Rare insights from the Federal Court on the business judgment rule
The ‘business judgment rule’ recognises the inherent risks associated with making business decisions and that bad outcomes do not necessarily mean that directors have breached their duty. Since it was incorporated into the Corporations Act 2001 (Cth) (Act) 15 years ago, it has been seldom invoked. Nevertheless, while its practical relevance has arguably been limited, the business judgment rule has proven to be a successful defence in a recent decision of the Federal Court.
The business judgment rule
The business judgment rule means a director is taken to have met their duty of care and diligence if they:
- make the judgment in good faith, and for a proper purpose
- do not have a material personal interest in the subject matter of the judgment
- inform themselves about the relevant subject matter to the extent they reasonably believe to be appropriate, and
- rationally believe that the judgment is in the company’s best interests.1
In the recent decision of the Federal Court in ASIC v Mariner Corporation Limited, the business judgment rule proved successful as a defence raised by three directors, with the Federal Court providing some compelling insights regarding, amongst other things, the courts allowing for ‘reasonable’ risk-taking and not relying too heavily on the benefit of hindsight.
In summary, ASIC contended that Mariner Corporation Limited (Mariner) and its three directors had breached the Act by announcing an off-market takeover bid without sufficient funding to undertake the bid itself (and in the absence of any secured third party funding), in addition to making an offer at a price lower than that required under the Act (having acquired shares at a greater price in the prior four months).
The Federal Court’s assessment of a ‘reasonable’ belief
Importantly, Beach J made reference to the comments of Austin J fromAustralian Securities and Investments Commission v Rich, reiterating that the reasonableness of a director’s belief should be assessed by reference to a range of factors, including:
- the importance of the business judgment to be made
- the time available for obtaining information
- the costs related to obtaining information
- the director or officer’s confidence in those exploring the matter
- the state of the company’s business at that time and the nature of competing demands on the board’s attention, and
- whether or not material information was reasonably available to the director.
An allowance for risk-taking, without the benefit of hindsight
Beach J, in assessing allegations made by ASIC against the three directors, emphasised that courts must balance the foreseeable risk of harm to the company against the potential benefits that could reasonably be expected to ensue as a result of their conduct. As Beach J acknowledged, directors are expected to take calculated risks, the role of a director essentially being to balance risk and reward.
In this regard, whether a particular risk is foreseeable in any given case should, according to the Federal Court, be judged by what the director knew or ought to have known at the time, and not with reference to hindsight. Beach J provided some particularly thought-provoking comments, recognising that ASIC is invariably required to second guess judgment calls made by directors in reliance on a paper-based analysis, and always with the benefit of hindsight, which does not adequately take into account:
- the reality of the timeframe directors are required to act within, and
- the speed at which decisions have to be made in real time, and often under considerable external pressures (whether time or otherwise).
It is therefore unreasonable to have regard only to the potential dangers and disadvantages to a director’s decision, without acknowledging the potential benefits that were weighed by the director in their decision-making process, and which (in some cases) could just as easily have been the end result.
In Mariner’s case, the court opined that even if one or more of the alleged risks of harm were reasonably foreseeable, the danger they posed was minimal, and the countervailing benefits of Mariner pursuing the proposed takeover bid were significant, substantially outweighing such risks.
This case is an important reminder for all directors of the multitude of factors that should be taken into consideration in decision-making processes, but also an important step forward with the Federal Court recognising the ‘safe harbour’ that was originally intended by the introduction of the business judgment rule.
Will ASIC v Mariner Corporation Limited expand protection?
Importantly, the Mariner case illustrates that the rule can offer a successful defence in relation to a decision concerning a significant transaction (not just a regular operational matter). The case may prompt further exploration and use of the defence in other matters. That said, directors must be aware of all of the elements of the business judgment rule. It does not cover decisions in which a director has a material personal interest. The Mariner case also illustrates the onus on the directors to inform themselves about the subject matter of the judgment.
Notably, the ‘business judgment rule’ is not itself a defence to contravention of other duties, including misuse of position, misuse of information and solvency obligations.
Finally, the manner in which board minutes are kept is a topic of a great deal of commentary. In circumstances where the ‘business judgment rule’ is likely to be relied upon, it is critical that the minutes contemporaneously reflect the appropriate consideration of the Board.