A critical analysis of the business judgement rule under Australian corporation law

¶ … Limitations of the Research or Gaps

A Critical Analysis of the Business Judgement Rule under the Australian Corporation Law

There have been many large businesses which have collapsed unexpectedly to cause irreparable damage to the investors worldwide in recent years. The most recent and larger cases are those of the fall of the mighty U.S.-based Enron International and the Australian firm, HIH Insurance. These cases shook the faith of the stakeholders in the ability and the intention of the directors who were in charge of the operation of these enterprises. These cases have also made it harder for the directors to negate the fiduciary duty imposed upon them by the law. For instance, according to the 1997 Directors' Duties and Corporate Governance prepared by the Commonwealth of Australia, 'There has been increasing debate in Australia about the standard of corporate governance, particularly in light of the experiences of the late 1980s. On the one hand, there have been calls by investor and shareholder groups for greater accountability by directors. On the other hand, directors have been demanding greater certainty in respect of their potential liabilities having regard to notable corporate civil litigation cases.'[footnoteRef:2] [2: Directors' Duties and Corporate Governance: Facilitating innovation and protecting investors. Corporate Law Reform Program for Reform Paper No. 3 (1997). Commonwealth of Australia [21[.]

According to Farrar (1997), Australia shares a 'confused inheritance of English Law with regard to the duty and standard of care of company directors' with the United Kingdom (UK), but Australia differs from the UK by drawing on the business judgement rule as developed in the United States in an effort to provide corporate directors with a defence against negligence liability when their business decisions are made without self-interest and in good faith.[footnoteRef:3] In Moreover, Australia was also an early mover in attempting to clarify and codify these protections for corporate directors. In this regard, Farrar (1997) adds that, 'Australia was the first in the British Commonwealth to enact a statutory duty in s 107 of the Victoria Companies Act 1958' which simply stated that 'director shall at all times act honestly and use reasonable diligence in the discharge of the duties of his office'.[footnoteRef:4] This legislation subsequently served as the foundation for comparable provisions in the Uniform Companies Acts that were passed by each Australian state during the period between 1961 and 1963. [3: J. H. Farrar, 'The Duty of Care of Company Directors in Australia and New Zealand,' in Corporate Governance and the Duties of Company Directors (1997), I M. Ramsey (ed.) [81].] [4: Farrar [81].]

The general requirement on the part of the stakeholders and more so by the shareholders is that the business be run in a profitable manner and there shall be an attempt which is seen as an honest effort to maximise shareholder value without engaging in unduly risky enterprises or taking actions that may be well intentioned but are not in the company's best interests.[footnoteRef:5] It is apparent that there has to be a balance between the two different viewpoints. The directors of an organisation must exercise a duty of caution, certainly, but sometimes the best intended and well considered decisions do not achieve the intended results, outcomes that could result in termination and litigation to malign a certain section of the management even if there is no evidence of dereliction of duty. In this environment, the business judgement rule provides substantive protections for corporate directors who can demonstrate that they reached a given decision based on a prudent business perspective. According to Black's Law Dictionary, the business judgment rule "immunizes management from liability in corporate transactions undertaken within both power of corporation and authority of management where there is reasonable basis to indicate that transaction was made with due care and in good faith."[footnoteRef:6] [5: J. H. Croese, (2016). Corporate and Commercial Law (2nd ed.). Melbourne: CCH Australia.] [6: Black's Law Dictionary, St. Paul, MN: West Publishing Co. [200]]

In some cases, directors make new and innovative business decisions that are intended to improve the earning quality of a firm and these decisions are taken keeping in mind the welfare of the shareholders, but these decisions are not successful all of the time. Indeed, the historical record confirms that some decisions can backfire and fail in a highly charged and dynamic marketplace. In sum, the business judgement rule protects directors in those cases wherein they are accused of making wrong decisions and acting against prudency provided that certain conditions are satisfied. In this regard, Greenhow reports that, "The business judgment rule will protect those directors who make business judgments in good faith and for a proper purpose, have acted on an informed basis without material personal interest and who have a rational belief that the decision is in the best interests of the corporation. If one of these requirements is not met, the rule will not provide any assistance."[footnoteRef:7] [7: A Greenhow, 'The Statutory Business Judgment Rule: Putting the Wind into Directors' Sails,' (1999) Bond Law Review, 11(1) [2].]

These protections are important because directors are always working in a fiduciary position on behalf of the shareholders of the firm and all their activities are supposed to be devoted towards increasing shareholder value. Directors are thus required to act honestly and faithfully without taking decisions which are against established corporate policies, so naturally the shareholders want the directors to act in a manner which is able to increase not only the shareholder's wealth but also maximise profitability; however, in some cases the desired outcomes may not be achieved notwithstanding the best decisions made by directors based on a prudent business view.[footnoteRef:8] [8: J. H. Hargovan, Australian Corporate Law (2014) Melbourne: Lexis Nexis [37].]

As of 13 March 2000, a statutory business judgment rule became effective in Australia pursuant to the Corporate Law Economic Reform Program Bill 1998 which was approved in October 1999. As a result, Greenhow (1999) emphasises that, "The position is now clear -- the merits of bona fide business judgments made by directors... will not be subject to judicial review. Directors will be taken to have met their duty of care and diligence."[footnoteRef:9] Likewise, the decision in Australian Securities and Investments Commission v Rich (2009) 236 FLR 1 ('ASIC v Rich') renewed interest in the business judgment rule in Australian corporate law, so that the rule is capable of providing a defence in some cases that would otherwise amount to a breach of a director's duty.[footnoteRef:10] [9: Greenhow [4].] [10: Legg & Jordan [3]]

The business judgment rule therefore according to Gevurtz (2013) thus acts as a lifeline to the embattled community of directors and others in management from any such liability that might be Invoked by shareholders when the decisions are taken within intra vires powers of the corporation and within the powers granted to the board of directors and which are taken within the definition of due care and honesty.[footnoteRef:11] From the perspective of Gevurtz and like-minded critics of the business judgement rule, "directors should not be treated any differently from doctors or lawyers and that business decisions are very similar to decisions of other professionals."[footnoteRef:12] [11: F. Gevurtz, Corporation Law (2nd ed.) (2013). Sydney: West [19].] [12: Greenhow [67].]

Three main factors serve to differentiate other professionals from corporate directors as follows:

1. Other professionals undergo extensive theoretical training (usually six years to complete a degree) followed by a period of practical training to achieve their position. Directors, on the other hand, whilst usually possessing university qualifications, must adapt to the philosophy and culture of the company, bearing in mind the nature of the company's activities.

2. Other professionals act within a narrow range where the variables are constant and there are, to an extent, protocols to be followed. Directors, on the other hand, are acting in an unpredictable environment, where factors such as economic conditions are outside their control.

3. At the end of the treatment (in the case of doctors) or the transaction (in the case of lawyers) the relationship ends (subject to any residual claims in tort). Directors are in a continuing relationship with the company and are more akin to permanent consultants rather than sub-contracted experts.

After the fact review of the decisions made by corporate directors, though, involves a determination of the same kind with respect to other professionals who are required to take risks in their fields of endeavour.[footnoteRef:13] For example, according to Greenhow, 'In [Gevurtz'] opinion, judges are called upon regularly to make decisions in cases involving conflicts of interest and argues that negligence cases should not be distinguished. Some have considered that the rule fails to recognise the practical workings of a Board.'[footnoteRef:14] [13: Greenhow [57].] [14: Greenhow [57].]

The business judgement rule functions by conceptualizing corporate boards as so many faculty members meeting to discuss the issues of most importance at the time, but corporate boards are in reality far different in composition and focus. In this regard, Greenhow points out that, 'Instead, boards operate by consensus and are more collegial than faculties. It is not so much a matter of what they do but what they do not do that is important.'[footnoteRef:15] Because the business judgment rule focuses on the decisions made by directors, an increasing number of corporate boards may feel compelled to develop a paper trail to secure the protections afforded by the business judgment rule. As Greenhow concludes, "When directors are faced with the possibility of litigation and therefore cautious about the nature of the documents that are created and retained, a paper trail may be revealed evidencing a proper purpose when there may be some ulterior improper purpose."[footnoteRef:16] Taken together, it is clear that there are divergent views about the business judgement rule's impact on Australian corporations, an issue that forms the problem of interest to this study which is described below. [15: Greenhow [57[.] [16: Greenhow [57].]

Statement of the Problem

The business judgement rule presumes that those who have undertaken informed and honest decisions with the sole intention of benefitting the company and its stockholders must be protected from litigations in case the decisions in particular circumstances fail to make substantial benefits for the stakeholders and shareholders lose because of the same.[footnoteRef:17] The business judgement rule is therefore intended to serve as a bulwark for directors who act in a prudent fashion that is based on a good faith effort and the known facts to maximise shareholder value in a company. The American Legal Institute sums up the same risk taking ability of the director as "if the courts of land continues to take a second guess on every decision taken by board of director of a firm then prudently speaking business would come to halt"; thus it becomes imperative to give protection to the decision-makers, even if they fail. This would lead them to learn and make better decisions in the times to come while encouraging the risk-taking activities that fuel economic growth. [17: J. Young, A Practitioner's Guide to Corporate Law (2nd ed.) (2007), Sydney: NSW Young Lawyers Business Law Committee [17].]

The general corporation law prescribes that a corporation is administered by the board of directors under express intent of the shareholders and not by the stockholders themselves and thus the board of directors are entitled to act in their best of ability and belief to preserve, extend and bring prosperity of the investments made by the shareholders. Thus the board members shall be made not to fear persistent litigations and which shall not hamper the work of the board and such maligned practices by individual shareholders shall not deter the flow of work undertaken by the board of directors.[footnoteRef:18] [18 Tomasic, Corporation Law in Australia (2nd ed.) (2014). Melbourne: The Federation Press [27].]

The determination of whether a director acted in this fashion, though, can be a highly subjective analysis depending on the perspective of the analyst and the precise circumstances in which the decision was made. Consequently, there are a number of gray areas that prevent the wholesale application of the business judgement rule to all decisions made by corporate directors that require further investigation. To this end, the objectives of this dissertation are described below.

Objectives of the Dissertation

The objectives of this dissertation were to deliver a systematic and critical review of the relevant literature to develop informed and timely answers to the guiding research questions:

a) Is it beneficial for the shareholders to keep the board members on tenterhooks all the time invoking principles of negligence and taking undue risks?

b) It has been seen in the past that many business decisions have succeeded because of directors undertaking too much risk. So how the shareholders would decide how much risk is too much risk and will time be on the side of the board to consult the shareholders regarding the same?

c) What is a fair judgment and what impact does it have on the business, profits and assets of the firm under analysis?

The scope of these research questions will extend to all Australian states and territories and the relevance of these research questions relate to their foundation in s 108(2) of the Corporations Act 2001.

Chapter Two - Critical Literature Review

Chapter Introduction

This chapter presents a review of the relevant peer-reviewed and scholarly literature aligned with the study's above-stated guiding research questions which are reiterated below, followed by a summary of the research in the chapter's conclusion.

Is it beneficial for the shareholders to keep the board members on tenterhooks all the time invoking principles of negligence and taking undue risks?

Directors today are on the front line of corporate operations and the decisions they make can spell the difference between sustained success, mediocrity and outright failure. Furthermore, the business environment in which corporate directors operate has become increasingly competitive and complex as a result of rapid globalisation, and current signs indicate that these trends will continue to accelerate in the future. Therefore, there has also been a corresponding need for corporate directors to identify opportunities for growth that are not unduly risky, propositions that are challenging under the even optimal circumstances. Indeed, there is some level of risk involved in virtually any business venture, and navigating large corporations through these complex waters has become especially challenging in recent years.

The fine line that directors must walk with respect to how much risk is too much versus not enough is narrowed even further when the business judgement rule is applied by any stakeholder, including the courts, in ways that tend to second-guess the rational basis and selection of factors upon which a business decision was made. In this regard, one legal analyst reports that, 'The balance between entrepreneurial risk-taking and a director's corporate responsibility are inversely correlated under current securities law. The success of any corporate enterprise is entrenched in the ability of its executive management to facilitate and incorporate risk as a function of its operating capability. It is antithetical to contend that shareholder value can be created without undertaking some risk as it is a fundamental component of the corporate profit-return ratio. Of course, these principles must be balanced in light of those directors who embrace risk as an extremity and who carelessly and dishonestly destroy value through overzealous adoption. While Australian corporate law has attempted to balance these conflicting notions with the enactment of risk assessment provisions such as the business judgement rule in s180(2) of the Corporations Act 2001 (Cth)1 -- the degree to which the law fosters and encourages directors to undertake structured entrepreneurial risk still remains questionable.'[footnoteRef:19] [19: 'Risk and Business Judgement' [3].]

So far as exposure to liability is concerned, the 'exposures' are increasing in both the criminal and the civil areas. Certainly, the argument can be made that it just makes good business sense to ensure that corporate directors are fully aware of their fundamental responsibilities to increase shareholder value while avoiding negligent decisions that involve undue risk taking. In response to these concerns, one of the main recommendations of the 1989 Cooney Report [xi] was that 'a business judgement rule be introduced into Australian company law.' The Cooney report's recommendations goes on to state that a business judgement rule 'should include an obligation of directors to inform themselves of matters relevant to the administration of the company. They should be required to exercise an active discretion in the relevant matter or, alternatively, to show a reasonable degree of care in the circumstances.'

This recommendation in particular was made in response to the fear that was being experienced by Australian directors in regards to both criminal and civil liability at the time due to what was perceived to be the subjective interpretation of the obligation on directors to exercise skill and care in the performance of their duties. The Cooney Report thus recommended the establishment of a clear objective duty of care for directors in Australian companies legislation. An objective standard of the proper exercise of directors' duty of care was defined by the Cooney Report as being 'one that all individuals would be expected to meet, regardless of their particular capacities and circumstances.'[footnoteRef:20] [20: M. Legg & D. Jordan, D 'The Australian Business Judgement Rule after ASIC v Rich: Balanceing Director Authority and Accountability.' (2013) [online] available: http://www.austlii.edu.au/au/journals/Adellawrw/2013/21.pdf. [2]]

The realistic assessment of risk is a core component of the decision-making process and is vital to the achievement of corporate profitability. To assert that shareholder value can be adequately returned without a degree of risk incorporation is to ill understand the nature of the corporate entity. S180 of the Corporations Act 2001 (Cth) seemingly merges the law of negligence at common law to the fiduciary nexus which must exist between a director and a company. It seeks to require a director to discharge their duties in manner, and with a degree of care, that a hypothetical reasonable person would exercise given the company's circumstances, the director's position and level of responsibility within the corporation.[footnoteRef:21] [21: Ford, Austin and Ramsay, Fords Principles of Corporations Law, 12th Ed, Lexisnexis Butterworths (2005) [387].]

The question as to whether a director has exercised reasonable care and diligence within the confinements of their statutory duties can only, as Ipp J. explained in Vrisakis v Australian Securities Commission, 'be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question.'11 In this light, it seemingly apparent that a subjective element to s180 should be required as opposed the objective comparison to the hypothetical reasonable person. Such an element should be incorporated into s180(2) which purports to ascertain whether a director has made a rationally executed decision -- termed the 'business judgement rule'. The rule attempts to act as a defensive shield for directors in determining whether their decision was made in good faith and with a proper purpose relevant to s180(1). The purpose of the business judgement rule was outlined in Corporate Law Economic Reform Program Bill providing that directors should not have to continuously consider the legal uncertainties of their actions but instead focus on undertaking rational decisions which encourage innovation and responsible risk taking. Despite this purported intention, the rule has little judicial exposure at common law because of its strict objective nature and its overbearing requirements. The reliance on the hypothetical reasonable person holds a director in the same judicial stead as that require under s180(1) and this affords no realistic utility to the defence. For example, the requirement

evinced in s180(2)(c) that a director is informed about the subject matter of a decision to an extent 'reasonably believed to be appropriate', infers that the Court will determine the reasonableness of 'care and diligence' that a director exercised in making the decision andobjectively determine whether this was appropriate. In a narrowly constructed light, it is difficult to imagine that the Court will look favourably on executed decisions which adopt a significant component of risk.

It is contended that this is an organic deficiency of s180(2) since the inherent nature of entrepreneurial risk-taking requires a merit based assessment of the available information before the risk is undertaken. The construction of an objective review of a director's decision-making process only articulates the procedural steps which were undertaken in reaching the decision. It is arguable that this poses a significant element of retrospectivity or 'hindsight review' which questions the reasonableness of the decision in light of an adverse outcome. This would, for example, provide no practicability to a director who is attempting to stave off liquidation by adopting an entrepreneurial risk that may rescue the company. Often companies in great financial difficult or on the verge of collapse require a higher degree of entrepreneurial risk in an attempt to preserve shareholder value and rescue the company from collapse. In light of s180(2), it would seem that such a course of action would be nonsensical as it could be easily argued by a complainant that no 'rationality' existed in a director attempting to undertake such a risk.

In this sense, it seems evident that the business judgement rule disregards entirely the notion of long- and short-term decision-making. The juxtaposition between long- and short-term risk adoption will always cause conflicting views as to whether a decision was rational or irrational in the given circumstances. Under the current s180(2), the balance between a short-term risk which returns significant shareholder value against that of a longer term, and more capital intensive risk, seemingly deters the former and rewards the later. This is entirely due to the objective nature of the current test requiring directors to substantially rationalize their decisions according to a prefixed substratum of information. Evidently, in the absence of such information, it is exceedingly difficult for a director substantiate that they 'informed themselves of the subject matter of the judgement' or that the decision was 'rational'. In this regard, under the current test, a director who undertakes short-term entrepreneurial risks which require opportunistic responses to dynamic market changes would be unable to substantiate their position regardless of the positivity of the outcome. It is ostensibly clear that such risks fall outside of the scope of the s180(2) and deter directors from capitalising on significant environmental changes that while opportunistic and value adding -- possess too great a legal risk to justify. This is perhaps why the business judgement rule has been scarcely the subject of Australian case law.[footnoteRef:22] [22: 'Risk and business judgment' [4].]

Because many business decisions can involve a virtually infinite number of variables and exigencies, though, the definition of duty of care provided by the Cooney Report can be viewed as falling short of the specificity that is needed by both directors and shareholders. Some additional specificity can be gained by consulting the primary source of the business judgement rule in Australia today. Pursuant to Section 180 of the Commonwealth Corporations Act 2001, Business Judgement Rule, a director or other officer of a corporation who makes a business judgment is assumed to have satisfied the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment provided they:

1. Make the judgment in good faith for a proper purpose; and,

2. Do not have a material personal interest in the subject matter of the judgment; and,

3. Inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and,

4. Rationally believe that the judgment is in the best interests of the corporation. The director's or officer's belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.

Notes:

[1] This subsection only operates in relation to duties under this section and their equivalent duties at common law or in equity (including the duty of care that arises under the common law principles governing liability for negligence) -- it does not operate in relation to duties under any other provision of this Act or under any other laws.

[2] In this section, 'business judgment' means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

Therefore, pursuant to their fundamental duty of care, all corporate directors are required to be diligent and prudent in the oversight of the affairs of the enterprise. In general, courts will not overturn or attempt to second-guess the decisions that are made by directors provided these decisions are made in good faith except in those events where the business judgment reached was considered unintelligent or ill-advised and which was based on inadequate information.[footnoteRef:23] Therefore, preparatory to making decisions that will affect their companies, directors must ensure that they have performed the requisite due diligence needed to inform themselves of all material information reasonably available to them and proceed with a critical eye in assessing corporate information.[footnoteRef:24] [23: M. Hoffman & J. B. Kamm, The Ethics of Accounting and Finance: Trust, Responsibility, and Control. (1996) Westport, CT: Quorum [33].] [24: Hoffman & Kamm [33].]

It is important, however, to note that in this context, 'prudent' does not necessarily mean 'risk-free'; indeed, the argument could be made in some situations that the prudent course of action that will serve to maximise shareholder value requires taking significant risks, but these risks are regarded as acceptable if they are firmly based on all material information that is reasonably available to them as noted above. While it is reasonable to posit that difference observers may believe that other material information should have been consulted and included in the business decision, hindsight is 20-20 but even the most savvy corporate directors are subject to the same limitations that are shared by all human actors in a dynamic marketplace where circumstances change and unexpected circumstances alter the apparent reasonableness of the business decision. Keeping corporate directors on tenterhooks by holding a punitive sword of Damocles over their heads that inhibits the types of risk-taking and innovation that are needed to develop and sustain a competitive advantage therefore is not in the best interests of directors or shareholders. The degree of risk that should be allowed directors in their oversight and operation of an enterprise's activities, though, also remains the source of serious debate as discussed further below.

It has been seen in the past that many business decisions have succeeded because of directors undertaking too much risk. So how the shareholders would decide how much risk is too much risk and will time be on the side of the board to consult the shareholders regarding the same?

Although the precise amount remains unclear, a growing body of research confirms that corporate success is driven by risk taking and innovation. The research is consistent in showing that, ceteris paribus, corporations that engage in risk-taking and innovation enjoy a competitive advantage over their less aggressive counterparts. For example, according to Schmidt and Soper (2013), 'An American Management Association (2010) survey identified creativity and innovation as one of the four skills needed for success today and in the future. A recent IBM poll of 1,500 CEO's also identified creativity as the No. l leadership competency of the future.'[footnoteRef:25] Corporations that encourage a certain amount of calculated risk-taking and innovation on the part of their directors are therefore conforming to best industry practices for developing and maintaining a competitive advantage in an increasingly competitive business environment. In this regard, Hoque and Walsh (2013) advise that, 'Enterprises have discovered that the management of business allows them to create a sophisticated organizing logic to encourage innovation, strategic experiments, and calculated risk taking.'[footnoteRef:26] The term 'calculated risk-taking' is especially telling because it directly relates to the business judgement rule since it assumes that all appropriate information and material facts, including considerations of the views of shareholders, were reviewed in the decision-making process and that the initiative was undertaken in the best interests of the firm. [25: J. J. Schmidt & J. C. Soper, 'Creativity in the Entrepreneurship Program: A Survey of the Directors of Award Winning Programs' (2013, January 1), Journal of Entrepreneurship Education 16 [31].] [26: F. Hoque & L. M. Walsh, The Power of Convergence: Linking Business Strategies and Technology Decisions to Create Sustainable Success (2013), New York: American Management Association [167].]

Although it is reasonable to suggest that it is virtually impossible to guarantee that every material fact and all relevant information was reviewed as part of the decision-making process, the prevailing definitions that are applied to the business judgement rule indicate that a line has to be drawn somewhere with respect to adequacy, and directors must be allowed to pursue risks in order to achieve the innovation that is needed to remain viable. As Mccormick (2012) points out, "Without relentless innovation, success will be fleeting. In most organisations innovation happens 'despite the system' rather than because of it. That's a problem because innovation is the only sustainable strategy for creating long-term value.'[footnoteRef:27] [27: I Mccormick, 'The Director: Why Boards Must Innovate,' (2012, September) New Zealand Management [654].]

Therefore, assuming that "innovation is the only sustainable strategy for creating long-term value,' shareholders should encourage these behaviours on the part of their corporate directors. This assumption, though, does not mean that corporate directors should be given carte blanche in their risk-taking, but it does mean that it is in the best interests of all stakeholders for corporations to pursue those initiatives that will help them grow their business and develop and sustain a competitive advantage even if these initiatives involve risks because this is primary responsibility of directors in the first place.

As noted in the study's introductory chapter, the fallout from the recent failures of high-profile multinational corporations have caused many boards to become more conservative in their risk-taking practices, but this trend has also hampered innovation. Nevertheless, risk-taking and innovation are the keys to corporate survival and the extent to which directors fail to pursue new opportunities and develop innovative practices on an ongoing basis will likely be the extent to which they can be viewed as having abrogated their fiscal responsibilities to the shareholders. As Mccormick concludes, 'Boards everywhere have battened down the hatches. But despite these stringent financial times, innovation is critical to survival. Our ability to adapt and innovate delivers both progress and prosperity.'[footnoteRef:28] [28: Mccormick [655].]

Unfortunately, though, identifying the appropriate balance between enough and too much risk as applied to a given business decision can be enormously challenging because all humans view the world through a unique lens based on a lifetime of experiences and personal values that will inevitably affect the analysis. Consequently, while some directors and shareholders may feel they are taking the appropriate amount of risk in their operation of the company, other directors and shareholders may feel they are not taking enough and are missing out on important opportunities. Because directors have been invested in their positions by virtue of their purported qualifications and expertise, the balance between too much and too little risk must be viewed in light of the enormous differences that exist between individuals but with the understanding that directors must be assumed to be acting in the best interests of the company unless or until a preponderance of evidence can be presented that indicates otherwise.

The freezing effect that existed prior to the implementation of the business judgement rule operated to prevent risk-taking by some corporate directors in ways that adversely affected their competitiveness and profitability by reducing their willingness to engage in risk-taking ventures that might backfire due to unforeseen circumstances or a perceived lack of due diligence in spite of their best efforts. In this regard, Harris (2009) emphasises that, 'Even those [directors] with a big idea won't succeed without a 'go for it' attitude and a willingness to take risks.'[footnoteRef:29] [29: S. Harris, 'Taking a Chance on Risk,' Daily Mail (London) [64].]

What is a fair judgment and what impact it would have or it has on the business, profits and assets of the firm under analysis?

The dictionary definition states that 'a fair judgment must be made in a situation where the existing laws do not provide an answer.'[footnoteRef:30] Applying this definition to the decisions made by corporate directors to determine whether business judgments satisfy the criteria required for protections by the business judgement rule (i.e., were the decisions made in good faith and for a proper purpose, did directors act on an informed basis without material personal interest and have a rational belief that the decision was in the best interests of the corporation) can therefore also be a highly subjective analysis, especially in the absence of any precedential case law or relevant policies. [30: 'Equity' Longman Dictionary of Contemporary English (2016).]

Given the infinite possibilities that exist in the business world, each of these criteria requires careful scrutiny in order to provide a business judgement rule defence. Even this step is confounded by the nebulosity of the concept of the terms involved and the uniqueness of each individual's conceptualisation of them. For example, according to Black's Law Dictionary, 'good faith' is 'an intangible and abstract quality with no technical meaning or statutory definition, and it encompasses among other things, an honest belief, the absence of malice, and the absence of design to defraud or to seek an unconscionable advantage and an individual's personal good faith is the concept of his own mind and inner spirit.'[footnoteRef:31] The results of a seminal study by Demott (1992) support the contention that the application of business judgement rule is complicated by the diversity of views concerning what constitutes good faith, particularly when viewed by outsiders who are not privy to the precise factors that contributed to a given business decision. In this regard, Demott (1992) emphasises that, "Many oppression cases, moreover, involve small corporations, frequently run by families, in which it is likely that many decisions are made for reasons that are not solely or even predominantly commercial. To accommodate a business judgment rule to this reality could, among other things, require a specialized definition of good faith.'[footnoteRef:32] [31: Black's Law Dictionary [692].] [32: Demott, D A, 'Directors' Duty of Care and the Business Judgment Rule: American Precedents and Australian Choices,' Bond Law Review 4(2) (1 December 1992) [143].]

Likewise, the determination of whether directors made business decision on an "informed basis" is also a highly subjective measure since the argument can always be made that additional -- and critical -- information was available that was not included in the decision-making process.

The determination as to whether directors possessed a "rational belief" that a business decision was in the best interests of the corporation is also clouded by the fact that like good faith, a rational belief is a highly individualised and abstract concept that transcends strict legal definition. Even the courts have engaged in circular reasoning to help define terms such as "rational belief" when applied to corporate directors. For instance, in ASIC v Rich, the court held that '[i]t is plausible to say that the drafters of the definition of rationally believe intended to capture this latter idea, namely that the director's or officer's belief would be a rational one if it was based on reason or reasoning.' Even casual observers would readily discern that this holding did little to clarify the muddy business judgement rule waters, and in fact only contributed to the ongoing debate over the language used in the Corporation Act concerning this rule as well as how it should be applied and interpreted in any given situation.

Interpreting the issue of what is in the "best interests" of a corporation also depends on who is doing the asking and who is doing the answering. For instance, in their ASIC 2011 report (p. 15), the Australian Securities and Investments Commission pointed out that, 'Legally, directors have a duty to the corporation. In the past, this has been seen primarily as a duty to consider the interests of shareholders. However, the reality of the 21st century is directors must also take into account a number of competing stakeholders (including shareholders, which need not all have the same interests, for example, long-term holdings and short-term holdings, the environment, the market, creditors and consumers).'

Taken together, it is clear that applying the fair judgement principle involves a wide array of factors and issues that make concrete declarations concerning its impact on profitability impossible, but it is also clear that directors must be able to exercise their corporate responsibilities in a timely fashion without the fear of being second-guessed by shareholders or the courts provided they conform to the foregoing criteria from their individual perspectives. For this purpose, they can draw on the provisions of Section 180 of the Corporations Act 2001 (Commonwealth Consolidated Acts) which stipulates as follows:

S 180: Care and diligence -- civil obligation only -- care and diligence -- directors and other officers

(1) A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

(a) were a director or officer of a corporation in the corporation's circumstances; and (b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

Note: This subsection is a civil penalty provision

S 180: Business judgment rule

(2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment if they:

(a) make the judgment in good faith for a proper purpose; and (b) do not have a material personal interest in the subject matter of the judgment; and (c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and (d) rationally believe that the judgment is in the best interests of the corporation.

The director's or officer's belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.

Note: This subsection only operates in relation to duties under this section and their equivalent duties at common law or in equity (including the duty of care that arises under the common law principles governing liability for negligence) -- it does not operate in relation to duties under any other provision of this Act or under any other laws.

(3) In this section: "business judgment" means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

Although unambiguous on its face, this section is nevertheless fully imbued of the same type of nebulosity that characterises the application of the fair judgement analysis. For example, the terms 'rationally believe,' 'good faith,' 'best interests,' can all be interpreted differently by different stakeholders whose interests may be markedly varied. Indeed, a survey of stakeholders concerning what is in the best interests of a corporation would likely show that there are nearly as many opinions as there are stakeholders. Therefore, even the most thoughtful, well reasoned and informed decisions taken by corporate directors which are intended to promote the best interests of the corporation may be viewed as irrational by stakeholders who hold contrary opinions.

Chapter Three - Analysis and Discussion

In an increasingly globalised and competitive business environment where corporate analysts proliferate, the sheer amount of material information available to corporate directors though has reached ponderous levels, and the argument can also be made that investing too much time and effort to learn all that is possible about a given decision may prevent the company from taking advantage of legitimate but transient business opportunities. In this regard, Ferran (1999) reports that, 'Against the argument that shareholders would benefit from the law's imposition of strict standards on corporate [directors] is the counter-argument that anxiety about possible liability could lead [them] to become more risk-averse and to decline potentially valuable, but high risk, proposals in favour of safer, but less potentially profitable, ventures.'[footnoteRef:33] [33: E. M. Ferran, Company Law and Corporate Finance (1999), Oxford: Oxford University Press [237].]

Clearly, there must be a balance between the two extremes of becoming expert concerning every potential eventuality of a business decision and making decisions based on "seat of the pants" feelings or intuition, but as the literature review above clearly demonstrated, this line is delicate and fraught with subjectivity at every turn. Indeed, from one perspective, to the extent that directors are constrained by fears of being considered in violation of their corporate responsibilities by virtue of proposing risky but potentially lucrative ventures can therefore be viewed as the extent to which they are actually abrogating these responsibilities because they are not acting in the corporation's best interests. Conversely, directors today may view their more conservative business practices as being in the corporation's best interest because they are acting as careful and thoughtful stewards of the scarce corporate resources with which they have been entrusted. For example, Kunc (2015) notes that, 'While directors are not trustees in the strict legal sense, I respectfully suggest that modern day directors would do well to resurrect the 19th and early 20th century perception that directors, as controllers of their own and other peoples' money held in the legal fiction of the company, occupy a significant moral position of trust.'[footnoteRef:34] [34: F. Kunc, 'Company directors: Decisions, duties and dilemmas,' Aspen, C: Australian Accountants, Lawyers and Directors Conference (9 January 2015) [5].]

Consequently, corporate directors today are faced with an untenable situation wherein they must make a determination from the outset concerning just how much due diligence is needed to justify a business decision before they can even begin to formulate the decision. In the Age of Information where the amount of information available about virtually anything has exploded in geometric fashion, searching for relevant information has been likened to drinking from a fire hose and it is difficult to determine where the cut-off point for the adequacy of due diligence on the part of corporate directors should be placed.

Moreover, this determination has not been well served by the relevant precedential case law. For example, according to the guidance provided by the Directors' Duties and Corporate Govenance (1997) concerning the business judgement rule, 'While the Courts have been reluctant to review judgements of directors exercised in good faith, they have also, on occasion, refused to exercise their discretion to excuse directors from liability where they have acted fairly and honestly. This has led to uncertainty in the minds of directors as to the extent of due diligence required of them.'[footnoteRef:35] [35: Directors' Duties and Corporate Governance: Facilitating innovation and protecting investors. Corporate Law Reform Program for Reform Paper No. 3. (1997). Commonwealth of Australia [21]. ]

According to Section 180, Chapter 2D, 'Officers and Employees,' the key decisions concerning the duty of care and diligence of corporate directors include the following cases:

• Daniels v Anderson (1995) 37 NSWLR 438; 118 FLR 248; 16 ACSR 607; 13 ACLC 614 (AWA case), where the New South Wales Court of Appeal imposed on all company directors the fundamental obligation to take the necessary steps that will enable them to effectively guide and monitor the management of the company (see Daniels v Anderson at 501 (NSWLR) per Clarke and Sheller JJA). As to what the obligation to "effectively" monitor entails, the Court stated that the nature, size and complexity of the company assist in determining the content of that obligation.

• The decision of Santow J. in Australian Securities & Investments Commission v Adler (2002) 168 FLR 253; 41 ACSR 72; 20 ACLC 576; [2002] NSWSC 171 has also become highly influential in recent times, providing a useful summary of the cases and legal principles at [372].

• Reference should also be made to Austin J's decisions in Australian Securities & Investments Commission v Vines (2003) 48 ACSR 291; [2003] NSWSC 1095 and Australian Securities & Investments Commission v Vines (2005) 55 ACSR 617; 23 ACLC 1,387; [2005] NSWSC 738[footnoteRef:36] where his Honour engaged in a detailed consideration of the requirements of s 180. An appeal against Austin J's decision in Vines was successful with respect to several (but not all) specific contraventions: [36: Vines v Australian Securities & Investments Commission (2007) 73 NSWLR 451; 62 ACSR 1; 25 ACLC 448; [2007] NSWCA 75.]

The personal legal liability issue has also extended into the realm of the accounting practices that are used by modern corporations which require forward-looking statements for inclusion in corporate and financial reports which are typically prepared by accounting professionals who may be external to the organization. A study by Huggins, Simnett and Hargoven (2015) focused on potential legal liabilities confronted corporate directors in Australia today. According to Huggins et al., "A key issue that has been the subject of growing concern in the Australian business community is... directors' reluctance to sign off on integrated reports due to personal legal liability concerns.' Directors are increasingly concerned about the legal environment in which they operate. Australia is witnessing the rise of shareholder class actions supported by litigation funding, making this jurisdiction a fertile ground for class action litigation.'[footnoteRef:37] [37: A Huggins, R Simnett & A Hargovan, 'Integrated reporting and directors' concerns about personal liability exposure: Law reform options,' (2015) Company and Securities Law Journal, 33, [4].]

These trends beg the question concerning just how much personal exposure corporate directors should bear with respect to the business decisions they make on a routine basis. Given that corporate directors are mere humans, it is reasonable to conclude that some business decisions will be better than others depending on the countless variables that go into shaping their decision-making process at any given point in time but does this mean that corporate directors should incur personal liability for otherwise sound business decisions to go awry?

On the one hand, the harsh reality is that corporate directors have a legitimate concern over these issues in an increasingly litigious society. As Huggins et al. (2015) point out, 'A major law firm has noted that directors and other officers and professional advisors are being increasingly targeted not only by class action plaintiffs but by the defendant companies as they seek to spread liability. Concerns, arising from such a high risk profile, have underpinned renewed calls for greater liability protection for directors from the Australian business community.'[footnoteRef:38] [38: Huggins et al. [5].]

On the other hand, though, some legal analysts charge that the business judgement rule is not only fraught with abstractions that make its consistent application problematic, there is no legitimate need for such a rule in the first place. For example, Redmond (1997) argued against the adoption of a business judgement rule thusly: 'The case has not been made by those who propose the introduction of a statutory business judgment rule" and cites the following reasons in support:

• Such a rule is largely irrelevant to the principal difficulties facing company directors and officers under the modern corporate law formulations of their duties, namely, the uncertain and indeterminately expanded tortious duty of care and the imposition of civil and criminal liabilities upon them under myriad statutes by virtue of their office, subject to particular defences. To these latter obligations a statutory business judgment rule, as it is commonly understood, would have no application.

• Within its sphere of operation, it is argued that there is no reason to believe that a statutory business judgment rule would offer superior protection to that provided by long established general law doctrines of directors' duties which protect business judgments from inappropriate hindsight review, including review of the merits of the business judgment [footnoteRef:39] [39: P. Redmond, 'Safe Harbours or Sleepy Hollows: Does Australia Need a Statutory Business Judgment Rule?' [185].]