and made no inquiries for Van Gorkom's bare assertions of value.
The availability of the business judgment rule therefore does not preclude the requirement that a director carries out his evaluative decision making in a manner that evidences reasonableness and is wholly disinterested for the interests of the shareholders of the company as a whole.
Not hindsight but assessment of conduct at relevant time
It is important and salutary that courts urged that any judgment on directors' decision making must not be from hindsight. The merit of the transaction ought to be evaluated given the knowledge then available to the board. Judgment on directors' actions must not be in a realm of unreal altruism or high abstraction but forward looking.
In ASC vs Rich & Anor (2009) Austin J of NSW Supreme Court laid down a very cogent analysis of the scope of the defence of Business Judgment under similar Australian provision. The ASC alleged that certain directors of the Board of One.Tel were in breach of statutory duty of care and diligence when they failed to disclose the true financial position of the company. Central to the ASC case was that in terms of cashflow, creditors, debtors and earnings and liquidity was far more precarious than what was represented to the board. Forecasts provided also had no proper basis.
Austin J confirmed the efficacy of business judgment defence in appropriate circumstances. Clearly, management decisions involving acquisition, divestment or corporate restructurings are construable as "business judgments." But what about management organisation and strategic planning?
Austin J observed that there must be a decision to take or to refrain from taking action. Construing the phrase "matter relevant to business" the judge held that these are words of considerable breadth. A key ingredient for seeking shelter under this safe haven is that there is a conscious judgment exercised. Mere neglect or complete passivity or rubber stamping will not qualify as a business judgment.
Austin J also held that decisions taken in planning, budgeting and forecasting are capable to receiving protection. As to whether the actions satisfy rational belief element (note the phrase of Malaysian provision differs by using "reasonably believes,") Austin J held that a director's or officer's belief would be a rational one if it was based on reason or reasoning (whether or not the reasoning was convincing to the judge and therefore "reasonable" in an objective sense), but it would not be rational belief if there was no arguable reasoning process to support it.
It may be that the Malaysian provision, in using the language of "reasonably believes" have opted for a more stringent objective test.
Commercial justification as in the interest of the company'
When a board meets to make a business decision, its collective judgment is called for to ascertain whether in making the decision the transaction will turn out to be of benefit to shareholders. There will be assessment of medium to long term view coupled with present interest of shareholders. Does this mean that profits must be maximised or are directors permitted to take a wider view? In Intraco Ltd v MultiPak Singapore Ltd [1995] the Singapore Court of Appeal gave wider latitude in construing as to what is commercially justifiable.
In this case a decision was made by a Board of Intraco who was creditor to engage in a debt equity swap with City Carton in an attempt to forestall the insolvency of City Carlton. The transaction was effected but did not avert the eventual collapse of City Carlton.
The Receiver challenged the transaction and argued that directors breached their fiduciary duties. The Court affirmed that no duty was breached as notwithstanding that the debt purchased was nearly worthless.
The test applied was that "whether an honest and intelligent man in the position of the directors taking an objective view could reasonably have concluded that the transaction was in best interest of the company."
Evidence was accepted that the debtequity swap will result in control of City Carton providing a strategic business alliance to a government linked corporation. There is also evidence that it will be part of a vertical integration of City Carlton's with the Acquirer's Group interest.
"Governance" has its roots in Latin "gubernatorial" which relates to navigation of a vessel. If the captains of a corporation were to avail themselves of the safe haven of business judgment the elements discussed in this paper would need to be heeded.
Philip TN Koh is a senior partner of Mah-Kamariyah & Philip Koh, Advocates & Solicitors.
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