The business judgment rule, giving oxygen to risk in strategic decisions
Businesses are increasingly influenced by changes, threats and opportunities in technological, regulatory, reputational and strategic spheres; mergers and acquisitions and other business decisions can have a transforming reach. The so called business judgment rule (“BJR”), in the terms and with the limitations described, sets out a standard of care of an orderly businessman, designed to give a certain degree of immunity to directors so they can take a reasonable amount of risk, a natural component of any business decision.
Originating from U.S. case law, the BJR was transposed in the Spanish Capital Companies Law by being included in article 226 through the reform made by Law 31/2014, of December 3, 2014 amending the Capital Companies Law to enhance corporate governance.
Legal requirements for the protection
The BJR sets out a standard of diligent conduct that guarantees immunity for directors in relation to strategic and business-related decisions, adopted within the business judgment rule, for which the following requirements must be met:
Acting in good faith: this general principle in the Spanish legal system (article 7.1 of the Civil Code) limits the managerial discretion of directors. It includes the contents of directors’ duties of loyalty and diligence.
Absence of personal interests: directors’ conduct must be disinterested and independent. They must defend the company’s interests over and above any third party’s, or indeed their own. Any decisions they adopt must be made to further the company’s purpose and aim.
Sufficient information: the directors must put all necessary means to being sufficiently informed before making decisions. This requirement involves assessing whether there has been an effort to be informed and exercise their judgment. Factors considered in the U.S. case law have been whether independent experts were used; experience and knowledge related to similar matters; the existence of a special committee to deal with a specific matter; the written information provided to each director, including from the standpoint of each individually; the time taken by directors on the various options and adopting a decision; and the like.
Adequate decision making procedure: article 226 contains no further specification as to procedure. The directors must have sufficient information and take it into consideration, besides following any procedure stipulated for each type of decision by law, in the bylaws, or in the board regulations.
Reasons for the BJR
The most-cited legal commentators have identified four reasons for the BJR:
To encourage risk taking: this is to protect bold, not reckless, directors. In business, decision making involves risks, but reasonable risk taking may even be desirable if justified in profitability terms. Incentives are needed for innovation, dynamism and constant change. The BJR guarantees immunity for a director who takes risks consistent with the standard of care and loyalty, within reason.
To place limitations on judges for judging business decisions: the courts should only enter into assessing satisfaction or otherwise of the requirements laid down in article 226 of the Capital Companies Law to determine whether there was a breach of the law in the director’s conduct, not the merits of the matter.
Avoid hindsight bias: this relates to the ability to assess possible outcomes being altered after the event. It is likely that a court will not be able to place itself in the director’s position when the contested decision was made. For that reason, the judge should only assess the decision making process not the decision itself.
No lex artis: there is no hard and fast rulebook against which to compare a specific step by a director. Directors’ activities should be innovative, involve a reasonable amount or risk, and in a state of constant change.
Legal practitioners must keep the business judgment rule firmly in sight, above all when new, and sometimes contradictory, paradigms such as shareholder activism, concern over sustainability, and the risks associated with the digital world make their presence felt in boardrooms. We therefore need to watch how the courts interpret article 226 and, in particular, how they interpret the undefined legal concepts it uses to see how the mechanism takes shape.
Alberto Guerra, partner at the Bilbao office of Garrigues