ABSTRACT
Every decision carries some level of risk. Though it is critical to assess the level of risk, no one can ensure full success. Putting someone behind bars for making a business choice in good faith, trust, and loyalty, means limiting the liberty of the organization and employees. The purpose of this article is to shed some light on the Business Judgment Rule’s applicability in India as well as the degree of protection it can provide to the directors when making decisions for the gain of the company. To provide a realistic understanding of the concept, landmark case laws have been included. The inclusion of an overview of the concept’s applicability in the United States has broadened the scope of this article.
Keywords – Business Judgment Rule, Directors, Duty of care, Arson v. Lewis, Mafatlal v. Maftalal, Independent Directors, Arm’s Length Principle
“Director” means a person who controls and manages the working of the organization. Under Section 2(34), Companies Act, 2013 a director has been defined as a person appointed by board of company. The ultimate role of the director is to keep a check on the activities of management of the company and to monitor the work of management to see that their work is carried in the path of the vision and mission of the company. Hence, they are known as the ‘brains of the company’.
Under Section 149(1), Companies Act, 2013 there should be minimum 3 numbers of directors in case of public company, minimum 2 numbers of directors in case of private company and in case of One Person Company, 1 director is needed. A company can select maximum 15 directors at one time. A company may change the upper limit of number of directors by passing a special resolution in its board meeting. Managing director, women director, independent director, resident director, additional director, alternative director, directors appointed by small shareholders are numerous kinds of directors which are available in an organization subject to the requirements mandate by Companies Act, 2013 .
It is the utmost duty of the directors to act as per the articles of the company. The expression ‘articles’ denotes article of association. It is a charter document of the company, which regulates the internal management of the company. Examples of such provisions are voting rights, dividends, procedure of winding up, classes of shares, calls on shares etc. The director, while working in a company must work in the finest interest of the company so as to put their general interest of the business above their personal interest. A director is required to exercise his duties with independent judgments and should avoid being in situations which creates conflict between their personal interest and company’s interest. He should act in utmost good faith with all the reasonable means for the company. Directors are not allowed to assign their office to any other person without giving notice to the board. Fiduciary Duties define the relationship of the guardian and wand, director and company, agent and principal. It includes trust, good faith, due care, confidentiality, prudence and loyalty.
In order to discharge the fiduciary duties effectively, directors have been assigned with various rights to safeguard themselves from criminal corporate liability. They have the right to inspect the books of accounts and minutes of meetings, right to record his dissent, right to vote and participate in board meetings.
It is not possible that every decision taken by a director is successful for the organization, in such case the doctrine of business judgment rule is applied to ensure that the director is not having an individual interest occurring from such transaction and that such decision was genuinely taken in good faith by the director in the best interest of the company.
BUSINESS JUDGEMENT RULE
The principle of Business Judgment Rule is a principle which acts as a safeguard for directors against their erroneous decisions on which they can be questioned. This doctrine was first propounded by Supreme Court of Delaware in the case of Aronson v. Lewis1. It gives a benefit of doubt to the management of the company that the action performed by the director was in the interest of the company, unless proven otherwise.
However, if it is found that the director was holding an interest in the transaction, he must not derive any pecuniary interest from it and must disclose all the material information to the shareholders prior to taking business decision.
In the case of Aronson v. Lewis, the court opined that business judgment rule can be initiated against litigious actions by shareholders. This was the first case in which the doctrine of business judgment rule was applied for the first time.
In another landmark case of Cede v. Technicolor2, the court broadened the aspects of this rule. The essence of due care and loyalty was made a crucial part of the doctrine. For a director to be qualified for the appliance of the principle of business judgment rule, it was stated that his actions should be performed by him after reasonable and due care. The element of loyalty was included to win the confidence of the board members that they were not guided by a treacherous director. In addition to this, the court concluded that the director should have an arm’s length distance in case he has a predetermined interest in the transaction.
Arm’s Length Principle is another principle which ensures that the parties to a transaction are independent and are not influencing each other. It was first discovered and recognized by OECD (Organization for Economic Corporation and Development). It institutes a pact which provides the needs of the parties equally. In corporate world, it is said that the director should not have any kind of conflict of interest in dealings on behalf of the corporation; both the director and company must have equal footings and should be unrelated, to avoid conflict of interest.
This doctrine is mostly applicable in common law countries like US, UK, Canada. However, it is available in other European codes like Spanish Company Code, Polish Company Code, German code and Austrian Code.
APPLICATION OF BUSINESS JUDGEMENT RULE IN INDIAN SCENARIO
In India, this doctrine has been established in the corporate legal system through judicial pronouncement. In the case of Pratip Chaudhuri, the former SBI Chairman, the atrocious need of making this doctrine a part of the corporate legal system was displayed. The former was arrested on a non-bailable warrant in a loan scam suit for selling a Non Performing Asset (NPA) worth of Rs 200 crores in Rs 25 crores to a related party.
It has not expressly embodied in Companies Act; however certain aspects are imbibed in Indian jurisprudence. Section 463(1), Companies Act, 2013 provides that an officer of a company facing any legal proceeding relating to breach of duty, negligence, default, breach of trust and the court gets satisfied that the officer may be liable under any of the said charges, but if it is proved that the acts were done in good faith, with reasonable due and care, the officer could be excused either wholly or partly, from such liability, as the court thinks fit.
The Apex court, in the case of Miheer H Mafatlal v. Maftalal Industries3held that the court cannot hold an officer liable if his conduct was just, fair and reasonable, in accordance to the thinking of a coherent business man, while taking a commercial business decision in benefit of the company.
The courts in India have positioned the interests of small shareholders in an imperative realm of corporate legal system. The onus of proof lies on the executive board to prove that their actions were made out of good faith, rational decision making and in the best interest of the company.
In the case of Globe Motors Ltd. Mehta Teja Singh4, it was held that even if the majority of the directors is interested in a business transaction, nevertheless they do not take part in decision making even after divulging such interest, their presence is enough to alter the mind set of other directors to engage in the transaction, thereby prioritizing individual interest over general interest. In this case, the applicability of disclosure of interest and Arm’s Length Principle was interrogated.
THE TIP OF THE ICEBERG
An issue faced by independent directors is that they usually do not attend the company on regular basis and hence can be deprived of internal information which might be sensitive in nature for decision making. They face problems for gathering information to make the best decision for the company. As a result, independent directors are dependent on the agenda note. It is their duty to test whether the agenda note provides them with required information or not. They ought to ask for additional information in case they feel that they are lacking in information. They cannot plea in the court of law that they were not able to make the decision in the finest interest of the corporation because of lack of information or that they were not informed regarding the meetings.
Another issue that adds fuel to the fire is that strategically board of the directors makes their close ones like friends, relatives, family as independent directors to make decision in their favor and to fulfill their personal interests. In such case, the autonomy of independent directors is jeopardized.
However, Business Judgment Rule does not apply to oppression claims. The rule is exclusively use in cases where the director is “disinterested” or is not influenced by the consideration. However, in case of oppression claims, the company may be closely connected and such claims can lead to division of groups which can enter into conflict later on. The group which has power will outshine the other group. That would incapacitate the business judgment rule.
CONCLUSION
In 1742, a basic idea was invented that an executive of a corporation should not be held liable for acting in bonum intention for the corporation. Later, the idea was converted into a legal assumption that took a cover of case derived doctrine. In the case of Charitable Corp. v. Sutton5, the English court held that it is difficult to determine that there is a breach of trust when an act is done with bonum intentio. Hence, it was stated by Sutton court that the acts of the executive must be done with fidelity and reasonable diligence. In 1829, the decision given by Sutton court was later promulgated by the Louisiana Supreme Court. In Re Percy v.
Millaudon6, the shareholder sued the director of the respective bank. It was held that one should not be held liable for his erroneous judgments if such errors were prudent. Percy v. Millaudon was the first American case in which defense of acts done in good faith not amounting to liability was taken.
The doctrine of business judgment rule has not been incorporated explicitly in Indian law however; we can witness it through case laws and various provisions of company law. The milestone case of Miheel Mafatlal, laid down the aspect of business judgment rule in Indian Context, it has certainly provided the immunity to directors against allegations laid by shareholders. Such rule can limit the scope of courts in the process of piercing the corporate veil. However, it can also help the courts in weeding out the flippant lawsuits against directors.
BIBLIOGRAPHY
1. https://linkedin.com/pulse/business-judgment-rule-explained-kelvin-sabao-1f/
2. https://investopedia.com/terms/b/businessjudgmentrule.asp#toc-what-is-the- business-judgment-rule
3. https://indiacorplaw.in/2022/08/analyzing-the-business-judgement-doctrine-in-the- indian-context.html
4. https://law.cornell.edu/wex/business_judgment_rule
5. https://indiankanoon.org/doc/1687638/
6. https://main.sci.gov.in/judgment/judis/15118.pdf
7. https://law.justia.com/cases/delaware/supreme-court/1984/473-a-2d-805-html
8. https://lexisnexis.com/community/casebrief/p/casebrief-cede-co-v-technicolor
9. https://indiankanoon.org/doc/790309/
10. https://cite.case.law/mart-ns/8/68/
11. https://investopedia.com/terms/b/businessjudgmentrule.asp
Notes:
1 473 A.2d 805
2 634 A.2d 345
3 JT 1996 (8) 205
4 24(1983) DLT 214
5 26 ER 464; 2 ATK 404
6 8 Mart. (n.s)68 1829
( Author Navya Saxena, a student of (Centre For Legal Studies), Gitarattan International Business School, Rohini, GGSIPU)
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