The Business Judgement rule

Business Judgement Rule

The key legal roles as discussed in the previous post of the governing body consist primarily of the fiduciary duty and the duty of care and skill towards the company. We stated that if a director fails on this duty, she may be prosecuted.

The South African Companies Act Ch 71 of 2008 introduced a way of establishing that these duties have been satisfactorily met. This is through the business judgement rule. It recognizes that business by nature is assuming risk in return for reward. Consequently some risk undertaken will not be controllable resulting in failure. Directors cannot be judged negligent simply because the desired strategy or goal failed. They should be judged instead based on the process followed in making the decision. That is the essence of the business judgement rule.

It is a two edged sword in that if complied with, it provides protection to directors BUT if violated it becomes basis of litigation against the directors.

In terms of the Act in Section 76 (4) a director is considered to have complied with the duty of care and skill if he satisfies the following:

“(a) will have satisfied the obligations of subsection (3) (b) and (c) if—

(i) the director has taken reasonably diligent steps to become informed about the matter; (Directors have a responsibility to seek and get information from management and not simply and passively rely on board packs. They make decisions based on being fully informed. The diligence to pursue information is the responsibility of the director. In my view it’s better to not make a decisions if information is inadequate. This also requires Directors to study the Board pack in time and get any required information before the Board meeting. By the time of the Board meeting, the director should have taken “diligent steps to become informed”.

(ii) either—

(aa) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a personal financial interest in the matter; ( The emphasis is to avoid a conflict of interest both personally and in terms of the director’s relationships. Some corporate governance experts insist that the director should find a way to satisfy the aspect of relatives not having a personal financial interest before the Board meeting as well. King IV deals with conflict of interest in the broader sense rather than the narrower sense used by the State here. It’s prudent for directors to work at the higher standard of the King IV Code. We shall discuss the issue of Conflict of Interest in a separate post later )

(bb) the director complied with the requirements of section 75 with respect to any

interest contemplated in subparagraph (aa); and

(b) is entitled to rely on—

(iii) the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company;  (“The minutes of the meeting must also reflect the material points of the discussion that took place and explain why the decision was taken. These minutes must reflect an accurate view of the discussion at the time rather than simply being a justification for the decisions taken. It is also not sufficient to merely record the outcome, without the rationale for the decision being documented. Directors also have an important responsibility to ensure that minutes of meetings appropriately capture the discussions and points of view of both the board and individual directors. Where directors dissent, this should also be recorded.” Source: CGN Guidance Note on Business Judgement Rule.} and

(i) the performance by any of the persons—

(aa) referred to in subsection (5); or

(bb) to whom the board may reasonably have delegated, formally or informally by

course of conduct, the authority or duty to perform one or more of the board’s

functions that are delegable under applicable law; and

(ii) any information, opinions, recommendations, reports or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (5).

(5) To the extent contemplated in subsection (4) (b), a director is entitled to rely on—

(a) one or more employees of the company whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided;

(b) legal counsel, accountants, or other professional persons retained by the company, the board or a committee as to matters involving skills or expertise that the director reasonably believes are matters—

(i) within the particular person’s professional or expert competence; or

(ii) as to which the particular person merits confidence; or

(c) a committee of the board of which the director is not a member, unless the director has reason to believe that the actions of the committee do not merit confidence.”

The IoDSA CGN Guidance note on the Business Judgement Rule provides clarification on the matter of reliance on other persons or committees as follows:

“In considering what information to rely on, directors should consider both the quality and relevance of the information. The quality of the information refers to the robustness of the process that the information goes through before it reaches the board and speaks to its credibility. The relevance of the information refers to what information was considered necessary to present to the board and what the process was of determining what information was relevant to the board’s decision and what was not. Where directors discover inconsistencies in the information presented to them, the directors have a responsibility to probe these inconsistencies and obtain appropriate answers and explanations. These inconsistencies may also be indicative of a lack of an appropriate process to ensure that directors receive the relevant information which is of a high quality.”

The Board can delegate wok but cannot delegate accountability and responsibility for its decisions. I remember having to vote against the recommendations of one of the Board committees because I was not comfortable with it. It is however unusual to go against the recommendations of a committee unless there are significant gaps in the way it handled the matter. My point here is mainly that the directors have finally accountability for approving recommendations and so cannot claim they were simply going on the basis of expert opinion. The expert can also be wrong.

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