Business Judgment Rule Research Articles

Law Enforcement on the Role of Independent Directors in the US: An Implication to China

This article investigates the enforcement of law on the role of independent directors in the US. The purpose is to find suggestions for Chinese policy makers to improve its system of law enforcement on the role of independent directors as effective monitors. In the US, there is a working system of law enforcement in place by way of charter provision, business judgment rule, shareholder litigation and SEC enforcement action. In China, similar elements of law enforcement are missing. Thus, a working system of law enforcement on the role of independent directors is not in place. Unless Chinese legal system can develop a working system of law enforcement on the role of independent directors, there is still a gap between the law on the books and the law in action regarding the role of independent directors, which makes independent directors failed to work as expected in China.

THE BUSINESS JUDGMENT RULE EN LOS ESTADOS UNIDOS: UNA REGLA CON DIMENSIÓN PROCESAL Y FUERZA SUSTANTIVA

In Delaware, in the United States, the Business Judgment Rule (bjr) has been described as “a presumption that in making a business decision the directors of a company acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company”. The party seeking to challenge the decision must rebut the application of that presumption. In the event that the party achieves rebut, the burden of proof will be reversed, so that it will be the administrators who must prove the “entire fairness” of the transaction. This article also discusses three justifications for bjr, like some criticism of the rule based on or associated with a cost-benefit analysis. Furthermore, this article focuses on the application of bjr on banking issues, particularly in cases involving mergers and acquisitions (M & A). Keywords author: Good business judgment rule, directors, board of directors, fiduciary duties, due diligence, loyalty, good faith, secondary duties, directors’ liability, actions against directors, mergers and acquisitions, hostile takeovers, banks, banking law, bank managers.

Modern Corporate Governance and the Erosion of the Business Judgment Rule in Delaware Corporate Law

This essay addresses the relationship between the forces shaping modern corporate governance and wisdom of a liability rule to enforce the fiduciary duty of care against corporate directors.

Corporate Director's Duty of Care and the Business Judgment Rule

Corporate Director's Duty of Care and the Business Judgment Rule

A Critical Analysis of the Protection of Stakeholders’ Interests under the South African Companies Act: (Part 2)

While the Companies Act 71 of 2008 does not provide for an explicit duty for directors to consider the interests of stakeholders, it may appear as if the shareholder value approach has become significantly more nuanced through the operation of other company law principles, such as the business judgment rule, the requirement for the appointment of a social and ethics committee, the remedies and the provision for the Memorandum of Incorporation as well as the link between governance and the law. This paper provides a critical analysis of these company law principles. The aim is to investigate to what extent these company law principles can be relied on as a means of guaranteeing the protection of stakeholders’ interests. The paper concludes that stakeholders’ interests are best protected where an explicit duty exists for directors to consider the interests of other stakeholders. A call for law reform is therefore made in this regard. DOI: 10.5901/mjss.2014.v5n3p66

Majority-of-The-Minority Voting and Fairness in Freezeout Mergers

In a landmark decision now on appeal, In re MFW Shareholders Litigation, the Delaware Chancery Court ruled that a freezeout merger negotiated by an independent special negotiating committee (SNC) and conditioned in advance on approval by a majority-of-the-minority (MOM) vote should be reviewed under the business judgment rule. Before MFW, the practice was to review all such mergers for entire fairness, albeit with the burden on the plaintiff if the merger is either negotiated by an independent SNC or ratified in a fully-informed MOM vote. In contrast, review under the business judgment rule requires plaintiffs to plead and prove their case – to show that the deal was not the product of good faith bargaining.The stated rationale for the ruling in MFW is that subjecting a freezeout merger to both conditions is equivalent to the protections afforded to stockholders in an arms-length merger with a third-party buyer. As the MFW court notes, routine fairness review seldom results in any significant increase in consideration and likely decreases stockholder wealth. Moreover, routine fairness review induces deals to be structured as a tender offer followed by a short-form merger, neither step of which is reviewed for fairness – even though such a structure may coerce minority stockholders to accept a lower price for fear of being left with an illiquid stub of shares following the tender offer. Although these are powerful arguments, the MFW court understates the case for the approach it endorses. As shown here, the MOM vote does more than merely ratify the proposed deal. Rather, it assures that the price to be paid is at least sufficient to satisfy the median price that would be demanded by the minority stockholders in a hypothetical stairstep auction. Since MOM voting permits minority stockholders to register their opinions as to the adequacy of the offered price without the pressure to tender, the vote can be trusted to reflect stockholder opinion free from the distorting effects of the coercion inherent in a tender offer. To be sure, majority rule means that higher valuing stockholders may be under-compensated while lower valuing stockholders will be over-compensated. But the aggregate premium paid by the controlling stockholder will be equal to the aggregate of the premiums that would be demanded individually by the minority stockholders. Since most stockholders are diversified, they will be overcompensated at least as often as they are undercompensated – on the average and over time. Thus, stockholders should favor the MFW approach not only because it assures fair price but also because it assures the maximum number of deals by minimizing the uncertainties inherent in fairness review – if not also assuring controlling stockholders against the danger of over-payment. Finally, negotiation by independent SNC assures that the minority will get any higher price that may result from a bilateral negotiation. In short, the MFW approach assures minority stockholders will get the better of the prices that would result from either approach alone. Thus, the price paid is by definition fair and should be protected by the business judgment rule subject only to review in an appraisal proceeding as is the general rule for mergers not involving a controlling stockholder.

The Goals of the Corporation under Shareholder Primacy: Just Profit Or Social Responsibility and Religious Exercise Too?

Under the doctrine of shareholder primacy, the duty of a corporate director is to act for the benefit of the shareholders. This is not the same as profit maximization. It is only the same if shareholders care about profit and nothing else. The current Hobby Lobby case regarding a corporation’s religious exemption from the Obamacare emergency contraception mandate is an example: the shareholders have made it clear they wish the directors to spend more on litigation than could possibly be saved by avoidance of the mandate. Goals other other than pure profit should be permitted both for public and for closely held corporations. Even for public corporations in financial “efficient markets”, maximization of market value may demand that the corporation sacrifice longterm profit for other goals. In some cases this will be to the detriment of minority shareholders who value profit alone, but the problem is no difference in essence from shareholder disagreement because of their differing time horizons or tax positions. While corporate directors should and do have a fiduciary duty to act only for the benefit of shareholders, not for customers, employees, or community, this is not precisely equivalent to profit maximization, nor does it require (or even allow) directors to ignore religious beliefs. In practice the business judgment rule gives directors enough slack to accommodate other goals besides profit maximization, but it is worth detailing the interplay between the beliefs and desires of shareholders and directors to aid conscientious directors in their duty.

The relationship between The Business Judgement Rule and the Malfeasance

The relationship between The Business Judgement Rule and the Malfeasance

A study on judicial precedents in Japan concerning business judgment rule

A study on judicial precedents in Japan concerning business judgment rule

Supplying the Adverb: The Future of Corporate Risk-Taking and the Business Judgment Rule

The business judgment rule precludes judicial review of most decisions by corporate directors. The rule is necessary to protect directors from potential liability for decisions that ultimately end in failure. Courts and legal commentators have long emphasized the importance that the rule has in promoting the kind of risk-taking by corporations that has resulted in new ideas, new technologies and new markets. In recent years, Delaware courts have shown so much deference to risk-taking that they have misapplied the still-evolving doctrine of good faith. Professor Rosenberg argues that courts should use the same standards of good faith to evaluate accusations of excessive risk-taking that they use to evaluate other kinds of director misconduct such as disloyalty and a failure to be adequately informed. This would go a long way to making Delaware fiduciary law more consistent as it is applied to a variety of alleged director misconduct, but would do little to damage the ability of directors to take the kind of beneficial risks that have been so central to the historical success of the American corporation.

Corporate Political Contributions as Bad Faith

A shareholder who objects to a corporate political contribution can file a derivative lawsuit to challenge that contribution as a breach of management’s duty of loyalty to the corporation. Such a lawsuit will face long odds, however, if it is founded upon a traditional theory for breach of the duty of loyalty, like waste or self-dealing. Yet, there is a better theory for a shareholder to employ when filing suit to challenge a corporate political contribution: bad faith. Bad faith is a better basis for challenging a corporate political contribution than either waste or self-dealing because bad faith is a more flexible concept than self-dealing and a less difficult standard to satisfy than waste. Even if she intends no harm, a director acts in bad faith when she (1) takes official action that is motivated primarily by any reason other than advancing the corporation’s best interests or (2) consciously disregards her fiduciary duties. This Article identifies several examples of political contributions — both real and hypothetical — that are ripe for challenge as bad faith because they are made for reasons other than advancing the corporation’s best interest. For example, a CEO acts in bad faith if she causes the corporation to make a contribution in support of her own political views or a friend who is running for office. However, in the absence of a “smoking gun,” it will be difficult for a plaintiff to prove that the contribution was made for personal reasons rather than to advance the interests of the corporation. To overcome the difficulty of proving motive, this Article offers a novel argument: essentially all corporate political contributions made by large public corporations today constitute bad faith because they reflect management’s conscious disregard for shareholders’ political views. In our zero-sum, two-party political system, a board simply must know that a political contribution in support of a candidate from either major party will upset a substantial number (and perhaps a majority) of shareholders. What’s more, although the duty of loyalty typically demands that management consider the best interests of the corporation as a whole, not individual shareholders, a different rule should apply to political contributions. The policy rationales for vesting decision-making power in the board, rather than shareholders or courts, simply do not apply to political contributions. Political matters are outside of management’s core competence, and shareholders probably do not view management as a proxy for such matters. Further, political contributions differ greatly from most corporate spending, including charitable contributions. As a result, even if political contributions are not strictly ultra vires — i.e., beyond the corporate powers — they certainly verge on being ultra vires. When a board acts “in the vicinity of” ultra vires, its authority is at its lowest ebb; to shore up that authority, the board ought to consult the shareholders. If failing to poll the shareholders constitutes bad faith, boards wishing to contribute corporate funds in support of political candidates might nonetheless obtain protection of the business judgment rule in two ways. First, the board could submit a non-binding resolution to the shareholders at each annual meeting to gauge shareholder support for political contributions, generally, and also to gauge support for each major party. Second, management could establish a good faith reason for not consulting the shareholders for a specific contribution — for example, if the contribution directly and unambiguously promotes the corporation’s core business.

The SEC and the Courtss Cooperative Policing of Related Party Transactions

A transaction between a corporation and its director or officer (a “related party transaction”) presents conflicts of interest that could harm, or alternatively, could also benefit the corporation. To sort beneficial related party transactions from detrimental ones, the current legal regime relies on both ex ante screening and ex post litigation. Disclosure plays an essential role in both stages. Based on a set of hand-collected data on actual disclosures from Fortune top fifty companies, this Article casts doubt on the effectiveness of the current regulation of related party transactions. The ambiguity of the federal securities regulations leaves too much room for manipulation. An approving committee of each company exercises considerable discretion not only over which proposed transactions to approve, but also over which transactions to disclose to its shareholders and what information to include in the disclosures. In the context of state corporate law, uncertainty exists in fiduciary duty of loyalty litigation regarding when and whether a court should bypass the fairness test and apply the business judgment rule to a related party transaction that satisfies certain safe harbor conditions, such as approval by disinterested directors. This Article proposes a fix by linking the strategic disclosure problem to the question of the applicable standard of review in fiduciary duty of loyalty litigation. To that end, the court should consider a disclosure under federal securities law as a strong signal of fairness of the disclosed transaction and be more willing to apply the business judgment rule rather than the fairness test in state duty of loyalty litigation. Potential benefits of the proposal include creating better incentives to disclose related party transactions, giving litigants more predictable rules, and allowing for richer accumulation of disclosure data over time, thus providing better guidance to companies and market participants in distinguishing between beneficial and harmful related party transactions.

The Duty to Manage Risk

Shareholders, consumers, homeowners, borrowers, employees and other citizens were harmed, in some cases substantially, by the business practices of individuals at various financial firms leading up to the 2008 financial crisis. Unlike after other crises in the financial markets, such as the 2001 accounting fraud scandals, the public was not treated to the catharsis of criminal prosecutions or even large civil judgments and settlements. Instead, financial firms that incurred large losses on behalf of its shareholders repeatedly withstood attempts at legal redress in the courts by those shareholders. Shareholders were turned away from the courthouse door in cases involving federal securities law claims and claims of breaches of state law fiduciary duties. Scholars and commentators have focused on one area of fiduciary duty that seemed to fit: a claim that the board of directors of a firm failed to exercise its oversight duty to monitor firm-wide financial risk. However, this claim was also unsuccessful in the courts as judges viewed the duty to monitor risk as repackaging of the duty of care, which is significantly shielded from judicial review. Therefore, shareholders were left without a cause of action for admittedly “boneheaded” decisions of managers in light of changing economic circumstances.This Article argues that the failure of the short life of the duty to monitor risk is not a bad development, but a logical and reasoned one. To say that shareholders, and by extension, courts, should not second-guess business decisions of boards of directors that are the result of a rational process, but to say that shareholders can second-guess the supervision of boards of those same decisions is inconsistent with decades of corporate governance jurisprudence. To make room for this duty within the duty of oversight or to create a separate duty to monitor financial risk would have the consequence of opening a side door to the questioning of all kinds of legal business decisions that have within them an element of business risk, political risk, currency risk, environmental risk, and legal risk. Though the oversight duty had before been cabined to holding directors responsible for the crimes and wrongful acts they should have known were being perpetuated by firm employees, the duty to monitor risk would subject legal but risky actions to judicial scrutiny. This eventuality would in effect reduce the business judgment rule to a nullity.

Shareholder Derivative Suits to Challenge Corporate Super PAC Contributions: A Closer Look

Management has exclusive domain over a corporation's day-to-day affairs; shareholders play no role in ordinary business decisions. Thus, in a post-Citizens United world, management may cause a corporation to contribute to a Super PAC without any shareholder input. If a shareholder discovers the contribution and objects, her only options under state corporation law are to elect a new board, her shares or sue management for breach of fiduciary duty – i.e., vote, or sue.Unfortunately, for most shareholders of publicly traded corporations, neither vote nor sell is an effective response a Super PAC contribution. Ousting the board is not an option due to the collective action problem. Selling one's shares also is no remedy because the stock market will already know of and have reacted to the contribution.But what about sue? Many corporate law scholars have summarily rejected this option, urging that management's decision to make the contribution would be protected by the business judgment rule. Yet, no such scholar has thoroughly analyzed this issue.Bucking this trend, two authors recently have urged that shareholders could successfully sue to challenge a corporate Super PAC contribution. However, these commentaries have been ignored in the law reviews and summarily panned in the blogosphere, leaving the idea largely unexamined. This Article remedies that oversight.After close scrutiny, one of the two theories proffered in these two papers – waste – is a sure loser in all but the most extreme circumstances. There is simply no good argument that a typical corporate Super PAC contribution meets the nearly-impossible-to-satisfy waste standard.By contrast, the second theory – self-dealing – may be viable if the candidate supported by the Super PAC advocates policies that favor the financial interests of management over those of most Americans. Yet, although self-dealing is a better theory than waste, it is nonetheless uncertain to succeed due to the attenuated causal connection between any Super PAC contribution and any potential financial benefit to management.As such, a shareholder derivative lawsuit challenging a Super PAC contribution faces long odds – unless, perhaps, she advances a theory other than waste or self-dealing.

Fairness and Risk in Stockton: Pensions, Bonds, and Taxes -- When Doing Nothing is Doing Well

Until very recently the political story line of municipal Chapter 9 bankruptcy has seen it deployed as a means to address unfunded public employee pension obligations. The reality has always been more complex but with the filings of Stockton and now Detroit the question of pensions vs. bonds has come to center stage. If the creditors cannot agree on a plan of adjustment, it can be crammed down but cramdown under Chapter 9 requires that the plan be fair and equitable. If a municipality pursues this route to confirmation, courts will need to resolve three questions.Do preferences created by state law control bankruptcy distributions?Can a plan of adjustment that prefers retirees (or bondholders) be crammed down over the objection of the impaired class?If the answer to the second question might be no, could a municipality move assume its collective bargaining agreements subject to only the business judgment rule to avoid battling over fairness at confirmation?This working paper suggests that each question should be answered in the negative. Notwithstanding the Tenth Amendment, when a state permits its cities to file, it loses control. In for a penny, in for a pound. If my conclusions are correct -- and even if they only may be correct -- all parties have an incentive to negotiate to a consensual plan.Dismissal is the appropriate remedy for an nonconsensual, unfair plan and the threat of sending everyone back to state court and state law remedies should be a sufficient penalty to encourage settlement.Comments, suggestions, and criticisms are actively solicited.

Present at the Creation: Reflections on the Early Years of the National Association of Corporate Directors

Effective corporate governance is critical to the productive operation of the global economy and preservation of our way of life. Excellent governance execution is also required to achieve economic growth and robust job creation in any country. In the United States, the premier director membership organization is the National Association of Corporate Directors (NACD). Since 1978, NACD plays a major role in fostering excellence in corporate governance in the United States and beyond.The NACD has grown from a mere realization of the importance of corporate governance to become the only national membership organization created by and for corporate directors. With a membership in excess of 14,000, today’s NACD is a reliable source of essential resources that assist board directors in strengthening board leadership. Now a member of the Global Network of Director Institutions (GNDI.org), NACD has worldwide impact. Even during the early years, NACD was a significant source of quality education and qualified directors to companies striving to achieve excellence in corporate governance. My interest in corporate governance covers more than thirty years. During my career, I have found the job of the corporate director both fulfilling and intellectually challenging. My involvement with the NACD dates back to 1978. At that time the Washington, DC-based organization was in its infancy; just a few months old. During NACD’s early months, I was a 28 year-old entrepreneur, serving as chairman and CEO of a Washington, DC-based financial services start-up. I needed to learn about corporate governance and recruit a board of directors capable of governing a national financial services entity, while communicating to the investor community that we were deserving of their support as we contemplated our initial public offering. NACD’s focus has changed over the years to reflect those issues receiving the most attention in corporate boardrooms at any given time. The Foreign Corrupt Practices Act, signed into law December 19, 1977, was a major development confronting directors as NACD was founded. Next, the SEC’s Advisory Committee on Corporate Disclosure, chaired by A.A. Sommer, held hearings focusing attention on the broad topic of corporate governance and served to highlight the need for increased professionalism by corporate directors. The 1985 decision in Smith v. Van Gorkom held that directors who make an uninformed decision are unprotected by the business judgment rule and, accordingly, face substantial personal liability exposure. Van Gorkom triggered a huge demand for director education. Focus on the need for effective audit committees resulted from the National Commission on Fraudulent Financial Reporting of 1987 (the “Treadway Commission”). NACD has also proven to be a great source of directors over the years for my involvement with early-stage companies. Experienced senior executive talent, in the form of independent outside board members, can prove to be a profoundly valuable intangible asset of any start-up enterprise. A lifetime of experience teaches that entrepreneurs may enhance the likelihood of ultimate enterprise success by recruiting the assistance of experienced executive talent. Corporate directors provide a useful mechanism in which to tap this asset and leverage many years of experience and personal relationships. This article discusses the growth of the New York and Baltimore/Washington, DC NACD chapters during these early days, especially at the local level. NACD’s primary strength is found in its local chapter system; these are the “grass roots” that make governance a viable field.

Why Defer to Managers? A Strong-Form Efficiency Model

We compare the efficiency with which management discretion and shareholder choice regulate hostile tender offers. This is the first paper in a long running debate that rigorously compares these legal rules to analyze both the critical informational assumptions and the interplay of those assumptions with principles of financial market efficiency. A critical innovation of our model is its focus on an informed management's choice among alternative corporate policies under the protection of the business judgment rule, but where agency costs exist. We assume that corporate assets and reinvestment opportunities are efficiently priced by financial markets, but that markets never learn the value of foregone investments. In this case, shareholder choice may create an agency problem whereby managers forego positive net present value investments that increase the risk of a hostile bid. We are able to determine analytic conditions under which the expected cost of this agency problem exceeds that of the standard agency problem usually identified with management discretion.

A New Era for the Business Judgment Rule in Japan? Domestic and Comparative Lessons from the Apamanshop Case

This chapter provides a translation and comparative analysis of one of the most important recent corporate law decisions by the Supreme Court of Japan: the Apamanshop Case (Supreme Court 15 July 2010 – Case No. 2009 ju 183). From a domestic perspective, the decision was a watershed moment in Japanese corporate law and governance for three reasons: (1) it marked the first time that the business judgment rule had been explicitly applied by the Supreme Court in Japan; (2) it affirmed the general framework for applying the business judgment rule which had previously been used in several lower court decisions; (3) the Supreme Court’s detailed examination of the content of the directors’ decisions suggested that the manner in which the business judgment rule is applied in Japan is markedly different from how it is applied in the United States. For three reasons, each of the aforementioned important findings, has the potential to significantly shape the future of Japanese corporate governance: (1) the Supreme Court’s recognition of the business judgment rule should provide a wider and more predictable ambit of protected managerial discretion for directors in Japan; (2) the Supreme Court’s recognition of the importance of engaging an outside lawyer for establishing the reasonableness of the decision-making process will likely further increase the role of lawyers in Japanese boardrooms; (3) the Supreme Court’s detailed examination of the content of the directors’ decisions suggests that the manner in which the business judgment rule is applied in Japan is markedly different from how it is applied in the United States. Interestingly, this decision also sheds light on two important debates in comparative corporate law: (1) it suggests that the theory that corporate legal transplants start from codified rather than case law is erroneous; and (2) it calls into question the use of coding or leximetrics as a useful tool for understanding corporate law comparatively.

Why Agents Need Discretion: The Business Judgment Rule as Optimal Standard of Care

Should managers be liable for ill-conceived business decisions? One answer is given by U.S. courts, which almost never hold managers liable for their mistakes. In this paper, we address the question in a theoretical model of delegated decision making. We find that courts should indeed be lenient as long as contracts are restricted to be linear. With more general compensation schemes, the answer depends on the precision of the court’s signal. If courts make many mistakes in evaluating decisions, they should not impose liability for poor business judgment.

Getting it right: directors’ assessment of information

Purpose– The purpose of this paper is to explore the increasing expectation against two concepts, information and process scepticism. In light of theCentrocase judgement, directors’ decisions are held to increasing standards of due care and diligence.Design/methodology/approach– This is a conceptual paper, drawing upon archival material, including statute law, case law, regulatory guidance material and media releases in Australasia. The authors review the statutory duty of care, skill and diligence expected of non-executive directors.Findings– Whether a director has exercised an appropriate level of reasonable care and skill and/or due diligence has been a matter for the courts to decide. Such retrospective analysis leaves directors vulnerable to the uncertainty of whether their individual interpretation of diligence matches up to that of the presiding judge. The authors provide directors with a framework to apply scepticism to information and processes provided by those on whom the directors may rely.Research limitations/implications– Two concepts are identified: reasonable reliance on others and the business judgement rule. The authors present arguments that challenge us to understand reasonable reliance, judgement and actions of directors in light of processing and information scepticism.Practical implications– Directors do have a different role to that of auditors; incorporating scepticism can enable directors to fulfil their responsibility towards shareholders. By applying information and process scepticism, directors of companies can reduce the likelihood and magnitude of litigation costs and out-of-court settlements.Originality/value– This paper provides a framework to apply scepticism to information and processes provided by people on whom the directors may rely.