[Anaya and Pulkit are students at Gujarat National Law University.]
It is a well-known fact that directors play a crucial role in making significant decisions for their company. Nevertheless, there are circumstances wherein the directors diligently discharge the duty of care, yet the results deviate from the anticipated outcome, which in all probability works against the interests of the company. It is in such situations, that the concept of "business judgment rule" (BJR) comes into play, which protects the directors from commercially unviable decisions that were not a result of directors’ mala fide.
Also known as the "business judgment presumption", BJR presumes that the decisions taken by directors are in good faith, acted upon after gathering the requisite information, and are made in the best interest of the company. The crux of BJR lies in its inherent presumption, fundamentally assuming that directors’ decisions as made in good faith. However, this presumption is rebuttable, and it is upon the contesting party to establish directors’ gross negligence, bad faith, or conflict of interest.
This concept was recently discussed comprehensively at the OECD-Latin America Roundtable Conference on Corporate Governance. An analysis was made as to the application of BJR in several jurisdictions, which revealed that the principle was adopted throughout those jurisdictions either by statutory incorporation or by judicial pronouncements which clearly laid out the scope of duties of directors coupled with real-life illustrations to explain the intricacies of the Rule.
The article aims to take insights from the application of BJR across different jurisdictions, evaluating its position in India, and ultimately scrutinizing whether the existing Indian legal framework concerning BJR is adequate or necessitates revision.
Application of BJR in Various Jurisdictions
The principle of BJR originated in the USA and was initially referenced in the case of Percy v. Millaudon. The court held that provided the directors acted diligently, they would not be personally liable for the consequences of their business decisions. This was later crystallized as a principle by the Delaware courts in the landmark case of Aronson v. Lewis which serves to be a global precedent. The principle, though not codified in the statutes, has been expressly evolved and acknowledged as a presumption by the judiciary. Furthermore, in Australia, the broad idea of BJR was laid out in the case of Turquand v. Marshall, where the courts refrained from intervening in matters unless directors’ actions demonstrated negligence. Subsequently, BJR was codified in the form of Section 180 of the Corporations Act 2001, which also lays down the parameters for the applicability of the rule. In the UK, the principles of BJR were formulated in the landmark case of Re City Equitable Fire Insurance Co Ltd, wherein the courts provided the directors with the necessary flexibility in their decision-making to address commercial realities. In the UK, BJR has been neither codified nor adopted in its entirety and the position is quite similar to that of India. However, there have been instances wherein the courts have accepted and tried to adopt the principle as developed by the US courts.
The USA, the UK, and Australia have implemented BJR to different degrees. Australia has codified BJR in statutes, the USA acknowledges it as a principle without codification, and the UK accepts certain facets but has not embraced the principle entirely, illustrating diverse approaches to BJR adoption.
India’s Stance on BJR
The concept of protecting directors for decisions made in good faith has been a longstanding principle dating back to the Companies Act 1956 (1956 Act). Section 463 of the Companies Act 2013 (2013 Act), which is a reproduction of Section 633 of the 1956 Act, stipulates that: (a) an officer (which definitionally includes any director under the 2013 Act) facing proceeding, arising out of his negligence, default, breach of duty, misfeasance, or breach of trust may be excused, either wholly or partly from his liability, and (b) an officer who has reason to apprehend that any proceeding will or might be brought against him in respect of any negligence, default, breach of duty, misfeasance or breach of trust, may apply to the High Court for relief, if the court before which such proceeding is ongoing or the High Court, as the case maybe, is of the view that the officer in question acted honestly and reasonably. In either case, the court before which the proceeding is ongoing or High Court shall serve a notice to the Registrar of Companies or any other person as deemed necessary, to show cause why such relief should not be granted.
Resembling BJR, Section 463 of the 2013 Act essentially excuses the acts of the directors provided they acted honestly and reasonably. However, a key distinction between the two is that, in the Indian context, it is at the court's discretion to grant protection based upon the facts and circumstances, as compared to a blanket presumption provided under BJR, which assumes that directors’ actions are made in good faith unless proven otherwise. In the case of Jagjivan Hiralal Doshi v. Registrar of Companies (1988), a single judge bench of the Bombay High Court, while interpreting the 1956 Act provision, emphasized that granting relief to directors "would always remain a question of judicial discretion". A single judge bench of the Delhi High Court in Jagannath Prasad Jhalani v. Provident Fund Commissioner (1987) stated that courts must be cautious while exercising such discretion and emphasized that it must be used sparingly. Thus, the protection cannot be claimed as a right but is a discretionary power vested with the courts. Moreover, the discretion of granting protection can only be exercised by courts after hearing the concerned parties. Thus, the directors have to establish that they are entitled to the protection under the aforementioned section along with facing rebuttals from the concerned parties. This runs contrary to the very essence of BJR, which is the element of "presumption".
Specific aspects of BJR, such as the requirement for directors to act in good faith, exercise reasonable care, and avoid conflicts of interest and undue gain, are embodied in Section 166 of the 2013 Act. Further, an additional protection has been provided to the independent directors under Section 149(12) of the 2013 Act, for acts or omissions that occur without their knowledge, consent, or connivance, or when they have acted diligently.
Apart from the statutory inclusion, the elements of BJR can also be traced back to the judicial decisions. There have been only a handful of cases pertaining to oppression and mismanagement, wherein the idea of BJR was reflected in the pronouncements. In the case of Miheer H Mafatlal v. Mafatlal Industries Limited, the apex court, while refraining from intervening in the directors’ actions, held that their conduct was just, fair, and reasonable. The court concluded that it shall not interfere in decisions made prudently and judiciously, even if a potentially better alternative might have existed. In Fidaali Moiz Mithiborwala v. Majolica Impex Private Limited, the National Company Law Tribunal held that the decisions of the management might not always align with the interest of its stakeholders, and in such instances, the only parameter under consideration should be the absence of mala fide and unfairness in such decisions. Apart from the courts and tribunals, regulatory authorities such as the Securities and Exchange Board of India acknowledged BJR as formulated by the Court of Delaware, and opined that this rule can be relied upon while adjudicating matters concerning the conduct of directors in relation to company affairs.
Conclusion and Way Forward
The absence of a judgment establishing a presumption in favor of directors and adopting BJR entirely may be attributed to the relatively low number of cases against directors in the context. Unlike in the USA, class action lawsuits against boards of directors are less common in India. The introduction of "class action" in India in 2016 through Section 245 (of the 2013 Act) allows members to initiate proceedings if they believe management’s actions to be prejudicial. Notably, shareholders nowadays have become increasingly vigilant about corporate actions and are constantly vocalizing their concerns regarding oppression and mismanagement, environmental concerns, etc. While the activism in India is slow, it is steadily increasing, and instances of financial scams and frauds are compelling shareholders to press for higher transparency and accountability. Owing to these factors, it is safe to conclude that India would witness an increase in the number of class action suits. In light of these developments, it becomes imperative to reassess the current stance on the protection afforded to directors and to reframe the law to align with more progressive and evolving corporate landscapes.
The present regime of law leans significantly towards enhancing directors' accountability and prioritizing shareholders' protection. Under the current legal framework, if the director makes decisions after due diligence, he would undoubtedly be saved by judicial discretion. However, introducing BJR, which presumes in favour of directors, would afford the directors greater economic and psychological freedom. This would in turn empower them to make riskier decisions in uncertain business conditions, as the presumption already safeguards them against litigations.
Furthermore, the presumption would not compromise on the accountability aspect, since it is rebuttable once the party establishes directors’ mala fide or lack of diligence. Also, as established above, the trend of litigations pertaining to this matter would increase in the near future. Constant threat of litigations coupled with a sole discretionary remedy under the law would discourage the directors from venturing into risky decisions.
At this juncture, it is fitting for a country like India, to boost its corporate and economic opportunities. Even in the absence of a statutory codification, it is imperative to adopt a framework for BJR as prevalent in other countries or as recommended in the OECD roundtable conference. Moreover, it is necessary to carve out detailed principles governing the rule, so as to reduce any ambiguity and align them with the corporate framework of India. It is crucial at this phase of expanding commercial and corporate activities, to provide directors with benefits, not only to align with corporate interests but also to facilitate ease of doing business in India.
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