A CRITICAL ANALYSIS OF THE BUSINESS JUDGEMENT RULE UNDER THE AUSTRALIAN CORPORATION LAW
https://ilokabenneth.blogspot.com/2017/04/a-critical-analysis-of-business.html
Author: Iloka Benneth Chiemelie
Published: 7th April 2017
Published: 7th April 2017
Introduction
In the course of the past decades, there have been an
increased call for[1]
and continuous government enquires into[2]
the importance of higher protection for directors from personal liabilities
established within the corporate law. Such concerns are outcomes based on the
view that corporation sanctions, and exposure to personal liability, adversely
affect the willingness of directors to undertake risky responsibilities[3],
or to voluntarily be part of other decision making processes in the company.
Recent observations on the voluntary willingness of directors to be part of decision
making in the company does indicate that voluntary update in the Australian
sphere as it related to practice of integrated reporting is being hindered by
the concerns of directors that they could be exposure to personal liability,
with particular reference to the case of forward-looking statements that might
be proved as unfounded.[4]
In the Treasury Paper (2007), explicit recognitions were given to ‘fundamental
issues’[5]
that have been long standing within the context of corporate governance – which
include the need to assess whether the present regulatory corporate framework
does strike necessary balance between the need to promote good behavior and
ensuring that directors are willing to take reasonable risks within the
commercial sphere.[6]
In relation to the risky nature of most businesses,
reluctance has been noticed from the courts’ direction when it comes to
intruding into the boardroom and querying the decisions of the director. So
long as the directors have been able to undertake their duties without seeking
personal interest, have kept themselves informed, and have undertaken their
duties in the best interest of the company, the court will not be willing to
interfere, else the decision are considered to be really foolish. It is only at
this point that the director in question will have to face actions for their
negligence. Essentially, it is possible that [7]directors
can make poor decisions without being attacked by the court. This notion that
shield the directors from all, expect the highlight egregious carelessness, is
known as business judgment principles. In certain jurisdictions, as is
obtainable in Australia, these principles have been established in the
principles of business judgment rule. This handers the director’s duty of
diligence and care.
Considering this critical balance issue, the Treasury Paper
(2007) did recognize associated risks with failing to get the right balance.
Observations from the paper does indicate a repetition. It simply imply that if
corporate law is engendering a highly conservative business approach to
decision making, decision process as whole could be discouraged, and this will
affect the performance of the company negatively. Decisions that are based on
risk aversion does increase agency costs and reduce the level of shareholders’
returns. It also has the potential of reducing efficiency of the business
process, overall productivity and economic growth.
Regrettably, evidence within the context of Australian
business law does indicate that there have not be any follow up actions to the
set of enquiries previously launched by the government. At present, the
existing gap within the context of ideas that can be used to establish balance
in corporate governance has been filled by two major law reformed based on
proposals released by the private sector. The proposed set of law reforms does
address the need to broaden overall defense against directors’ breach of duty.[8]
One of the central issues throughout the development of
corporate law is the importance of having an effective corporate governance
system[9].
The recent economic recession has once again raised eye-brows where it relates
to the laws of director’s liability and corporate governance. The functionality
of corporations are totally dependent on human actors. Thus, directors and
corporate officers[10]
function as the link between decision making process of a company and the
direction such company is moving towards. As such, it is easy to notice
directors at the core of any given business scandal and failures registered
within recent decades, and this has made the public so engrossed.[11]
The common issue that has been linked to majority of the
outstanding corporate bankruptcy in recent years is that of poor corporate
governance and director’s decisions.[12]
Despite being the sources of recent economic meltdowns, it would be wrong for
someone to think of corporate scandal and failures as being isolated to only
America.[13]
Considering the present setting, it is not a surprise that legal elements of
corporate governance and directional liability has been the subject of numerous
reviews and analysis coming from the spheres of national legislatures, global
corporate communities and academics.[14]
Considering that companies play significant roles on the
economic development of any given company, it is clear that company laws have
direct impact on such economy. Companies offer huge social benefits as well. On
a similar note, the possibility of a separate legal personality existing could
result to direct exploitation from the company, and this can negatively affect
the society on a big scale.
Companies represent vehicles for conducting business
activities and wealth creation. At present, the dominant form of structure in
today’s business activities are corporations. The importance of corporate activities
within the Australian context does emanate from the following:
·
Over one million corporations were registered on
the Australian Securities Commission (ASC) as at the 30th of June
1997, with over 17,000 of them being public corporations;[15]
·
From 1995-1996, the top 50 listed companies in
the Australian Securities Commissions generated revenues representing 36% of
the country’s GDP (an approximated $489 billion) with these listed companies
earning $9.4 billion in profit;[17]
and
·
Companies listed in the Securities also
generated tax of over $19 billion from 1995-1996 (which represents 16.6 percent
of commonwealth tax revenue).[18]
Thus, it is evident that companies represent an efficient
organizational medium for supervising and directly capital inflow into the
productive activities occurring within industries. They also represent vital
investment tools and medium for capital accumulations. From the research
conducted by the ASX, it was indicated that total share ownership (both direct
and indirect) now involves over one third of the population of Australian (or
4.7 million Australians).[19]
Considering that directors are tasked with the
responsibility of managing corporations for and on behalf of the company’s
shareholders, it becomes important that any legal and regulatory features that
these directors are accountable to should not be allowed to comprise the
fundamental of obligation of these directors to maximize shareholders’ returns.
The behavior of directors have a direct influence on the efficient running of
the company. In cases where directors are forced into undue transaction costs
from personal liability, it is easily understandable that, they will pass such
cost unto the corporation - which the company will also pass unto the consumers
and the cycle continues.
From a different point of view, in cases where directors are
offered necessary freedom to undertake their duties unaffected by regulations
and different degrees of control from shareholders, the confidence of investors
on the corporation medium through be undermined potentially due to such lack of
control. Thus, it is evidently clear (especially in the corporate collapse of
the 1980s) that how a director conducts activities in the corporation can
significantly impact on public perceptions of such company, and market
confidence.
In a document released by the Treasury in 2007, the intended
objective was to inform the basis for reviewing civil and criminal sanctions
contained in the Corporation Act: “Review of sanctions in corporate law”.[20]
This paper is viewed as a new kind of safe harbor for directors of company with
the view of protecting them against liabilities occurring from all of their
core duties as:
•
s 181 Duties of Good Faith;
•
s 182 Use of Position;
•
s 183 Use of Information; and
•
s 588G Insolvent Trading.
At first, it may appear that this is a simple question of
whether or not the current business judgment rules needs necessary extensions
beyond the present applications in s 180 of the Corporation Act (and its
equivalent common law duty) to cover for risks and liabilities from the side of
the directors. However, a closer exploration does indicate that this kind of
safe harbor appears to be different. In the current business judgment rules, conditions
are set for preserving the good faith of directors with added focus on the
importance of their duty of care and diligence in the course of decision making
within the corporate setting. Considering that the objective of the new
proposed rule is to provide necessary protections against the breach of all
major duties undertaken by the directors, it is important that a broader
terminology is adopted for this process. This could actually weaken the link
between the duties themselves.
Statement of problem
In the business judgment rule, it is assumed that those who
take part in informed and honest decision making with the sole purpose of
enhancing performance of the company and improving shareholders returns must be
offered necessary protections against litigations in cases where decisions made
within a given setting does not provide desired benefits for the shareholders –
resulting to losses for these shareholders as a result of such decisions.[21]
Thus, the objective of the business judgment rule is to offer directors who
undertake their business process in a diligent and prudent fashion necessary
protections in line with good faith effort and established purpose of
increasing shareholders value for the company they manage. A summary of the
director’s risk taking ability as it influences performance of firms was
presented by the American Legal Institute 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”; and this makes it clear
that necessary protection should be given to decision makers, even if their
decisions do not produce shareholders desired outcome. This will ensure that
they learn from the process and adopt better decisions in future, while also
encouraging risk taking abilities necessary for continued economic growth.
In general, the corporation law presents the notion that
companies are run by the board of directors that under high express intent to
meet corporate goals set by the shareholders and not by the stockholders
themselves. As such, it is expected that the board of directors should act in
the best of their abilities and norms towards preserving, extending and
enhancing prosperity for the investments that these shareholders have made. As
such, necessary measures need to be put in place to ensure that the members of
the board are not put under constant fear of litigation and no action that can
hamper the board’s productivity should be effected in the process. Maligned
practices emanating from the decisions of individual shareholders should not be
allowed to deter the flow of work that these boards are undertaking. [22]
The process of determining whether or not the director acted
in such desired fashion does involve high level of subjectivity in terms of its
analysis, and it can depend on varied views of the analysis as well as the
circumstances surrounding the decision making process. On that note, there are
a number of confusing factors that hinder successful application of business
judgment rule as it related to the decision made by corporate executives that
demand further investigation. On that note, the objective of this dissertation
is developed in reference to these issues as below.
Objectives of the
Dissertation
The objectives of this dissertation is to deliver a
systematic and critical review of the important literatures that will be used
to developed informed and quick answer to the established 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
Introduction
In this chapter, a review of relevant literatures is
presented in line with the research topic. Critical point from the literatures
are also highlighted in order to understand associated pros and cons from
effecting the decisions established in the literature.
Is it beneficial for
the shareholders to keep the board members on tenterhooks all the time invoking
principles of negligence and taking undue risks?
In corporate governance, ownership structure is one of the
major dimensions and it is broadly perceived to by other-country level
corporate governance features like the development of stock market and the how
stated intervene and regulate the business process.[23]
The structure of shareholders are different across nations, with the US and UK
experiencing more of a dispersed ownership among their listed firms, as against
the controlled ownership that is frequently featured in the European zones. [24]
In a study by Faccio and Lang (2002), data where gathered from 5232 policy
trade unions in 14 countries across Europe and findings indicate that only
36.95% of these first where widely held.[25]
Additionally, La Porta et al. (1999) conducted a cross-country study in order
to point out how large corporations in the advanced economies are widely held;
and found out that controls are normally exercised via pyramidal groups that
features the top holding company or more subsidiaries controlling the business
process; and the shareholders that exercise control are proactively involved in
the management of the company as are seen sitting on the board of directors.[26]
While some of the corporations in the US are controlled by their largest
shareholder (for instance, Ford, Wal-Mart, and Microsoft), firms that feature
such level of control are relatively few and as such they attract little
attention in corporate governance debates.[27]
In line with past survey, there are two obvious consequences for these
differences in ownership structure.[28]
For the dominant shareholders, they have both the incentive and power to
influence discipline in the management, while the concentrated shareholders can
establish terms for new issues as a result of the interest of controlling and
minority shareholders not being aligned. For a detailed description of these
differences, a comparison of the ownership structure between the main economies
in Europe with that of the US and UK.[29]
The major concern of corporate governance is how rights and
responsibilities are structured among the parties that have stake with the
company.[30] This
raises the question of who has right and who has stakes in a firm. The focus of
many definitions have been to accord rights and stakes to the shareholders and
board of members, while ignoring the essential roles of stakeholders as a
whole. In any case, the difference in practices across the world when it comes
to corporate governance makes it impossible to provide a common definition.[31]
In majority of the researches, a dual dichotomous model has been contrasted
between the Anglo-American and Continental Europe corporations.[32]-[33]
For instance, the UK and US are featured as markets with disperse ownership
where corporate control, legal regulation and contractual incentives and
critical for the mechanisms of governance. In Japan and continental Europe,
large shareholders like financial institutions and families does have high
level of capacity when it comes to exercising direct control; and as such they
function in a corporate context that features lesser disclosure rules for
market orientation, weaker incentives for the management, and higher debt
supply. In the accounting and finance literatures, the most predominantly
reflected role of corporate governance is the agency perspectives. [34]
[35]
[36]
Although the concern of the shareholders are ore on how to maximize returns at
a reasonable risks; board members might want ore of profitable growth (empire
building could offer prestige or higher wages), could be lazy or fraudulent,
and might retain costly labor or standards which are above the reasonable level
required for competitive minimum. Considering the potential for separation of
ownership and control,[37]
and varied mechanisms are required for aligning the interest of agents and
principals.[38]
Agency costs is the outcome of the issues faced by shareholders in monitoring
management: as they don’t have the complete information necessary for effecting
qualified decisions; making it difficult to enforce contractual limitations to
the discretion of management. In or
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?
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?
[1]
See, for example, Baxt, R 'Do we Need a Business Judgment Rule for Company
Directors?' (1995) 69 Australian Law Journal 571; 'The Duty of Care of
Directors: Does it Depend on the Swing of the Pendulum?' in I Ramsay (ed), Corporate Governance and Duties of
Company Directors (Centre for Corporate Law and Securities Regulation, University of Melbourne, 1997);
Dr Austin, B 'Boards that Lead Need Better Protection' Australian Financial Review (21 March 2013)
[2]
Senate Standing Committee on Legal and Constitutional Affairs, Company
Directors' Duties , Report on the Social and Fiduciary Duties and Obligations of Company
Directors (1989); House of Representatives Standing Committee on Legal and Constitutional Affairs,
Corporate Practices and the Rights of Shareholders (1991); Directors' Duties and Corporate Governance:
Facilitating innovation and protecting investors, Corporate Law Economic Reform Program, Proposals for Reform: Paper
No. 3, (1997); Review of Sanctions in Corporate Law - Roundtable Paper 1 (2007), The Treasury,
Commonwealth of Australia; Insolvent Trading: A Safe Harbour for Reorganisation Attempts Outside of External
Administration (2010), The Treasury, Commonwealth of Australia.
[3]
See Review of Sanctions in Corporate Law - Roundtable Paper 1 (2007), The
Treasury, Commonwealth of
Australia.
[4]
Drummond S, 'Integrated Reporting Brings Legal Worries', Australian Financial
Review (17 April 2013)
http://www.afr.com/f/free/markets/capital/cfo/integrated_reporting_brings_legal_RvN24L7rPruGI4M90qe4dI
viewed 9 October 2014; Drummond S and King A, 'Confusion just one of the
Hurdles for Integrated Reporting',
Australian Financial Review (27 November 2013); See
further, Huggins, A, Simnett, R and Hargovan, A,
'Integrated Reporting and Directors' Concerns about
Personal Liability Exposure: Law Reform Options' (2014)
Company and Securities Law Journal (forthcoming); Du
Plessis, J and Ruhmkorf, A 'New Trends Regarding
Sustainability and Integrated Reporting for Companies:
What Protections do Directors have? (2014) The
Company Lawyer) (forthcoming).
[5]
Review of Sanctions in Corporate Law - Roundtable Paper 1 (2007), The Treasury,
Commonwealth of
Australia, [1.4].
[6] Ibid.
[7] Ibid.
[8]
See Australian Institute of Company Directors - A Proposal for Law Reform: The
Honest and Reasonable
Director Defence (AICD, Sydney, August 2014) -
available at www.companydirectors.com.au ; See Dr Austin,
B ‘Boards that Lead Need Better Protection' Australian
Financial Review (21 March 2013).
[9] R
Naidoo Corporate Governance: An Essential Guide for South African Companies 2nd
Ed. (2009)
at 2.
[10]
The term ‘directors’ will be used to refer generally to corporate officers and
directors throughout this
dissertation despite the uncertainty as to whether
this is the case: L Johnson ‘Corporate Officers and
the Business Judgment Rule’ (2005) 60 Business Lawyer
439 and the sources cited therein; Lawrence
A. Hamermesh & A. Gilchrist Sparks III ‘Corporate
Officers And The Business Judgment Rule: A
Reply To Professor Johnson’ (2005) 60 Business Lawyer
865; JB Hardin & SR Tellies ‘California’s
Business Judgment Rule is not a Defence for Corporate
Officers’ (June 2013) Orange County Lawyer
32. Viewed at
http://ocbusinesslawyerblog.com/secure/wp-content/uploads/2013/09/201306061437-
2.pdf [last viewed on 3 February 2014].
[11] J
Mayanja ‘Promoting Enhanced Enforcement of Directors’ Fiduciary Obligations:
The Promise of
Public Law Sanctions’ (2007) Australian Journal of
Corporate Law 20(2) 157. See also: The Failure
of HIH Insurance: A corporate collapse and its lessons
Vol.1 (2003) viewed at
http://www.publicaccountants.org.au/media/76396/a00009280.pdf
[last viewed 30 January 2014]; and
R Monem ‘The One-Tel Collapse: Lessons for Corporate
Governance’ viewed at
http://www98.griffith.edu.au/dspace/bitstream/handle/10072/42673/74746_1.pdf;jsessionid=C7819C
A25660076F1B7D3E546655FBB9?sequence=1 [last viewed 30
January 2014]
[12]
Australian Securities and Investments Commission, In the Matter of Richstar
Enterprises Pty Ltd
(ACN 099 071 968) v Carey (No.3) [2006] FCA 433;
(2006) 24 ACLC 581 at 583-4.
[13] Ibid.
[14]
TM Aman ‘Cost-benefit Analysis of the Business Judgment Rule: A Critique in
Light of the
Financial Meltdown’ (2010) 74(1) Albany Law Review 1.
[15] ASC
estimates.
[16] ASX,
Monthly Index Analysis, Issue no. 208, June 1997, p 23
[17]
Australian Bureau of Statistics, Australian National Accounts: National Income,
Expenditure
and Product, Cat 206.0; Company Profits Australia, Cat
5651.
[18] Australian
Bureau of Statistics, Taxation Revenue Australia, Cat 5506.0.
[19] ASX,
Australian Share Ownership Survey, 1997 p 4.
[20]
The Treasury, ‘Review of Sanctions in Corporate Law’, 2007, at
<http://www.treasury.gov.au>.
[21] J
Young, A Practitioner’s Guide to Corporate Law (2nd ed.) (2007), Sydney: NSW
Young Lawyers Business Law Committee [17].
[22] R
S B Tomasic, Corporation Law in Australia (2nd ed.) (2014). Melbourne: The
Federation Press [27].
[23]
La Porta, R., López-de-Silanes, F., Shleifer, A. and Vishny, R. (1998) Law and
Finance, Journal of Political
Economy, 106, 1113-1155.
[24]
La Porta R, Lopez-de-Silanes F, Shleifer A, Vishny R. (1999) Corporate
ownership around the world, Journal of
Finance 54: 471– 517.
[25]
Faccio, Mara and Larry Lang. (2002) The Ultimate Owner of Western European
Corporations, Journal of Financial Economics, 65(3): 365– 95.
[26]
Ibid
[27]
Aguilera, R. V., Jackson, G. (2003) The cross-national diversity of corporate
governance: dimension and determinants, Academy of Management Review, 28:
447–465
[28]
Morck, Randall, Daniel Wolfenzon and Bernard Yeung. (2005) Corporate
Governance, Economic Entrenchment and Growth, Journal of Economic Literature,
43:3, pp. 655–720.
[29]
Enriques, L. and Volpin, P. (2007) Corporate Governance Reforms in Continental
Europe, Journal of Economic
Perspectives, Vol. 21, pp. 117–40.
[30]
Aoki, M. (2001) Towards a comparative institutional analysis. Cambridge, MA:
MIT Press.
[31]
Aguilera, R. V. (2005) Corporate governance and director accountability: An
institutional comparative perspective, British Journal of Management, 16
S39–S53.
[32]
Becht, M., Roel, A. (1999) Blockholding in Europe: An international comparison,
European Economic Review, 43 1049–1056.
[33]
Hall, P. A., D. Soskice, eds. (2001) Varieties of Capitalism: The Institutional
Foundations of Comparative Advantage. Oxford University Press, Oxford, UK.
[34]
Fama, E. and Jensen, M. (1983) Separation of ownership and control, Journal of
Law and Economics, 26: 301– 325.
[35]
Baysinger, B. and Hoskisson, R.E. (1990) The composition of boards of directors
and strategic control effects on corporate strategy, Academy of Management
Review 15 (1): 72–87.
[36]
Bathala, C. and Rao, R.P. (1995) The determinants of board composition: An
agency theory perspective, Managerial and Decision Economics, 16: 59–69.
[37]
Berle, A. and Means, G. (1932) The modern corporation and private property. New
York: Macmillan.
[38]
Fama, E. (1980) Agency problems and the theory of the firm, Journal of
Political Economy, 88: 288–307.
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