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A “SAFE HARBOUR” FOR DIRECTORS IN SOUTH

AFRICA? A COMPARATIVE STUDY OF THE BUSINESS

JUDGMENT RULE

by

ANNA ELIZABETH OOST

submitted in accordance with the requirements

for the degree of

DOCTOR OF LAWS

at the

UNIVERSITY OF SOUTH AFRICA

SUPERVISOR: PROF IM ESSER

CO-SUPERVISOR: PROF MK HAVENGA

JULY 2020

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DECLARATION

Name: Anna Elizabeth Oost

Student number: 34861440

Degree: LLD

A “SAFE HARBOUR” FOR DIRECTORS IN SOUTH AFRICA? A COMPARATIVE

STUDY OF THE BUSINESS JUDGMENT RULE

I declare that the above thesis is my own work and that all sources that I have used or quoted

have been indicated and acknowledged by means of complete reference.

I further declare that I submitted the thesis to originality checking software and that it falls

within the acceptable parameters of originality.

__________________________ _____________________

SIGNATURE DATE

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SUMMARY

Section 76(4) of the Companies Act 71, 2008 has introduced into South African company law

a provision which one may regard as providing a “safe harbour” for directors against a breach

of their fiduciary duty to act in the best interest of the company and their duty of care, skill,

and diligence. Should directors in South Africa meet the requirements of the business judgment

rule, they will be safe from incurring any personal liability.

The Companies Act, 2008 has also partially codified directors’ duties in section 76(3). It is

shown that the South African business judgment rule applies only to directors’ codified

fiduciary duty to act in the best interest of the company and their duty of care, skill, and

diligence.

The main aim of this study is to make recommendations in an attempt to improve/refine the

formulation of the current section 76(4) of the Companies Act, 2008. These recommendations

are based on the comparisons drawn between the jurisdictions examined (US, UK and

Australia). I selected these jurisdictions for the comparative survey for specific reasons in

order to recommend an improved and more effective version of section 76(4).

Although the UK does not include a statutory business judgment rule in its Companies Act,

the consideration of this jurisdiction is relevant for two reasons. First, to enrich the discussion

by ascertaining why the country opted not to include the rule in its Companies Act, 2006. But

also, the company law of the other jurisdictions discussed, including South Africa, were based

on English law so it remains relevant for purposes of comparing the significance and

application of the business judgment rule in the different jurisdictions.

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OPSOMMING

Artikel 76(4) van die Maatskappywet 71, 2008 het in die Suid-Afrikaanse maatskappywet 'n

bepaling ingestel wat 'n mens kan beskou as die verskaffing van 'n “veilige hawe” vir direkteure

teen 'n oortreding van hul fidusiêre plig om in die beste belang van die maatskappy en hul plig

van sorg, vaardigheid en ywer op te tree. Sou direkteure in Suid-Afrika aan die vereistes van

die sake-oordeelreël voldoen, sal hulle beskerming geniet teen enige persoonlike

aanspreeklikheid.

Die Maatskappywet, 2008 het ook direkteure se pligte gedeeltelik gekodifiseer in artikel 76(3).

Daar word getoon dat die Suid-Afrikaanse sake-oordeel reël slegs van toepassing is op

direkteure se gekodifiseerde fidusiêre plig om in die beste belang van die maatskappy op te

tree en op hul plig van sorg, vaardigheid en ywer. Die hoofdoel van hierdie studie is om

aanbevelings te maak in 'n poging om die formulering van die huidige artikel 76(4) van die

Maatskappywet, 2008, te verbeter/te verfyn. Hierdie aanbevelings is gebaseer op die

vergelykings getrek tussen die jurisdiksies ondersoek (VSA, die Verenigde Koninkryk en

Australië). Ek het hierdie jurisdiksies om spesifieke redes gekies vir die regsvergelykende

studie om 'n verbeterde en meer effektiewe weergawe van artikel 76(4) aan te beveel.

Alhoewel die Verenigde Koninkryk se Maaatskappywet nie 'n statutêre sake-oordeelsreël

insluit nie, is die oorweging van daardie jurisdiksie om twee redes relevant. Eerstens om die

bespreking te verryk deur vas te stel waarom die reël nie in die Maatskappywet, 2006, ingesluit

is nie. Maar ook bly die jurisdiksie relevant vir doeleindes van die vergelyking en toepassing

van die sake- oordeelsreël in die ander jurisdiksies, insluitend Suid-Afrika, omdat hul

maatskappyereg aanvanklik op die Engelse reg gebaseer was.

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KAKARETSO

Karolo ea 76 (4) ea Molao oa Likhamphani 71, 2008 e kentse molao oa khamphani oa Afrika

Boroa tokisetso e fanang ka “kamohelo e sireletsehileng” bakeng sa batsamaisi khahlanong le

tlolo ea mosebetsi oa bona oa botsitso ho sebetsa molemong oa k’hamphani le mosebetsi oa

bona tlhokomelo, boiphihlelo, le mafolofolo. Ha batsamaisi Afrika Boroa ba ka fihlela litlhoko

tsa molaoana oa kahlolo ea khoebo, ba tla bolokeha hore ba se ke ba itlama ka molato.

Molao oa Likhamphani, 2008 o boetse o na le likarolo tse 'maloa tsa batsamaisi ba likarolo tse

ka Karolong ea 76 (3). Ho bonts'oa hore kahlolo ea khoebo ea khoebo ea Afrika Boroa e sebetsa

feela ho batsamaisi mosebetsi o felletsoeng oa ho etsa lintho molemong oa k'hamphani le

boikarabello ba bona ba tlhokomelo, boiphihlelo le mahlahahlaha. Mesebetsi ena e e lekola

khaolong e sebetsanang le Afrika Boroa bakeng sa phetheho.

Sepheo sa mantlha sa thuto ena ke ho etsa litlhahiso molemong oa ho ntlafatsa le ho ntlafatsa

sebopeho sa karolo ea 76 (4) ea Molao oa Likhamphani, 2008. Litlhahiso tsena li ipapisitse le

papiso e bapisoang pakeng tsa matla a molao a hlahlojoang (US, UK. le Australia). Ke ile ka

leka ho nka meeli e meng ho latela khetho le tlhahlobo ka hloko ho khothaletsa mofuta oa

ntlafatso oa karolo ea 76 (4).

Le ha UK e ne e sa kenyeletse molao oa kahlolo ea khoebo e amanang le molao o bohlokoa

moqoqong ona hore na ke hobaneng ha UK e khethileng ho se kenye molao ho Molao oa

Likhamphani, 2006 le ho bapisa bohlokoa ba molao oa kahlolo ea khoebo ka ho fapaneng

melao.

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Key terms:

Business decision, Business judgment rule, Codification, Company, Directors, Duty of care,

Fiduciary duties, Liability, Officers, Safe harbour, Australia, Delaware, United Kingdom

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ACKNOWLEDGEMENTS

My sincere appreciation is extended to my promotors, Prof M Havenga and Prof IM Esser for

their support and guidance throughout. Your comments were invaluable and guided me to

completion.

I should also like to thank the team at the Unisa library who assisted me with locating sources

and Neville Botha who attended to the editing of the thesis.

My gratitude also goes to my employer – but especially to Shaun Maharaj – for his motivation

throughout the process.

I am deeply grateful for the support, patience, and love I have received from my family.

Without your support this would not have been possible. I love you all greatly.

Lastly, to God my Savior. He was with me throughout my journey and without Him affording

me the ability to complete this thesis it would not have been possible.

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TABLE OF ABBREVIATIONS

AICD Australian Institute of Company Directors

ALI American Law Institute

ASIC Australian Securities and Investment Commission

BCCI Bank of Credit and Commerce International

CLERP Corporate Law Reform Program

CLRSG Company Law Review Steering Group

FEDUSA Federation of Unions of South Africa

JSE Johannesburg Stock Exchange

NSW New South Wales

UK United Kingdom

US United States of America

VBS Venda Building Society

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TABLE OF CONTENTS

DECLARATION............................................................................................. 2

SUMMARY……………..………………………………………………… 3

KEY TERMS ………………………………………………………………

6

ACKNOWLEDGMENTS ……………………………………….................. 7

TABLE OF ABBREVIATIONS …………………………………………… 8

TABLE OF CONTENTS …………………………………………………… 9

1. CHAPTER 1: INTRODUCTION …………………………….

17

1.1 INTRODUCTION ………………………………………………………

17

1.2 PURPOSE OF THE STUDY ………………………………………….. 23

1.3 SAFE HARBOUR ……………………………………………………… 25

1.4 RESEARCH METHODOLOGY ………………………………………

1.4.1 Literature study ………………………………………………………………..

1.4.2 Legal comparative study ………………………………………………………

1.4.3 Outline of the study …………………………………………………………….

27

27

27

28

1.6 REFERENCE TECHNIQUES …………………………………………

30

2. CHAPTER 2: UNITED STATES OF AMERICA …………...

32

2.1 INTRODUCTION ………………………………………………………

32

2.2 UNITED STATES CORPORATION LAW: HISTORICAL

OVERVIEW …………………………………………………………………

2.3 DIRECTORS’ DUTY OF CARE, SKILL AND DILIGENCE….…….

36

39

10

2.3.1 Background …………………………………………………………………….

2.3.2 Smith v Van Gorkom …………………………………………………………...

39

43

2.4 THE BUSINESS JUDGMENT RULE ………………………………..

2.4.1 Background ……………………………………………………………………

2.4.2 Elements of the business judgment rule ……………………………………..

2.4.2.1 Business decision ………………………………………………………

2.4.2.2 Informed basis ……………………………………………………………

2.4.2.3 Good faith ………………………………………………………………..

2.4.2.4 Independent and without conflicts of interest ……………………………

2.4.3 Rationale for the business judgment rule ……………………………………..

2.4.3.1 Encouraging directors to serve and take risks ……………………………

2.4.3.2 Avoiding judicial infringement in business decisions …………………

2.4.3.3 Preserving the board’s governance role ………………………………….

2.4.4 Two formulations of the business judgment rule in the United States of

America …………………………………………………………………………..

2.4.4.1 The Delaware business judgment rule …………………………………..

2.4.4.2 American Law Institute’s business judgment rule ……………………...

47

47

49

51

51

52

53

53

54

55

55

57

57

63

2.5 APPLICATION OF THE DIRECTORS’ DUTY OF CARE AND

THE BUSINESS JUDGMENT RULE IN DELAWARE AND NEW

YORK CASE LAW AFTER SMITH V VAN GORKOM ……………

2.5.1 Unocal Corp v Mesa Petroleum Corp ………………………………………..

2.5.2 Revlon Inc v MacAndrews & Forbes Holdings Inc ……………………..…..

2.5.3 Paramount Communication Inc v QVC Network Inc ………………………

2.5.4 Krasner v Moffet ………………………………………………………………

2.5.5 Emerald Partners v Berlin ……………………………………………………

2.5.6 In re Family Dollar Stockholder Litigation ………………………………….

66

67

68

70

72

73

76

11

2.5.7 In re MFW Shareholder Litigation …………………………………………….

2.5.8 In re KKR Financial Holdings LCC Shareholder Litigation ………………..

2.5.9 Singh v Attenborough …………………………………………………………

2.5.10 In re Integrated Resources Inc ………………………………………………

2.5.11 In re Kenneth Cole Production, Inc, Shareholder Litigation ………………

78

79

79

81

82

2.6 TABLE: LEGAL REQUIREMENTS AND APPLICATION OF THE

US BUSINESS JUDGMENT RULE …………………………………

83

2.7 CONCLUSION ………………………………………………………...

86

3. CHAPTER 3: UNITED KINGDOM ………………………….

93

3.1 INTRODUCTION ……………………………………………………….

93

3.2 UNITED KINGDOM COMPANY LAW: HISTORICAL

OVERVIEW ……………………………………………………………..

3.2.1 South Sea Bubble ………………………………………………………………

3.2.2 Period after the South Sea Bubble: 1844-1900s ……………………………...

3.2.3 Period from 1844 – 1998 ………………………………………………………

95

95

98

100

3.3 UNITED KINGDOM COMPANY LAW AND CORPORATE

GOVERNANCE REVIEW ……………………………………………

3.3.1 Cadbury Report ………………………………………………………..

3.3.2 Greenbury Report ……………………………………………………..

3.3.3 Hampel Report ………………………………………………………...

3.3.2 Company Law Review Process Prior to Promulgation of the

Companies Act, 2006 …………………………………………………………

107

107

110

111

113

3.4 THE STATUTORY DUTY OF CARE, SKILL AND DILIGENCE …

118

3.5 REASONS WHY THE UNITED KINGDOM OPTED NOT TO

INCLUDE THE STATUTORY BUSINESS JUDGMENT RULE

12

IN THE COMPANIES ACT, 2006 ……………………………………..

126

3.6 CONCLUSION …………………………………………………………..

138

4. CHAPTER 4: AUSTRALIA …………………………………

144

4.1 INTRODUCTION ……………………………………………………..

144

4.2 AUSTRALIAN CORPORATION LAW: HISTORICAL

OVERVIEW ……………………………………………………………

146

4.3 AUSTRALIAN DIRECTORS’ DUTY OF CARE, SKILL AND

DILIGENCE BEFORE THE PROMULGATION OF SECTION

180(1) OF THE CORPORATIONS ACT, 2001 ……………………..

4.3.1 Directors’ common-law duty of care ………………………………………..

4.3.2 Directors’ statutory duty of care before AWA Ltd v Daniels ….……………..

4.3.3 AWA Ltd v Daniels ……………………………………………………………...

4.3.4 Reform programme ………………………………………………………….

154

154

155

160

165

4.4 THE STATUTORY DUTY OF CARE AND DILIGENCE UNDER

SECTION 180(1) OF THE AUSTRALIAN CORPORATIONS

ACT, 2001 ……………………………………………………………….

168

4.5 THE STATUTORY BUSINESS JUDGMENT RULE ………………

4.5.1 Section 180(2) of the Corporations Act, 2001 ………………………………

4.5.2 Application of the business judgment rule in case law …………………….

4.6 TABLE: LEGAL REQUIREMENTS AND APPLICATION OF

THE AUSTRALIAN BUSINESS JUDGMENT RULE ……………….

181

181

188

200

4.7 CONCLUSION ………………………………………………………….. 202

5. CHAPTER 5: SOUTH AFRICA ………………………………

208

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5.1 INTRODUCTION ……………………………………………………….

208

5.2 SOUTH AFRICAN COMPANY LAW: HISTORICAL

OVERVIEW……………………………………………………………...

210

5.3 DIRECTORS IN SOUTH AFRICA ………………………………….

5.3.1 Executive and non-executive directors ………………………………………

5.3.2 De facto and shadow directors ……………………………………………….

5.3.3 De jure and nominee directors ……………………………………………….

5.3.4 Temporary directors ………………………………………………………….

5.3.5 Puppet directors ………………………………………………………………

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216

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220

221

222

5.4 DIRECTORS’ DUTIES IN SOUTH AFRICA ………………………

5.4.1 Directors’ duty to act in the best interest of the company …………………

5.4.2 Directors’ duty of care, skill and diligence ……………………................

5.4.2.1 Common-law duty of care, skill and diligence ………………………..

5.4.2.2 The duty of care, skill and diligence before the Companies Act, 2008….

5.4.2.2.1 The Companies Act 61 of 1973 …………………………….

5.4.2.2.2 The King Reports …………………………………………...

a) King I ………………………………………………………

b) King II ……………………………………………………..

c) King III …………………………………………………..

d) King IV …………………………………………………….

5.4.2.2.3 The Department of Trade and Industry’s Guidelines for

Company Reform …………………………………………..

5.4.2.3 The duty of care, skill and diligence in the Companies Act, 2008 …….

223

224

236

236

243

243

247

247

250

255

257

258

259

5.5 THE BUSINESS JUDGMENT RULE …………………………………

266

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5.5.1 Arguments for and against the statutory business judgment rule ………….

5.5.2 The South African statutory business judgment rule ……………………….

5.5.2.1 Legal requirements …………………………………………………….

a) Business judgment ………………………………………………….

b) Informed business judgment ……………………………………….

c) Decision made in the best interest of the company ………………...

d) Personal interest ……………………………………………………

5.5.2.2 Application of the rule ………………………………………………..

a) Good faith and proper purpose ……………………………………

b) Directors’ duties …………………………………………………..

c) Common law ……………………………………………………...

d) Directors and officers …………………………………………….

e) Safe harbour or presumption ………………………………………

5.5.2.3 Abstention and immunity doctrines and standard-of-liability test …..

266

270

271

271

273

278

280

284

284

285

287

289

289

292

5.6 TABLE: LEGAL REQUIREMENTS AND APPLICATION OF

THE SOUTH AFRICAN BUSINESS JUDGMENT RULE ………..

298

5.7 CONCLUSION …………………………………………………………

299

6. CHAPTER 6: CONCLUSION AND

RECOMMENDATIONS ………………………………………

310

6.1 INTRODUCTION ………………………………………………………

310

6.2 COMPARISON OF THE OWNERSHIP STRUCTURES,

SHAREHOLDER MODELS AND AGENCY

COST PROBLEMS ……………………………………………………..

313

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6.3 JURISDICTIONAL COMPARISONS OF THE PROTECTION

THE BUSINESS JUDGMENT RULE OFFERS AND

RECOMMENDATIONS……………………………………………….

6.3.1 Legal requirements …………………………………………………………….

6.3.1.1 Business judgment ………………………………………………………

6.3.1.2 Informed business judgment ……………………………………………

6.3.1.3 Best interest of the company ……………………………………………

6.3.1.4 Personal interest ………………………………………………………...

6.3.2 Application of the business judgment rule …………………………………..

6.3.2.1 Good faith and proper purpose …………………………………………

6.3.2.2 Directors’ duties ………………………………………………………..

6.3.2.3 Common law …………………………………………………………...

6.3.2.4 Directors and officers …………………………………………………..

6.3.2.5 Safe harbour or presumption …………………………………………….

319

319

319

323

327

331

336

336

338

340

342

343

6.4 TABLE: COMPARISON OF THE BUSINESS

JUDGMENT RULE IN DIFFERENT JURISDICTIONS …………..

346

6.5 PROPOSED NEW SECTION 76(4) OF THE

COMPANIES ACT, 2008 ………………………………………………

349

BIBLIOGRAPHY ………………………………………………..

353

BOOKS AND THESES ……………………………………………………

353

JOURNAL ARTICLES AND PAPERS ………………………………….

367

TABLE OF STATUTES, CODES AND BILLS …………………………

AUSTRALIA ……………………………………………………………….

381

381

16

UNITED KINGDOM ……………………………………………………….

UNITED STATES OF AMERICA …………………………………………

SOUTH AFRICA ……………………………………………………………

383

383

384

TABLE OF CASE LAW …………………………………………………..

AUSTRALIA ………………………………………………………………..

UNITED KINGDOM ……………………………………………………….

UNITED STATES OF AMERICA …………………………………………

SOUTH AFRICA …………………………………………………………...

384

384

386

387

393

REPORTS ………………………………………………………………….

AUSTRALIA ……………………………………………………………….

UNITED KINGDOM ………………………………………………………

UNITED STATES OF AMERICA ………………………………………..

SOUTH AFRICA …………………………………………………………..

396

396

396

397

397

INTERNET SOURCES …………………………………………………..

398

OTHER SOURCES ………………………………………………………

405

INDEX …………………………………………………………………….

406

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CHAPTER 1

1.1 INTRODUCTION

In recent decades the corporate world has experienced major financial collapses

resulting, in the main, from board mismanagement. Much has been written about the

concept “corporate governance” but there is still uncertainty regarding the exact meaning

of the term. Many economists, academics, and other commentators have attempted to

define it in various ways. The Cadbury Committee on Financial Aspects of Corporate

Governance’s Final Report and Code of Best Practice (Cadbury Report)1 defines

corporate governance as “the system by which companies are directed and controlled”.

This definition remains for many the most authoritative.2

The Enron3 and WorldCom4 group of companies in the United States of America (the

US) are notable examples of corporate collapses internationally. South Africa has had

1 Cadbury Committee on Financial Aspects of Corporate Governance Final Report and Code of Best Practice

1992 para 2.5. 2 Committee on Corporate Governance, Final Report, January 1998 para 1.16 (the “Hampel Report”); Keasy,

Thompson & Wright Corporate Governance 22; and Morris et al Finance Director’s Handbook 268. 3 “On 16 October 2001, Enron stunned Wall Street by announcing that it had a $618 million net loss for the third

quarter and would reduce shareholder equity by $1.2 billion. On 17 October, the SEC lodged an inquiry. The

following Friday, Enron notified its auditor, Arthur Andersen, that the SEC had initiated an inquiry into Enron’s

financial accounting practices. Four days later, Andersen’s Enron engagement team began the wholesale

destruction of Enron-related documents. Andersen and its lead partner on the Enron audit team stood convicted

of obstruction of justice, four former Enron executives pleaded guilty to fraud charges, and Enron’s chief financial

officer was indicted on 98 counts of fraud and related offences. Enron is bankrupt, and civil and criminal

investigations continue to examine Enron’s complex accounting practices, and deceitful financial schemes.” See

Brickey (2003) 81 Washington University Law Review 357. See also Fox Enron: The Rise and Fall 1-5 and

Collins Ethical Lessons from Enron 1-162. 4 “On 25 June 2002, WorldCom, a large long-distance telecommunications company, announced that it had

overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion. WorldCom filed for bankruptcy

protection on 21 July 2002. On 8 August, the company announced that it had also manipulated its reserve accounts

in recent years, affecting an additional $3.8 billion. The response in Washington was swift. On 26 June, the SEC

charged the company with massive accounting fraud and quickly obtained a court order barring the company from

destroying financial records, limiting its payments to past and current executives, and requiring an independent

monitor. Several company officials have been indicted.” See CRS Report for Congress Order Code RS21253

available at research.policyarchive.org/3622.pdf (accessed: 01/02/2017). Monks & Minow Corporate

Governance 577-579; Fernando Business Ethics and Corporate Governance 15.29.

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similar experiences – the Saambou,5 Masterbond, and Fidentia6 scandals of the late 1990s

are among the most notable.7 To illustrate: Masterbond was at the time South Africa’s

biggest corporate scandal and involved more than R600 million – most of it drawn from

pension funds.8 Three Masterbond directors were arrested, charged and on conviction on

multiple counts of fraud, each imprisoned for ten years.9 The trio had fraudulently

claimed that their company, Masterbond, was a registered bank whose deposits would

be protected by the South African Reserve Bank. They then procured deposits from

individuals, claiming to purchase land on which they would develop residential estates

and shops. However, most of these developments were fictitious and in many cases

Masterbond claimed to have purchased land that was in fact in the sea.10

In a keynote address the then South African Director-General of Trade and Industry,

Tshediso Matona, stated:

5 “Saambou was South Africa’s seventh-largest bank prior to its collapse in 2002. The bank’s failure occurred

when depositors lost their confidence and frantically withdrew over R1 billion of savings. When the bank went

under curatorship in February 2002, it had 35 000 clients as well as R16 billion in assets. In 2005, Saambou

Bank’s CEO and two directors were arrested. The men faced ten charges of fraud, one of theft, as well as two of

contravening the Companies Act, 1973. They pleaded not guilty to the charges. The charges, which entailed

R640 000 000, resulted from allegations that certain schemes undertaken had not taken into account the risk to

the company and separate disclosures had not been provided of the schemes concerned in the financial statements

of Saambou Bank and Saambou Holdings, as is required by law. In the Pretoria High Court Van der Merwe J

handed down a lengthy judgment in which he discharged the former head of Saambou Bank group finance, De

Clercq, and former senior manager and executive director Edwards on 13 criminal charges. He criticised the

state's chief witness, forensic accountant Johan van der Walt, for not investigating the matter properly, ignoring

or misinterpreting important documents, and incorporating irrelevant detail in his forensic report.” See

http://personalfinance.iafrica.com/scamwatch/129332.html (accessed: 15/05/2017). For a detailed discussion of

the Saambou collapse see Mbuya Rise and Fall of Saambou Bank 7-134. See further, Pretorius Beyond Play Ch

12. 6 “The Western Cape based asset management company, Fidentia, was placed under provisional curatorship by

the Cape High Court in February 2007. The Financial Services Board inspectors could not trace R680 million of

the almost R2 billion taken from various investors. Much of the money was owed to widows and orphans of

deceased members of the Mine Workers Provident Fund.” See Haupt et al Introduction to Law 165. 7 Steenkamp Fidentia 26. 8 For a full report on Masterbond see The Final Report of the Commission of Inquiry into the Affairs of the

Masterbond Group and Investor Protection in South Africa 2001 available at

http://www.gov.za/sites/www.gov.za/files/nel_com_masterbond_0.pdf (accessed: 02/02/2017). 9 The three directors of Masterbond: Joncker, Winkler, and Brits. See https://www.moneyweb.co.za

/archive/masterbond-lawyer-kills-himself/ (accessed: 02/02/2017). 10 Final Report of the Commission of Inquiry into the Affairs of the Masterbond Group and Investor Protection

in South Africa 2001 available at https://www.gov.za/documents/nel-commission-inquiry-affairs-masterbond-

group-and-investor-protection-south-africa (accessed: 02/02/2017).

https://www.moneyweb.co.za/

19

Events at Fidentia happened at an opportune time for us to be able to identify some

weaknesses in our corporate governance regime.11

More recently, South Africa has been faced with the KPMG and Steinhoff scandals.

KPMG, a leading auditing firm in South Africa, was implicated in a scandal relating to

the “Gupta wedding”.12 The media reported that KPMG had failed to challenge the

allegedly irregular treatment of expenses for the Gupta wedding. The reports were based

on emails posted on the amaBhungane website, which gave an account of events

surrounding the 2014 wedding. The emails indicated that KPMG had been aware that

the Gupta family companies were categorising the wedding costs as business expenses,

which meant they could be deducted for tax purposes.13 As a consequence there were a

number of leadership changes within KPMG. Amongst others, the Chief Executive

Officer and the Chief Operations Officer resigned.14 In addition to the leadership change

KPMG undertook to strengthen its corporate governance structures.15

The Steinhoff saga has been labelled by the general secretary of the Federation of Unions

of South Africa (“FEDUSA”) as the biggest scandal to hit South Africa. Investor fear

has resulted in a loss of as much as R282 billion in market value for Steinhoff and a

11 Matona “Keynote Address” Director-General: Trade and Industry Conference on South African Company Law

for the 21st Century 2007. The current Director-General of the Department of Trade and Industry is Lionel

October, who was appointed on 21 April 2011. See http://www.dti.gov.za/about_dti.jsp (accessed: 03/02/2017). 12 The wedding, held in June 2013 at Sun City is also referred to as “Guptagate”. The Gupta family, originating

from India, arrived in South Africa in 1993. They established businesses in South Africa with their most notable

business being a computer assembly and distribution company called Sahara Computers. The Gupta family has

ties to former president of South Africa, Jacob Zuma. Zuma has openly acknowledged his friendship with the

family, most notably during a discussion in the National Assembly on 29 June 2013. See

https://citizen.co.za/news/south-africa/1334530/who-are-the-guptas-details-according-to-madonsela/ (accessed:

15/05/2019). “The friendship between the Gupta family and former president Zuma has since been embroiled in

scandal with Zuma being accused of having a corrupt relationship with the Gupta family, and even allowing them

to interfere in ministerial appointments.” See Pauw The President’s Keepers at 70, 72, 159 & 168. 13 See https://www.businesslive.co.za/bd/companies/financial-services/2017-06-30-kpmg-to-be-investigated-for-

audit-of-linkway/ (accessed: 19/12/2017). 14 See full statement: KPMG execs quit over Gupta, SARS report available at https://www.fin24.com/

Companies/Financial-Services/full-statement-kpmg-execs-quit-over-gupta-sars-report-20170915 (accessed:

14/01/2020). 15 Ibid.

20

further seven companies linked to the Steinhoff group. The loss was prompted by

concerns over accounting irregularities and possible fraud at the furniture and household

goods retailer.16 As a result of the losses Steinhoff International Holdings NV held a

general meeting of shareholders in April 2018. At the general meeting the supervisory

board was restructured in an attempt to improve corporate governance.17

Another scandal relates to the Venda Building Society (“VBS”) which bank was

established in 1982 by the Venda Homeland Government to assist small communities to

invest trough the Mutual Banks Act 124 of 1993.18 Within the bank’s management

system, depositors became shareholders with voting rights. In 2016 the bank granted then

President Jacob Zuma a loan of around R7 million to pay back his debt for the upgrades

on his Nkandla home.19 During this same period, Zuma became one of the bank’s major

shareholders. This changed the small regional bank to a national bank overnight.20

Shortly after this, African National Congress-controlled councils in Limpopo and one in

Gauteng started depositing money into VBS bank. These funds were then redirected to

bank executives like Mphephu Ramabulana, politicians and other implicated

individuals.21 In 2018 the bank collapsed, unable to pay its customers.22

16 Steinhoff's South African brands include HiFi Corp, Pennypinchers, Timbercity, Pep, Ackermans, Shoe City,

Incredible Connection, and Unitrans. See https://www.fin24.com/Companies/Retail/steinhoff-hits-junk-as-

r282bn-in-value-is-lost-20171210 (accessed: 19/12/2017). 17 See the Steinhoff Saga: Part two – The board that looked the other way available at

https://www.fin24.com/Opinion/the-steinhoff-saga-part-two-the-board-that-looked-the-other-way-20180628

(accessed: 14/01/2020). 18 See https://www.forensics4africa.com/the-vbs-scandal (accessed:08/11/2021). The Mutual Banks Act 124 of

1993 requires that Mutual Banks be regulated by the Reserve Bank. 19 https://www.forensics4africa.com/the-vbs-scandal (accessed:08/11/2021). 20 Ibid. 21 Ibid. 22 Ibid. See also https://ewn.co.za/2020/06/17/from-bank-heist-to-arrests-a-timeline-of-the-vbs-scandal

(accessed: 08/11/2021).

21

These corporate collapses and scandals have driven many countries to reconsider

whether in the current commercial world, company directors meet the standard of care

that shareholders expect. Many countries have revised their company and related

legislation to increase directors’ duties and liabilities. These countries include Ireland,

Australia, Italy, Spain, China, the United Kingdom, Japan, Canada, and the US.23

South Africa embarked on a corporate governance review process beginning with the

King Report on Corporate Governance, 1994;24 this was followed by the King Report

on Corporate Governance, 2002;25 and the King Report on Corporate Governance,

2009. The latest development in the process is the King Report on Corporate

Governance, 2016.26 In addition, in 2004, the Department of Trade and Industry issued

a policy paper entitled South African Company Law for the 21st Century: Guidelines for

Corporate Law Reform.27 The Minister of Trade and Industry at the time stated that the

Department’s decision to review and modernise company law in this country was

[b]ased on the need to bring our law in line with international trends and to reflect

and accommodate the changing environment for business, both in South Africa

and globally.28

23 Ferran (2005) 69 Rabel Journal of Comparative and International Private Law 1-37; Adams “Corporate law

reform: Evolution or revolution?” available at http://www.austlii.edu.au/au/journals/ALRS/2012/1.html

(accessed: 02/02/2017); Tan (1999) 10 Australian Journal of Corporate Law 1-29; Morita DH “Corporate Law

Reform in the People’s Republic of China” (2014) available at https://sydney.edu.au/law/anjel/

documents/2014/ZJR_37_02_Morita_9.pdf.’] (accessed: 03/02/2017). 24 The Institute of Directors in South Africa King Report on Corporate Governance for South Africa 1994 (King

I) available at http://www.iodsa.co.za (accessed: 14/03/2016). See further discussion of the King Reports in Ch 5

para 5.4.2.2.2. 25 The Institute of Directors in South Africa King Report on Corporate Governance for South Africa 2002 (King

II) available at http://www.iodsa.co.za (accessed: 14/03/2016). See Ch 5 para 5.4.2.2.2 (b). 26 The Institute of Directors in South Africa King Report on Corporate Governance for South Africa 2009 (King

III) available at http://www.iodsa.co.za (accessed: 14/03/2016). See Ch 5 para 5.4.2.2.2 (c); The Institute of

Directors also recently released the King Report on Corporate Governance for South Africa 2016 (King IV). See

Ch 5 para 5.4.2.2.2 (d). 27 Department of Trade and Industry Policy Paper South African Company Law for the 21st Century: Guidelines

for Corporate Law Reform 2004 (Policy Paper). See Ch 5 para 5.4.2.2.3. 28 Matona “Keynote Address” Director-General: Trade and Industry. Conference on South African Company

Law for the 21st Century 2007.

https://sydney.edu.au/

22

The company-law review process that followed involved consultations with industry

participants and company-law experts, and was aimed at the possibility of incorporating

international best practice in the South African context.29 The South African review

culminated in the Companies Act 71 of 200830 which largely repealed the Companies

Act 61 of 1973. There are, however, still certain provisions of the 1973 Companies Act

that remain in force.31 Of importance for this thesis is that the Companies Act, 2008,

partially codified the common-law duties of directors and introduced a South African

variant of the statutory business judgment rule into company law. 32

The business judgment rule, which was developed in the US alongside directors’ duty of

care, skill and diligence, is the topic of this thesis.33 The rationale underpinning the

business judgment rule are discussed in Chapter 2.34 In addition, Chapter 5, which

addresses South African law, highlights arguments for and against the incorporation of

a statutory business judgment rule from a South African perspective.35 The business

judgment rule protects a director from liability for a breach of his or her duties as a

director if the requirements set for the rule have been met.36

29 Department of Trade and Industry Companies Bill. Memorandum on the Objects of the Companies Bill 2008

para 1.1.5. 30 The Companies Act 71 of 2008 came into effect on 1 May 2011. 31 The provisions of Ch 14 of the Companies Act 61 of 1973 dealing with the winding up and liquidation of

insolvent companies, will continue to govern those matters. The intention is, at some stage, to introduce a new

and modern insolvency statute in South Africa in order comprehensively to govern insolvencies of all types of

entity. Secondly, certain provisions of the Companies Act, 1973, will continue to apply insofar as is required by

the ‘transitional arrangements’ of the Companies Act, 2008, as set out in Sch 5. 32 Section 76(3) of the Companies Act 71 of 2008 partially codifies directors’ fiduciary duties and the duty of

care. Section 76(4) of the Companies Act 71 of 2008 codifies the business judgment rule, as discussed in Ch 5

paras 5.4.2.3 & 5.5.2. 33 See Ch 2 paras 2.3 & 2.4; Ch 3 paras 3.4 & 3.5; Ch 4 paras 4.4 & 4.5; Ch 5 paras 5.4 & 5.5; and Ch 6 para 6.3. 34 These rationales include: encouraging directors to take risks; avoiding judicial infringement in business

decisions; and preserving the board’s governance role. See Ch 2 para 2.4.3. 35 See Ch 5 para 5.5.1. 36 In the US, the business judgment rule applies to directors’ fiduciary duties and the duty of care. See Ch 2 para

2.4. The UK did not include a statutory business judgment rule in the Companies Act, 2006. See Ch 3 para 3.5

for the reasons. The Australian business judgment rule applies only to the directors’ duty of care and diligence.

See Ch 4 para 4.5. In South Africa, the business judgment rule applies to a limited scope of fiduciary duties and

the duty of care, skill and diligence. See Ch 5 para 5.5.2.

23

It is important to discuss not only the business judgment rule, but also director’s duties

related to the rule more generally. Save for the chapter dealing with South African law,

this thesis addresses only the directors’ duty of care and not their fiduciary duties.37

Directors’ fiduciary duty to act in the best interests of the company is briefly discussed

in the South African chapter as in South Africa the statutory business judgment rule

applies to both the fiduciary duty to act in the best interests of the company, and to the

duty of care.38

This thesis discusses and compares various jurisdictions based on their codification and

application of directors’ duty of care and the business judgment rule. Based on the

review, recommendations are made with regard to the South African statutory business

judgment rule in section 76(4) of the Companies Act, 2008.39

1.2 PURPOSE OF THE STUDY

The purpose of the study is to answer the following principal research question: Should

and does the South African variant of the business judgment rule provide the same degree

of protection as other jurisdictions and does it provide a safe harbour for South African

directors to protect them against incurring liability for a breach of their duties. In

addition, based on the comparisons drawn between the different jurisdictions, the

purpose of the study is to make certain recommendations regarding section 76(4) of the

Companies Act, 2008, in an attempt to improve it.40 The discussion will not deal with

the consequences of applying the business judgment rule, but rather with whether the

37 See Ch 2 para 2.3; Ch 3 paras 3.3 and 3.4; Ch 4 paras 4.3 and 4.4; and Ch 5 para 5.4.2. 38 See Ch 5 para 5.5. It should be noted, however, that the South African version of the statutory business judgment

rule only applies to directors’ fiduciary duty to act in the best interests of the company and not to all fiduciary

duties. 39 See Ch 6 para 6.3. 40 Ibid.

24

rule is applied in the different jurisdictions, and if not, to establish the reasons why. If it

is applied, it will be established how and in what way the rule is applied. The main

question is to consider the business judgment rule in South Africa and compare it with

other jurisdictions in order to come to a conclusion on the way forward and on ways to

improve it. It is also the aim to ascertain whether directors in South Africa require

protection from the statutory business judgment rule to protect them from being found

liable for breach of their duties. To achieve the main aim and the ancillary objectives of

this thesis, a comprehensive literature study of relevant South African law together with

a study of comparable literature from the selected jurisdictions is undertaken

As was alluded to earlier, undertaking a discussion of the director’s duty of care will

enhance the study as the rule has been made an integral part of the rule under the 2008

Companies Act. The duty is also discussed from the context of the respective

jurisdictions considered in this study to ascertain the position of the duty vis-à-vis the

rule. Where codified, the reason why codification (partially or fully) was decided on,

and what implications this has on the application of the rule, if any, will be determined.41

The duty of care is discussed from both common and statutory law perspectives.42 Much

emphasis in the analysis is directed at the differences and similarities observed in the

application and, in certain instances, the codification of the rule in the jurisdiction

examined.43 The aim of the thesis is ultimately to examine the business judgment rule as

codified in section 76(4) of the South African Companies Act and to draw comparisons

between the way in which directors’ duties of care and skill are regulated in the

jurisdictions selected for comparative review.

41 See Ch 2 para 2.3; Ch 3 para 3.4; Ch 4 para 4.4; Ch 5 para 5.4.2.3. 42 See Ch 2 para 2.3; Ch 3 paras 3.3 & 3.4; Ch 4 paras 4.3 & 4.4; Ch 5 paras 5.4.2 & 5.4.2.3. 43 See Ch 5 para 5.5.

25

Critically, the analysis establishes whether for South African directors the statutory

business judgment rule constitutes a “safe harbour” against liability for breach of the

duties set out in section 76(3) of the Companies Act, 2008.44 In the conclusion, and based

on the comparative analysis of the interpretation of the business judgment rule in the

jurisdictions considered in this study, the study draws lessons and makes

recommendations to improve on the interpretation/application of the rule in the context

of South African company law. In this regard, one may argue/submit early on that the

South African version of the rule does exhibit/expose fundamental limitations and to the

extent one considers necessary improvements have been suggested to ensure that the rule

functions optimally and is able to be applied/interpreted so as to realise the purpose for

which it was intended.45

1.3 SAFE HARBOUR

A safe-harbour provision is a provision in a statute or regulation which reduces or

eliminates a party’s liability under the law, on condition that the party acted in good faith

or in compliance with defined standards.46 Legislatures may, for example, include safe-

harbour provisions to protect unintentional or excusable violations, or to incentivise the

adoption of the desired practice.47

44 See Ch 2 para 2.4; Ch 3 para 3.5; Ch 4 para 4.5; and Ch 5 para 5.5. 45 Ch 6 para 6.5. 46 Morrison (2013) 361 University of Michigan Law: Public law and Legal Theory Research 14. See discussion

of the business judgment rule as a safe harbour in Chapter 5 para 5.5.2.2 (e). 47 For the purposes of this thesis only the business judgment rule will be discussed but other examples of safe

harbours include exculpatory clauses in corporate constitutions; delegation and reliance; approval of directors’

conduct by shareholders or independent directors; indemnification by the corporation for damages; and directors

and officers insurance. See generally Conaglen & Hill (2017) 17 Sydney Law School: Legal Studies Research

Papers 1; Bhatia Legal Language and Legal Writing 328; Talbot Great Debates in Company Law 529; and

Ashford International Commercial Arbitration 231. A practical example of a safe-harbour provision is the safe-

harbour agreement between the European Union (the EU) and the US relating to the transfer of personal data

from EU member states to the US for commercial and trade purposes and vice versa. In order for US corporations

to qualify for protection under the safe-harbour provisions, they had to comply with the safe-harbour privacy

principles. These principles were set out in a European Commission Decision Document issued to clarify

circumstances under which the safe harbour would apply to US corporations. The principles allowed the US to

collect, retain, and process the personal data of European citizens based on an adequate level of protection and in

26

In terms of directors’ duties, it is argued by Conaglen and Hill that standards of conduct

that constitute directors’ duties (also known as “conduct rules”) are often relatively strict

and that legal safe harbours can dilute those rules resulting in the application of more

lenient standards of judicial review (known as “decision rules”).48 The potential gap

between conduct rules and decision rules – which has been labelled “acoustic separation”

– is, according to Conaglen and Hill, particularly striking in the context of the duty of

care.49

The study considers whether the South African business judgment rule is a safe harbour

or a presumption.50 It will be discussed that the US has two formulations of the business

judgment rule, namely the Delaware business judgment rule and the American Law

institute’s (“ALI”) business judgment rule.51 It will be shown that the Delaware business

judgment rule is a presumption whilst the ALI business judgment rule is a safe harbour

for directors against incurring liability for a breach of their duty of care.52 The UK

decided against including a statutory business judgment rule in its company law, but it

is still prevalent to discuss the UK law for reasons as set out below.53 The study will

further illustrate that the Australian business judgment rule is a safe harbour as opposed

to a presumption.54

line with EU regulations. If a US corporation adhered to these principles it would, under the safe-harbour

provision, be safe from incurring liability for any infringements relating to the retention, collection, and

processing of personal data. See De Busser Data Protection 115. 48 Conaglen & Hill (2017) 17 Sydney Law School: Legal Studies Research Papers 1. 49 Ibid. For a discussion of “acoustic separation” see Dan-Cohen (1984) 97 Harvard Law Review 625-677. 50 Ch 5 para 5.5.2.2 (e). 51 Ch 2 para 2.4.4.1; Ch 2 para 2.4.4.2. 52 Ibid. 53 Ch 1 para 1.4.3; Ch 3 para 3.5. 54 Ch 4 para 4.5.

27

1.4 RESEARCH METHODOLOGY

This study will use the research methodology described below to achieve the purposes

of the thesis.

1.4.1 Literature study

The research is conducted by means of a literature study of the business judgment rule

as applied in the selected international jurisdictions and South Africa.55 A chapter on the

UK has been included in this study as an example of a jurisdiction that opted not to

include the business judgment rule.56 The study uses a qualitative instead of a

quantitative approach, utilising desk-top primary sources such as legislation, case law,

and common law, and secondary sources such as commissioned reports, text books,

articles and other electronic material from various internet sites.

1.4.2 Legal comparative study

Because the business judgment rule is a statutory defence, statutory interpretation takes

precedence to principles which might have been developed through common law

interpretation of the rule. This however does not mean these common law interpretations

cannot be adopted if they fit within the legislative context. It is difficult to determine

exactly how South African courts will apply the business judgment rule in conjunction

with existing common law. Consequently, a comparative study of how the rule has been

applied in the jurisdictions selected is undertaken.57 This comparative approach is

particularly relevant as section 5(2) of the Companies Act, 2008, provides that:

55 Ch 2 para 2.4; Ch 4 para 4.5; Ch 5 para 5.5. 56 Ch 3 para 3.5. 57 Comparative law is the study of the differences and similarities between the laws of different countries. More

specifically, it involves the study of the different legal systems in existence in the world, including the common

law, the civil law, socialist law, Islamic law, Hindu law, and Chinese law. It includes the description and analysis

of foreign legal systems, even where no explicit comparison is undertaken. The importance of comparative law

28

To the extent appropriate, a court interpreting or applying this Act may consider

foreign company law.

This section complements section 5(1) of the Companies Act, 2008, which directs that

the Act be interpreted and applied in a manner that gives effect to the purpose of section

7 which provides, in turn, that:

One of the purposes of the Act is to continue to provide for the creation and use of

companies, in a manner that enhances the economic welfare of South Africa as a

partner within the global economy.58

1.4.3 Outline of the Study

A comparison with foreign law is provided in Chapters 2, 3 and 4.59 The jurisdictions

covered are the US, the United Kingdom (UK), and Australia.

Chapter 2 reviews the US’s framework for directors’ duty of care and the business

judgment rule with particular reference to the states of Delaware and New York. The US

is particularly relevant to the study as the business judgment rule originated in the US

and tracing how it has developed since its inception provides valuable insights. This is

especially relevant given that the rule has not been codified in the US.

has increased enormously in the present age of internationalism, economic globalisation, and democratisation.

Gutteridge Comparative Law 3; Watkins & Burton Research Methods in Law Ch 6; and Siems Methods of

Comparative Corporate Law 13. 58 Section 7 of the Companies Act 71 of 2008. 59 “Research methods can also include empirical research methods or historico-legal methods. Empirical research

is a way of gaining knowledge by means of direct and indirect observation or experience. Empirical evidence (the

record of one’s direct observations or experiences) can be analysed quantitatively or qualitatively. By quantifying

the evidence or making sense of it in qualitative form, a researcher can answer empirical questions, which should

be clearly defined and answerable with the evidence collected (usually termed data). Legal history is more than

the study of the development of material legal norms. It includes the analysis of these rules in the light of the

external legal history (the economic, cultural, political, social, philosophical, and religious development). The

analysis provides answers as to why a legal system has certain characteristics.” See Leeuw & Schmeets Empirical

Legal Research 2; Watkins & Burton Research Methods in Law Chs 3 and 5.

29

Chapter 3 examines UK company law. Although the South African Companies Act,

2008, has adopted elements from various jurisdictions, it is still based principally on

English law, which makes this chapter particularly relevant. 60 In both South Africa and

the UK, company law has been reformed in recent years – for example, in both countries

the duties of directors have been codified.61 The UK statute opted for full codification of

directors’ duties; whereas in South Africa a partial codification was adopted. As is

pointed out, the UK decided against including a statutory business judgment rule in its

company law. Why the UK chose to follow this route is explained in Chapter 3.62

Chapter 4 considers corporate law in Australia. Australian corporate law is of

comparative value when considering South African company law as it is also based on

English common law.63 It is therefore of interest to see how Australian corporate law

regarding directors’ duties has developed over the years and to compare the position in

South African company law. Australia, like South Africa, has included a statutory

business judgment rule in its corporate law by way of section 180(2) of the Corporations

Act, 2001. The drafting and application of the business judgment rule in the different

jurisdictions is compared.64

Chapter 5 is devoted to South African company law. Before the promulgation of the

Companies Act, 2008, directors’ rights and duties derived, in the main, from contracts

entered into with the company, the memorandum and articles of association, the

60Naidoo Essentials of Corporate Governance 10-12. 61 See s 170(3) of the Companies Act, 2006 (UK) and s 76(3) of the Companies Act 71 of 2008 (SA). See Ch 3

para 3.4 and Ch 5 para 5.4.2. 62 See Ch 3 para 3.5. 63 Du Plessis 2010 Acta Juridica 263. 64 See Ch 6 para 6.3.

30

Companies Act, 1973,65 and the common law. It is therefore important to discuss the

common law – which still applies – and the statutory position before the Companies Act,

2008, was adopted.66 The emphasis in this chapter is, however, on the incorporation of

the statutory business judgment rule in section 76(4) of the Companies Act, 2008. In

addition, the rule is discussed in conjunction with the duty of care as well as the fiduciary

duty to act in the best interests of the company under the Companies Act 2008. This

approach is necessitated by the fact that for a director to invoke the rule that director

must have complied with these duties. Thus, this causal connection curtails the

invocation of the rule not unless one has complied with the duties.

Chapter 6 employs a comparative analysis of the operation of the business judgment rule

in all the jurisdictions considered in this study. Drawing on the findings/observations,

recommendations are offered aimed at improving the South African variant of the

business judgment rule.67 In conclusion, specific amendments to the Companies Act 71

of 2008 are proposed. 68

1.6 REFERENCE TECHNIQUES

Authorities are referred to in abbreviated form in the footnotes. Case law will be cited in

full in the footnotes. Both the abbreviated and the full references are provided in the

Bibliography which appears at the end of the thesis. In the interests of consistency, the

spelling “business judgment rule” as opposed to “business judgement rule” is used for

this specific term throughout the thesis. Reference to the “duty of care, skill and

65 Companies Act 61 of 1973. 66 See Ch 5 para 5.4.2.1 & 5.4.2.2. 67 Ch 6 para 6.3. 68 Ch 6 para 6.5.

31

diligence” will be fully referenced in the headings and footnotes, as it applies in the

various jurisdictions, but in the body reference will only be made to the “duty of care”.

32

CHAPTER 2

UNITED STATES OF AMERICA

2.1 INTRODUCTION

The US is a federal republic

1 consisting of fifty states2 and one federal district – Washington, the District of

Columbia.3 The country has two separate and distinct types of judicial system. On the

one hand, is the federal court system which enforces federal laws, rules, and regulations,

and applies and interprets the Constitution of the US;4 on the other, is the state court

system which enforces the laws, rules, and regulations of a given state and its civil courts,

and also applies and enforces the state’s own constitution.5

US corporate law is therefore a collection of fifty different systems of corporate law –

one for each state. But because over 40 per cent of the corporations listed on the New

York Stock Exchange, and a majority of the publicly-traded Fortune Five Hundred

1 A federal republic is a state in which the powers of the central government are restricted, and in which the states

retain a degree of self-governance. Ultimate sovereign power rests with the voters who choose their governmental

representatives. Brown et al Practicing Texas Politics 42; Pfeiffer & Timmerbeil “US-American company law –

an overview” 597 available at http://www.zjs-online.com/dat/artikel/2008_6_122.pdf (accessed: 14/08/2018). 2 Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii,

Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan,

Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New

York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina,

South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, and

Wyoming. See http://www.50states.com/ (accessed: 02/09/2013). 3 “Formally known as the District of Columbia, and commonly referred to as Washington ‘the District’ or simply

DC. The city is home to all three branches of the federal government, as well as the White House, the Supreme

Court and the Capitol Building.” See Harris Race and Radicalism 1. 4 Jenkins The American Courts: A Procedural Approach 97; Symeonides American Private International Law

18-19. 5 De Jongh From the Classroom to the Courtroom 23; Jones (2005) 4 University of Richmond: UR Scholarship

Repository 1.

33

companies are incorporated in Delaware, the latter state has for the last century been the

preeminent state in corporate law and so also in the regulation of fiduciary duties.6

The discussion in this chapter focuses principally on Delaware, but will also consider

New York in that the business judgment rule was formulated and applied in New York

earlier than in Delaware. Moreover, New York is the major centre for banking and other

financial activities in the US.7 The chapter also reviews the formulation of the business

judgment rule by the American Law Institute (“ALI”), as the recommendations from the

latter body have been influential in the country as a whole.8

First an introduction to the history of US corporate law is provided before moving to a

background to directors’ duty of care.9 In the US the duty of care forms part of a

director’s fiduciary duties – unlike in South Africa, for example, where the duty of care

is distinct from fiduciary duties.10 Historically, neither Delaware nor New York held

directors to be in a fiduciary relationship to the corporation and its shareholders. Initially,

Delaware followed the “gratuitous mandatories”11 approach while New York adopted a

trust analogy.12 Subsequently, this changed and in Guth v Loft13 the Delaware Court of

6 Padfield (2004) 79 University of Akron School of Law: Legal Studies Research Paper Series 86; and Scarlett

(2013) 61 Buffalo Law Review 903. 7 The first reported instance of a United States of America court referring to the business judgment rule is in

Marony v Applegate 266 A.D. 412 422 42 N.Y.S. 2d 768, 779 (N.Y. App. Div 1943) available at

https://www.casemine.com/judgement/us/5914cb7aadd7b04934802cff (accessed: 06/06/2018). 8 See para 2.4.4.2. 9 See paras 2.2 and 2.3.1. Hereafter reference will only be made to “duty of care” as opposed to “duty of care,

skill and diligence, unless a distinction is required. 10 See Ch 5 para 5.4.1. 11 See para 2.3.1 below for a brief explanation of gratuitous mandatories. See also Spering’s Appeal 71 Pa. 11,

17, 24 (1872). 12 See para 2.3.1. See also Hun v Cary 82 NY. 65, 70-71 (1880). 13 Guth v Loft 23 Del. Ch. 255, 5 A.2d 503 (Del. Ch. 1939).

34

Chancery14 ruled that directors stand in a fiduciary relationship to the corporation they

serve.15 This was later reaffirmed by other jurisdictions including New York.16

Secondly, the position relating to a director’s duty of care leading up to Smith v Van

Gorkom17 – one of the most renowned corporate-law cases decided by the Delaware

Supreme Court18 – is discussed.19 The decision and its consequences are considered.20

One of these consequences was the enactment of section 102(b)(7) of the Delaware

General Corporation Law which allows directors to be absolved from liability for a

breach of their duty of care.

Next, the business judgment rule is discussed by briefly sketching the background to its

origins and explaining the basic principles behind the rule.21 Before discussing the

application of the business judgment rule by Delaware and New York courts,22 the

chapter highlights the elements of23 and the rationale24 behind the rule. It is shown that

the business judgment rule was devised to protect directors from personal liability when

14 “The Delaware Court of Chancery is widely recognised as the preeminent US forum for the determination of

disputes involving the internal affairs of Delaware corporations and other business entities through which a vast

amount of the world’s commercial affairs is conducted.” See http://courts.delaware.gov/chancery/ (accessed:

11/01/2017). See Quillen & Hanrahan (1992) 18 Delaware Journal of Corporate Law for a discussion on the

history of the Delaware Chancery Court. 15 Guth v Loft 23 Del. Ch 255, 5 A.2d 503 (Del. Ch 1939). 16 See Francis v United Jersey Bank 432 A.2d 814, 824 (N.J. 1981). See also Pepper v Litton 308 US 311 (U.S.

1939). 17 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). 18 “The Delaware Supreme Court is the highest court in the State of Delaware. The court has final appellate

jurisdiction in criminal cases in which the sentence exceeds certain minimums, in civil cases as to final judgments,

and for certain other orders of the Court of Chancery, the Superior Court, and the Family Court.” See

http://courts.delaware.gov/supreme/ (accessed: 11/01/2017). 19 See para 2.3.1. 20 See para 2.3.2. 21 See para 2.4.1. 22 See para 2.4.4. 23 See para 2.4.2. 24 See para 2.4.3.

35

making a business decision on an informed basis, in good faith, and in the honest belief

that the action was in the best interest of the corporation.25

As has been indicated, the US currently has two formulations of the business judgment

rule, but within the Delaware rule there are two competing doctrines: the abstention

doctrine; and the standard-of-liability test. These are analysed and it is shown that the

standard-of-liability test is the preferred test in the Delaware courts.26 The alternative

ALI business judgment rule,27 in terms of which the business judgment rule is seen as a

safe harbour, is briefly discussed.28

It is then shown how the business judgment rule and a director’s duty of care are applied

in both Delaware and New York case law with specific emphasis on the period following

the decision in Smith v Van Gorkom.29 The reason for this is that after the ruling in this

case there was a proliferation of hostile takeovers30 resulting in the Delaware courts

significantly extending the obligations of directors to protect the best interests of

shareholders. These heightened obligations are illustrated by way of case law and it is

contended that there are now three tiers of review used by American courts for evaluating

directors’ decisions, of which the business judgment rule is one.31 Lastly, salient aspects

arising from the discussions are summarised.32

25 See para 2.4.3. 26 See para 2.4.4. 27 See para 2.4.4.2. 28 For a discussion on the term “safe harbour” see Ch 1 para 1.3. See also para 2.4.4.2. 29 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). 30 See, for example, Unocal Corp v Mesa Petroleum Corp 493 A.2d 946 (Del. 1985); Revlon Inc v MacAndrews

& Forbes Holdings Inc 506 A.2d 173 (Del. 1986). 31 See para 2.5 below. The three tiers are: 1) the business judgment rule; 2) enhanced scrutiny; and 3) entire

fairness. When applicable, the enhanced scrutiny standard of review places on defendants the burden of proving

they acted reasonably. The entire fairness standard, on the other hand, replaces the business judgment rule,

requiring defendants to prove the overall fairness of the transaction when the plaintiff successfully refutes the

presumption of valid business judgment by showing that the directors have a personal interest and lack

independence. 32 See para 2.6.

36

2.2 UNITED STATES OF AMERICA CORPORATION LAW:

HISTORICAL OVERVIEW

Just like Australia33 and South Africa,34 US corporation law was influenced by English

company law.35 Explorers under the British flag first appeared on the North American

coast as early as 1497,36 but the first British colony was established on the continent in

1607 with a permanent settlement in Jamestown, Virginia.37

In the early years, companies, or corporations as they were called in the American

colonies (which later became the US), were created by Charters38 and were known as

Charter Companies.39 Unlike the UK, the US had no history of “companies” but used

“corporations” as the legal entity to conduct business activities.40 During the first century

of settlement, the American colonies saw little interference from the British government

until the Glorious Revolution which took place in the UK.41 During this time, the British

33 See Ch 4 para 4.2. 34 See Ch 5 para 5.2. 35 Davis History of American Corporations 3; Talbot Critical Company Law 5; Siems Convergence in

Shareholder Law 20. 36 Chartrand Forts of Colonial North America 4. 37 Fishkin English Colonies in America 5-6. See also Hamby Outline of US History 6. “The second colony

followed the sailing of the Mayflower to Massachusetts in 1620 and by 1650 four further colonies (Connecticut,

New Hampshire, Rhode Island and Maryland) had been added. The remainder of the thirteen American colonies

were established by 1732, including New York and Delaware (New Jersey, North and South Carolina,

Pennsylvania and Georgia). Master Christopher Jones and several business partners purchased the ship

Mayflower in about 1607 and made numerous trips primarily to Bordeaux, France, returning to London with

cargoes of French wine, cognac, vinegar and salt. Departing on 6 September 1620, the ship was at sea for 66 days,

arriving in America on 9 November 1620.” See http://mayflowerhistory.com/history-of-the-mayflower (accessed:

02/02/2018). See also Farmer Access to History 1; Johnson Colonial America 37. 38 Companies in the UK were also historically formed by Royal Charters. See Ch 3 para 3.2. Australia also uses

corporations rather than companies. See Ch 4 para 4.2. 39 Chisholm v Georgia 2 US. 419, 448 (1793); Davis History of American Corporations 7; Miller Social History

of Crime and Punishment in America 289; Padfield (2004) 79 University of Akron School of Law: Legal Studies

Research Paper Series 86; Veasey (2011) 79 Law and Contemporary Problems 95. See further Ch 3 para 3.2. 40 “Often, the terms ‘company’ and ‘corporation’ are used interchangeably to refer to legal entities that engage

in business activities. The two have distinctive meanings in law, however. The term ‘company’ has been used

consistently in the United Kingdom and in other countries in the British Commonwealth such as India, South

Africa and New Zealand. The term corporation, on the other hand, has been generally applied in American law

and Australia.” See Vasudev PM “Corporate law and its efficiency: A review of history” (2010) at 5 available at

http://ssrn.com/abstract=1537985 (accessed: 01/08/2019). 41 “The Glorious Revolution of 1688–1689 replaced the reigning king, James II, with the joint monarchy of his

protestant daughter Mary and her Dutch husband, William of Orange.” See Vallance “The Glorious Revolution”

37

parliament sought to render the imperial42 system more efficient and profitable by

regulating its trade through various Navigation Acts.43 These developments were not

welcomed by America with colonists fearing that the bureaucracy44 would replace the

customary self-government which they had long regarded as one of their fundamental

rights.45 These fears ultimately culminated in the American War of Independence46

which saw the birth of America’s independence from Great Britain.47 Delaware was the

first of the thirteen original colonies to become a state. The other colonies soon followed

suit.48

During the 1800s, different states49 began to enact general corporate laws.50 New York

was the first state with a general incorporation statute, but it was available only to

at https://www.independent.co.uk/arts-entertainment/books/reviews/the-glorious-revolution-by-edward-

vallance-revolution-by-tim-harris-6108372.html (accessed at 1/08/2019). 42 Imperialism is a policy or practice by which a country increases its power by gaining control over other areas

of the world. Cain & Harrison Imperialism Vol 2 61; Hobson Imperialism 1. 43 The Navigation Act, 1660, and the Navigation Act, 1696. “These Acts restricted American trade in the

following ways: 1) only British ships could transport imported and exported goods; 2) only British citizens were

allowed to trade with the colonies; and 3) commodities such as sugar, tobacco and cotton wool that were produced

by the colonies could be exported only to British ports.” See Klose & Jones United States History 33; Mangone

United States Admiralty Law 25; and Reich Colonial America 84. 44 A bureaucracy is a large group of people who are involved in running a government but who are not elected.

Hill State of Public Bureaucracy 205. 45 “This fear was further enflamed when Britain gave Vice Admiralty Courts jurisdiction over the revenue laws

affecting the colonies. (Vice Admiralty Courts were juryless courts which were located in British colonies. These

courts were granted jurisdiction over local legal matters related to maritime activities. Judges were given five per

cent of the confiscated cargo if they found a smuggling defendant guilty. The legal concept of the Vice Admiralty

Courts was that a defendant was assumed guilty until he proved himself innocent. Failure to appear as commanded

resulted in an automatic guilty verdict.).” See Couser Ministry and the American Legal System 9; Friedman

History of American Law (rev ed) 53; Wilson The US Justice System 12. 46 The war lasted from 1775 to 1783 and was a result of the rebellion of the thirteen British American colonies

which declared themselves independent in 1776 as the US. Ferling Almost a Miracle 3. 47 “The UK formally recognised the independence of the US in the Treaty of Paris. At the same time, Britain

signed separate peace treaties with France and Spain (which had entered the conflict in 1779), bringing the

American Revolution to a close after eight long years.” See http://www.history.com/topics/american-

revolution/american-revolution-history (accessed: 09/04/2015). 48 “The responsibility for granting charters now fell on the legislature and was only granted on a case-by-case

basis. The US, however, had a distrust of the selective bestowing of privileges generally associated with the

British Crown, and the ineffectiveness of the special charter system. It consequently elected to move away from

the process special charters to general corporate law.” See McLaughlin History of the American Nation, for a

detailed discussion on the American colonies and their transformation into states. Padfield (2004) 79 University

of Akron School of Law: Legal Studies Research Paper Series 88. 49 See para 2.2. 50 Pistor et al (2003) 23 University of Pennsylvania Journal of International Economic Law 808.

38

corporations manufacturing textiles, glass, metals, and paint.51 After the American War

of Independence, general Incorporation Acts were customary but restrictions on

corporations, such as limits on size and the scope of corporate activity, remained

common until approximately 1890.52 Authors attributed the caution to an attitude of

suspicion and fear toward the corporate mechanism.53

In 1896, New Jersey enacted what may be regarded as the first “lenient” contemporary

incorporation Act which conferred broad powers on corporations by removing

restrictions on capital and duration, and allowing three or more persons to become a

corporation.54 Although New Jersey was the first to enact such a permissive

incorporation statute, Delaware later enacted a virtually identical statute known as the

General Corporations Act, 1899. 55 When New Jersey revised its statute in 1913 to make

it more restrictive, Delaware became the leader in incorporation – a status it retains to

this day.56

51 Howard (1938) 46 Journal of Political Economy 499; McBride “General corporation laws: History and

economics” 3 available at https://scholarship.law.duke.edu/lcp/vol74/iss1/2/ (accessed: 20/06/2015); Mitchell

(2009) 63 NYU Journal of Law and Business 69; Scarlett (2013) 61 Buffalo Law Review 902. 52 Scarlett ibid. 53 See Louis K Liggett Co v Lee 288 US 517, 548-49 (U.S. 1933) 288, where Judge Brandeis explains that

incorporation for business purposes was commonly denied because of fear: “Fear of the subjection of labour to

capital. Fear of monopoly. Fear that the absorption of capital by corporations, and their perpetual life, might bring

evils similar to those which attended mortmain. There was a sense of some insidious menace inherent in large

aggregations of capital, particularly when held by corporations”; Scarlett (2013) 61 Buffalo Law Review 902. 54 Scarlett (2013) 61 Buffalo Law Review 903; Treacy & Milton General Corporation Act of New Jersey 5. 55 Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 596; Seligman (1976) 1 Delaware School of

Widener College Inc 250; Veasey & Guglielmo (2005) 153 University of Pennsylvania Law Review

1402. 56 Scarlett (2013) 61 Buffalo Law Review 903; Padfield (2004) 79 University of Akron School of Law: Legal

Studies Research Paper Series 86.

39

2.3 DIRECTORS’ DUTY OF CARE, SKILL AND DILIGENCE

2.3.1 Background

The General Corporations Act, 1899, was largely silent on the standards to be adhered

to by officers and directors in the performance of their duties.57 Initially, the courts in the

US followed the British58 rule of “gratuitous mandatories” as at this stage directors were

serving as such without remuneration.59 Characteristically, those who owned all or a

majority of a corporation’s stock managed the corporation.60 Directors, if they were not

the owners, served for the status associated with the position and not to be remunerated.61

In the early twentieth century, courts were abandoning the notion of directors as

“gratuitous mandatories” and replacing it with the notion of directors as corporate

fiduciaries.62

In Spering’s Appeal,63 the Supreme Court of Pennsylvania described corporate directors

as “persons who have gratuitously undertaken to perform certain duties, and who are

therefore bound to apply ordinary skill and diligence, but no more”. Judge Sharswood

held that directors were not liable for mistakes of judgment, even if they appeared to be

absurd and ridiculous, provided they were honest and had acted within the scope of the

57 Pistor et al (2003) 23 University of Pennsylvania Journal of International Economic Law 833; Seligman (1976)

1 Delaware School of Widener College Inc 251. 58 See para 2.2 above for a discussion on the history influence Britain had on the United States of America. 59 Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 595; Trible v American Co 61 NJ. Eq. 340

(1901). 60 Mitchell (2009) 63 NYU Journal of Law and Business 69. 61 Ibid; Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 594. 62 See, for example, the case of Twin-Lick Oil Co v Marbury 91 US 587, 588-89 (1875) at 588-89 where the court

held: “[T]hat a director of a joint-stock corporation occupies one of those fiduciary relations where his dealing

with the subject matter of his trust or agency, and with the beneficiary or party whose interest is confided to his

care, is viewed with jealousy by the courts, and may be set aside on slight grounds, is a doctrine founded on the

soundest morality, and which has received the clearest recognition in this court and in others …”. See also Pepper

v Litton 308 US 295 (1939). 63 Spering’s Appeal, 71 Pa. 11, 17, 21 (1872).

40

powers of the management body.64 They were therefore required to avoid gross

negligence only.65

Not all jurisdictions in the US followed this approach. The Court of Appeal of New York

adopted a different attitude in Hun v Cary.66 In this case an action was brought by the

receiver67 of the Central Savings Bank of the City of New York against the bank’s

trustees for making bad investment decisions.68 The court held the directors to a higher

degree of care, that is, “the degree of care that an ordinarily prudent person would

exercise in conducting personal business affairs”.69 Judge Earl stressed that the standard

was “not the highest degree, not such as a very vigilant or extremely careful person

would exercise” because, as he reasoned, “if such were required, it would be difficult to

find trustees who would incur the responsibility of such trust positions”.70 But he also

found the lowest degree of care inappropriate.71 In striking a balance between the highest

degree of care and the lowest, Judge Earl ruled that directors must exercise ordinary care

and prudence in the trusts committed to them – the same degree of care and prudence

that a person would exercise when prompted by self-interest in dealing with his or her

own affairs.72 The courts consequently began a shift from an agency analogy to a trust

64 Spering’s Appeal, 71 Pa. 11, 17, 21 (1872) 11, 17, 24. 65 Mitchell (2009) 63 NYU Journal of Law and Business 73. The rule was also applied in the case of Swentzel v

Penn Bank 147 Pa. St. 140, where the court held that directors – who are gratuitous mandatories – are only liable

for fraud or for such gross negligence that amounts to fraud. 66 Hun v Cary 82 NY. 65, 71 (N.Y. 1880). 67 In the US a receiver may be appointed when a bank is in receivership. Receivership deprives the owners and

managers of their rights in the bank and the opportunity to save the bank from financial failure. This will usually

be done when a bank is insolvent or on the brink of becoming insolvent. Ramsey & Head Preventing Financial

Chaos 69. 68 Hun v Cary 82 NY. 65, 71 (N.Y. 1880) 71. 69 Ibid. 70 Ibid. 71 Mitchell (2009) 63 NYU Journal of Law and Business 74. 72 Hun v Cary 82 NY. 65, 71 (N.Y. 1880) 71.

41

analogy with a corresponding shift to a higher expectation of care on the part of

directors.73

Earlier Delaware cases were often not clear as to whether the state followed the earlier

agency theory of director care or the newer New York trust-law theory.74 But in 1939, a

Delaware court was more explicit in stating the duties and obligations owed to the

shareholders by the directors of a corporation.75 In Guth v Loft,76 the court held that while

the directors were not trustees, they stood “in a fiduciary relation to the corporation”.77

It is noteworthy that in Delaware the fiduciary duties of directors are generally

subdivided into the duty of care and the duty of loyalty (including good faith).78 In the

US, therefore, the duty of care forms part of a director’s fiduciary duties, unlike in South

73 Hun v Cary 82 NY. 65, 71 (N.Y. 1880) 71; Spering’s Appeal 71 Pa. 11, 17, 24 (Pa. 1872). 74 See Loftland v Cahall 118 A (Del. 1922) 1 where the court found that the directors of a corporation were trustees

of the interests of the shareholders of the corporation. A year later in Allied Chemical & Dye Corp v Steel & Tube

Co 120 A (Del. Ch 1923) 494 the court determined that when the majority stockholders injure the minority

stockholders in the exercise of their power “by letting … equitable assets go for an unfair and inadequate price,

the act of the trustee in making the sale will in equity be condemned as wrongful”. 75 Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 598. 76 Guth v Loft 23 Del. Ch 255, 5A (2d) 503 (Del. Ch 1939). 77 Pistor et al (2003) 23 University of Pennsylvania Journal of International Economic Law 833; Seligman (1976)

1 Delaware School of Widener College Inc 251. The courts of other states also followed this Delaware decision.

It was argued that the relationship between a director and the corporation’s shareholders is a fiduciary one because

the shareholders have given control over the corporation’s assets to the directors with the expectation that the

directors will exercise that control for the shareholders’ benefit. In Pepper v Litton 308 US 311 (U.S. 1939) 308

the court held that: “He who is in such a fiduciary position cannot serve himself first and his cestuis second. He

cannot manipulate the affairs of his corporation to their detriment and in disregard of the standards of common

decency and honesty. He cannot by the intervention of a corporate entity violate the ancient precept against

serving two masters.” See also, Francis v United Jersey Bank 432 A.2d 814,824 (N.J. 1981); Alpert v 28 William

St Corp 473 N.E.2d 19, 25-26 (N.Y. 1984). 78 Smith v Van Gorkom 488 A.2d 858, 872 (Del. 1984). To clarify, while good faith was once “described

colloquially as part of a ‘triad’ of fiduciary duties that includes the duties of care and loyalty”, the Delaware

Supreme Court in Stone v Ritter 911 A2d 362, 370 (Del. 2006), clarified the relationship of “good faith” to the

duties of care and loyalty by explaining: “The obligation to act in good faith does not establish an independent

fiduciary duty that stands on the same footing as the duties of care and loyalty. Only if the latter two duties, where

violated, it may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The

second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or

other recognisable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good

faith.” Featherby Global Business and Human Rights 397.

42

Africa,79 the UK,80 and Australia81 where the duty of care is traditionally a duty distinct

from the fiduciary duties of a director. This notwithstanding, for purposes of this thesis,

only the duty of care is discussed in this chapter. 82

In the New York case of Litwin v Allen,83 the court ruled that because directors of a

corporation stood in a fiduciary relationship to the shareholders, they were bound by all

the rules of conscientious fairness, morality, and honesty in purpose, and had fiduciary

obligations.84 The court held that a director should not only act honestly, but also exercise

some degree of skill, prudence, and diligence.85

In the period leading up to Smith v Van Gorkom,86 the Delaware courts’ interpretation of

directors’ duty of care became somewhat blurred. In Graham v Allis-Chalmers Mfg Co,87

for example, the Supreme Court explained that directors must use that degree of care

which ordinarily, careful and prudent men would use in similar circumstances. But in

Aronson v Lewis88 the gross negligence standard was used by the court. This implied that

a director would only be held liable for a breach of his or her duty of care if his or her

actions were grossly negligent.89 Certain authors noted that before Smith v Van Gorkom,

79 See Ch 5 para 5.4.1. 80 See Ch 3 para 3.4. 81 See Ch 4 par 4.3. 82 See para 2.3. 83 Litwin v Allen 25 NY.S.2d 667, 677 (N.Y. 1940). 84 Litwin v Allen 25 NY.S.2d 667, 677 (N.Y. 1940) 677. 85 Ibid. 86 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). See discussion of Smith v Van Gorkom in para 2.3.2. 87 Graham v Allis-Chalmers Mfg Co 188 A.2d 125, 130 (Del. 1963) 130. 88 Aronson v Lewis 473 A.2d 805, 813 (Del. 1984). 89 In the US there are different positions relating to gross negligence. Some states confirm that gross negligence

is a significant term, and others deny that there is any significance in the term gross negligence. The fundamental

conflict in those states which have retained gross negligence in their substantive law, is whether gross negligence

differs from ordinary negligence only as a matter of degree or whether the difference is really one of kind. See

for example, Wedel v Klein 282 N.W. (Wis. 1938) 606 and Kastel v Stieber 215 Cal. 37, 39 (Cal. 1932).

43

personal liability for directors in the US for a breach of their fiduciary duties was possible,

but largely theoretical.90

2.3.2 Smith v Van Gorkom

Smith v Van Gorkom91 is possibly the most famous corporate-law case decided by the

Delaware Supreme Court.92 The Supreme Court found the directors of Trans Union

Corporation personally liable for breach of their fiduciary duty of care.93 The court stated

that the directors had breached this duty by failing “to inform themselves of all

information reasonably available to them”.94 Because of its importance, the facts of the

case are stated briefly.95

Van Gorkom, the Chairman96 of Trans Union Corporation, had personally negotiated a

merger without consulting the Trans Union board.97 After conducting the negotiations

the Chairman called a meeting of the board of directors98 at which he announced for the

first time that he had procured a potential buyer for the corporation.99 After meeting for

only two hours, the directors approved the sale of Trans Union Corporation by means of

90 Williams, Koch & Lyons (2012) 26 Insights 1. 91 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). 92Bainbridge S “Did Facebook's Zuckerberg just have a Van Gorkom moment?” available at

http://www.professorbainbridge.com/professorbainbridgecom/2012/04/did-facebooks-zuckerburg-just-have-a-

van-gorkom-moment.html (accessed on 20/04/2015); Lubben & Darnell (2006) 31 Delaware Journal of

Corporate Law 590; Sharfman (2008) 33 Delaware Journal of Corporate Law 287 and Hopt Comparative

Corporate Governance 324. 93 Fairfax (2005) 42 Houston Law Review 410; Lubben & Darnell (2005) 42 Houston Law Review 590. 94 Smith v Van Gorkom 488 A.2d (Del. 1985) 876, 893. 95 For more information on the facts see Sharfman (2008) 33 Delaware Journal of Corporate Law 291-294. 96 Jerome W van Gorkom, Trans Union’s Chairman and Chief Executive Officer. See Bainbridge (2008) 08-13

Law & Economics Research Paper 2. 97 Smith v Van Gorkom 488 A.2d (Del. 1985) 866-867. Jerome van Gorkom personally negotiated the deal with

Jay Pritzker an American entrepreneur and conglomerate. See also http://www.economist.com/node/184547

(accessed: 20/05/2015). 98 See http://financial-dictionary.thefreedictionary.com/Outside+Director (accessed: 20/04/2015). 99 Smith v Van Gorkom 488 A.2d (Del. 1985) 866-867.

44

a cash-out merger,100 with “New T Company”101 as the surviving corporation.102 The

directors relied solely on Van Gorkom’s representation of the details and desirability of

the proposed transaction in reaching their decision.103 The merger agreement provided

for a fixed price of 55 dollars per share and the directors made no attempt to verify the

adequacy of the merger price.104 After a four-month “market test” period during which

Trans Union was allowed to entertain other offers, Trans Union shareholders approved

the proposed merger.105

The directors were considered to have been grossly negligent because they had not

informed themselves of all relevant information before making important corporate

decisions.106 They were found to be in breach of their duty of care for not making an

informed business decision and therefore could not rely on the business judgment rule107

as a defence. The court held that: “Under the business judgment rule there is no protection

for directors who have made an unintelligent or unadvised judgment.”108

The decision alerted the business community to the dangers inherent in careless

investigations, particularly because, as Fairfax describes it, “the directors were precisely

100 Cash-out merger is where an acquiring firm buys the target firm’s stock with cash instead of the more common

practice of buying with its own stock. See http://www.businessdictionary.com/definition/cash-out-merger.html

(accessed: 20/05/2015). 101 New T Company was a subsidiary of the defendant Marmom Group Inc, owned by Jay and Robert Pritzker.

See Smith v Van Gorkom 488 A.2d (Del. 1985) 863-864. 102 Ibid. 103 Smith v Van Gorkom 488 A.2d (Del. 1985) 868-869, 874. An outside lawyer retained by Van Gorkom advised

the directors that a fairness opinion was not required by law and that they might be sued for not accepting the

offer. Smith v Van Gorkom 488 A.2d (Del. 1985) 868-869. 104 Smith v Van Gorkom 488 A.2d (Del. 1985) 866, 874-877. “Van Gorkom apparently based the offering price

of $55 per share on a calculation that Carl Peterson, the corporation’s controller, made to determine whether a

leveraged buy-out at $55 was feasible.” See Smith v Van Gorkom 488 A.2d (Del. 1985) 866. 105 Smith v Van Gorkom 488 A.2d (Del. 1985) 870. 106 Smith v Van Gorkom 488 A.2d (Del. 1985) 877. The Supreme Court reaffirmed the gross-negligence standard

of Aronson v Lewis 473 A.2d 805, 813 (Del. 1984) a few months earlier. See para 2.3.1. 107 The business judgment rule is discussed in detail below at para 2.4. 108 Smith v Van Gorkom 488 A.2d (Del. 1985) 872.

45

the kind of seasoned and sophisticated business people whose decisions appeared worthy

of protection under the business judgment rule”.109

In response to Smith v Van Gorkom, insurance companies increased their premiums

dramatically and even threatened to stop underwriting directors’ and officers’ liability

insurance.110 Sensing a potential corporate flight from Delaware, the state legislature

enacted section 102(b)(7) of the Delaware General Corporation Law,111 allowing

directors to be released from liability for all breaches of the duty of care by allowing

corporations to include a provision in their certificates of incorporation eliminating or

limiting the personal liability of a director.112

109 Fairfax (2005) 42 Houston Law Review 411; Klughaupt “Good faith in the world of Delaware corporate

litigation: A strategic perspective on recent developments in fiduciary duty law” 284 available at

https://law.bepress.com/expresso/eps/849/ (accessed: 19/07/2018); Lubben & Darnell (2006) 31 Delaware

Journal of Corporate Law 590. 110 Also known as D&O liability insurance. See DeMott (1988) 66 Washington University Law Review 295;

Klughaupt “Good faith in the world of Delaware corporate litigation: A strategic perspective on recent

developments in fiduciary duty law” 284. 111 Delaware General Corporation Law Del. Code Ann. tit. 8, § 102(b)(7), 2001. 112 Section 102(b) provides: “In addition to the matters required to be set forth in the certificate of incorporation

by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following

matters: … (to indicate there is an unquoted section in between) (7) A provision eliminating or limiting the

personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary

duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any

breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good

faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv)

for any transaction from which the director derived an improper personal benefit. No such provision shall

eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision

becomes effective. All references in this paragraph to a director shall also be deemed to refer (x) to a member of

the governing body of a corporation which is not authorized to issue capital stock, and (y) to such other person or

persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with s 141(a) of this

title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors

by this title.”

46

After Delaware adopted section 102(b)(7) other states followed suit.113 In New York the

corresponding section is section 402(b) of the New York Business Corporations Law.114

These sections are referred to as “exculpatory sections”.115 A corporation’s adoption of

an exculpatory statute implies that directors not only avoid financial liability, but also

that lawsuits in which the shareholders’ sole allegation is a violation of the duty of care

will automatically be dismissed.116 Directors once again felt secure in the knowledge that

they could engage in risk-taking that might, in hindsight, be viewed as unwise or

irrational, provided that a majority of the board was both disinterested and

independent.117 The Smith v Van Gorkom decision initiated debate among commentators.

Some criticised the decision for undermining the business judgment rule, while others

praised it for the same reason.118 The chapter now turns to the business judgment rule.119

113 Six states imposed mandatory provisions limiting director liability: Florida (Fla. Stat. Ann. se 607.0831 (West

2001); Indiana (Ind. Code Ann. s 23-1-35-1(e) (West 2005); Nevada (Nev Rev Stat. s 78.138 (2003); Ohio (Ohio

Rev Code Ann. s 1701.59(D) (West 1994 & Supp. 2003); Virginia (Va. Code Ann. s 13.1-692.1 (1999); and

Wisconsin (Wis. Stat. Ann. s 180.0828 (West 2002). “Most, however, enacted their own charter-option

provisions; forty-four states now have some form of charter-option statute. In an abundance of caution, two states

– Louisiana and Utah – have both a self-executing liability limitation and a charter-option provision. Only one

jurisdiction – the District of Columbia – has not adopted any additional protection for corporate managers.” See

Fairfax (2005) 42 Houston Law Review 412. 114 New York Business Corporations Law, 2016 s 402(b). Section 402(b) provides: “The certificate of

incorporation may set forth a provision eliminating or limiting the personal liability of directors to the corporation

or its shareholders for damages for any breach of duty in such capacity, provided that no such provision shall

eliminate or limit: (1) the liability of any director if a judgment or other final adjudication adverse to him

establishes that his acts or omissions were in bad faith or involved intentional misconduct or a knowing violation

of law or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled

or that his acts violated s 719, or (2) the liability of any director for any act or omission prior to the adoption of a

provision authorized by this paragraph.” 115 See Kapnick & Rosen “The exculpatory clause, defence to shareholder derivative claims” available at http://docplayer.net/10878491-The-exculpatory-clause-defense-to-shareholder-derivative-claims.html

(accessed: 18/07/2018). 116 Fairfax (2005) 42 Houston Law Review 412. 117 See, for example, In re Caremark Int’l Derivative Litigation 698 A.2d 959 (Del. Ch. 1996) and Gagliardi v

TriFoods Int’l Inc 683 A.2d 1049, 1052 (Del. Ch. 1996). 118 Chittur (1985) 10 Delaware Journal Corporate Law 543 where he states: “Trans Union is a long-overdue

judicial affirmation of the need for better informed directors and, consequently, more responsible corporate

behaviour”. 119 See para 2.4.

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2.4 THE BUSINESS JUDGMENT RULE

2.4.1 Background

The business judgment rule is firmly entrenched in US common law120 and can be traced

back as far as 1829.121 Neither Delaware nor New York have codified the business

judgment rule. There is no documented reason why these states have opted not to codify

the business judgment rule, but one of the reasons may be that the rule has already been

well developed and established by case law, therefore there is no need for codification

of the rule.122 Courts in New York adopted the business judgment rule before those in

Delaware.123 By 1944, New York courts had formally adopted the rule, holding that in

the absence of fraud or self-interest, directors’ decisions would not be reviewed by the

120 See for example, Bodell v General Gas & Elec Corp 15 (Del. Ch 1927); Beard v Elster 39 153, 160 A.2d 731,

738 (Del.1960); Warshaw v Calhoun 43 148, 221 A.2d 487, 492-93 (Del.1966); Sinclair Oil Corp v Levien 280

A.2d 717, 722 (Del.1971); Kaplan v Centex Corp 284 A.2d 119, 124 (Del. Ch 1971); Puma v Marriott 283 A.2d

693, 695-96 (Del. Ch 1971). 121 Percy v Millaudon, 8 Mart NS (La.1892) 74. The court held that the duties of directors of banks are presumed

to call for nothing more than ordinary care and attention, and the exercise of that care suffices. 122 Some states have opted to codify the business judgment rule. California for example codified the business

judgment rule in section 309 of California’s Corporate Code. Section 309 reads: “(a) A director shall perform

the duties of a director, including duties as a member of any committee of the board upon which the director may

serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its

shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position

would use under similar circumstances. (b) In performing the duties of a director, a director shall be entitled to

rely on information, opinions, reports or statements, including financial statements and other financial data, in

each case prepared or presented by any of the following: (1) One or more officers or employees of the corporation

whom the director believes to be reliable and competent in the matters presented. (2) Counsel, independent

accountants or other persons as to matters which the director believes to be within such person’s professional or

expert competence. (3) A committee of the board upon which the director does not serve, as to matters within its

designated authority, which committee the director believes to merit confidence, so long as, in any such case, the

director acts in good faith, after reasonable inquiry when the need therefore is indicated by the circumstances and

without knowledge that would cause such reliance to be unwarranted. (c) A person who performs the duties of a

director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to

discharge the person’s obligations as a director. In addition, the liability of a director for monetary damages may

be eliminated or limited in a corporation’s articles to the extent provided in paragraph (10) of subdivision (a) of

Section 204. 123 The first reported instance of a US court referring to the business judgment rule, is in Marony v Applegate 266

A.D. 412 422 42 N.Y.S. 2d (N.Y. App. Div 1943) 768,779, which held that “if the directors showed they were

guided by the financial necessities of the situation, and not by any ulterior motive, and were attempting faithfully

to serve the interests of their corporation, they should be protected in their actions and decisions.” See also,

Weinberger v Quinn 264 A.D. 405, 408, 35 N.Y.S.2d 567, 570-71 (N.Y. App. Div).

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court, regardless of how imprudent they might have been.124 It was assumed that

directors’ judgments would be honest, unbiased, and exercised reasonably.125

While the Delaware courts did not formally recognise the business judgment rule until

1960, they already showed a high regard for the rule from early in the twentieth

century.126 Early signs of the recognition of the business judgment rule first emerged in

Delaware in 1924. In Robinson v Pittsburgh Refining Co,127 the corporation’s directors

were authorised by a shareholder resolution to entertain bids to sell the assets of the

corporation. When the directors’ decision to accept one bid over another was challenged,

the Delaware Court of Chancery pronounced three of the basic principles of the modern

business judgment rule as applied in Delaware:

(1) It will be presumed the directors acted in the best interests of the corporation;

(2) The terms of the transaction must be so manifestly unfair as to overcome this

presumption; such that

(3) The director’s action was so unreasonable as to be removed entirely from the

realm of the exercise of honest and sound business judgment.128

As we have seen, in the US there are two major formulations of the business judgment

rule129 – the Delaware business judgment rule which was formally adopted in the case

124 In Bayer v Beran 49 N.Y.S.2d (N.Y. Sp. Term 1944) 2, 5-6, the court held that the director of a business

corporation is given a wide latitude to act. The law does not seek to deprive him of initiative, daring and vision. 125 Casey v Woodruff 49 N.Y.S.2d 625, 643 (N.Y.S. Term 1944). 126 Whitmer v Whitmer & Sons Inc 99 A. 428, 431 (Del. Ch 1916); Scully v Auto Fin Co 101 A. 908, 909 (Del.

Ch 1917); Atlantic Refining Co v Hodgman 13 F.2d 781, 788 (3d Cir. 1926) – holding the sale of the same issue

of stock at different prices to different persons will be sustained, if based on the exercise of fair business

judgement. 127 Robinson v Pittsburgh Refining Co 126 A. 46 (Del. Ch 1924). 128 Robinson v Pittsburgh Refining Co 126 A. 46 (Del. Ch 1924) 48-49. 129 The business judgment rule and its framework have been adopted not only by courts applying Delaware law,

but also by courts applying the law of more than 35 other jurisdictions: (Alabama, Alaska, Arizona, Arkansas,

California, Colorado, Connecticut, the District of Columbia, Florida, Georgia, Illinois, Indiana, Iowa, Kansas,

Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, Nevada, New

Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Puerto Rico, Rhode Island,

Tennessee, Texas, Utah, Virginia, Washington, Wisconsin, and Wyoming). Even those states that have not

expressly adopted the business judgment rule in their codes often follow the Delaware framework in analysing

director and officer breach of fiduciary duty cases. See, for example, the Alaskan court ruling of Bennet v Weimar

975 P.2d 691 (Ala. 1999). In the Colorado decision of Hirsch v Jones Intercable, Inc 984 P.2d 629 (Colo. 1999)

at 629 the court held that the “business judgment doctrine bars judicial inquiry into the actions of [a manager]

taken in good faith and in the exercise of honest judgment in furtherance of a lawful and legitimate corporate

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of Aronson v Lewis130 where the court described the rule as a presumption;131 and the

ALI-business judgment rule132 which declares the business judgment rule a safe

harbour.133 These formulations are discussed in greater detail later in this chapter,134 but

first, in order to understand what the business judgment rule entails, it is important to

discuss the elements of135 and the rationale behind136 the rule.

2.4.2 Elements of the business judgment rule

The business judgment rule is a judicially-created doctrine that protects directors from

personal civil liability for the decisions they make on behalf of a corporation.137

Interestingly, in Delaware138 and New York139 the rule applies to directors and other

corporate officers,140 but some federal courts have found that the business judgment rule

applies only to directors and not to officers.141 In South Africa the statutory business

purpose”; Gray v Manhattan Med. Center Inc 18 P.3d 291 (Kan.Ct.App 2001) 291. See also, Stockham MW &

Wallace MS “Fiduciary duty litigation and burden shifting” 3 available at https://www.americanbar.org/404/

(accessed: 03/11/2017). There is also another formulation of the business judgment rule in the United States of

America namely: The Model Act business judgment rule derived from the Model Business Corporations Act,

1984 s 8.30 which does not contain an explicit business judgment rule but does recognise that there is one (or

more). Section 8.30(a) states: “A director shall discharge his duties as a director, including his duties as a member

of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise

under similar circumstances; and (3) in a manner he reasonably believes to be in the best interests of the

corporation.” 130 Aronson v Lewis 473 A2d 805, 812 (Del. 1984). See also, Kaplan v Centex Corp 284 A.2d 119 (Del. Ch 1971)

124 where the court held that: “The acts of directors are presumptively acts taken in good faith and inspired for

the best interests of the corporation, and a minority stockholder who challenge[s] the bona fides of purpose has

the burden of proof.” See further, Robinson v Pittsburg Oil Refining Corp 126 A. 46 (Del. Ch 1924) 48. 131 See para 2.4.4.1 below for a discussion on the Delaware business judgment rule as a presumption. 132 See the American Law Institute, Principles of Corporate Governance: Analysis and Recommendations

(Proposed Final Draft, 31 March 1992) s 4.01 (c). 133 See para 2.4.4.2 below for a discussion on the ALI business judgment rule as a safe harbour. 134 See paras 2.4.4.1 & 2.4.4.2. 135 See para 2.4.2. 136 See para 2.4.3. 137 Bainbridge (2003) 03-18 Law & Economics Research Paper 57; McMillan (2013) 4 William & Marry Business

Law Review 521. 138 Kelly v Bell 266 A.2d 878, 879 (Del. 1970). 139 Detwiler v Offenbecher 728 F. Supp. 103, 149 (S.D.N.Y. 1989). 140 Examples of corporate officers are: the chief executive officer; chief risk officer; chief information officer;

etc. For a discussion on corporate directors see Lane Representing Corporate Officers Ch 2. 141 See, for example, Kelly v Bell 266 A.2d 878, 879 (Del. 1970) and Detwiler v Offenbecher 728 F. Supp. 103,

149 (S.D.N.Y. 1989). Recent court rulings in California have declared that the business judgment rule will not

apply to officers but only to directors. See FDIC v Perry 2011 U.S. Dist. LEXIS 143222 (C.D. Cal. 2011) and, in

an unreported ruling on 1 August 2011 in National Credit Union Administration v Siravo Case No. CV-10-01597

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judgment rule also applies to both directors and officers.142 In Delaware, however, it is

still not settled whether the courts will use the business judgment rule in the same all-

encompassing manner for officers as it has been used for corporate directors.143

The traditional business judgment rule is often described as a presumption that in making

a business decision144 the directors of a corporation act on an informed basis,145 in good

faith,146 and in the honest belief that the action taken is in the best interests147 of the

corporation.148 Taking into consideration the definition as set out above, various

elements of the business judgment rule have been identified. These are now discussed.149

(C.D. Cal.), a different federal district court judge in California also ruled that the business judgment rule did not

apply to officers, based on the language of the California statutory business judgment rule which applies only to

directors. Whether these decisions will be followed in other states remains to be seen. See also FDIC v Hawker

2012 U.S. Dist. LEXIS 79320 (E.D. Cal. June 7, 2012); FDIC v Van Dellen 2012 U.S. Dist. LEXIS 146648 (C.D.

Cal. Oct. 5, 2012); and FDIC v Faigin 2013 U.S. Dist. LEXIS 94899 (C.D. Cal. July 8, 2013) where the court

reaffirmed the judgment in FDIC v Perry. See further Platt v Richardson 1989 U.S. Dist. LEXIS 7933 (M.D. Pa.

June 6, 1989) where the Pennsylvania federal court also ruled that the business judgment rule will only apply to

directors and not officers. The state of Georgia went even further and in FDIC v Laudermilk 2013 U.S. Dist.

LEXIS 166924 (N.D. Ga., Nov 25, 2013) excluded directors and officers of a failed bank from the protection of

the business judgment rule. 142 See Ch 5 para 5.5.2.2.d. 143 See, for example, the case of Gander v Stephens 965 A.2d 695 (Del. 2009) 708-709 where the court held that

the defendants breached their fiduciary duties as officers without discussing the business judgment rule in

reference to the officers. Johnson (2005) 60 The Business Lawyer 413. 144 See para 2.4.2.1. 145 See para 2.4.2.2. 146 See para 2.4.2.3. 147 See para 2.4.2.4. 148 See discussion on the Delaware business judgment rule in para 2.4.4.1. See further Aronson v Lewis 473 A.2d

805, (Del. 1984); Warshaw v Calhoun 43 Del. Ch. 148, 157-58, 221 A.2d 487, 492-93 (Del. 1966) 492, which

provides: “In the absence of a showing of bad faith on the part of the directors or of a gross abuse of discretion

the business judgment of the directors will not be interfered with by the courts … The acts of directors are

presumptively acts taken in good faith and inspired for the best interests of the corporation, and a minority

stockholder who challenges their bona fides of purpose has the burden of proof.” See also Johnson (2000) 55 The

Business Lawyer 27; Weinberger (2010) 27 Thomas M. Cooley Law Review 284. 149 See para 2.4.2.

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2.4.2.1 Business decisions

The rule will only apply in the event that a business decision to act or not to act is made.150

The court ruled in Aronson v Lewis151 that the business judgment rule will have no effect

where the directors have either abdicated their functions or failed to act.152 Should a

director fail to act after having fully considered the matter, he or she will enjoy the

protection of the business judgment rule.153 However, a director’s failure to make due

inquiry, or any other failure to take action without considering the matter, does not

qualify for protection under the rule. The director must have made an actual or a

conscious business decision on whether or not to act.154

2.4.2.2 Informed basis

The decision must be made on the basis of a reasonably sufficient amount of

information.155 This implies that the director must have informed himself or herself as

regards the decision to the extent that he or she reasonably believes to be appropriate

under the circumstances. A reasonable decision-making process must be followed.156 In

order to establish whether these requirements have been met, the courts have held that

the requirement refers to the process followed by directors in making a decision rather

150 Eisenberg (1998) 28 Background Study 40; Giraldo CAL & Canon MPD “Modern business judgment rule: A

case study on Delaware jurisprudence” 19 available at http://www.redalyc.org/pdf/824/82400501.pdf (accessed:

12/01/2018); Veasy, Abrams & Finger Counselling Directors 1-8; and Weinberger (2010) 27 Thomas M. Cooley

Law Review 284. 151 Aronson v Lewis 473 A2d 805, 813 (Del. 1984). 152 Ibid. 153 Ibid; Rabkin v Philip A. Hunt Chem Co 547 A.2d 963, 972 (Del. Ch 1986). 154 TW Service Incorporated v SWT Acquisition Corporation C.A. No. 10427 (Del. Ch 1989); Block, Barton &

Radin The Business Judgment Rule 39. 155 See s 4.01(c)(2) of the ALI Principles of Corporate Governance: Analysis and Recommendations, which states

that a director must inform him- or herself with respect to the business judgment rule to the extent that he or she

reasonably believes appropriate under the circumstances; Federal Deposit Insurance Corporation v Stahl 89 F.3d

1510, 1517 (Eleventh Cir. 1996); Emerson EF “The demise of the business judgment rule: A case of judicial

realism” 4 available at http://www.andrew-emerson.com/wp-content/uploads/2014/10/exemplary-

paper_aemerson_2.pdf (accessed: 07/12/2017). 156 Thomas v Kempner 398 A.2d 320 (Del. Ch 1979); Eisenberg (1998) 28 Background Study 40.

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than to the content of their decision.157 The business judgment rule is, therefore, process-

oriented rather than content-oriented. In the decision of In Re Caremark International

Incorporated Derivative Litigation,158 for example, it was ruled that:

A director’s duty of care can never appropriately be judicially determined by

reference to the content of the board decision that leads to a corporate loss, apart

from consideration of the good faith or rationality of the process employed.159

The determination of whether the decision was informed is based on all the material

information reasonably available to the board.160

In Official Committee of Unsecured Creditors v Baldwin,161 the Court of Appeal ruled

that the District Court had incorrectly granted a motion for summary judgment in favour

of the defendant directors, and ruled that the business judgment rule did not apply

notwithstanding the director’s apparent thoroughness.162 The Court of Appeal held that

the plaintiff had presented credible evidence that the board had received numerous red

flags that senior officers, upon whom the board relied in making its decision, were neither

competent nor diligent, avoided a viability study before filing for bankruptcy, and

diverted assets to another charitable organisation.163 This decision shows that all features

of a board’s decision should be reasonable and thorough, and that the business judgment

rule may not apply even if all other aspects of the decision-making process are

appropriate.

2.4.2.3 Good faith

A business decision is only protected when it was made in good faith – in other words,

in the belief that the decision was made in the best interests of the corporation.164 The

decision must have been taken with honesty and integrity.165 If, for example, a director’s

157 In Re Caremark International Incorporated Derivative Litigation 698 A.2d 959, 967 (Del. Ch. 1996); Hanson

Trust PLC v ML SCM Acquisition, Incorporated 781 F.2d 264, 274-75 (2d Cir. 1986); Giraldo CAL & Canon

MPPD “Modern business judgment rule: A case study on Delaware jurisprudence” 22 available at

http://www.redalyc.org/pdf/824/82400501.pdf (accessed: 12/01/2018). In Brehm v Eisner 746 A.2d (Del. 2000)

244, 262, the court ruled that due care in the decision making context is process due care only. 158 In Re Caremark International Incorporated Derivative Litigation 698 A.2d 959, 967 (Del. Ch 1996). 159 In Re Caremark International Incorporated Derivative Litigation 698 A.2d 959, 967 (Del. Ch 1996) 968. 160 Smith v Van Gorkom 488 A.2d (Del. 1985) 858, 872. 161 Official Committee of Unsecured Creditors v Baldwin 2011 U.S. App. LEXIS (3d Cir. 2011) at 19312. 162 Ibid. 163 Ibid. 164 Block, Barton & Radin The Business Judgment Rule 90-93. 165 Eisenberg (1998) 28 Background Study 40; Weinberger (2010) 27 Thomas M. Cooley Law Review 286.

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decision was not made in good faith, and the director is aware of this, he or she will not

be protected by the business judgment rule.166

2.4.2.4 Independent and without conflicts of interest

To be protected by the business judgment rule, a decision must have been made by

directors who had no self-interest and who were independent.167 Conflicts of interest

occur when, for example, a director stands to gain a personal financial benefit168 from a

particular decision and this fact is not shared with stakeholders, or where the decision

would be more beneficial for the director than for the stakeholders.169 A director may

also be considered to be self-interested, and accordingly lose the protection of the

business judgment rule, if he or she allows another self-interested director to intimidate

him or her into making a particular decision.170

2.4.3 Rationale underlying the business judgment rule

The foundation for the business judgment rule can be seen as the acknowledgment by

courts that in the intrinsically risky environment of business, boards must be allowed to

make business decisions and take risks without a persistent fear of lawsuits affecting

their judgment.171 This is particularly so in the US which is known for being a litigious

society. The board of directors should consequently be allowed to make decisions

without fear of being second-guessed at a later stage with the benefit of hind-sight.172 In

Dodge v Ford Motor Co,173 the historical position was still followed by the court in ruling

that “judges are not business experts”.174 Accordingly, courts are reluctant to second-

guess the business decisions of directors when they appear to have been made in good

166 Nagy v Bistricer 770 A.2d (Del. Ch 2000) 43, 48-49, Vice-Chancellor Strine, observed that the concept of

good faith functions as a “constant reminder (1) that a fiduciary may act disloyally for a variety of reasons other

than personal pecuniary interest; and (2) that, regardless of his motive, a director who consciously disregards his

duties to the corporation and its stockholders may suffer a personal judgment for monetary damages for any harm

he causes.” 167 Palm & Kearney (1997) 42 Villanova Law Review 1098–1107. 168 See s 4.01(c)(1) of the ALI Principles of Corporate Governance: Analysis and Recommendations. 169 Rales v Blasband 634 A.2d 927, 936 (Del.1993). 170 In New Jersey Carpenters Pension Fund v Info GROUP Inc 2011 Del. Ch LEXIS (Del. Ch 2011) 147 the court

ruled that: “It is reasonable to infer that [the interested director] dominated the Board Defendants through a pattern

of threats aimed at intimidating them, thus rendering them non-independent for purposes of voting on the Merger.” 171 See, for example, Gagliardi v TriFoods International Inc 683 A.2d (Del. Ch 1996) 1049, 1052 where the

rational for the rule is set out. See also FDIC v Stahl 89 F.3d 1510 (11th Cir. 1996). 172 Janelyn 2008 UST Law Review 153; Kerr (2007) 29 Cardozo Law Review 636; McMillan (2013) 4 William &

Marry Business Law Review 526-527; Weinberger (2010) 27 Thomas M. Cooley Law Review 290. 173 Dodge v Ford Motor Cor 170 N.W. (Mich. 1919). 174 Dodge v Ford Motor Cor 170 N.W. (Mich. 1919) 668.

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faith.175 The business judgment rule is consequently intended to ensure that courts do

not, in hindsight, reverse the judgment of directors who are presumed to have acted in

good faith and in the best interests of the corporation.176 Several policy rationales are

said to underlie the business judgment rule.177 These are: encouraging directors to serve

and take risks;178 avoiding judicial infringement in business decisions;179 and preserving

the board’s central decision-making role in corporate governance.180 These rationales are

each described and discussed below.181

2.4.3.1 Encouraging directors to serve and take risks

A core obligation of being a director is the making of business decisions which at times

involve a certain amount of taking risks. Courts recognise this, and also that competent

directors can make decisions which, in hindsight, were not always the best decision for

the corporation.182 If those decisions result in a corporation losing a significant amount

of money, a legal rule holding directors too readily liable for the loss will deter persons

from serving as directors.183 Consequently, the business judgment rule was formulated

to protect directors from personal liability and so to encourage competent individuals

who might otherwise have declined the position/office to become directors.184 In Reget

v Paige,185 it was stated that the business judgment rule contributes to encouraging

qualified people to serve as directors by ensuring that honest errors of judgment will not

175 Dodge v Ford Motor Cor 170 N.W. (Mich. 1919) 684; In re PSE&G Shareholder Litigation 173 N.J. (N.J

2002) 258 – the business judgment rule protects a board of directors from being questioned or second-guessed on

the conduct of corporate affairs except in instances of fraud, self-dealing, or unconscionable conduct. 176 FDIC v Stahl 89 F.3d 1510, 1517 (11th Cir. 1996); Joy v North 692 F.2d 880 (2nd Cir. 1982); Percy v Millaudon

8 Mart NS 68 (La.1892); Potter v Pohlad 560 N.W.2d 389, 393 (Minn. Ct. App. 1987). 177 Janelyn 2008 UST Law Review 154; Johnson (2005) 60 The Business Lawyer 455. 178 See para 2.4.3.1. 179 See para 2.4.3.2. 180 See para 2.4.3.3. 181 See paras 2.4.3.1 & 2.4.3.3. 182 Gagliardi v TriFoods International Inc 683 A.2d 1049, 1052 (Del. Ch 1996); Joy v North 692 F.2d 880, 886

(2d Cir. 1982); Washington Bancorp v Said 812 F.Supp. 1256 (D.D.C. 1993). 183 Johnson (2005) 60 The Business Lawyer 455; McMillan (2013) 4 William & Marry Business Law Review 527. 184 See, for example, in Air Line Pilots Association International v UAL Corp 717 F. Supp. (N.D. Ill. 1989) 575,

582, where the court held that the business judgment rule encourages competent individuals to become directors

who otherwise might decline for fear of personal liability. 185 Reget v Paige 626 N.W.2d (Wis. Ct. App. 2001) 310.

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subject them to personal liability. More recently in Quadrant Structured Products

Company v Vertin,186 the court reaffirmed this position.187

2.4.3.2 Avoiding judicial interference in business decisions

Some commentators argue that judges are not business experts and should therefore

desist from second-guessing decisions made by directors.188 They suggest that the courts

do not have the experience, expertise, or information necessary to make complex

business decisions.189 Courts are, in fact, quick to adopt this rationale and to reiterate that

they are not business experts190 and are ill-equipped to second-guess business

judgments.191 Drawing on the insights of behavioural economics, Bainbridge argues that

– like all decision-makers candidly acknowledging their own cognitive limitations and

information asymmetries – judges sensibly respond to these challenges by choosing, as

their decision-making strategy, a policy of deferring to directors’ judgments.192

2.4.3.3 Preserving the board’s governance role

Not all shareholders agree with a board’s decisions all the time, and some shareholders

who do not agree may elect to challenge these decisions in a court of law. If every

decision a board makes is reviewed by courts on its merits, it will have a significant

186 Quadrant Structured Products Company v Vertin 102 A.3d (Del. Ch 2014). 187 Quadrant Structured Products Company v Vertin 102 A.3d (Del. Ch 2014) 155. 188 Dahlberg Overcoming the Business Rule Presumption 18. 189 Gries Sports Enters Inc v Cleveland Browns Football Co Inc 496 N.E.2d 959, 963 (Ohio 1986). See also

Solash v Telex Co 97, WL (Del. Ch. 1988) 3587, where the court explained that “because businessmen and women

are correctly perceived as possessing skills, information and judgment not possessed by reviewing courts and

because there is great social utility in encouraging the allocation of assets and the evaluation and assumption of

economic risk by those with such skill and information, courts have long been reluctant to second-guess such

decisions when they appear to have been made in good faith.” 190 To illustrate, in Dodge v Ford Motor Co 170 N.W. (Mich. 1919) 684 the Michigan Supreme Court, for

example, invoked the business judgment rule in refusing Henry Ford’s plans to expand on production, by

observing that “judges are not business experts”. 191 In Auerbach v Bennett 393 N.E.2d (N.Y. 1979) 1000 the court noted that the business judgment rule is

grounded, in part, on the “prudent recognition that courts are ill equipped and infrequently called on to evaluate

what are and must be essentially business judgments”. 192 Bainbridge (2003) 03-18 Law & Economics Research Paper 118–120.

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impact on the board’s decision-making process.193 Moreover, courts have held that the

decisions of a board of directors should be respected so as, in turn, to respect the structure

of the corporation which gives governing decision-making power to the board.194 The

business judgment rule therefore protects the directors from interference by disgruntled

shareholders in decision-making. Most publicly traded companies in the US, especially

larger ones, have a dispersed shareholding, also known as “dispersed ownership

structure”.195 Dominant shareholders are rare and investors have typically taken a “hands

off” approach to corporate affairs.196 However, the “hands-off” approach has dynamics

of its own and does not take away shareholder concern that the arrangement creates risks

because corporate executives might exploit the discretion they possess and where that

occurs a vertical agency cost problem for shareholders would have been imposed.197 An

agency cost problem arises for example, whenever the welfare of one party, termed the

“principal” depends upon actions taken by another party, termed the “agent”.198 An

agency cost problem involves for example, the conflict between the company’s

shareholders and its hired management. Here the shareholders are the principals and

management are the agents.199 In the US, the obligation of the board is to maximise the

profit of the corporation for the benefit of the shareholders. This is known as the

193 Bainbridge (2003) 03-18 Law & Economics Research Paper 124-126. 194 Smith v Van Gorkom, 488 A.2d (Del. 1985) 858, 872, where the court relied on this as the essential basis of

the business judgment rule: “Under Delaware law, the business judgment rule is the offspring of the fundamental

principle … that the business and affairs of a Delaware corporation are managed by or under its board of

directors.” See, too, Aronson v Lewis 473 A.2d 805, 811 (Del. 1984); Cede & Co v Technicolor Inc 634 A.2d

345, 360 (Del. 1993); and Pogostin v Rice 480 A.2d 619, 624 (Del. 1984). 195 Dispersed ownership normally has 100% small shareholders. The fraction of the voting shares of one

shareholder is below 5% of the whole company. See Strik The Implication of Dispersed Ownership Structure vs

Large Shareholders on Company Performance in the US 6. 196 Ibid. 197 Ibid. 198 Kraakman & Hansmann The Anatomy of Corporate Law 21. 199 Kraakman & Hansmann The Anatomy of Corporate Law 22. There is also other agency cost problem which

for example: 1) involves the conflict between the company itself and other stakeholders and 2) the conflict of

shareholders who possess the majority or controlling interest in the firm and, on the other hand, the minority or

non-controlling shareholders. See Kraakman The Anatomy of Corporate Law 22.

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director’s primacy model.200 Shareholders essentially have no power to initiate corporate

actions and are entitled to approve or disapprove only a very view board actions.201 In

Delaware for example, shareholder voting rights are essentially limited to the election of

directors, mergers, sale of substantially all the assets of the corporation, voluntary

dissolution and approval of charter or bylaw amendments.202 This is in contrast to the

shareholder primacy model followed by the UK, Australia and South Africa.203 The

shareholder primacy model encompasses the shareholder wealth maximisation norm, but

adds to its control claims.204 Shareholder primacy contends not only that shareholders

are the principals on whose behalf corporate governance is organised, but also that

shareholders exercise unlimited control of the corporate enterprise.205 Hence, for

example, shareholder primacy assumes shareholder voting rights are both exclusive and

strong.206 It may therefore be argued that the need for a business judgment rule in the US

is stronger due to the power and ultimately the risk that is bestowed on US directors.

2.4.4 Two formulations of the business judgment rule in the United States of America

Earlier in the chapter it was stated that the US has two major formulations of the business

judgment rule.207 These are discussed below.

2.4.4.1 The Delaware business judgment rule

The Delaware courts formulate the business judgment rule as a presumption to the effect

that in making a business decision, the directors of a corporation acted on an informed

200 Bainbridge Director v Shareholder Primacy in the Corporate Debate 47. 201 Ibid. 202 Ibid. 203 See Ch 3 para 3.5; Ch 4 para 4.4; Ch 5 para 5.4.1. 204 Bainbridge Director v Shareholder Primacy in the Corporate Debate 47. 205 Ibid. 206 Ibid. 207 See para 2.1.

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basis, in good faith, and in the honest belief that the specific action taken was in the best

interests of the corporation.208 When a court raises the presumption of the business

judgment rule it evaluates director conduct not by looking at the result of a given decision,

but rather at the process the board followed in reaching the decision.209 Accordingly,

Delaware courts hesitate to review board decisions themselves and focus instead on the

circumstances surrounding the decisions.210 It is argued that provided that directors act in

good faith and on a reasonable basis, their business decisions should not be subject to

being second-guessed.211 The Delaware Supreme Court explained in Aronson v Lewis

that “directors have a duty to inform themselves, prior to making a business decision, of

all material information reasonably available to them”. It continued that the protection

afforded by the business judgment rule could be neutralised by a showing of “gross

208 In Aronson v Lewis 473 A.2d (Del. 1984) 812, the court ruled that “the business judgment rule is a presumption

that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in

the honest belief that the action taken was in the best interests of the corporation. In the absence of an abuse of

discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to

establish facts rebutting the presumption.” See, too, Kaplan v Centex Co 284 A.2d 1 19, 124 (Del. Ch. 1971). In

Sinclair Oil Co. v Levien 280 A.2d (Del.1971) 720 the court stated that a board of directors enjoys a presumption

of sound business judgment and in In re Walt Disney Co Derivative Litigation 906 A.2d 27, 52 (Del. 2006)

(quoting Aronson v Lewis 473 A.2d 812 (Del. 1984)). Johnson (2013) 38 Delaware Journal of Corporate Law

411. 209 In Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 45 n 17, the court explained that

compliance with a director’s duty of care can never appropriately be judicially determined by reference to the

content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality

of the process employed. That is, substantively wrong, or degrees of wrong extending through “stupid” or

“egregious” or “irrational”, provide no ground for director liability, so long as the court determines that the

process employed was either rational or employed in a good faith effort to advance corporate interests. Thus, the

business judgment rule is process-oriented and informed by a deep respect for all good faith board decisions. 210 Azzollini (2004) 63 Fordham Law Review 578; Warren IH & Aronstam BR “Delaware’s business judgment

rule and varying standards of judicial review for assessing director conduct in M&A transactions” 6 available at

http://www.ramllp.com/media/article/12_Canadian%20Institute%20Article.pdf (accessed: 28/02/2017). This

was again illustrated in a Delaware Supreme Court decision of Singh v Attenborough 137 A.3d 151, 151-52 (Del.

2016) available at http://courts.delaware.gov/Opinions/Download.aspx?id=240520 (accessed: 28/02/2017). 211 In Unocal Corp v Mesa Petroleum Co 493 A.2d (Del. 1985) at 954 it was held that the court will not substitute

its judgment for that of the board if the latter’s decision can be attributed to any rational business purpose. See

also Lipton (1979) 35 The Business Lawyer 121; Balotti, Varallo, & Czeschin (2005) 60 The Business Lawyer

1406.

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negligence”212 in this regard.213 However, in Brehm v Eisner214 the court stressed that “a

board is not required to be informed of every fact, but rather is required to be reasonably

informed”.

Because the court recognises a presumption in favour of directors through the business

judgment rule, the challenging party must carry the burden of proving that the directors

violated their duty in some way.215 The burden of proof will, however, shift if a plaintiff

shows that a majority of the directors had a personal interest in the transaction.216

Consequently, when the burden of proof shifts to the directors, they must show that the

transaction was fair.217 To cause the burden of proof to shift to directors, a plaintiff must

show self-interest on the side of the director(s), as opposed to a benefit which devolves

upon the corporation or on all shareholders generally.218 This presumption against

judicial review of the duty of care is also known as the “abstention doctrine”.219 Under

the abstention doctrine, the court will refrain from reviewing the substantive merits of a

212 Delaware’s current understanding of gross negligence is conduct that constitutes reckless indifference or

actions that are without the bounds of reason. See McPadden v Sidhu 964 A.2d 1262 (Del. Ch 2008). 213 See Aronson v Lewis 473 A.2d 805, 812 (Del. 1984). See also the discussion on Smith v Van Gorkom 488 A.2d

858, 874-93 (Del. 1985) in para 2.3.2 above, where the gross negligence standard was applied in so far as the

court ruled that the directors were considered to have been grossly negligent because they did not inform

themselves of all relevant information before making important corporate decisions. They were found to be in

breach of their duty of care for not making an informed business decision and therefore could not rely on the

business judgment rule as a defence. 214 Brehm v Eisner 746 A.2d 244, 259 n. 49 (Del. 2000). See also the discussion of the Unocal and Revlon duties

in para 2.5 below relating to the position where the business decision concerns control of the corporation, as in

the context of a takeover, resolution of the conflict between directors’ and shareholders’ interests and how much

discretion courts will allow directors under the business judgment rule. 215 Aronson v Lewis 473 A.2d 805, 812 (Del. 1984) 812. 216 In Guth v Loft Inc 5 A.2d 503, 510 (1939) 510 the court held that “the rule that requires an undivided and

unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest.”

Johnston (1990) 40 Catholic University Law Review 160; Aydin Due Care Liability in Delaware 87. 217 In AC Acquisitions Corp v Anderson, Clayton & Co 519 A.2d 103, 111 (Del. Ch 1986) 111 the court stated

that “court’s unwillingness to assess the ... [fairness] of business decisions ends when a transaction is one

involving a predominantly interested board with a financial interest in the transaction adverse to the corporation.” 218 See Sinclair Oil Corp v Levien 280 A.2d 717, 720 (Del. 1971). See also Aronson v Lewis 473 A.2d 805, 812

(Del. 1984). 219 See Schlensky v Wrigley 237 NE2d 776 (Ill. App. 1968) for an illustration of the business judgment rule as an

abstention doctrine. See also Bainbridge (2003) 03-18 Law & Economics Research Paper 7; McMillan (2013) 4

William & Marry Business Law Review 529. See also Kamin v American Express Co 383 N.Y.S.2d 807 (N.Y.

Sup. 1976).

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director’s conduct unless the plaintiff can rebut the business judgment rule’s presumption

of good faith.220

The other concept that competes with the abstention doctrine in Delaware, is the standard-

of-liability test.221 The standard-of-liability test requires some objective review of the

merits of the board’s decisions and enables the plaintiff to shift the burden of proof if he

or she can establish the existence of certain conditions – for example, fraud, illegality,

self-dealing, or that no decision was made by the directors.222 It appears that the modern

approach by the Delaware courts is to follow the standard-of-liability test. This is

illustrated in Omnicare Inc v NCS Healthcare Inc223 where it was held that as a standard

of judicial review, the business judgment rule is a common-law recognition of the

statutory authority vested in the board of directors to manage a corporation.224 Therefore,

the effect of the business judgment rule in this formulation is to raise the standard of

liability for a director’s decision from simple negligence to gross negligence to found

liability.225 Bainbridge criticises the use of the standard-of-liability test, stating that, first,

it trivialises the business judgment rule.226 Under the standard-of-liability test, directors

who violate their duty of care do not receive the protection of the business judgment rule.

The whole reason for the business judgment rule is to prevent courts from even asking

220 See Brehm v Eisner 746 A.2d 244, 264 n.66 (Del. 2000) 264. 221 Bainbridge (2003) 03-18 Law & Economics Research Paper 7. 222 See Cede & Co v Technicolor Inc 634 A.2d 361 (Del.1993) for an illustration of the business judgment rule as

a standard of liability. The court ruled that “in order to rebut the rule, a shareholder plaintiff assumes the burden

of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their

fiduciary duty – good faith, loyalty or due care. If a shareholder plaintiff fails to meet this evidentiary burden, the

business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our

courts will not second-guess these business judgments. If the rule is rebutted, the burden shifts to the defendant

directors, the proponents of the challenged transaction, to prove to the trier of fact the “entire fairness” of the

transaction to the shareholder plaintiff”. Bainbridge (2003) 03-18 Law & Economics Research Paper 7. See also

Bainbridge (2008) 08-13 Law & Economics Research Paper 11; McMillan (2013) 4 William & Marry Business

Law Review 529. 223 Omnicare, Inc v NCS Healthcare Inc 818 A.2d at 914, 927 (Del. 2003). 224 Omnicare, Inc v NCS Healthcare Inc 818 A.2d at 914, 927 (Del. 2003) 927. 225 Brehm v Eisner 746 A.2d 244 (Del. 2000) 264 n 66. 226 Bainbridge (2003) 03-18 Law & Economics Research Paper 7.

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the question: “Did the board breach its duty of care?”227 Secondly, he argues that it has

significant settlement implications and, lastly, by opening the courthouse door to care

questions at the outset of the litigation, this standard appears to broaden the scope of

judicial review of board decision-making to reach not only the process by which the

decision was made, but also the substance of the director’s decision.228 Bainbridge

advocates using the formulation of the business judgment rule used in Brehm v Eisner,229

which pronounces that:

Courts do not measure, weigh or quantify director’s judgments. We do not even

decide if they are reasonable in this context. Due care in the decision-making

context is process due care only … Thus, directors’ decisions will be respected by

courts unless the directors are interested or lack independence relative to the

decision, do not act in good faith, act in a manner that cannot be attributed to a

rational business purpose or reach their decision by a grossly negligent process

that includes the failure to consider all the material facts reasonably available.230

McMillan argues that the abstention doctrine as proposed by Bainbridge, will probably

not be adopted by courts, as this form of doctrine differs significantly from the four

primary abstention doctrines commonly applied by judges and litigators.231 Abstention is

a doctrine under which federal courts may choose not to hear a case even if all the formal

requirements for jurisdiction have been met.232

227 See http://www.professorbainbridge.com/professorbainbridgecom/2009/12/the-business-judgment-rule.html

(accessed: 22/05/2018). 228 Bainbridge (2003) 03-18 Law & Economics Research Paper 7. See also Bainbridge (2008) 08-13 Law &

Economics Research Paper 20. 229 Brehm v Eisner 746 A.2d 244 (Del. 2000) at 264. 230 Ibid. See also In re Citigroup Inc. Derivative Litigation 964 A.2d (Del. Ch 2009) at 122 citing Brehm v Eisner

746 A.2d 244 (Del. 2000) at 259; McMillan (2013) 4 William & Marry Business Law Review 536. 231 McMillan (2013) 4 William & Marry Business Law Review 540; Scarlett (2008) 57 University of Kansas Law

Review 75. 232 See https://www.law.cornell.edu/wex/abstention (accessed: 22/05/2018).

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Under the four primary abstention doctrines – known as Pullman,233 Burford,234

Younger,235 and Colorado River236 abstentions – federal courts may dismiss actions

pending before them in certain circumstances even though they have jurisdiction under

the Constitution and federal statute.237 All of these abstention doctrines signify a sorting

of the relationship between state and federal courts, and therefore McMillan argues that

the proposed doctrine of abstention for the business judgment rule does not fit that

predominant rationale.238 According to Scarlett, applying an abstention approach to the

business judgment rule does not relieve the tension in the relationship between state and

federal courts. Rather, the tension in such matters is based purely on a private relationship

between directors and shareholders. For this reason, courts are unlikely to adopt an

abstention-doctrine approach to the business judgment rule.239

It is further argued that Bainbridge’s proposed abstention approach to the business

judgment rule functions no differently in practice than the current formulation of the

rule.240 The current Delaware formulation views the business judgment rule as a

233 The Pullman abstention doctrine allows a federal court “to avoid the decision of a federal constitutional

question when the case may be disposed of on questions of state law”. See RR Comm’n of Tex v Pullman Co 312

U.S. 496, 501–02 (U.S. 1941); Walker (1981) 67 Cornell Law Review 219–244 for further discussion of the

abstention doctrine. 234 The Burford abstention doctrine allows a court to dismiss a case in order to avoid needless conflict with a

state’s administration of its own affairs. See Burford v Sun Oil Co 319 U.S. 315, 317-18 (U.S. 1943); New Orleans

Public Service Inc v Council of New Orleans 491 U.S. 350, 361 (U.S. 1989). 235 The Younger abstention doctrine requires federal courts to “refrain from hearing constitutional challenges to

state action under circumstances in which federal action is regarded as an improper intrusion on the right of a

state to enforce its laws in its courts.” See Younger v Harris 401 U.S. 37, 43–46 (U.S. 1971). 236 The Colorado River abstention doctrine avoids duplicate litigation by allowing a federal court to stay or dismiss

an action on the ground that a similar action is “pending in state court in which the controversy between the parties

can be resolved”. See Colorado River Water Conservation Dist v United States 424 U.S. 800, 818 (U.S. 1976).

For a discussion on this abstention doctrine Caballero J “Colorado River abstention doctrine in the fifth circuit:

The exceptional circumstances of likely reversal” 277-308 available at http://www.baylor.edu/content/

services/document.php/176870.pdf (accessed: 12/04/2018). 237 Scarlett (2008) 57 University of Kansas Law Review 75; McMillan (2013) 4 William & Marry Business Law

Review 540; and Walker (1981) 67 Cornell Law Review 219-244. 238 McMillan (2013) 4 William & Marry Business Law Review 540. 239 Scarlett (2008) 57 University of Kansas Law Review 77. 240 Bainbridge (2003) 03-18 Law & Economics Research Paper 7 and Scarlett (2008) 57 University of Kansas

Law Review 70.

http://www.baylor.edu/

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presumption protecting directors’ decisions. Under the proposed abstention approach,

courts begin with a presumption against review and “will abstain from reviewing the

substantive merits of the directors’ conduct unless the plaintiff can carry the very heavy

burden of rebutting that presumption”.241 According to Scarlett, both the current approach

and the proposed abstention approach establish a presumption of non-review under which

courts will not review the challenged conduct unless the plaintiff can rebut that

presumption.242

2.4.4.2 The ALI business judgment rule

The ALI was established in 1923 to promote the clarification and simplification of US

common law and adapt it to changing social needs.243 In 1978, the ALI formally initiated

the Corporate Governance Project in furtherance of its mandate. Its Principles of

Corporate Governance: Analysis and Recommendations (“Principles”)244 were

eventually published in 1992.245 Most of the provisions in the Principles are ”restatement

rules”246 and cover only a limited number of selected topics in corporate law, namely: the

objective and conduct of the business corporation;247 the structure of the corporation;248

the duty of care;249 the duty of fair dealing;250 the role of directors and shareholders in

241 Schlensky v Wrigley 237 NE2d 776 (Ill. App. 1968) 780. Bainbridge (2003) 03-18 Law & Economics Research

Paper 15-16. 242 Scarlett (2008) 57 University of Kansas Law Review 71. 243 Eisenberg (1993) 48 The Business Lawyer 1271; Jeffrey Science-Based Legal Reform 3. 244 The American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992. 245 Myers M “Corporate reform movements and corporate law: Lessons from the ALI’s Principles of Corporate

Governance” 1 available at http://moritzlaw.osu.edu/events/mslsc/myers.pdf (accessed: 21/06/2018). “Although

formally initiated in 1978, the Corporate Governance Project did not begin in earnest until 1980 and took

approximately twelve years to complete.” See Eisenberg (1993) 48 The Business Lawyer 1272 n 1. See also

Carney (1988) 66 Washington University Law Review 248. 246 “Restatements are secondary sources that seek to “restate” the legal rules that constitute the common law in a

particular area into a series of principles or rules.” See http://tarltonguides.law.utexas.edu/restatements (accessed

on 20/05/2015). See also http://guides.brooklaw.edu/restatements (accessed: 20/05/2015). 247 See American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 2.01. 248 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 ss 3.01

and 3.02 (a). 249 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 4.01. 250 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 5.02.

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transactions involving control and tender offers;251 and remedies.252 This thesis focuses

only on the ALI’s formulation of the business judgment rule under the discussion of the

duty of care in the Principles.253

The ALI’s business judgment rule is found in section 4.01(c) of the Principles which

states:

A director who makes a business judgment in good faith fulfils the duty

under this Section if he or she: (1) is not interested ... in the subject of the

business judgment; (2) is informed with respect to the subject of the

business judgment to the extent the director … reasonably believes to be

appropriate under the circumstances; and (3) rationally believes that the

business judgment is in the best interests of the corporation.254

At first glance, section 4.01(c) does not differ significantly from the Delaware business

judgment rule, but the one pertinent difference is that section 4.01(c) labels the business

judgment rule a “safe harbour” and not as a “presumption”.255 In accordance with the

safe- harbour application, the business judgment rule protects a director from liability if

he or she made a business decision while meeting the following requirements:256 he or

she had no conflict of interest in relation to the subject of the decision;257 he or she was

informed with respect to the subject of the business judgment to the extent that he or she

reasonably believed it to be appropriate under the circumstances;258 and he or she

251 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 6.02. 252 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 Part VII. 253 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 4.01 (c). 254 A similar provision is found in the Revised Model Business Corporation Act, 1986 s 8.30, stating: “General

Standards For Directors: (a) A director shall discharge his duties as a director, including his duties as a member

of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise

under similar circumstances; and (3) in a manner he reasonably believes to be in the best interests of the

corporation.” 255 See discussion of the Delaware business judgment rule in para 2.4.4.1 above. See also American Law Institute

Principles of Corporate Governance: Analysis and Recommendations 1992 s 4.01(c); Balotti & Hanks (1993) 48

The Business Lawyer 1338; Dooley (1992) 47 The Business Lawyer 478; and Weinberger (2010) 27 Thomas M

Cooley Law Review 284. 256 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 4.01(c). 257 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s

4.01(c)(1). 258 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s

4.01(c)(2).

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rationally believed that the business judgment was in the best interests of the

corporation.259 For a safe harbour, if, as regard a specific business judgment, these

conditions have been met, the standard of conduct will have been satisfied without further

judicial inquiry and the directors will be safe from incurring liability. This is also known

as the “immunity doctrine” which insulates the director from liability resulting from bad

decisions. Under the immunity doctrine there is no examination of the merits of the

decision as under the standard-of-liability doctrine, or of whether the directors have

breached their duties – even an inquiry into good faith is excluded.

The safe-harbour approach draws a distinction between the levels of judicial scrutiny of

the director’s decision itself and reviews the process the director used to arrive at the

decision. The ALI business judgment rule is therefore not only procedural in nature – as

is the case with the Delaware rule – but also takes into consideration the actual decision

taken by the director.260

On the one hand, in order for the ALI business judgment rule to apply, the director must

be informed with regard to the subject matter of the business judgment to the level that

he or she “reasonably believes” to be appropriate under the circumstances. On the other

hand, the director must only “rationally believe” that the business judgment is in the best

interests of the corporation.261 This distinction between “reasonable” and “rational” is

explained by section 4.01(d):

It is recognized that the word ‘rational’, which is widely used by courts, has a close

etymological tie to the word ‘reasonable’ and that, at times, the words have been

used almost interchangeably. But a sharp distinction is being drawn between the

259 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s

4.01(c)(3). 260 See para 2.4.4.2. 261 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s

4.01(c)(2)&(3).

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words here. The phrase ‘rationally believes’ is intended to permit a significantly

wider range of discretion than the term ‘reasonable’, and to give a director or

officer a safe harbour from liability for business judgments that might arguably

fall outside the term ‘reasonable’ but are not so removed from the realm of reason

when made that liability should be incurred.262

One's understanding of the explanation is that, first, the ALI advocates for the

application of a “standard of reasonable belief” as a test for judgment when a director's

conduct is being determined whether or not it falls under the “safe harbour” protection

net. Second, the ALI appears to equate “rationally believe” with the Delaware “gross

negligence” standard explained earlier. 263 This therefore means that similar to gross

negligence, a heightened objective test is advocated for by the ALI business judgment

rule as opposed to the normal objective test for negligence.

In terms of the ALI formulation of the business judgment rule, the directors have the

burden of establishing the presence of the rule’s elements as set out in section 4.01(c).

Should they, however, establish the elements of the rule, the payoff – in the words of

Branson – “will be great and directors would sail into an impregnable harbour”.264

The discussion now turns to how directors’ duty of care and the business judgment rule

in Delaware and New York have been applied in case law post Smith v Van Gorkom.

2.5 APPLICATION OF THE DIRECTOR’S DUTY OF CARE AND THE

BUSINESS JUDGMENT RULE IN DELAWARE AND NEW YORK

CASE LAW SINCE SMITH V VAN GORKOM

In the early to mid-1980s there was an outbreak of hostile takeovers in the US and, in

response, courts in both Delaware and New York expanded the obligations of directors

262 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 s 4.01(d). 263 American Law Institute Principles of Corporate Governance: Analysis and Recommendations 1992 181 n 1. 264 Branson (2002) 36 Valparaiso University Law Review 636.

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significantly to protect the best interests of the corporation and its shareholders.265 The

cases examined hereunder are some of the most important and have influenced the

discourse on the interpretation and application of the director's duty of care vis-à-vis the

business judgment rule.266

2.5.1 Unocal Corp v Mesa Petroleum Corp

In Unocal Corp v Mesa Petroleum Corp267 the Delaware Supreme Court formulated a

new improved standard of review.268 The court considered whether a corporation’s board

could attempt to avoid a hostile takeover by using defensive measures that could benefit

certain shareholders and the board members themselves over the interests of the

shareholders attempting the hostile takeover.269 The court found that in the setting of a

transaction involving corporate control, the duty of care requires an analysis of whether

the decision of the board of directors was reasonable in relation to the threat posed.270

The directors must satisfy the court that they acted in good faith, after a reasonable

investigation, and pursuant to a clear duty to protect the corporation.271 If these standards

were met the board’s action would be protected under the business judgment rule and the

265 See, for example, Unocal Corp v Mesa Petroleum Corp 493 A.2d 946 (Del. 1985) 946. Here the court held

that directors addressing a takeover bid have an “enhanced duty which calls for judicial examination at the

threshold before the protections of the business judgment rule may be conferred”. See also Revlon Inc v

MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 173 where it was held that the board’s duty is to

“maximise the company's value at a sale for the stockholders’ benefit”. 266 See paras 2.5.1 to 2.5.11. 267Unocal Corp v Mesa Petroleum Corp 493 A.2d 946 (Del.1985) 954. 268 Fleischer A & Sussman AR “Directors fiduciary duties in takeovers and mergers” 9 available at

http://www.friedfrank.com/siteFiles/ffFiles/sri_directors_duties.pdf (accessed: 23/02/2018). 269 Chalmers HR “Delaware court approves poison pill trigger below 5 percent” (accessed: 23/04/2015). 270 Ibid; Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 601; Muir & Schipani (2005) 20 New

York University Journal of Legislation and Public Policy 300. 271 Fleischer A & Sussman AR “Directors fiduciary duties in takeovers and mergers” 9 available at

http://www.friedfrank.com/siteFiles/ffFiles/sri_directors_duties.pdf (accessed: 23/02/2018).

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board would incur no liability.272 This test, known as the “Unocal test”, found limited

application and was used only in hostile takeover situations.273

2.5.2 Revlon Inc v MacAndrews & Forbes Holdings Inc

In Revlon Inc v MacAndrews & Forbes Holdings Inc274 the court found that if the sale of

a corporation or pieces thereof is inevitable, the directors must act as efficient auctioneers

and attempt to secure the highest price for the shareholders.275 The test developed in

Unocal Corp v Mesa Petroleum Corp276 was therefore extended to include takeover

situations involving one or more competing bidders and not solely hostile takeover

bids.277 The board of Revlon Incorporated278 instituted a series of defensive measures279

aimed at upsetting an impending hostile tender offer for Revlon shares by Pantry Pride.280

Subsequent to the tender offer by Pantry Pride, Revlon’s board rejected the offer and

272 “The entire fairness standard of review is the standard most favourable to plaintiffs in order to avoid dismissal

at the pleadings stage. That standard requires a court to analyse a challenged transaction for fair dealing and fair

price. It is not a divided review, but rather one ‘requiring an examination of all aspects of the transaction to gain

a sense of whether the deal in its entirety is fair’. If entire fairness is the standard of review, defendants have the

burden of establishing that a transaction is fair, based on a non-divided review of price and process”. See Lazarus

& McCartney (2011) 36 Delaware Journal of Corporate Law 974–975. 273 Fleischer A & Sussman AR “Directors fiduciary duties in takeovers and mergers” 9 available at

http://www.friedfrank.com/siteFiles/ffFiles/sri_directors_duties.pdf (accessed: 23/08/2018). This has, however,

changed seeing that in later decisions the Delaware Supreme Court has greatly expanded the range of situations

to which it applies Unocal’s enhanced standard of review. For example, in Unitrin Inc v American General Corp

651 A.2d 1367 (Del. 1995), the Delaware Supreme Court significantly extended Unocal's scope and applied the

enhanced standard to a board’s decision to repurchase its own stock. 274 Unocal Corp v Mesa Petroleum Corp 506 A.2d 173 (Del. 1986). 275 Revlon Inc. v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986). This duty will be referred to as the

“Revlon duty”. 276 Unocal Corp v Mesa Petroleum Corp 493 A.2d 946, 954 (Del.1985). 277 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 184: “Favouritism for a white knight

to the total exclusion of a hostile bidder might be justifiable when the latter's offer adversely affects shareholder

interests, but when bidders make relatively similar offers, or dissolution of the corporation becomes inevitable,

the directors cannot fulfil their enhanced Unocal duties by playing favourites with the contending factions.” 278 Revlon Incorporated is a cosmetics, skin care, fragrance, and personal care company founded in 1932 by

Charles Revlon and his brother Joseph, along with a chemist, Charles Lachman. See

http://www.revlon.com/about/fact-sheet (accessed: 24/04/2015). 279 See nn 271, 272 and 273. 280 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 177. Pantry Pride Incorporated was a

supermarket chain in the US first known as Food Fair but which later, in the 1970s, changed its name to Pantry

Pride. The Revlon directors believed that the Pantry Pride offer would be inadequate, and that Pantry Pride’s

directors intended to acquire Revlon and break up the corporation by selling off its assets. Revlon Inc v

MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 177.

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implemented additional defensive measures.281 Pantry Pride made a second, higher, offer

which the Revlon board also rejected.282 The board then authorised negotiations with

other companies interested in taking Revlon over and eventually approved a sale to

Forstmann Little & Co283 on terms that included liquidating certain of Revlon’s assets to

finance the deal.284

The Delaware Supreme Court overturned the Revlon board’s decision to grant a lock-up

cancellation fee,285 and a no-shop286 provision to its white knight287 in the face of a

competing bidder, on the basis that these agreements hindered rather than promoted

competitive bidding for the target corporation.288 The court determined that under the

facts of Revlon,289 the Revlon board’s duty as protector of the corporation changed when

it rejected Pantry Pride’s tender offer as inadequate, but then entered into negotiations

with other parties.290 At the point when the Revlon board recognised that the corporation

281 MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 177. 282 MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 177-178. 283 Forstmann, Little & Company is a private equity firm which was founded by Theodore Forstmann and his

partner William Brian Little. Malik Broadbandits 162. 284 The agreement included a “lock-up option” which gave Forstmann an option to buy two divisions of Revlon

for a price substantially below their actual value. Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d

(Del. 1986) 178. “A “lock-up” provision is a term used in corporate finance which refers to an option granted by

a seller to a buyer to purchase a target corporation’s stock as a prelude to a takeover. The major or controlling

shareholder is then effectively “locked-up”, and is not free to sell the stock to a party other than the designated

party (potential buyer).” See Johnson & Siegel (1987) 136 University of Pennsylvania Law Review 341. 285 A “cancellation fee” provides liquidated damages to the bidder in the event the acquisition fails to close.

Johnson & Siegel (1987) 136 University of Pennsylvania Law Review 341. 286 A “no-shop” provision provides a “no-shop” clause in an agreement between a seller and a potential buyer that

prohibits the seller from soliciting a purchase proposal from any other party once a letter of intent or agreement

in principle is entered into between the parties. Johnson & Siegel (1987) 136 University of Pennsylvania Law

Review 341. 287 A “white knight” is a friendly acquirer sought by the target company in response to a hostile bidder’s tender

offer. Johnson & Siegel (1987) 136 University of Pennsylvania Law Review 341. In this case the white knight

was Forstmann, Little & Co. 288 A “target corporation” is a corporation which is the subject of a merger or acquisition attempt. Siegel (2013)

15 University of Pennsylvania Journal of Business Law 611; Mills Acquisition Co v Macmillan Inc 559 A.2d

(Del. 1989) 1288 in which the Delaware Supreme Court reiterated that a target board faces enhanced duties when

engaged in a bidding contest. Moreover, the court refused to limit those duties to active auctions only, rather

extending Revlon to other types of sale such as management buyouts and restructurings. 289 Revlon, Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 177. 290 Revlon, Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 182.

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was for sale, it had a duty to secure the best price possible for the corporation.291 When

the Revlon board granted Forstmann a lock-up option, it violated its duty to maximise

share value because the lock-up terminated the auction.292 The court therefore declared

that the Revlon board could not overcome its burden under the enhanced standards set in

Unocal Corp v Mesa Petroleum Corp293 by proving that the defensive actions were

reasonable in relation to the threat posed to the corporation by Pantry Pride’s offer.294

New York, also taking the Delaware standards into account, applied the ordinary business

judgment rule in preference to a heightened standard of review, to board decisions in the

merger and takeover context.295

2.5.3 Paramount Communications Inc v QVC Network Inc

In Paramount Communications Inc v QVC Network Inc,296 Paramount Communications

Incorporated (“Paramount”)297 canvassed candidates in the entertainment, media, and

communications industry with a view to a possible merger or acquisition.298 The board

was, however, cautious in selecting an appropriate merger candidate and so adopted a

291 Revlon, Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 182. 292 Revlon, Inc v MacAndrews & Forbes Holdings Inc 506 A.2d (Del. 1986) 183-184. 293 Unocal Corp v Mesa Petroleum Corp 493 A.2d (Del.1985) 946, 954. 294 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 183-184 (Del. 1986) 183-184; Mills Acquisition

Co v Macmillan Inc 559 A.2d (Del. 1989) 1261. The court here clearly noted that there was an active bidding

process in progress, and the board’s role as auctioneer had been invoked under Revlon and Paramount

Communications Inc v Time Inc 571 A.2d 1150 (Del. 1990) 1150. The court reasoned that “generally speaking

and without excluding other possibilities, two circumstances trigger Revlon duties: (1) when a corporation initiates

an active bidding process seeking to sell itself or to effect a business reorganisation involving a clear break-up of

the corporation, and (2) when in response to a bidder’s offer, a target abandons its long-term strategy and seeks

an alternative transaction involving the breakup of the corporation”. 295 Dynamics Corporation of America v WHX Corporation 967 F. Supp. 59 (S.D.N.Y. 1997). See also Minzer v

Keegan CV-97-4077 (CPS), 1997 U.S. Dist. 16445, 32 (E.D.N.Y. 1997) where the court ruled that an ordinary

business judgment rule applies to merger decisions absent “fraud, illegality or self-dealing” under New York law. 296 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 34. 297 Paramount Corporation Inc is a film studio founded in 1912. Among the founding members were Adolph

Zukor, Jesse Louis Lasky, and Cecil Blount DeMille. Stephens, Christaldi & Wanamaker Images of America:

Early Paramount Studios 7. 298 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 38.

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“poison pill”299 rights agreement to make Paramount unattractive to any hostile takeover

attempts.300 Paramount’s board attempted to enter into a merger transaction with Viacom

Incorporated (“Viacom”).301 At that time, QVC Network (“QVC”)302 expressed an

interest in entering the bidding process,303 but Paramount immediately informed QVC

the corporation was not for sale.304 In 1992, Paramount and Viacom reached a merger

agreement, but the board also approved a number of defensive measures to make it more

difficult for a potential competing bid to succeed.305 Despite Paramount’s attempts to

deter competitive bids, QVC made a competitive offer but was met with hesitancy from

the Paramount board.306 Confronted with Paramount’s hesitancy, QVC filed suit seeking

to enjoin the merger agreement with Viacom.307

The court found that the Paramount board had breached its fiduciary duties to

shareholders by refusing to negotiate with QVC.308 Applying Revlon, the court held that

once the board had decided to sell the corporation, its primary obligation was to secure

299 “‘Poison pills’ impede the market for corporate control by eliminating the possibility of hostile takeovers in

firms that have poison pills in place. In other words, the consequences of the poison pill are to require the acquirers

to obtain the approval of the target company’s board of directors before proceeding”. See Macey Corporate

Governance 124. 300 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 38. 301 Viacom is one of the world’s largest media networks with holdings that span the cable, broadcasting,

publishing, internet and video industries. Some of Viacom’s leading brands include MTV, Nickelodeon & VH1.

Pasiuk Vault Guide to the Top Media 276. Negotiations broke down when the parties could not agree on the price

or terms of a stock option that Viacom demanded. Paramount Communications Inc v QVC Network Inc ibid. 302 QVC Network Inc was founded in July 1986 by Joseph M Segel and is one of the largest cable television

shopping businesses in the United States of America, selling a wide variety of merchandise including clothing,

jewellery, cosmetics, electronics, and sporting equipment. See http://www.referenceforbusiness.com/history2

/2/QVC-Network-Inc.html (accessed: 24/04/2015). 303 Paramount Communications Inc v QVC Network Inc 637 A.2d 38 (Del. 1994) 38. 304 Ibid. 305 Paramount Communications Inc v QVC Network Inc 637 A.2d 38 (Del. 1994) 39. 306 Ibid. The CEO of Paramount, advised the Paramount board that to engage in such negotiations would breach

the no-shop provision in its agreement with Viacom unless conditions imposed under that agreement were met.

The board eventually agreed to consider QVC’s bid, but was extremely slow in actually sitting down to

discussions. 307 Ibid. 308 Kamar “The story of Paramount Communications Inc v QVC Network: Everything is personal” 16 available

at http://mylaw2.usc.edu/centers/class/class-workshops/cleo-working-papers/documents/C08_23_paper.pdf

(accessed: 29/10/2017); Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 608; Muir & Schipani

(2005) 20 New York University Journal of Legislation and Public Policy 301.

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the best price reasonably available for the corporation – for the benefit of all its

shareholders.309 The board had failed to meet this obligation when it adopted defensive

measures which prohibited it from negotiating with a competitive bidder.310 Furthermore,

the Paramount directors had acted improperly by refusing to educate themselves about

QVC’s offer.311 The court declared that in the context of the sale of a corporation,

directors incur both the special obligation to secure the best price reasonably available,

and to take the necessary steps reasonably to inform themselves of competing offers.312

The court therefore ruled that directors involved in such situations may not hide behind

the protection of the business judgment rule, but will instead be subjected to increased

judicial scrutiny.313

2.5.4 Krasner v Moffet

In Krasner v Moffet314 the court held that if a party challenging the board’s decision is

able to prove that those involved in the decision-making process lacked independence or

otherwise breached any of their fiduciary duties, the presumption of the business

judgment rule will have been rebutted and the court will apply the entire fairness

standard.315 The entire fairness standard requires the controlling shareholder

affirmatively to demonstrate both fair dealing with the board and that the transaction was

completed at a fair price.316 Krasner v Moffet details a two-step process whereby a

309 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 49-50. 310 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 50-51. 311 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 50. 312 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 48-49. 313 Paramount Communications Inc v QVC Network Inc 637 A.2d (Del. 1994) 45. 314 Krasner v Moffet 826 A.2d (Del. 2003). 315 Krasner v Moffet 826 A.2d (Del. 2003) 277, 287. 316 In Sterling v Mayflower Hotel Corporation 93 A.2d 107, 110 (Del. 1952) it was held that a majority shareholder

standing “on both sides of the transaction … bear[s] the burden of establishing its entire fairness”.

https://law.justia.com/cases/delaware/supreme-court/1952/93-a-2d-107-1.html (accessed: 27/06/2018);

Rosenblatt v Getty Oil Corporation 493 A.2d 929, 937 (1985); Weinberger v UOP Inc 457 A.2d 701, 710 (Del.

1983).

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director will not be protected from incurring liability by the business judgment rule. First,

when a majority of the board of directors is the ultimate decision maker and that majority

of the board is interested in the transaction, the presumption of the business judgment

rule is rebutted.317 Secondly, when the presumption of the business judgment rule has

been rebutted, the entire fairness rule is applied by the court and the defendants bear the

burden of proof.318 The fair-price and fair-dealing components are not viewed in isolation

but rather in conjunction.319 The “entire fairness” standard requires the court to examine

all aspects of a transaction strictly to ensure fairness.320

2.5.5 Emerald Partners v Berlin

There is an ongoing debate in Delaware over the different views articulated by the Court

of Chancery and the Supreme Court in their rulings on director liability for breaches of

the duty of care.321 The Court of Chancery has typically assumed a deferential stance

toward director decisions, while the Supreme Court has not.322 Emerald Partners v

Berlin323 concerned a merger agreement between May Petroleum Inc (“May Petroleum”)

and thirteen corporations owned by the chairman and chief executive officer of May

Petroleum, Graig Hall.324

317 See Krasner v Moffet 826 A.2d (Del. 2003) 287. 318 Ibid. 319Emerald Partners v Berlin 787 A.2d 85, 97 (Del. 2001). See also Weinberger v UOP Inc 457 A.2d 701 (Del.

1983). 320 In re TD Banknorth Shareholders Litigation 938 A.2d 654 (Del. Ch 2007). 321 Lubben & Darnell (2006) 31 Delaware Journal of Corporate Law 612. 322 Brehm v Eisner 746 A.2d 244 (Del. 2000); Emerald Partners v Berlin 726 A.2d 1215 (Del. 1999); Emerald

Partners v Berlin 787 A.2d 85, 87 (Del. 2001); Emerald Partners v Berlin 840 A.2d 641 (Del. 2003); McMullin

v Beran 765 A.2d 910 (Del. 2000); MM Cos v Liquid Audio Inc 813 A.2d 1118 (Del. 2003). 323 Emerald Partners v Berlin 726 A.2d 1215 (Del. 1999). 324 Emerald Partners v Berlin 726 A.2d 1215 (Del. 1999) 1218. Also joined as defendants were May’s directors,

Berlin, Florence, Sebastian, and Strauss (collectively the “director defendants”). Added later as a defendant was

Hall Financial, the successor in interest to Hall Financial Group Inc, the corporate defendant produced by the

merger of May and the Hall corporations.

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In March 1988, Emerald Partners, a New Jersey incorporated corporation and shareholder

in May Petroleum, filed an action to enjoin325 the merger on the ground that the merger

would trigger a super majority voting326 provision in May Petroleum’s certificate of

incorporation.327 On 18 March 1988, the Court of Chancery issued a preliminary

injunction enjoining the merger on the ground that article 14 of May’s certificate of

incorporation required a supermajority vote, and that at the special meeting of the

stockholders there had either been no quorum, or the merger had not received the required

vote.328

The Court of Chancery granted the injunction329 but the decision was subsequently

reversed by the Delaware Supreme Court330 which referred the matter back to the Court

of Chancery on two separate occasions.331 The Delaware Supreme Court ruled that when

shareholders challenge a decision by the board of directors, generally three standards of

judicial review are applied: 1) the traditional business judgment rule; 2) an intermediate

standard of enhanced judicial scrutiny; or 3) the entire fairness analysis.332

The Delaware Supreme Court held that the Court of Chancery was “required to decide

the issue of entire fairness at trial, which they did not do, thus referring the matter back

to the Court of Chancery for a third time”.333 The Supreme Court held that the entire

325To enjoin means for a court to order that someone either do a specific act, cease a course of conduct, or be

prohibited from committing a certain act. To obtain such an order, called an injunction, a private party or public

agency has to file a petition for a writ of injunction. West’s Encyclopaedia of American Law, 2 ed (2008) available

at http://legal-dictionary.thefreedictionary.com/enjoin (accessed: 10/01/2017). 326 Supermajority voting is a corporate amendment in a corporation's certificate of incorporation requiring a large

majority (EG, from 67-90% or even a unanimous vote) of shareholders to approve important changes, such as a

merger. Glaser & Traynor Strategic Practice Management 82. 327 Emerald Partners v Berlin 726 A.2d (Del. 1999) 1218. 328 The certificate of incorporation required a 66,6% supermajority vote to approve a merger. Ibid. 329 See N 312. 330 Emerald Partners v Berlin 726 A.2d (Del. 1999) 1218-1219. 331 Emerald Partners v Berlin 726 A.2d (Del. 1999) 1223. 332 Ibid. 333 Ibid.

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fairness review must be applied by first examining the process the directors followed in

discharging their fiduciary duties, notwithstanding the existence of a section 102(b)(7)

Charter provision which releases the directors from any personal liability for the payment

of monetary damages for breaches of their duty of care.334

The Supreme Court further held that in order to demonstrate entire fairness, the board

must present evidence of the cumulative manner by which it had discharged all of its

fiduciary duties. An entire fairness analysis then requires the Court of Chancery to:

Consider carefully how the board of directors discharged all of its fiduciary duties

with regard to each aspect of the non-bifurcated components of entire fairness: fair

dealing and fair price.335

In return, the Court of Chancery found that the merger was entirely fair to the corporation

and its minority shareholders and entered judgment in favour of the defendant directors

so protecting them from any personal liability.336 The Delaware Supreme Court affirmed

this decision.337

Since the decision in Smith v Van Gorkom,338 it could be argued that Delaware generally

has three tiers of review for evaluating director decision-making: 1) the business

judgment rule – for a decision to remain independent or to approve a transaction not

involving a sale of control;339 (2) enhanced scrutiny340 – for a decision to adopt or employ

334 Apparently, the Court of Chancery’s decision not to conduct an entire fairness review in its post-trial opinion

is attributable to the position asserted in the director defendants’ post-trial reply brief. In that reply brief, the

director defendants argued that the Court of Chancery did not have to look at anything other than the s 102(b)(7)

Charter provision. See Emerald Partners v Berlin 840 A.2d (Del. 2003) 641. 335 Ibid. 336 Ibid. 337 Ibid. 338 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). See para 2.3.2. 339 See para 2.4 above for the discussion on the business judgment rule. 340 “When applicable, the enhanced scrutiny standard of review places on defendants the burden of proving they

acted reasonably. Before conferring the protections of the business judgment rule, courts engage in enhanced

scrutiny as to whether the rule should be applied.” See http://apps.americanbar.org/litigation/committees/

trialevidence/articles/winter2014-0314-fiduciary-duty-litigation-burden-shifting.html (accessed: 04/03/2018).

http://apps.americanbar.org/litigation/committees/

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defensive measures or to approve a transaction involving a sale of control; and (3) entire

fairness341 – for a decision to approve a transaction involving management or a principal

shareholder, or for any transaction in which a plaintiff successfully rebuts the

presumption of the business judgment rule.342 Delaware’s default standard of review is

the business judgment rule,343 with enhanced scrutiny344 as Delaware’s intermediate

standard of review, and then entire fairness which is the most onerous standard.345

2.5.6 In re Family Dollar Stockholder Litigation

More recent case law shows that the three tiers of review for evaluating director decision-

making are still used by Delaware courts. To illustrate, in the Delaware Court of

Chancery decision In re Family Dollar Stockholder Litigation,346 Chancellor Bouchard

applied the enhanced scrutiny standard as set out in Revlon Inc v MacAndrews & Forbes

“Directors must satisfy two tests: 1) the reasonableness test – a judicial determination regarding the adequacy of

the decision-making process employed by directors; and 2) the proportionality test – a judicial examination of

the reasonableness of the directors’ actions in light of the circumstances then existing”. See Aronson v Lewis

473 A.2d 805, 812 (Del. 1984) 812; See also Paramount Communications Inc v QVC Network Inc 637 A.2d 34,

45 (Del. 1994) 43; Mills Acquisition Co v Macmillan Inc 559 A.2d 1261, 1288 (Del. 1989) 24. 341 The entire fairness standard replaces the business judgment rule, requiring the defendants to prove the entire

fairness of the transaction when the plaintiff successfully refutes the presumption of valid business judgment by

showing the directors have a personal interest and lack independence. See Aronson v Lewis 473 A.2d, 812 (Del.

1984) 381. See also Beam v Stewart 845 A.2d 1040, 1049 (Del. 2004) – “to refute the business judgment rule, the

plaintiff has the burden of providing evidence that the directors, in reaching their challenged decision, breached

any one of the triad of fiduciary duties – good faith, loyalty, or due care.” If the business judgment rule’s

presumption is rebutted by this proof, the burden shifts to the defendant directors, to prove the entire fairness of

the transaction to the shareholder in terms of both fair dealing and fair price. This was also illustrated in Cede &

Co v Technicolor Inc 634 A.2d 345, 361 (Del. 1993) 350-351. 342 Reis v Hazelett Strip-Casting Co 28 A.3d 442, 457 (Del. Ch. 2011); Lubben & Darnell (2006) 31 Delaware

Journal of Corporate Law 629. 343 Aronson v Lewis 473 A.2d 805, 812 (Del. 1984); Grimes v Donald 673 A.2d 1207, 1217 n.15 (Del. 1996);

Heineman v Datapoint Corporation 611 A.2d 950, 952 (Del. 1992); Levine v Smith 591 A.2d 194, 207 (Del.

1991); Scattered Corporation v Chi Stock Exchange 701 A.2d 70, 72-73 (Del. 1997). 344 In re El Paso Corporation Shareholders Litigation 41 A.3d 432, 439 (Del. Ch 2012); Revlon Inc v MacAndrews

& Forbes Holdings Inc 506 A.2d 177, 182 (Del. 1986); Unocal Corp v Mesa Petroleum Co 493 A.2d 946 (Del.

1985). 345 Cinerama Inc v Technicolor Inc 663 A.2d 1156, 1163 (Del. 1995); Gesoff v IIC Industrial Inc 902 A.2d

1130, 1145 (Del. Ch 2006). 346 In re Family Dollar Stockholder Litigation C.A. No. 9985-CB 2014 (Del. Ch 2014) available at

http://www.delawarelitigation.com/2015/01/articles/chancery-court-updates/chancery-denies-injunction-based-

on-revlon-claim/ (accessed: 06/05/2015).

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Holdings Inc347 because the action dealt with the sale of corporate control.348 In this

context, the goal of directors is to maximise the corporation’s value at a sale for the

shareholders’ benefit. In doing so the directors are charged with obtaining the highest

value reasonably attainable for the benefit of the shareholders.349

This case involved a merger between Family Dollar Stores Inc and Dollar Tree Inc. The

shareholders of Family Tree sought a preliminary injunction to enjoin a vote on the

merger.350 The shareholders sought the injunction in light of an offer made by a third

corporation, Dollar General Inc, which the shareholders argued had not been taken

seriously by the board of Family Dollar Stores.351

The court held that under Revlon, directors are generally free to select the path to value

maximisation, provided that the route they choose is reasonable. The burden is on the

defendant directors to show that when they made the decision(s) at issue, they were

adequately informed and acted reasonably.352

347 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 177, 182 (Del. 1986). 348 See para 2.5.2 above for the discussion of Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 177,

182 (Del. 1986). 349 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 177, 182 (Del. 1986) 182. 350 Ibid. See also n 325 for a definition of “enjoin”. 351 In re Family Dollar Stockholder Litigation C.A. No. 9985-CB 2014 29 (Del. Ch 2014) 1 available at

http://www.delawarelitigation.com/2015/01/articles/chancery-court-updates/chancery-denies-injunction-based-

on-revlon-claim/ (accessed: 06/05/2015). 352 Ibid; C & J Energy Services Inc v City of Miami General Employees’ and Sanitation Employees’ Retirement

Trust Nos. 655 /657 (Del.Ch 2014). The Delaware Supreme Court clarified that: (1) Revlon did not require an

auction before a corporation is sold, (2) a reasonable sale process is all that is required, not a perfect one; and (3)

the standard to enjoin a merger is particularly high when a mandatory injunction is sought that affects third party

rights”.

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2.5.7 In re MFW Shareholders Litigation

The entire fairness standard was again considered in In re MFW Shareholders

Litigation.353 In this case the Delaware Court of Chancery applied a standard for the

examination of transactions where the controlling shareholder offers to purchase the

remainder of the corporation’s shares in a going private merger.354 The court ruled that

under certain conditions a controlling shareholder’s transaction355 would be examined

through the lens of the business judgment rule rather than the entire fairness review which

normally applies to such transactions.356 This standard was also applied in In re Orchard

Enterprises, Incorporated Stockholder Litigation357 where the action dealt with a freeze-

out merger.358 In this case the plaintiffs declared that the entire fairness standard of review

should be used by the court, while the defendants argued that the business judgment rule

was the proper standard of review.359 The court held that when the transaction involving

self-dealing by a controlling shareholder is challenged, the applicable standard of judicial

review is entire fairness, with the defendants having the burden of persuasion.360

353 In In re MFW Shareholders Litigation 67 A.3d 496 (Del. Ch 2013) 496, the court specified six necessary

conditions for invoking the business judgment rule in freeze-out mergers: “(i) [T]he controller conditions the

procession of the transaction on the approval of both a Special Committee and a majority of the minority

stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select

its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair

price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority”. 354 “Going private” is a term used to describe a transaction (or series of transactions) with a controlling stockholder

or other affiliated person(s) that reduces the number of stockholders of a public company, allowing the company

to terminate its public company status and related reporting obligations. Sanborn NL et al “Going Private

Transactions: Overview” at 1 available at https://www.davispolk.com/files/uploads/davis.polk.going.private.pdf

(accessed: 10/01/2017). 355 Controlling stock transaction can be defined as strategic transaction that is accomplished for the purpose of

eliminating unwanted minority shareholders. A controlling stock transaction can be used by one or more majority

shareholders to eliminate one or more minority shareholders. Biggart (1978) 47 Fordham Law Review 223. 356 See In re MFW Shareholders Litigation 67 A.3d (Del. Ch 2013). For a detailed discussion see Bitton & Minnes

(2014) 7 Journal of Business Entrepreneurship & the Law 447-466. 357 In re Orchard Enterprises Inc Stockholder Litigation C.A. No. 7840 (Del. Ch 2014). 358 A freeze-out merger is a strategic merger transaction that is accomplished for the purpose of eliminating

unwanted minority shareholders. A freeze-out merger can be used by one or more majority shareholder to

eliminate one or more minority shareholder. Smith, Gambrell & Russel “The big chill: “Freeze out” minority

shareholders in Georgia corporations” available at http://www.sgrlaw.com/ttl-articles/912/ (accessed on

10/01/2017). 359 In re Orchard Enterprises Inc Stockholder Litigation C.A. No. 7840 (Del. Ch 2014) 33. The case is available

at http://courts.delaware.gov/opinions/download.aspx?ID=201990 (accessed: 10/01/2017). 360 In re Orchard Enterprises Inc Stockholder Litigation C.A. No. 7840 (Del. Ch 2014) 34.

https://www.davispolk/

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2.5.8 In re KKR Financial Holdings LLC Shareholder Litigation

In In re KKR Financial Holdings LLC Shareholder Litigation361 the court ruled that there

are a number of ways a plaintiff can rebut the business judgment presumption, including

by showing that: 1) a controlling stockholder stands on both sides of a transaction; or 2)

at least half of the directors who approved the transaction were not disinterested or

independent.362 If the plaintiff rebuts the business judgment presumption, the court will

apply the entire fairness standard of review to the challenged action and place the burden

on the directors to prove that the action was entirely fair.363

2.5.9 Singh v Attenborough

In relation to merger transactions, the Delaware Supreme Court held in Singh v

Attenborough364 that a fully informed, un-coerced vote by the disinterested stockholders

invoked the business judgment rule standard of review.365 This was reaffirmed in In re

Volcano Corporation Stockholder Litigation.366 In Volcano the stakeholders received

cash for their shares, and in such instances the Revlon standard of review presumably

applies, in this instance because Volcano’s “fully informed, uncoerced, disinterested

stakeholders approved a merger by tendering a majority of the Company’s outstanding

shares into the tender offer, the business judgment rule standard of review irrefutably

applies367 In this context, if the business judgment rule is irrefutable, then a plaintiff can

361 In re KKR Financial Holdings LLC Shareholder Litigation 101 A.3d 980 (Del. Ch 2014). 362 In re KKR Financial Holdings LLC Shareholder Litigation 101 A.3d 980 (Del. Ch 2014) 14. 363 Ibid. See also In re Zale Corp Stockholders Litigation 2015 WL 5853693 (Del. Ch 2015). 364 Singh v Attenborough 137 A.3d 151, 151-52 (Del. 2016). 365 Singh v Attenborough 137 A.3d 151, 151-52 (Del. 2016) 1-2. 366 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016). The ruling is available at

http://courts.delaware.gov/Opinions/Download.aspx?id=243120 (accessed: 27/06/2018). 367 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 19-20. The defendants included,

Goldman Sachs & Co, KT Gallahue, LH Howe and others.

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only contest a transaction on the basis of waste – ie, that it cannot be “attributed to any

rational business purpose”.368

According to the defendants, the shareholders’ approval of the merger had that cleansing

effect369 despite that: 1) the merger would otherwise have been subject to the Revlon

standard of review; and 2) the tender offer was statutorily required to complete the

merger. The defendants therefore asserted that the plaintiffs could challenge the merger

solely on the basis that it constituted waste.370

The plaintiffs disagreed, arguing that a tender offer does not have the same cleansing

effect as a shareholder vote, and thus that the court should not shift its standard of review

from Revlon to the business judgment rule. Alternatively, the plaintiffs maintained that

even if a tender offer had the same cleansing effect as a shareholder vote and the business

judgment rule presumption applied, that presumption is rebuttable.371 Finally, the

plaintiffs argued that regardless of the theoretical cleansing effect of Volcano’s

shareholders’ approval of the merger by tendering their shares, no such cleansing effect

should be rendered here because those shareholders were not, in fact, fully informed.372

The court held, the approval of a merger by a majority of a corporation’s shareholders

who are fully informed, un-coerced, and disinterested, renders the business judgment

368 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 20. See also Cede & Co v

Technicolor Inc 634 A.2d 345, 361 (Del. 1993). 369 Cleansing of self-dealing transactions will apply if: 1) defendants can show the transaction is entirely fair to

the corporation; 2) disinterested shareholders may approve the transaction; or 3) disinterested directors may

approve the transaction. See Lynch v Vickers Energy Corp 383 A.2d 278, 281 (Del. 1977). 370 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 20. The plaintiffs included

Melvin Lax, Melissa Gordon, and Mohammed Munawar. 371 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 20-21. 372 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 21.

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rule irrefutable.373 The court further held that shareholder approval of a merger by

accepting a tender offer has the same cleansing effect as a vote in favour of that merger.

Lastly, the court held that the business judgment rule irrefutably applied to the merger

as Volcano’s disinterested, un-coerced, and fully-informed shareholders had tendered a

majority of the company’s outstanding shares to the tender offer.374

2.5.10 In Re Integrated Resources Inc

In the New York decision In Re Integrated Resources Inc,375 the court, quoting from Mills

Acquisition Corporation v Macmillan Inc,376 held that the appropriate test for breach of

the directors duties is the entire fairness review, rather than the business judgment rule,

only “in the face of illicit manipulation of a board’s deliberative processes by self-

interested corporate fiduciaries”.377 In Delaware, on the other hand, the entire fairness

standard will be triggered in instances where a majority of the directors approving the

transaction are interested, or where a majority stockholder stands on both sides of the

transaction.378 In my view, New York follows a more lenient approach than Delaware in

this instance as the entire fairness standard will only be triggered if there is both “illicit

manipulation” and “self-interest”.

In the New York case Levandusky v One Fifth Avenue Apartment Corp,379 the Court of

Appeal used the business judgment rule as the judicial standard for review by ruling that

373 Ibid. See also Singh v Attenborough 137 A.3d 151, 151-52 (Del. 2016). 374 In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch 2016) 22. This ruling was re-affirmed

in In Re Solera Holdings Inc Stockholder Litigation C.A. No. 11524-CB, slip op. (Del. Ch 2017) available at

http://courts.delaware.gov/Opinions/Download.aspx?id=251000 (accessed: 28/02/2017). 375 In Re Integrated Resources Inc 147 B.R. 650 (S.D.N.Y 1992). 376 Mills Acquisition Corporation v Macmillan Inc 559 A.2d 1261, 1279 (Del. 1988). 377 In Re Integrated Resources Inc 147 B.R. 650 (S.D.N.Y 1992). 378 Weinberger v UOP Inc 457 A.2d 701 (Del. 1983); Krasner v Moffet 826 A.2d 277, 287 (Del. 2003); In re TD

Banknorth Shareholders Litigation 938 A.2d 654 (Del. Ch 2007). 379 Levandusky v One Fifth Avenue Apartment Co 75 N.Y.2d 530 (N.Y. 1990).

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unless an apartment owner shows that a board acted in bad faith, without authority, or for

an illegitimate purpose, a board can rest assured that courts will summarily dismiss

challenges to its actions.380

2.5.11 In re Kenneth Cole Productions, Inc, Shareholder Litigation

In a recent New York court decision, In re Kenneth Cole Productions, Inc, Shareholder

Litigation,381 the New York Court of Appeals adopted Delaware’s standard of review for

shareholder suits challenging controlling-party buy-out deals. It held that:

New York courts should apply the business judgment rule as long as certain

shareholder-protective conditions are present; if those measures are not present,

the entire fairness standard should be applied.382

The Court of Appeals recognised its own precedent that in freeze-out mergers by

management or controlling shareholders, “the burden shifts to the interested directors or

shareholders to prove good faith and the entire fairness of the merger”.383

In conclusion, it appears that there are three standards of review used by courts in

evaluating director decision-making: the business judgment rule; enhanced scrutiny; and

the entire fairness standard. It has also emerged that Delaware’s default standard of

review is the business judgment rule, while enhanced scrutiny is Delaware’s intermediate

standard of review, and entire fairness is the most onerous standard. In New York, the

courts will also use the business judgment rule as the default standard of review and will

380 510 East 84th Street Co v Genitrini 2011 N.Y. Slip Op 50202(U) (Sup. Ct. N.Y. 2011); Lorne v 50 Madison

Avenue LLC, 65 A.D.3d 879 (1st Dept. 2009); Sherlock v 20 East 9th Street Owners Corp 2011 WL 1337447

(Sup. Ct. N.Y.2011). 381 In re Kenneth Cole Productions Inc Shareholder Litigation No. 54, (N.Y. 2016). 382 Ibid at 1-2. The court followed the Delaware court’s approach in Kahn et al v M&F Worldwide 88 A.3d 635

(Del. 2014). 383 In re Kenneth Cole Productions Inc Shareholder Litigation No. 54, (N.Y. 2016) 8. See, for example,

Levandusky v One Fifth Avenue Apartment Co 75 N.Y.2d 530 (N.Y. 1990).

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only use the entire fairness standard in instances where there has been both “illicit

manipulation” and “self-interest” on the part of the directors.


US BUSINESS JUDGMENT RULE

The table below provides a summary of the legal requirements and application of the two

formulations of the business judgment rule in the US and also indicates whether the rule

is classified as a presumption or a safe harbour.

Table 1:

Item Delaware ALI

Legal Requirements

Business judgment Yes – An actual conscious

business decision must be

made.384

Yes – Section 4.01(c) of

the ALI Principles states

that a business decision

must be made in order for

the business judgment rule

to apply.385

Informed business

judgment

The directors must inform

themselves of the subject

matter of the business

judgment.386

An objective standard of

review is followed to

determine whether the

director informed

himself/herself of the

subject matter of the

business judgment. The

process must be

rational.387

The directors must inform

themselves of the subject


judgment.388

A subjective standard of

review is followed in

section 4.01(c). Directors

must reasonably believe

that the steps taken to

become informed were

adequate.389

384 Aronson v Lewis 473 A2d 805, 813 (Del. 1984) at 813. 385 See para 2.4.4.2. See further s 4.01 (c) of the American Law Institute Principles of Corporate Governance:

Analysis and Recommendations 1992. 386 See para 2.4.4.2. 387 See para 2.4.4.2. See further Paramount Communications Inc v QVC Network Inc 637 A2.d (Del. 1994) 45 n

17. 388 See para 2.4.4.2. 389 Ibid. See further s 4.01 (c) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations 1992.

84

Personal interest No mention is made that a

director should not have

an interest in the subject


judgment, whether

personal or financial.390

Section 4.01(c) of the ALI

Principles states that the

director should not be

“interested” in the subject


judgment. No mention is

made as to whether this

interest is personal of

financial.391

Best interest of the

corporation

In Delaware an objective

standard of review is

followed. Courts will not

second-guess decisions

when the process followed

was rational.392

A subjective/objective

standard of review is

followed. Section 4.01

(c)(3) provides that the

director must rationally

believe that the decision is

in the best interest of the

corporation.393

Application of the

business judgment rule

Good faith and proper

purpose

A business judgment must

be made in good faith but

need not be for a proper

purpose.394

Section 4.01(c) does not

require that the business

judgment be made in good

faith and for a proper

purpose.395

Director’s duties In the US the directors’

duty of care forms part of

the fiduciary duties. The


will thus apply to both the

directors’ duty of care and

their fiduciary duties.396

In the US the directors’

duty of care forms part of

their fiduciary duties. The


will thus apply to both the

directors’ duty of care and

their fiduciary duties.397

Common law Delaware and New York

has opted not to codify the

business judgment rule,

hence it will apply to

common law.398

The Delaware and New

York has opted not to

codify the business

judgment rule, hence it

will apply to common

law.399

390 See para 2.4.4.1. 391 See para 2.4.2.2. See further s 4.01 (c) of the American Law Institute Principles of Corporate Governance:

Analysis and Recommendations 1992. 392 See para 2.4.4.1. 393 See para 2.4.4.2. See further s 4.01 (c)(3) of the American Law Institute Principles of Corporate Governance:

Analysis and Recommendations 1992. 394 See para 2.4.4.1. See further Aronson v Lewis 473 A2d 805, 813 (Del. 1984) 813. 395 See para 2.4.4.2. See further s 4.01 (c) of the American Law Institute Principles of Corporate Governance:

Analysis and Recommendations 1992. 396 See para 2.1 & 2.3.1. 397 Ibid at para 2.3.1. 398 See para 2.4.1. 399 Ibid.

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Directors and officers Yes – the business

judgment rule will apply

to both directors and

officers.400

Yes – the business

judgment rule will apply

to both directors and

officers.401

Burden of proof The plaintiff bears the

burned of proof. It can

however be shifted to the

defendants if it can be

shown that the majority of

directors had a personal

interest in the

transaction.402

In terms of the ALI

formulation of the

business judgment rule,

the directors bear the

burden of establishing the

existence of the rule’s

elements as set out in

section 4.01(c).403

Safe harbour or

presumption

In Delaware the business

judgment rule is a

presumption.404

The ALI business

judgment rule is a safe

harbour.405

Abstention-, immunity

doctrine, or standard of

liability test.

Abstention doctrine Delaware applies both the

abstention doctrine and the

standard-of-liability

test.406

The abstention doctrine is

not applied in the ALI

business judgment rule.407

Immunity doctrine The business judgment

rule in Delaware does not

apply the immunity

doctrine.408

Yes, the ALI business

judgment rule is applied

as an immunity

doctrine.409

Standard-of-liability test Delaware applies both the

abstention doctrine and the

standard-of-liability

test.410

The standard-of-liability

test is not applied in the

ALI business judgment

rule.411

400 Ibid. See further Kelly v Bell 266 A.2d 878, 879 (Del. 1970) 879. 401 See para 2.3.1 & 2.4.2. 402 See para 2.4.4.1. 403 See para 2.4.4.2. 404 See para 2.4.4.1. 405 See para 2.4.4.2. 406 See para 2.4.4.1. 407 See para 2.4.4.2. 408 See para 2.4.4.1. 409 See para 2.4.4.2. 410 See para 2.4.4.1. 411 See para 2.4.4.2.

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2.7 CONCLUSION

In this chapter an overview was provided of the development of the business judgment

rule in the US. The discussion positioned the US as a federal republic with two types of

judicial systems - on the one hand the federal court system, and on the other the state

court system. Corporate law in the US is consequently a collection of 50 different

systems of corporate law – one for each state.412 The brief history presented of corporate

law in the US showed that the US first enacted general corporate laws in the 1800s. These

were very restrictive with regard to the type of corporations to which they applied.413

New Jersey enacted the first permissive contemporary incorporation act by removing

restrictions on capital, size, and duration of the corporation, but later revised its statute

to make it more restrictive. Delaware enacted a similar lenient statute known as the

General Corporations Act, 1899, which allowed Delaware to become the leader in the

incorporation of corporations – a position it continues to hold.414

Historically, the US did not view directors as standing in a fiduciary relationship to the

corporation, but rather saw them as gratuitous mandatories, that is, as standing in a

trustee relationship to the corporation.415 It was not until Guth v Loft416 that Delaware

explicitly established that directors stand in a fiduciary relationship to the corporation –

a view later also adopted in New York.417 It was argued that the relationship between a

director and the corporation’s shareholders is a fiduciary one in that the shareholders

have given control over the corporation’s assets to the directors in the expectation that

412 See para 2.2. 413 Ibid. 414 Ibid. 415 Ibid. 416 Guth v Loft 23 255 A.2d 503 (Del. Ch. 1939). 417 Alpert v 28 William St Co 473 N.E.2d 19, 25-26 (N.Y. 1984); Francis v United Jersey Bank 432 A.2d 814,

824 (N.J. 1981).

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the directors will exercise that control for the shareholders’ benefit.418 In the US the duty

of care forms part of these fiduciary duties.

Leading to the case of Smith v Van Gorkom,419 Delaware courts had not interpreted

directors’ duty of care with clarity. In some instances courts ruled that directors must

exercise the care which an ordinary, careful, and prudent person would exercise in

similar circumstances;420 but in other instances, the courts used the “gross negligence”

standard.421 The decision in Smith v Van Gorkom alerted the business community to the

dangers inherent in breaching the duty of care. In this case the directors were found to

have been grossly negligent by not informing themselves of all relevant information

before making important corporate decisions.422 Consequently, they were found to be in

breach of their duty of care and could not rely on the business judgment rule as a

defence.423 Reacting to the concerns raised by Smith v Van Gorkom, the Delaware

legislature quickly enacted section 102(b)(7) of the Delaware General Corporation

Law.424 This section allows directors to be absolved of liability for breaches of the duty

of care. Most corporations took advantage of the new statute, making it very difficult to

succeed in court in holding directors accountable for breaches of the duty of care.

This chapter also revealed that in the US the business judgment rule can be traced back

to as early as 1892 when it was developed by the courts as a device for insulating

corporate decision-makers from personal liability for mistakes in business judgment.425

418Bodell v General Gas & Electric Co 132 A 442 (1926); Gottlieb v McKee 107 A2d 240 (Ch Ct 1954); Pepper

v Litton 308 US 295 (1939). 419 Smith v Van Gorkom 488 A.2d 858 (Del.1985). 420 Graham v Allis-Chalmers Mfg Co 188 A.2d. 125, 130 (Del.1963). 421 Aronson v Lewis 473 A.2d 805, 813 (Del.1984). See para 2.3.1. 422 Smith v Van Gorkom 488 A.2d 877 (Del.1985). 423 Ibid. 424 New York followed suit and incorporated s 402(b) of the N.Y.Bsc. 425 See para 2.4.1.

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The elements of426and the reason underlying427 a business judgment rule was also

discussed. It was demonstrated that the US currently recognises two major formulations

of the business judgment rule: the Delaware business judgment rule;428and the ALI

business judgment rule.429 The Delaware rule is based on a presumption that in making

business decisions, the directors of a corporation acted on an informed basis, in good

faith, and in the honest belief that the specific action was in the best interest of the

corporation.430 In raising the business judgment rule as a presumption the court will focus

on the process the board followed in reaching its decision and not the decision itself.431

Because the court recognises a presumption in favour of directors – through the business

judgment rule – the challenging party bears the burden of proving that the directors

violated their duty in some way. It was, however, also established that the burden of

proof will shift if the plaintiff can show that a majority of the directors had a personal

interest in the transaction. If the burden of proof shifts to the directors, it is they who

must show that the transaction was fair. This presumption against judicial review of the

duty of care is known as the abstention doctrine.432

The other concept that competes with the abstention doctrine in Delaware case law is the

standard-of-liability test.433 This test requires an element of objective review of the

426 See paras 2.4.2 to 2.4.3. Stating that the elements for the business judgment rule include that a business decision

must have been made on an informed basis, in good faith and in the honest belief that the action was taken in the

best interest of the corporation. 427 See para 2.4.3. The following rationales were identified: encouraging directors to serve and take risks; avoiding

judicial infringements of business decisions; and preserving the board’s central decision-making role in corporate

governance. 428 See para 2.4.1. 429 See para 2.4.4.1. The Delaware business judgment rule was formally adopted in Aronson v Lewis 473 A.2d

805, 812 (Del.1984). 430 American Law Institute Principles of Corporate Governance: Analysis and Recommendations (Proposed Final

Draft, 31 March 1992) s 4.01(c). 431 Paramount Communications Inc v QVC Network Inc 637 A.2d 34, 45 n 17 (Del. 1994). 432 Brehm v Eisner 746 A.2d 244, 264 n. 66 (Del. 2000). 433 See para 2.4.4.1.

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merits of the board’s decisions. The plaintiff will be able to shift the burden of proof if

the plaintiff can establish the existence of certain factors, such as fraud, self-dealing, or

the failure to make a decision by the board. We furthermore concluded that the preferred

approach of the Delaware courts appears to be the standard-of-liability test.434

The ALI business judgment rule, on the other hand, classes the business judgment rule

as a safe harbour and not a presumption.435 In order for the ALI business judgment rule

to apply, the director must be informed as regards the subject matter of the business

decision to a level which he or she “reasonably believes” to be appropriate under the

circumstances. However, the director’s belief that the business decision is in the best

interest of the corporation need only be “rational”.436 As regards the process followed

to reach the decision, the standard appears to be consistent with the norm of ordinary

negligence. However, when it comes to the substance of the decision, the ALI’s version

of the business judgment rule lowers the standard of care to a rational belief.437

The application of the business judgment rule in Delaware and New York was then

illustrated with reference to case law.438 It has been noted that following certain corporate

scandals in the period post Smith v Van Gorkom, Delaware courts significantly expanded

the obligations of directors to protect the best interests of their shareholders. In Unocal

Corp v Mesa Petroleum Corp439 the Delaware Supreme Court formulated a new,

434 Omnicare Inc v NCS Healthcare Inc 818 A2d 914, 927 (Del. 2003). 435 See para 2.4.4.2. See s 4.01(c) of the American Law Institute Principles of Corporate Governance: Analysis

and Recommendations 1992. The South African business judgment rule is also a safe harbour and not a

presumption. See Ch 5 at 294. 436 See para 2.4.4.2. 437 Ibid. 438 See para 2.5. 439 Unocal Corp v Mesa Petroleum Corp 493 A.2d 946, 954 (Del.1985).

90

enhanced standard of review.440 The court found that in a transaction involving corporate

control, the duty of care required an analysis of whether the decision of the board of

directors was reasonable in relation to the threat posed.441 The directors had to satisfy the

court that they had acted in good faith, after a reasonable investigation, and pursuant to a

clear duty to protect the corporation.442 If this standard was met the board’s action would

be subject to the business judgment rule. This was known as the Unocal test and was used

only in hostile takeover situations. 443

Then, in Revlon Inc v MacAndrews & Forbes Holdings Inc,444 the court further found

that if a corporation is for sale, or the breakup of the corporation is inevitable, the directors

must act as efficient auctioneers and attempt to secure the highest price for the

shareholders.445 The Unocal test446 was therefore extended to include takeover situations

involving one or more competing bidder and not solely to hostile takeover bids.447 It has

been suggested that although New York courts took the Delaware standards into account,

they elected to apply the ordinary business judgment rule rather than a heightened

standard of review to board decisions in the merger and takeover context.448 The court

440 Fleischer & Sussman “Directors fiduciary duties in takeovers and mergers” at 9 available at

http://www.friedfrank.com/siteFiles/ffFiles/sri_directors_duties.pdf (accessed: 23/08/2018). 441 Muir & Schipani (2005) 20 New York University Journal of Legislation and Public Policy 300; Lubben &

Darnell (2006) 31 Delaware Journal of Corporate Law 601 and Chalmers “Delaware court approves Poison Pill

trigger below 5 percent” available at http://www.agg.com/media/interior/publications/Chalmers-ABA-

Litigation-News-Delaware-Supreme-Court-Approves-Poison-Pill-Trigger-Below-5-Percent.pdf (accessed on

23/04/2015). 442 Fleischer & Sussman “Directors fiduciary duties in takeovers and mergers” 9 available at

http://www.friedfrank.com/siteFiles/ffFiles/sri_directors_duties.pdf (accessed: 23/08/2018). 443 See para 2.5.1 above for a discussion on the Unocal test. 444 Unocal Corp v Mesa Petroleum Corp 506 A.2d 173 (Del. 1986). 445 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 173, 184 (Del. 1986). 446 Unocal Corp v Mesa Petroleum Corp 493 A.2d 946, 954 (Del.1985). 447 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 173, 184 (Del. 1986); Paramount Communications

Inc v QVC Network Inc 637 A.2d 45 (Del. 1994). 448 Dynamics Corporation of America v WHX Corporation 967 F. Supp. 59 (S.D.N.Y. 1997); Minzer v Keegan

CV-97-4077 U.S. Dist. 16445, 32 (E.D.N.Y. 1997).

91

ruled that once the Revlon board had recognised that the corporation was for sale, it had

a duty to secure the best possible price for the corporation.449

The Delaware courts went further and held that if a party challenging the board’s decision

is able to allege and prove that those involved in the decision-making process lacked

independence, or had otherwise breached any of their fiduciary duties, the business

judgment rule’s presumption will have been rebutted and the court will apply the entire

fairness doctrine.450 This requires the controlling shareholder to show both fair dealing

with the board and that the transaction had been completed at a fair price.451 Krasner v

Moffet452 established a two-step process in terms of which a director would not be

protected by the business judgment rule. Firstly, when a majority of the board of directors

are the ultimate decision-makers and that majority has an interest in the transaction, the

presumption of the business judgment rule would be rebutted.453 Secondly, when the

presumption has been rebutted, the entire fairness rule comes into play and defendants

bear the burden of proof.454

It has further been noted that since Smith v Van Gorkom455 the Delaware courts generally

have three tiers of review for evaluating director decision-making: 1) the business

judgment rule;456 2) enhanced scrutiny;457 and (3) entire fairness.458 It was shown that

449 Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 173, 184 (Del. 1986) 182. See para 2.5.2. 450 Krasner v Moffet 826 A.2d 277, 287 (Del. 2003). 451 Sterling v Mayflower Hotel Corporation 93 A.2d 107, 110 (Del. 1952). See also Weinberger v UOP Inc 457

A.2d 701, 710 (Del. 1983) and Rosenblatt v Getty Oil Co 493 A.2d 929, 937 (1985). 452 Krasner v Moffet 826 A.2d at 277, 287 (Del. 2003) 277. 453 Ibid. 454 Ibid. 455 Smith v Van Gorkom 488 A.2d 858 (Del. 1985). See para 2.3.2. 456 See para 2.5. The court held recently that the approval of a merger by a majority of a corporation’s shareholders

who were fully informed, un-coerced, and disinterested renders the business judgment rule irrefutable. In re

Volcano Corporation Stockholder Litigation No. 10485 (Del Ch. 2016) at 21. See also Singh v Attenborough 137

A.3d 151, 151-52 (Del. 2016). 457 See para 2.5. 458 Ibid.

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Delaware’s default standard of review is the business judgment rule, whilst enhanced

scrutiny is the intermediate standard of review, and entire fairness is the most onerous

standard.459 Recent case law illustrates that this three-tier approach is still used by

Delaware courts. In contrast, New York courts will only apply the entire fairness standard

– as opposed to the business judgment rule – if the plaintiffs can establish that self-

interested corporate fiduciaries illicitly manipulated the board’s deliberative processes.

It was therefore argued that New York follows a more lenient approach than Delaware as

the entire fairness standard will only be triggered in New York if there has been both

“illicit manipulation” and “self-interest”. In Delaware the entire fairness standard will be

triggered in instances where a majority of the directors approving the transaction are

interested or a majority of the shareholders stand on both sides of the transaction.

459 Cinerama Inc v Technicolor Inc 663 A.2d 1156, 1163 (Del. 1995); Gesoff v IIC Industrial Inc 902 A.2d 1130,

1145 (Del. Ch. 2006).

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CHAPTER 3

UNITED KINGDOM

3.1 INTRODUCTION

The United Kingdom of Great Britain and Northern Ireland, collectively known as the

United Kingdom (“UK”),1 consists of four countries2 forming three distinct

jurisdictions.3 Each jurisdiction has its own legal system: England and Wales; Scotland;

and Northern Ireland.4 The UK was established in 1801 with the union of Great Britain

and Ireland, but its present form dates from 1922 with the partition of Ireland and the

establishment of the independent Republic of Ireland.5 Each of these jurisdictions had its

own company registry, based in Edinburgh and Belfast respectively.6 This position

changed, however, with the commencement of the Companies Act, 2006, on 1 October

2009. This Act provides for a single company law regime that applies to the whole of the

UK.7 Companies are now UK companies rather than companies of Great Britain or

Northern Ireland, and the same legislation applies to all companies.8

1 It is interesting to note that the United Kingdom does not have a constitution that is contained in a separate

document. The constitution is found in the statutes passed by Parliament and in the common law. Gillespie &

Weare The English Legal System 21. 2 The four countries are England, Scotland, Wales and the province of Northern Ireland. See, generally, Waugh

& Bushell New Foundations 6. 3 Gillespie & Weare The English Legal System 20. 4 Ibid. 5 Priestly History of the British Isles: 1714-2010 105. 6 Milman National Corporate Law in a Globalised Market 13. 7 Companies Act 2006 (Commencement No 8, Transitional Provisions and Savings) Order, 2008, SI 2008/2860

art 3. 8 Although all companies are now UK companies there are some deviations in certain provisions, for example, in

the instance of derivative actions. Sections 260 and 264 of the Companies Act, 2006, deal with derivative claims

for England, Wales and Northern Ireland, whilst Ch 2 Part II deals separately with derivative actions in Scotland.

Sheikh Guide to the Companies Act 2006 136, 137; Dickson Law in Northern Ireland n 142.

94

This chapter provides a short overview of the history of company law in the UK which

concentrates on directors’ duty of care.9

It shows that under the common law the standard of care expected of directors in the UK

was initially not very high. At first, a director would only be held liable for breach of the

duty of care if gross negligence was involved.10 Early case law and the gradual move

towards the application of a more objective test are discussed, 11 followed by an

examination of the company-law review process which resulted in certain

recommendations on the codification of directors’ duties and the non-inclusion of the

business judgment rule in UK company law.12

Case law discussed hereunder shows how the courts interpret and apply the duty of care

under s 174.13 It further reveals that courts interpret the section as requiring the adoption

of a combined objective/subjective standard of judgment when reviewing whether a

director's conduct in the circumstances complied with the expected standard.14 The

discussion below further shows that a statutory business judgment rule has not been

included in the Companies Act 2006, and explains why the rule was deliberately

omitted.15 The reasons why the UK opted to exclude the business judgment rule will be

compared to the South African arguments to include/exclude a statutory business

judgment rule.16

9 See para 3.2. 10 See para 3.2. 11 Ibid. 12 See para 3.3. 13 See para 3.4. 14 See, for example, the discussion of Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 para 3.4. 15 See para 3.5. 16 See Ch 5 para 5.5.1.

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3.2 UNITED KINGDOM COMPANY LAW: HISTORICAL OVERVIEW

3.2.1 South Sea Bubble

In England, the term “company” was first used when merchant adventurers were granted

a Royal Charter17 which allowed them to trade overseas.18 A company could only be

formed by Royal Charter granted directly by the King or on the authority of Parliament

acting on powers delegated to it by the King.19 The King or Parliament had to be

convinced that the incorporation of a company would serve the public interest.20

Numerous business corporations were created by Royal Charter and granted

unchallenged privileges to engage in overseas trading.21

In 1711 a joint-stock company22 – the South Sea Company – was formed in order to buy

existing short-term government debt to help manage the national debt.23 During this

period, £9 471 325 of government floating debts were converted into South Sea

Company stock. The holders of government debt were offered the opportunity to transfer

their debt into South Sea stock. The South Sea company, in turn, was promised a

17 A Royal Charter is a formal document issued by a monarch as a letter patent, granting a right or power to an

individual or an institution. French et al Mayson, French & Ryan on Company Law 7. 18 Cheffins Corporate Ownership and Control 133. Davies et al Principles of Company Law 23. See further Ch 2

para 2.2 where it was indicated that charter companies were also historically used in the US. 19 Harris (2013) 33 Oxford Journal of Legal Studies 4; and Djelic “When limited liability was (still) and issue –

Conflicting mobilization in nineteenth century England” 5 available at

https://spire.sciencespo.fr/hdl:/2441/81bmh6v5q90t8pntmr5pmni68/resources/2013-djelic-when-limited-

liability-was-still-an-issue.pdf (accessed: 13/07/2016). 20 A prime example would be the English East India Company which was founded in 1600 as a maritime trading

company. See Bowen et al Worlds of the East India Company xv. For a detailed history on the English East India

Company consult Keay The Honorable Company1-496; 20 Harris (2013) 33 Oxford Journal of Legal Studies 4;

Djelic “When limited liability was (still) and issue – Conflicting mobilization in nineteenth century England” 5. 21 Examples of such companies include the Muscovy (or Russia) Company (1555), the Levant Company (1581),

the East India Company (1600), the Hudson’s Bay Company (1670), and the Royal Africa Company (1672).

Milman National Corporate Law in a Globalised Market 4. 22 Joint-stock companies were normally established to raise large amounts of capital. Capital was raised by selling

shares to investors, who became partners in the venture. One of the earliest joint-stock companies was the Virginia

Company, founded in 1606 to colonise North America. By law, individual shareholders were not responsible for

actions undertaken by the company and, in terms of risk exposure, shareholders could lose only the amount of

their initial investment. See https://global.britannica.com/topic/joint-stock-company (accessed: 13/07/2016). 23 During this period £9 471 325 of government floating debts were converted into South Sea Company stock.

For a full discussion on the South Sea Company see Carswell South Sea Bubble. See also Dale Lessons from the

South Sea Bubble 41-46.

96

monopoly on all trade – mostly in slaves – to the Spanish colonies in South America.24

The South Sea Company’s directors25 had no experience in trading in the New World26

and from the outset their trading business was beset by frustrations.27 The final blow to

the company came when war broke out between England and Spain in 1719 and all assets

of the South Sea Company in Spanish territories were seized.28 All trade with Spain was

halted and the South Sea Company had nothing to fall back on.29 In order to escape from

this impasse, the South Sea Company proposed to yet again attempt a conversion of

government debt obligations into new equity shares in the company.30 The South Sea

Company subsequently developed a scheme to convert the entire remaining national debt

into South Sea shares, with the exclusion of the debt already in the hands of the East

India Company and the Bank of England.31 The British government was committed to

the success of the scheme as it was approved by the Parliament in the South Sea Act of

24 For Spanish colonists ordinary trade with any country other than Spain was strictly forbidden, but after the

conclusion of the Treaty of Utrecht (1712), the South Sea Company was given sole rights to carry on British trade

with Spanish America – the so-called South Seas. The South Sea Company had also obtained for a period of 30

years the Asiento de Negros, a contract to be the sole supplier of slaves to the South Seas. Milman National

Corporate Law in a Globalised Market 5. 25 The South Sea Company was founded in 1711 by the Lord Treasurer Robert Harley and John Blunt, the former

director of the Sword Blade Company. Dale Lessons from the South Sea Bubble 49. 26 The Americas (the European term for North and South America) were discovered by Christopher Columbus in

1492 and known as the New World. Young Christopher Columbus and the New World 248. See also Wilson

British Business History 44. 27 For example, in 1712 the company attempted to dispatch two cargo vessels to Spain. There was £200 000 worth

of goods on the cargo ships, but due to some delays the goods decayed in the port: Dale Lessons from the South

Sea Bubble 49. 28 Ibid. 29 Unlike the East India Company with its strong Asian trade, and the Bank of England with its home counties

banking monopoly, the South Sea Company had no other options. Tucker Global Chronology of Conflict 725. 30 Mays & Shea “East India Company and Bank of England shareholders during the South Sea Bubble: Partitions,

components and connectivity in a dynamic trading network” 5 available at

https://ideas.repec.org/p/san/cdmawp/1109.html (accessed: 09/01/2017). 31The South Sea Company made the largest bid for the entire operation (£4 million with a possible increase to

£7.6 million). Brewer Sinews of Power 101; Mays & Shea “East India Company and Bank of England

shareholders during the South Sea Bubble: Partitions, components and connectivity in a dynamic trading network”

5.

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1720.32 The South Sea Act, 1720, empowered the company to offer the holders of current

government debt either cash or stock in the form of newly issued South Sea stock.33

In order for the scheme to succeed, both the company directors and the government had

to ensure that the stock in the company would keep on rising, and by inflating the value

of the stock a “bubble” was created.34 Between January and July of 1720 the South Sea

stock rose from £128 to £950.35 The holders of government debt sold out their debt in

exchange for South Sea stock in droves at highly inflated prices.36 A substantial portion

of government debt was consequently extinguished.37 This apparent success of the South

Sea Company shares resulted in a general trend among speculators to buy shares in other

companies.38 This trend threatened the South Sea Company’s success and profitability.

As a result the company sought the intervention of the government and the government

assisted the South Sea Company by passing the Bubble Act in June 1720.39

32 The South Sea Act of 1720 was approved and enacted in April 1720. Brewer Sinews of Power 101; Harris

Industrializing English Law 72. 33 Brewer Sinews of Power 101. 34 This bubble that was created was known as the South Sea Bubble. See Talbot Critical Company Law 18. 35 Poitras Equity Capital 239. 36 Brewer Sinews of Power 101. 37 Ibid. 38 According to Talbot the other companies also inflated their stock prices, creating “mini bubbles”. Talbot

Progressive Corporate Governance 6. 39 “The Bubble Act prohibited the sale of freely transferable shares by associations operating without a charter.

The South Sea Company hoped that the more restricted availability of shares in the market would further enhance

the value of the company’s shares. The Bubble Act did not, however, have the desired effect and in the autumn

of 1720 the share price of the South Sea Company collapsed and caused holders of South Sea stock to incur

serious financial losses. Despite this, the Bubble Act was restructured and continued to operate for more than a

century after the South Sea Bubble and was only repealed in 1825”. Talbot Critical Company Law 18; Cross &

Prentice Law and Corporate Finance 132, Brewer Sinews of Power 101. Banner Anglo-American Securities

Regulation 44.

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3.2.2 Period after the South Sea Bubble: 1844–1900s

In 1844 the Joint Stock Companies Act was adopted.40 This Act provided for general

incorporation by a system of registration, rather than through Royal Charter or an Act of

Parliament.41 The Act also provided for a Registrar of Companies where particulars of a

company’s constitution and its annual returns were lodged.42 The Joint Stock Companies

Act, 1844, however, provided for no limitation of liability and made it clear that members

were liable for the debts of the company just as if they were partners.43 This position was

later amended by the enactment of the Limited Liability Act, 1855, which conferred

limited liability on companies registered under the Joint Stock Companies Act, 1844.44

In order for a member to receive protection under the Limited Liability Act, the word

“Limited” had to appear as the last word of the company's name, acting as a red flag

warning the public of the risk involved in dealing with the company.45

In 1856, the Limited Liability Act, 1855, and the Joint Stock Companies Act, 1844, were

consolidated into and replaced by the Joint Stock Companies Act, 1856.46 This Act

provided that directors would be liable if they paid dividends while knowing the

company was insolvent. This, along with the requirement for the word “Limited”, were

40 The Joint Stock Companies Act 1844 was also known as the Gladstone Act, because it was formulated under

the leadership of William Gladstone who was the Prime Minister of the United Kingdom at the time. See

Blumberg et al Blumberg on Corporate Governance 3-14; McLaughlin & McLaughlin Unlocking Company Law

14; Hunt (1935) 43 Journal of Political Economy 331. 41 Sheikh Guide to the Companies Act 2006 12; Tomasic, Bottomley & McQueen Corporations Law in

Australia 12. 42 Bathurst TF “The historical developments of corporations law: Francis Forbes society for Australian legal

history – Introduction to Australian legal history” (2013) 9 available at

http://classic.austlii.edu.au/au/journals/NSWJSchol/2013/34.pdf (accessed: 10/01/2017). 43 Sheikh Guide to the Companies Act 2006 at 12; Bathurst TF “The historical developments of corporations law:

Francis Forbes society for Australian legal history – Introduction to Australian legal history” (2013) 10. 44 The Limited Liability Act, 1855, did not apply to Scotland. See Limited Liability Act, 1855, s 18. Mackie

(2011) 4 Juridical Review 93; Bathurst TF “The historical developments of corporations law: Francis Forbes

society for Australian legal history – Introduction to Australian legal history” (2013) 10. 45 Gower (1953) 18 Law and Contemporary Problems 537; Bathurst TF “The historical developments of

corporations law: Francis Forbes society for Australian legal history – Introduction to Australian legal history”

(2013) 11. 46 The Joint Stock Companies Act, 1956, now also included Scotland. Mackie (2011) 4 Juridical Review 294.

http://classic.austlii.edu.au/au/journals/NSWJSchol/2013/34.pdf

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effectively the only safeguards provided to shareholders and creditors at the time.47 From

the enactment of the Joint Stock Companies Act, 1856, until the fundamental review of

company law in 1998,48 a number of Companies Acts and Amendment Acts were passed

in the UK.49

Under the common law,50 the standard of care expected of a director was not very high.51

Early case law shows that a director would only be held liable for a breach of the duty

of care if gross negligence was proved.52 This was in contrast to the courts’ approach to

fiduciary duties, where the fiduciary was more likely to be held accountable.53

Early cases such as Turquand v Marshall,54 Overend & Gurney Co v Gibb,55 Re Cardiff

Saving Banks,56 and Re National Bank of Wales Ltd,57 all confirmed that in the absence

47 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– Introduction to Australian legal history” (2013) 9. 48 The British government announced the establishment of an independent fundamental review of company law

in March 1998. See Department of Trade and Industry Modern Company Law for a Competitive Economy, 1998,

para 7. 49 Companies Act, 1862; Companies Act, 1867; Companies Act, 1877; Companies Act, 1879; Companies Act,

1880; Companies Act, 1886; Companies Act, 1907; Companies Act, 1928; Companies Act, 1947; and Companies

Act, 1985. 50 The common-law duties may be categorised under fiduciary duties and duties of care, skill, and diligence.

Carciumaru “An assessment of the impact of corporate governance codes and legislation on directors and officers

liability insurance in South Africa” 49 available at http://insurancegeteway.co.za (accessed: 08/02/2017); Cabrelli

“Presentation for Universita ‘Brocconi on the reform of the law of directors’ duties in the UK Company Law” 3

available at https://www.research.ed.ac.uk/portal/en/publications/the-reform-of-the-law-of-directors-duties-in-

uk-company-law(4b418e09-6de0-4fc6-ab7f-8e16329a163b).html (accessed: 08/02/2017). 51 Griffin et al UK Company Law 401; Cabrelli “Presentation for Universita ‘Brocconi on the reform of the law

of directors’ duties in the UK Company Law” 3; and Butcher Directors’ Duties 33. 52 In Turquand v Marshall [1869] LR 4 Ch App 376 at 386 the court ruled that “however ridiculous and absurd

their conduct might have been, it is the misfortune of the company that chose such unwise directors”. Similarly,

in Grimwade v Mutual Society [1885] 52 LT 409 415, Judge Chitty held that directors were not bound to be wiser

than those who appointed them. Birds (2002) Reform of the United Kingdom Law 154. 53 See, for example, Regal (Hastings) Limited v Gulliver [1967] 1 AER 378 3 in which the court held that “the

general rule of equity is that no one who has duties of a fiduciary nature is allowed to enter into engagements in

which he or she has or can have a personal interest conflicting with the interests of those whom he or she is bound

to protect. If he or she holds any property, so acquired as trustee, he or she is bound to account for it to his or her

cestui que trust”. See also Re Smith & Fawcett Ltd [1942] Ch 304. 54 Turquand v Marshall [1869] LR 4 Ch App 376. 55 Overend & Gurney Co v Gibb [1872] LR 5 HL 480. 56 Re Cardiff Saving Banks [1892] 2 Ch 100. 57 Re National Bank of Wales Ltd [1899] 2 Ch 629.

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of gross negligence, a mere error of judgment was not enough to render directors liable

for breach of their duty of care.58 In Turquand v Marshall, for example, the directors

made a loan to one of their fellow directors. He died insolvent and without repaying the

loan. The court found that, as it was within the directors’ powers to make this loan, they

were not liable for the loss. The court ruled that:

Whatever may have been the amount lent to anybody, however ridiculous and

absurd their conduct might seem, it was the misfortune of the company that they

chose such unwise directors; but as long as they kept within the powers in their

deed, the Court could not interfere with the discretion exercised by them.59

3.2.3 Period from 1900–1998

In 1911, in Re Brazilian Rubber Plantation and Estates Ltd,60 the court held that

directors’ duty of care was to act with such care as is reasonably expected from them

having regard to their own knowledge and experience.61 In 1906, members of the public

were invited to purchase shares in Brazilian Rubber Plantations and Estates Limited to

enable the company to enter into a contract for the purchase of a rubber plantation in

Brazil.62 The descriptions of the plantation were contained in the prospectus which was

based on a report by one Meiter, who was a member of a syndicate which had acquired

an option to purchase the plantation for £15 000 and was selling it on to the company for

£150 000.63 The report claimed to be based on Meiters’ personal knowledge and

inspection of the plantation. However, although he had been in Brazil, Metier had never

personally visited the plantation and had fabricated the information set out in the report.64

The directors of the company had accepted Meiter’s report without investigation or

58 Turquand v Marshall [1869] LR 4 Ch App at 386; Overend & Gurney Co v Gibb [1872] LR 5 HL 480 487.

See also Bekink (2008) 20 SA Merc LJ 97. 59 Turquand v Marshall [1869] LR 4 Ch App 376 386. 60 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425. This case is available at http://0-

www.lexisnexis.com.oasis.unisa.ac.za/uk/legal/search/ (accessed: 05/08/2016). 61 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 437. 62 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 426. 63 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 427. 64 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 428.

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inquiry.65 The prospectus based on Meiter’s report thus contained various false

statements.66 The public subscribed to the shares on the basis of the prospectus and the

company subsequently acquired the plantation. When the truth regarding the plantation

was discovered, the directors made no attempt to resolve the matter and two years later

the company was compulsorily wound up.67 The liquidator brought proceedings for

damages against the directors for malfeasance in issuing the prospectus and signing and

carrying out the contract.68

The court considered the extent of directors’ duties towards their companies and found

that so long as the directors had acted honestly, they could not be held responsible for

damages, unless they were guilty of gross negligence.69 The court went on to state that

the directors were not guilty of negligence, but merely of a lack of sound commercial

judgment.70 It was emphasised by the judge that the actions of directors were not to be

tested by considering what a court itself would regard as reasonable.71

65 “The directors were Sir Arthur Aylmer, Bart, Edward Barber, H.W. Tugwell and Edward Henry Hancock. Sir

Arthur Aylmer was absolutely ignorant of business. He only consented to act because he was told he would not

incur any responsibility as a director of the company. H.W. Tugwell was a partner in a firm of bankers in a good

position in Bath; he was seventy-five years of age and very deaf and was induced to join the board by

representations made to him in January 1906. Barber was a rubber broker and was told that all he would have to

do would be to give an opinion as to the value of the rubber when it arrived in England. Hancock was a man of

business who said he was induced to join by seeing the names of Tugwell and Barber, whom he considered good

men”: Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 428. 66 Some of these false statements included: “(1) that the property contained 12 500 acres, whereas the real extent

was about 2500; (2) that there were on the property four well-built houses for officials and forty small houses for

workpeople, whereas the buildings on the estate were in fact mere huts roughly put together, and there were none

fit for the occupation of a European official; (3) that there were on the estate 400 000 trees of the species Hevea

brasiliensis, the Par rubber tree, but in fact there were none etc”: Re Brazilian Rubber Plantation and Estates Ltd

[1911] 1 Ch 425 428-429. 67 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 430. 68 Malfeasance is wrongdoing, especially by officials or persons who should know better. Garland et al

Encyclopaedia of Law 621. Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 430. 69 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 436-437. 70 Ibid. 71 Ibid; Keay Directors’ Duties 178; Griffin et al UK Company Law 401. See also Millet “Directors’ duties in the

context of complex international finance” 1-30 available at https://www.journal.ky/2010/02/03/directors-duties-

and-complex-international-finance/ (accessed: 01/08/2017).

102

One of the most important early cases to deal with directors’ duty of care toward a

company is Re City Equitable Fire Insurance Co.72 In this case the company, City

Equitable, suffered huge losses as a result of the fraudulent acts73 of Gerhard Lee Bevan,

who became a director of the company in 1916.74 Bevan was convicted and sentenced,

but the question arose as to whether, during the period covered by Bevan’s activities, the

other directors and the auditors of the company had properly discharged the duties they

owed to the company.75

In this case, Judge Romer set out some common-law principles which applied to a

director’s duty of care.76 First, in the performance of his or her duties a director need not

exhibit a greater degree of skill than may reasonably be expected from a person of his or

her knowledge and experience.77 Within the corporate world this principle sparked some

confusion over how the case should have been interpreted. On the one hand, it was

believed that Judge Romer followed a low subjective standard test. This would mean that

there was no minimum standard of skill set for a director. In terms of this approach, a

director had to act with the care that could be expected of him or her based on his or her

knowledge and experience.78 On the other hand, it was believed that Judge Romer used

72 Re City Equitable Fire Insurance Co [1925] Ch 407. The case is available at http://0-

www.lexisnexis.com.oasis.unisa.ac.za/uk/legal/search/ (accessed: 05/08/2016). 73 The company was ordered to be wound up. An investigation of the affairs of the company was made which

showed a shortage in the funds which the company should have been possessed. The collapse of the company

was due to bad investments, bad debts, and misappropriation on the part of Bevan: Re City Equitable Fire

Insurance Co [1925] Ch 407. 74 Re City Equitable Fire Insurance Co [1925] Ch 407 425. 75 Ibid. 76 Millet “Directors’ duties in the context of complex international finance” 9 available at

https://www.journal.ky/2010/02/03/directors-duties-and-complex-international-finance/ (accessed: 1/08/2017);

and Keay Directors’ Duties 179. 77 Judge Romer cited Lagunas Nitrate Co v Lagunas Syndicate ([1899] 2 Ch 392 at 435 where the court ruled

that: “If directors act within their powers, if they act with such care as is reasonably to be expected from them,

having regard to their knowledge and experience, and if they act honestly for the benefit of the company they

represent, they discharge both their equitable as well as their legal duty to the company.” Re City Equitable Fire

Insurance Co [1925] Ch 407 428. 78 Elias “Business judgment rule: Directors’ saviour from legal quagmire” 357 available at http://mak.trunojoyo.

ac.id/wp-content/uploads/2014/04/P33_Business-Judgment-Rule_Zaharah1.pdf (accessed: 02/08/2018).

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a subjective/objective standard test which set a minimal objective standard of care and

skill.79

Secondly, a director was not bound to pay continuous attention to the company’s affairs;

his or her duties were seen as intermittent to be performed at periodic board meetings

and meetings of any committee of the board on which he or she happened to sit. The

director was not bound to attend all such meetings, but ought to attend when reasonably

able to do so.80 Thirdly, having regard to the demands of the business, and in the absence

of grounds for suspicion, a director was justified in trusting the officers of the company

to perform their duties honestly. 81

In the case of Multinational Gas and Petrochemical Co v Multinational Gas and

Petrochemical Services Ltd and others,82 the court held that the duties owed by a director

include a duty of care as was recognised by Judge Romer in Re City Equitable Fire

Insurance Co Ltd – although as Judge Romer pointed out, the nature and extent of the

duty may depend on the nature of the business of the company and on the particular

knowledge and experience of the individual director. This interpretation of Re City

Equitable Fire Insurance Co Ltd indicated that by not only referring to the particular

79 Dignam Cases and Materials on Company Law 385. This confusion was later addressed in Norman v

Theodore Goddard [1991] BCLC 1028 1030-1031; Re D’Jan of London Ltd [1993] BCC 646 648. 80 Re City Equitable Fire Insurance Co [1925] Ch 407 428. 81 Judge Romer referred to In Re National Bank of Wales Ltd [1899] 2 Ch. 629 673, where the court asked: “Was

it his duty to test the accuracy or completeness of what he was told by the general manager and the managing

director? This is a question on which opinions may differ, but we are not prepared to say that he failed in his legal

duty. Business cannot be carried on upon principles of distrust. Men in responsible positions must be trusted by

those above them, as well as by those below them, until there is reason to distrust them. We agree that care and

prudence do not involve distrust; but for a director acting honestly himself to be held legally liable for negligence,

in trusting the officers under him not to conceal from him what they ought to report to him, appears to us to be

laying too heavy a burden on honest business men.” Re City Equitable Fire Insurance Co [1925] Ch 407 430. 82 Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd and others

[1983] 2 All ER 563.

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knowledge and experience of the individual director but also to the nature of the business,

Judge Romer intended to apply a subjective/objective standard test.

In the case of Dorchester Finance Co Ltd v Stebbing83 the court found a director, who

was also chairman of the board, guilty of gross negligence while the other two non-

executive directors were found guilty only of negligence.84 In this case a money-lending

company, Dorchester Finance, had three directors; two non-executive directors who

were not actively involved in the company, and one executive director, Stebbing, who

worked full-time for the company.85 The two non-executive directors signed blank

cheques at the request of Stebbing in order to secure capital for loan payments to its

clients.86 However, Stebbing used these funds to make loans that were illegal and so

irrecoverable. Understandably, the company suffered considerable losses and instituted

legal action against the directors based on the breach of their duty of care.87

The court rejected the argument of counsel for the defendants that only directors guilty

of gross negligence were in breach of their duty of care.88 The court held that, firstly, a

director must show the skill and care that may reasonably be expected from a person

with his or her knowledge and experience.89 Secondly, the director must take such care

as an ordinary person might be expected to take of his or her own affairs.90 Thirdly, the

83 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498. 84 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 505. Butcher Directors’ Duties 42. 85 Parons and Hamilton were the non-executive directors. Worthington Text, Cases, and Materials in Company

Law 381. 86 Ibid; Jess Insurance Of Commercial Risks 234. 87 Worthington Text, Cases, and Materials in Company Law 381. 88 Keay Directors’ Duties 183. 89 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 505. See also Re Produce Marketing Consortium Ltd

[1989] 5 BCC 569 595 where the court held that “executive directors had to apprise themselves of such

information as could be ascertained with reasonable diligence and an appropriate level of general knowledge,

skill, and experience. Judge Know pointed out that this was a minimum standard and that regard should also be

had to the functions the director performed, the particular type of company in question, and its business”. 90 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 505.

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director must exercise any power vested in him or her in good faith in the best interests

of the company.91

Another case which illustrates a move by courts towards the dual objective/subjective

standard for directors’ duty of care is Re D’Jan of London Ltd.92 In this case a director

signed an insurance form which provided incorrect information.93 This resulted in the

insurance company repudiating a claim when a fire caused the company to suffer

substantial losses due to valuable stock loss.94 The company was subsequently liquidated

as a result of the losses suffered in the fire.95 Mr D’Jan, the director, alleged that he had

not personally completed the form but merely signed it. The court ruled that the insurance

form was a simple document which D’Jan was in the best position to complete and that

by signing the document he had accepted that he was the person who should take

responsibility for its contents.96 The court further ruled that section 214(4) of the

Insolvency Act, 1986, was an accurate statement of the duty of care owed by a director

at common law in this context.97 Taking section 214(4) and the dual objective/subjective

standard it set into consideration, the court held that D’Jan had not shown reasonable

diligence when he signed the form. He was therefore in breach of his duty to the

company.98

91 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 505. 92 Re D’Jan of London Ltd [1994] 1 BCLC 561. 93 The insurance company was Guardian Royal Exchange Assurance and the mistake made on the insurance form

was that the defendant did not disclose that he had been a director of a company that was previously liquidated:

Re D’Jan of London Ltd [1994] 1 BCLC 561 562. 94 Re D’Jan of London Ltd [1994] 1 BCLC 561 563. 95 Ibid. 96 Ibid. 97 Ibid. This approach was also adopted by Lord Goldsmith in the House of Lords when he said: “the standard of

care which a director owes is enormously important … it is now accepted that the duty of care … is accurately

stated in s 214(4) of the Insolvency Act. Under the clause you take account of both the general knowledge, skill,

experience that may be reasonably expected of a person carrying out those functions and the general knowledge,

skill and experience that the director has. It is a cumulative requirement … I want to emphasise the point that it

is not making a change from what is already in the common law”: Lord Goldsmith Lords General Committee 6

February 2006 para 284. 98 Re D’Jan of London Ltd [1994] 1 BCLC 561 563.

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The collapse of Barings Bank in February 1995 raised important issues regarding the

application of directors’ duties in the UK.99 The collapse was caused by the lack of

supervision and monitoring of the dealings of a rogue trader, Nick Leeson, who had been

conducting arbitrage in derivatives between markets in Singapore.100 Larson made

enormous losses, but hid it from directors of Barings Bank. These losses ultimately led

to the collapse of Barings Bank which was purchased for £1 by a Dutch banking and

insurance group ING Group. After the collapse, the Secretary of State for Trade and

Industry sought the disqualification of three directors of Barings Bank under the

Company Directors Disqualifications Act 1986 in Secretary of State for Trade and

Industry v Baker.101 The essence of the case turned on the nature and scope of directors’

duties of care, skill and diligence. Parker J expressed his three limbed formulation of

directors duties as follows:

i) directors have, both collectively and individually, a continuing duty to acquire

and maintain sufficient knowledge and understanding of the company’s business

to enable them to discharge their duties as directors.

ii) whilst directors are entitled (subject to the articles of association of the

company) to delegate particular functions to those below them in the management

chain, and to trust their competence and integrity to a reasonable extent, the

exercise of power of delegation does not absolve a director from the duty to

supervise the discharge of the delegated functions.

iii) no rule of universal application can be formulated as to the duty referred to in

ii above. The extent of the duty, and the question whether it has been discharged

must depend on the facts of each particular case, including the director’s role in

the management of the company.102

99 Barings Bank was one of the oldest investment banks in the UK which was founded in 1762 by John and Francis

Baring. See https://ethicsunwrapped.utexas.edu/case-study/collapse-barings-bank (accessed 13/01/2019). 100 Arbitrage is the simultaneous purchase and sale of an asset to profit from an imbalance in the price. See

https://www.investopedia.com/terms/a/arbitrage.asp (accessed 13/01/2019). 101 See ss 6-8 of Company Directors Disqualifications Act 1986. The three directors were: Andrew Tuckey,

Ronald Baker and Anthony Gamby: Secretary of State for Trade and Industry v Baker (No.5) [1999] 1 BCLC

433. 102 Ronald Baker and Anthony Gamby: Secretary of State for Trade and Industry v Baker (No.5) [1999] 1

BCLC 436, 489.

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The court held that the three directors failed to ensure that Leeson’s proprietary trading

activities were properly monitored and should be disqualified.103

3.3 UNITED KINGDOM COMPANY LAW AND CORPORATE

GOVERNANCE REVIEW

Even before the company law review process started in 1998,104 investigations had been

initiated in the UK into ways to improve the corporate governance of listed companies.

These were high-profile investigations led by experienced individuals whose names were

linked to the final reports. These reports include the Cadbury Report,105 the Greenbury

Report,106 and the Hampel Report,107 which are briefly discussed below to provide some

background.108

3.3.1. Cadbury Report

In response to a variety of corporate scandals,109 a distinguished panel of experts was

convened to examine the workings of boards of directors, and the relationship between

103 Ronald Baker and Anthony Gamby: Secretary of State for Trade and Industry v Baker (No.5) [1999] 1

BCLC 433. The ruling was upheld on appeal in Secretary of State for Trade and Industry v Baker and Others

[2000] 1 BCLC 523, CA. 104 See para 3.3. 105 Committee on the Financial Aspects of Corporate Governance, 1992 (“Cadbury Report”). 106 Directors' Remuneration: Report of a study group chaired by Sir Richard Greenbury, July 1995 (‘Greenbury

Report’). 107 Committee on Corporate Governance, 1998 (“Hampel Report”). 108 See paras 3.3.1.1 to 3.3.1.3. There were also other reports dealing with corporate governance during the period

before the Companies Act, 2006, was enacted 1) The Turnbull Report, which provided some guidelines to

directors regarding internal control. Institute of Chartered Accountants in England and Wales Internal control:

Guidance for Directors on the Combined Code, September 1999; 2) The Higgs Report which reviewed the role

and effectiveness of non-executive directors. Review of the Roles and Effectiveness of Non-Executive Directors,

chaired by Derek Higgs, January 2003; and 3) the Smith Report which provided some guidance on the audit

committee functions. Audit Committees Combined Code Guidance: A Report and Proposed Guidance by an FRC-

appointed group chaired by Sir Robert Smith, January 2003. These reports are not discussed in this thesis as they

did not make material recommendations regarding directors’ duty of care or the business judgment rule. 109 The Polly Peck scandal is one example. Polly Peck International was a small British textile company which

expanded rapidly in the 1980s and became a constituent of the FTSE 100 Index before collapsing in 1990 with

debts of £1.3 bn. See http://www.theguardian.com/business/2010/aug/26/polly-peck-business-asil-nadir

(accessed: 15/07/2014). Another example is the Bank of Credit and Commerce International (“BCCI”) scandal.

BCCI defrauded depositors of $10 billion in the 1980s in what was called the “largest bank fraud in world financial

108

auditors, boards, executives, and shareholders.110 The Committee, chaired by Sir Adrian

Cadbury, was set up in May 1991 by the Financial Reporting Council, the London Stock

Exchange, and the accounting profession.111 The focus of the Committee was fairly

narrow;112 as its mandate was limited only to the control and reporting functions of

boards of directors and the role of auditors.113 Notwithstanding, its proposals were

crafted to contribute positively and broadly to the promotion of good corporate

governance as a whole..114

At the heart of the Cadbury Report, as it was known, was the Code of Best Practice

which was later implemented by the London Stock Exchange.115 The London Stock

Exchange required all listed companies registered in the UK, to state whether they

complied with the Code of Best Practice and to provide reasons for any areas of non-

compliance.116 The Code of Best Practice was a brief nineteen-paragraph description of

how companies should conduct their governance practices. The recommendations made

in relation to directors are relevant to this study.

history” by former Manhattan District Attorney Robert Morgenthau. See Boyd (1996) 2 Journal of Business

Ethics 168. 110 Jordan C “Cadbury twenty years on” 1 available at http://scholarship.law.georgetown.edu/cgi/

viewcontent.cgi?article=1003&context=ctls_papers (accessed: 20/09/2017). 111 Committee on the Financial Aspects of Corporate Governance Report, 1992, para 2.1. See also Solomon,

Corporate Governance and Accountability 55. Boyd (1996) 2 Journal of Business Ethics 167; Jordan C “Cadbury

twenty years on” 1. 112 It will later be argued that while King I was influenced by the Cadbury Report, its terms of reference were

much wider having regard to circumstances unique to the South African business environment, general corporate

governance, and accounting practices. See Chapter 5 para 5.4.2.2.2. 113 Committee on the Financial Aspects of Corporate Governance, 1992, para 11. 114 Ibid. 115 “London Stock Exchange originated in 1773; the regional exchanges were merged in 1973 to form the Stock

Exchange of Great Britain and Ireland, which was later renamed the London Stock Exchange.” For a detailed

discussion on the London Stock Exchange and its history, see Michie London Stock Exchange. 116 This is known as the “comply and explain” implementation mechanism. Jordan C “Cadbury twenty years on”

4 available at http://scholarship.law.georgetown.edu/cgi/ viewcontent.cgi?article=1003&context=ctls_papers

(accessed: 15/09/2017); Committee on the Financial Aspects of Corporate Governance Report, 1992, para 11;

Keasy, Thompson & Wright Corporate Governance 25.

109

The Code of Best Practice proposed a level of formality in the selection of non-executive

directors. Given the importance of their distinct contribution, it was recommended that

non-executive directors should be selected with the same impartiality and care as senior

executives.117 The Committee further emphasised that both executive and non-executive

directors should be responsible for the board’s actions and decisions.118 An essential

quality which non-executive directors should bring to the board’s deliberations,

according to the Committee, was that of independent judgment.119 The Committee

therefore recommended that the majority of non-executive directors on a board should

have no links to the company.120 The Code of Best Practice also advocated a division of

responsibilities between the Chief Executive Officer of the company and the Chairman

of its board which would ensure a balance of power and authority and that no single

individual would have unfettered powers and discretion.121

117 Committee on the Financial Aspects of Corporate Governance Report, 1992, para 4.15. 118 Committee on the Financial Aspects of Corporate Governance Report, 1992, para 4.3. 119 The Code of Best Practice states that non-executive directors should bring an independent judgment to bear

on issues of strategy, performance, resources, including key appointments and standards of conduct: Committee

on the Financial Aspects of Corporate Governance Report, 1992, para 2.1. 120 The Code of Best Practice states that non-executive directors should bring an independent judgment to bear

on issues of strategy, performance, resources, including key appointments and standards of conduct: Committee

on the Financial Aspects of Corporate Governance Report, 1992, para 4.12: “Some debates followed regarding

the definition of independence and whether it was necessary to have independent non-executive directors on the

board. Arguments for the inclusion of independent non-executive directors included the following: Independent

directors play a balancing role to executive directors and senior management; independent directors will make

decisions in the best interests of the company, and not in their self-interest; independent directors are distanced

on the remuneration policy of senior management; etc.”: Muth & Donaldson (1998) 6 Corporate Governance:

An international review 6. See also Nolan (2005) 6 Theoretical Inquiries in Law 414. Arguments against the

necessity of the inclusion of a majority of independent non-executive directors included: Independent directors

would not necessarily be able to afford protection to the company against mismanagement. In the Report of the

HIH Royal Commission (“Owen Report”) of 2003, Judge Owen emphasised that although the board of HIH had

several independent directors they were not able to protect the company against the folly of management. This

view was also supported by other commentators: Du Plessis et al Principles of Corporate Governance 79; Harvey

(1995) 8 International Business Law Journal 954. 121 Committee on the Financial Aspects of Corporate Governance Report, 1992, para 4.9. Boyd (1996) 2 Journal

of Business Ethics 171. Jordan C “Cadbury twenty years on” 2 available at

http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1003&context=ctls_papers (accessed: 17/

01/2018). Some of the other recommendations included: “1) The Committee believed that the calibre of the non-

executive members of the board was of special importance in setting and maintaining standards of corporate

governance. 2) In terms of advice sought from independent parties by directors it was recommended that directors

should always be able to consult the company’s advisers. If, however, they considered it necessary to take

independent professional advice, it was recommend that directors should be entitled to do so at the company’s

expense through an agreed procedure laid down formally, for example in a Board Resolution. 3) It was also

110

3.3.2 Greenbury Report

After the publication of the Cadbury Report,122 attention turned to the controversial

subject of directors’ remuneration.123 Public concerns had been raised regarding the level

of directors’ remuneration.124 In response, the Greenbury Committee offered suggestions

on how to address these concerns.125 The Committee’s mandate was to identify good

practices in determining directors’ remuneration and to prepare a Code that could be used

by companies listed in the UK.126 The Greenbury Committee fulfilled its mandate by

issuing the Greenbury Report127 accompanied by a Code of Best Practice on executive

remuneration.128 This Code of Best Practice was based on the principles of

accountability, transparency, and a link between reward and performance,129 which

included extensive disclosure of remuneration in annual reports.130 The Greenbury

Report further recommended the establishment of a remuneration committee made up of

non-executive directors131 with no personal financial interest, no potential conflicts of

interest, and no day-to-day involvement in running the business.132 The majority of these

recommended that all directors should undertake some form of internal or external training, etc.”: Committee on

the Financial Aspects of Corporate Governance Report, 1992, paras 4.10, 4.18 and 4.19. 122 See para 3.3.1.1. 123 Rani & Mishra Corporate Governance: Theory and Practice 65; Keasy, Thompson & Wright Corporate

Governance 30. 124 Some of these concerns raised included: The increases in directors’ remuneration, which was often not related

to an increase in the company’s performance; the extent of remuneration awarded in the form of share options;

the length of directors’ contracts which led to large compensation payments when such directors were dismissed;

and the lack of disclosure of directors’ remuneration, particularly with regard to share options. Greenbury Report

paras 1.6-1.8. Keasy, Thompson & Wright ibid; and Villiers & Viesca “Controlling directors’ pay in English law

and Spanish law” 377 available at https://journals.sagepub.com/doi/abs/10.1177/1023263X9500200405

(accessed: 22/01/2018). 125 The Greenbury Committee was headed by Sir Richard Greenbury, the then CEO of Marks and Spencer, a UK

retail company founded in 1884. See http://corporate.marksandspencer.com/?intid=gft_company (accessed:

29/07/2014); Keasy, Thompson & Wright ibid; and Villiers & Viesca “Controlling directors’ pay in English law

and Spanish law” 30-31. 126 Greenbury Report para 1.2. The report is available at https://web.actuaries.ie/sites/default/files/erm-

resources/244_greenbury_report.pdf (accessed: 14/07/2016). 127 Ibid. 128 Greenbury Report para para 2. 129 Ibid Chairman’s Preface 7; Rani & Mishra Corporate Governance: Theory and Practice 65. 130 Greenbury Report para 2.5; Calder Corporate Governance 40. 131 Ibid. 132 Rani & Mishra Corporate Governance: Theory and Practice 66.

111

recommendations were included in the United Kingdom Stock Exchange Listing

Rules.133

3.3.1.3 Hampel Report

The Committee on Corporate Governance – the Hampel Committee – was established in

November 1995 on the initiative of the Chairman of the Financia1 Reporting Council,

Sir Sydney Lipworth,134 following the recommendations of the Cadbury and Greenbury

Committees135 that a new committee should review the implementation of their

findings.136

The Committee was requested to confine its review to listed companies and its main

purpose was to promote high standards of corporate governance in the interests of

investor protection and to enhance the standing of companies listed on the Stock

Exchange.137 More specifically, the Committee was requested to review both the

Cadbury and Greenbury Committees’ Codes of Best Practice.138 The result of the review

133 The Listing Rules are a set of regulations applicable to any company listed on the London Stock Exchange,

subject to the oversight of the United Kingdom Listing Authority. Some of the recommendations included in the

rules are: “1) The board should include non-executive directors of sufficient calibre and number for their views

to carry significant weight in the board’s decisions. Non-executive directors should comprise not less than one

third of the board. 2) The majority of non-executive directors should be independent of management and free

from any business or other relationship which could materially interfere with the exercise of their independent

judgment. 3) In order to avoid potential conflicts of interest, boards of directors should set up remuneration

committees of independent non-executive directors to make recommendations to the board etc.” See United

Kingdom Stock Exchange Listing Rules A.3.1, A3.2 and B.2.1. The Listing Rules are available at

https://www.fca.org.uk/publication/ukla/listing-rules-august-2002.pdf (accessed: 08/03/2017). 134 Hampel Report 5. 135 See paras 3.3.1.1 and 3.3.1.2. 136 The Committee was chaired by Sir Ronald Hampel who was Chairman of ISG (International Stadia Group).

See http://www.forbes.com/profile/ronald-hampel/ (accessed: 4/08/2014). Solomon Corporate Governance and

Accountability 56. 137 Hampel Report 15. Oxelheim & Wihlborg Markets and Compensation for Executives in Europe 10. 138 Hampel Report 14. See further paras 3.3.1.1 and 3.3.1.2 above.

112

was the Hampel Report139 and its “Combined Code” published in 1998.140 The Hampel

Report indicated that a flexible approach to corporate governance should be followed:

Good corporate governance is not just a matter of prescribing particular corporate

structures and complying with a number of hard and fast rules. There is a need for

broad principles. All concerned should then apply these flexibly and with common

sense to the varying circumstances of individual companies. This is how the Cadbury

and Greenbury Committees intended their recommendations to be implemented. It

implies on the one hand that companies should be prepared to review and explain

their governance policies including any special circumstances which in their view

justify departure from generally accepted best practice, and on the other hand that

shareholders and others should show flexibility in the interpretation of the code and

should listen to directors’ explanations and judge them on their merits.141

In chapter 3 of the Hampel Report recommendations were made relating to the roles of

directors.142 It was confirmed that the basic legal duties of directors are to act in good

faith in the interests of the company, for a proper purpose, and to exercise care and

skill.143 The Report recommended that the view should not necessarily be that non-

executive directors should face less onerous duties than executive directors,144 although

non-executive directors will inevitably not be as well informed about the company’s

business as executive directors.145 In order to determine whether the director has fulfilled

his or her duty, factors such as the nature of the company and the position of the director

should be taken into account.146 It was recommended that a non-executive director

should have both strategic and monitoring functions.147 In addition, and particularly in

smaller companies, non-executive directors may contribute valuable expertise not

otherwise available to management; or they may act as mentors to relatively

139 Hampel Report 14. 140 Cheffins (1999) 10 Duke Journal of Comparative & International Law 9; Cross “Corporate governance,

information technology and the electronic company in the United Kingdom” 118 available at

http://www.tandfonline.com/doi/abs/ 10.1080/1360083042000210541 (accessed: 17/07/2016). 141 Hampel Report 10; Solomon Corporate Governance and Accountability 56; Moore (2009) 60 Northern Ireland

Legal Quarterly 88. 142 Hampel Report 23-31. 143 Hampel Report 23. 144 Ibid. 145 Ibid. 146 Ibid. 147 Hampel Report 25.

113

inexperienced executives.148 The Hampel Report further supported the Cadbury

Committee’s recommendations that a majority of non-executive directors should be

independent of management and free from any business or other relationship which could

materially interfere with the exercise of their independent judgment.149

The effectiveness of a board (including, in particular, the role played by the non-

executive directors) depends largely on the form, timing, and quality of the information

it receives.150 The Hampel Report indicated that reliance purely on what is volunteered

by management is unlikely to be adequate in all circumstances and further enquiries may

be necessary if the particular director is to fulfil his or her duties properly.151

3.3.2 Company Law Review Process Prior to Promulgation of the Companies Act, 2006

In 1995, the Department of Trade and Industry152 requested the Law Commission of

England and Wales, together with the Scottish Law Commission, to make

recommendations on company-law reform153 – the first time such a request had emanated

from the Department of Trade and Industry.154 Accordingly, the Company Law Review

148 Hampel Report 25. 149 Hampel Report 26. See para 3.3.1.3. 150 Hampel Report 23. 151 Hampel Report 23-24. “On the basis of Hampel’s suggestions, the Combined Code was divided into two

different, but linked, levels of prescription comprising seventeen relatively open-ended principles supplemented

by a larger number of more detailed explanatory provisions. Companies were from then on required by the Listing

Rules to produce a two-part corporate governance statement in their annual reports and accounts, explaining,

firstly, in broad and narrative terms, how they apply the higher-level Principles of the Code, detailing the

particular governance policies that the boards have adopted in order to implement those Principles within the

specific and current circumstances of the company's business; and, secondly, whether the company complies with

all of the more specific lower-level Provisions of the Code, together with supporting reasons in the event of non-

compliance with any one or more of those Provisions”. See Hampel Report 14. This approach differed from the

“comply and explain” approach recommended in the Cadbury Report – see para 3.3.1.1. See Review of the Role

and Effectiveness of Non-Executive Director, 2003, 72. 152 The Department of Trade and Industry is a British government department with primary responsibility for

company law. See Arden (2007) 81 Australian Law Journal 162. 153 The Law Commission is a statutorily independent body created by the Law Commissions Act 1965 to keep

the law under review and to recommend reform where it is needed. The aim of the Commission is to ensure that

the law is fair, modern, simple, and cost-effective. See http://www.lawcom.gov.uk/ (accessed: 27/07/2016) and

http://www.scotlawcom.gov.uk/ (accessed: 27/06/2016). Arden (2007) 81 Australian Law Journal 163. 154 Arden (2007) 81 Australian Law Journal 163; Hood (2015) 13 Journal of Corporate Law Studies 3.

114

Steering Group (“CLRSG”) was established to manage the review process.155 The terms

of reference for the CLRSG were that the review process should be clear in concept,

internally coherent, well-articulated, and workable.156 The CLRSG produced a series of

consultation documents between 1999 and 2001.157 A Final Report, Modern Company

Law for a Competitive Economy: The Final Report,158 was released in July 2001.159

The CLRSG made some recommendations relating to the codification of directors’ duties

of care, skill, and diligence, and the inclusion of a statutory business judgment rule in UK

company legislation.160 The CLRSG was in favour of the basic duties and principles

governing company directors being governed by common law, but also stated that the

codification of all principal fiduciary and other duties of directors would make the law

more accessible.161 In its Developing Framework Report162 the CLRSG recommended a

detailed statutory code setting out the duties of directors. Further recommendations on

directors’ duty of care were made in Chapter 3 of the Report in terms of which a dual

objective/subjective standard of review was proposed:163

155 Ferran (2005) 69 Rabel Journal of Comparative and International Private Law 629; Arden (2007) 81

Australian Law Journal 163; Reisberg (2010) 63/1 Current Legal Problems 325; Keay Company Directors’

Responsibilities to Creditors 173. 156 Department of Trade and Industry Modern Company Law for a Competitive Economy: Final Report 1999;

Lowry (2009) 68 Cambridge Law Journal 609. 157 The three main consultation documents were: Department of Trade and Industry: Modern Company Law for

a Competitive Economy: The Strategic Framework 1999 (“Strategic Framework”); Department of Trade and

Industry: Modern Company Law for a Competitive Economy: Developing the Framework 2000 (“Developing the

Framework”); Department of Trade and Industry: Modern Company Law for a Competitive Economy:

Completing the Structure 2000 (“Completing the Structure”). The reports are available at

webarchive.nationalarchives.gov.uk/ (accessed: 27/07/2016). 158 Department of Trade and Industry: Modern Company Law for a Competitive Economy: The Final Report 2001

(“Final Report”). Reisberg (2010) 63/1 Current Legal Problems 328. The Final Report is in three parts and

identifies three core policies which lie at the heart of the Review: (1) the “think small first” strategy for small and

private companies; (2) an open, inclusive and flexible regime for company governance; (3) an appropriate

institutional structure for law reform, enforcement and related matters. See also Ferran (2005) 69 Rabel Journal

of Comparative and International Private Law 5; and Birds (2002) Reform of the United Kingdom Law 149. 159 Department of Trade and Industry Final Report 2001. Reisberg (2010) 63/1 Current Legal Problems 328. 160 Birds (2002) Reform of the United Kingdom Law 151. 161 Birds (2002) Reform of the United Kingdom Law 151 and 154. 162 Developing the Framework 2000 para 3.40. 163 In Developing the Framework 2000 para 3.82 the Steering Group stated that: “We have not been able to think

of any new principles, nor areas where it is desirable to leave scope for the judges to develop completely new

115

A director must exercise the care, skill and diligence which would be exercised by

a reasonably diligent person with both the knowledge, skill and experience which

may reasonably be expected of a director in his position and any additional

knowledge, skill and experience which he has.164

Additional recommendations on the roles of company directors were made in the

subsequent Completing the Structure165 and Final Reports.166 The Final Report also

proposed the following draft clause regarding a director’s duty of care:

A director must exercise the care, skill and diligence which would be expected by

a reasonable diligent person with both:

a) the knowledge, skill and experience which may reasonably be expected of a

director in his position; and

b) any additional knowledge, skill and experience which he has.167

It is clear that the CLRSG recommended a dual subjective/objective test for directors’

duty of care.168 The first portion of the proposed draft – “reasonably be expected of a

director in his position” – implies an objective test, while the second portion – “any

additional knowledge, skill and experience which he has” – suggests a subjective test.

The question whether to codify directors’ duties was briefly considered by the Company

Law Committee (known as the Jenkins Committee) in its 1962 Report of the Company

Law Committee.169 The Committee stated that any attempt to define the duties of

ones. There would also be an objection of principle to the judges inventing wholly new based of liability for

company directors, with retrospective effect, rather than new obligations being imposed prospectively and after

democratic debate by Parliament. We are therefore inclined to favour the proposed restatement being treated as

exhaustive. Our view at this stage is that the restatement should set out all the general duties which apply to

directors in the exercise of their functions as such. The only duties which apply to them will be those which are

imposed by other provisions of the legislation.” 164 Developing the Framework 2000 para 3.40. 165 Completing the Structure 2000. 166 Final Report 2001, Ch 6 131-150. Matters addressed were, for example: directors’ powers and duties;

employment contracts of directors; directors’ dealing in share options, and loans secured on shares; companies’

and directors’ relationships with third parties, etc. 167 Final Report 2001, Annexure C Sch 2 para 4. 168 This resembles s 214(4) of the Insolvency Act, 1986, and the common law in para 3.2.3 above. See, for

example, Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 at 505; Re D’Jan of London Ltd [1994] 1

BCLC 561; Norman v Theodore Goddard [1991] BCLC 1028. 169 Board of Trade Report of the Company Law Committee, 1962, paras 86, 87 and 99(a). The Report is

available at http://www.takeovers.gov.au/content/Resources/other_resources/downloads/jenkins_committee

_v2.pdf (accessed: 09/03/2017).

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directors more clearly would involve the risk that, as it would be impossible to define

such duties exhaustively, there would be inevitable omissions which might well make it

more difficult to establish in any particular set of circumstances what these duties

were.170 It did, however, recommend that a director of a company should observe the

utmost good faith towards the company in any transaction with it or on its behalf, and

should act honestly in the exercise of his or her powers and the discharge of the duties

of his or her office.171

Before the enactment of the Companies Act, 2006, there had been previous attempts to

codify directors’ duties of care and skill in the UK. The Companies Bill, 1973, contained

a statutory provision similar to that suggested by the Jenkins Committee, which provided

that a director of a company should observe the utmost good faith towards the company

in any transaction with it or on its behalf, and should act honestly in the exercise of the

powers and the discharge of the duties of his or her office.172 The Companies Bill, 1973,

was, however, never enacted as the Conservative government was replaced by the

Labour Party following the 1974 general election.173

In 1978, another Companies Bill was introduced. Clause 44(1) of the Companies Bill,

1978, dealt with directors’ fiduciary duties but no reference was made to their duty of

care.174 Clause 44(1) read:

A director of a company shall observe the upmost good faith towards the company

in transactions with it or on its behalf and owes a duty to the company to act

honestly in the exercise of the powers and the discharge of the duties of his office.

170 Board of Trade Report of the Company Law Committee, 1962, para 87. 171 Board of Trade Report of the Company Law Committee, 1962, para 99(a). 172 Section 51(2) of the Companies Bill, 1973. 173 McLaughlin & McLaughlin Unlocking Company Law para 11.2.2; Rawlings Law, Society, and Economy 94. 174 Section 44 of the Companies Bill, 1978.

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This Companies Bill was, however, also not enacted as the Labour Party was defeated

by the Conservative Party in the 1997 general election.175 After these two failed attempts

to enact a new Companies Act, the Department of Trade and Industry issued two White

Papers. The first, Modernising Company Law, was published in July 2002 and dealt with

a range of issues, including draft clauses addressing directors’ duties similar to those in

the Final Report.176 After a consultation period,177 the second White Paper, Company

Law Reform, was published in March 2005, and the Company Law Reform Bill, renamed

the Companies Bill, was introduced in the House of Lords on 1 November 2005.178 The

UK’s new Companies Act, 2006, received royal assent on 8 November 2006.179

Section 1299 of the 2006 Act provides that, save as otherwise provided, the provisions

of the Companies Act, 2006, extend to the whole of the UK,180 thereby introducing a

single company-law regime applicable throughout the UK. Companies are therefore

termed UK companies rather than, for example, Great Britain companies or Northern

Ireland companies.181 Nothing, however, prevents Northern Ireland, for example, from

amending or repealing the Companies Act, 2006, independently if they so decide.182

175 In 1997 the Conservative Party was defeated in the general election. Williams UK Government & Politics 48. 176 Hood (2015) 13 Journal of Corporate Law Studies 3. 177 Reisberg (2010) 63/1 Current Legal Problems 329. 178 Lowry (2009) 68 Cambridge Law Journal 609. 179 Arden (2007) 81 Australian Law Journal 162. 180 See para 3.1 above where it is stated that the United Kingdom consists of Northern Ireland, Scotland, England

and Wales. 181 Section 1299 of the Companies Act 2006 provides that: “[E]xcept as otherwise provided, the provisions of the

Companies Act, 2006, will extend to the whole of the United Kingdom. Although the Companies Act, 2006,

applies to the whole of the United Kingdom, some provisions in the Act apply only to Scotland; some only to

England and Wales; and some only to Northern Ireland. Previously, the Companies Act, 1985, did not apply to

Northern Ireland which had its own company legislation.” Slorach & Ellis Business Law 2016-2017 at 40. Sheikh

Guide to the Companies Act 2006 136. 182 Northern Ireland has its own legislative competence and the Companies Act, 2006, may be amended separately

or repealed in Northern Ireland if that were so desired. Sheikh Guide to the Companies Act 2006 136.

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3.4 THE STATUTORY DUTY OF CARE, SKILL, AND DILIGENCE

Directors’ duties were fully codified in the Companies Act, 2006.183 Interestingly, this

Act states in section 170(3) that the new statutory duties are a replacement for the old

equitable and common-law duties of directors. The new duties are to “have effect in place

of those rules and principles”.184 Although the common law in respect of directors’ duties

will no longer apply, the courts may still refer to it when interpreting the new codified

duties subject to two propositions.185 Section 170(4) prescribes: first, that the statutory

general duties “shall be interpreted and applied in the same way as the common law

duties or equitable principles” so that the existing case law on the common-law duties

will remain, in most instances, relevant to the interpretation of the statutory duties.186

The second proposition is that “regard shall be had to the corresponding common law

rules and equitable principles in interpreting and applying the general principles”.187

Authors Davies and Rickford suggest that as regards the second proposition’s purpose,

the law relating to directors was often developed by the courts by analogy to the rules

relating to the duties of trustees to their beneficiaries, and of agents to their principals.188

Those rules continue to be embodied largely in the common law. The second proposition

enables the courts when developing the statutory duties of directors, to take into account

developments in the equivalent common-law duties applicable to trustees and agents.189

Consequently, there was no desire on the part of the legislature to cut the law of directors’

183 Sections 170-174 of the Companies Act, 2006. 184 Section 170(3) of the Companies Act, 2006. 185 Paolini Handbook on Directors’ Duties 76. 186 Section 170(4) of the Companies Act, 2006. South Africa has only partially codified directors’ duties and as a

result the common law duties will still apply to South African directors. 187 Section 170(4) of the Companies Act, 2006. 188 Davies & Rickford “An introduction to the new Companies Act” 63 available at

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1151805 (accessed: 21/05/2016). 189 Ibid.

119

duties off from its historical roots in the duties applicable to other persons acting in a

fiduciary capacity; rather it sought to provide a readily accessible statement of the basic

structure of those duties.190

The duty to exercise reasonable care, skill, and diligence is codified in section 174 of the

Companies Act, 2006. That section provides:

(1) A director of a company must exercise reasonable care, skill and diligence.

(2) This means the care, skill and diligence that would be exercised by a

reasonably diligent person with –

(a) the general knowledge, skill and experience that may reasonably be expected

of a person carrying out the functions carried out by the director in relation

to the company, and

(b) the general knowledge, skill and experience that the director has.191

A director, therefore, has a statutory duty to exercise reasonable care, skill, and

diligence.192 The first part of the test in section 174 is objective and sets a minimum

standard of care expected of all directors by reference to the director’s function in a

particular company.193 The second part is subjective and raises the standard. Directors

who possess particular skills, knowledge, and experience will be expected to exercise

these with reasonable care, skill, and diligence.194

190 “There could, however, be a potential problem in the event of a departure in the statutory statement from the

previous common law; it would obviously be inappropriate for the courts to refer to that common law in the

interpretation of the statutory duties. However, as the Act does not on the face of it reveal where it is confirming

and where it is departing from the common law, it will be necessary to understand where the statute departs from

the common law in order to determine the relevance of common-law decisions to the interpretation of the statute.”

Davies & Rickford ibid. See also Arden (2007) 81 Australian Law Journal 166. 191 Section 174 of the Companies Act, 2006. The Act is available at http://www.legislation.gov.uk/ukpga/

2006/46/section/174 (accessed: 21/05/2016). 192 Section 174(1) of the Companies Act, 2006. 193 Section 174(2)(a) of the Companies Act, 2006. Lowry “The irreducible core of the duty of care, skill and

diligence of company directors: Australian Securities and Investments Commission v Healey” at 252. The Steering

Committee also made recommendations in this regard. See its Final Report s 4 as discussed in para 3.3.2. 194 Section 174(2)(b) of the Companies Act, 2006. The wording is aligned with the provisions of s 214(4) of the

Insolvency Act, 1986. See discussion of s 214(4) in para 3.2.3.

120

Under the objective standard, a director’s performance is measured against what a

reasonably diligent and experienced person in the same role might reasonably have been

expected to do in the same circumstances.195 The subjective standard, on the other hand,

requires the director to exercise the general knowledge, skill, and experience that he or

she actually has – if that exceeds the objective standard.196 In effect, then, an individual

director will not be able to rely on his or her subjective level of experience unless that

subjective level of experience is higher than would objectively and reasonably be

required from a director. This marks a final departure from the traditional subjective

approach adopted in Re Brazilian Rubber Plantation and Estates Ltd 197 and Re City

Equitable Fire Insurance Co,198 and a move towards an approach similar to that applied

in Norman v Theodore Goddard199 and Re D’Jan of London Ltd.200

Recent case law on directors’ duties of care, skill, and diligence has provided the courts

with the opportunity to interpret section 174. In Gregson v HAE Trustees Ltd and

others,201 a discretionary trust was created by a deed of settlement (“the Settlement”)202

195 McKenna “Directors’ duties under the Companies Act 2006” at 5 available at https://www.law-

now.com/~/media/lawnow/pdfs/cms%20publications/.../writepdffile13.pdf (accessed: 19/01/2017); Tully

Corporate Legal Responsibility 81. 196 McKenna “Directors’ duties under the Companies Act 2006” 5. 197 Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425. See para 3.2.3. 198 Re City Equitable Fire Insurance Co [1925] Ch 407. See para 3.2.3. 199 Norman v Theodore Goddard [1991] BCLC 1028 (CLD). See para 3.2.3. 200 Re D’Jan of London Ltd [1994] 1 BCLC 561 (Ch). See para 3.2.3. 201 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006. 202 Two elements are normally present for there to be a settlement. Firstly, there has to be some form of

arrangement, where property or income belonging to one person is passed to another. Property here includes

money, land and other types of physical assets as well as incorporeal assets such as shares, rights and options.

Secondly, there must be an element of giving or getting something for nothing or for less than the open market

value. This is known as bounty. Settlements may involve written agreements or deeds. Trusts are a common type

but a settlement can also be a disposition, covenant or agreement. However, there does not have to be a deed and

so settlements can also include an unwritten arrangement or even a straightforward gift or transfer of property.

See https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/323655/hs270.pdf (accessed:

16/08/2016).

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between Henry Cohen (“the settlor”)203 and the first defendant (“HAE”).204 The settlor

and his two brothers had previously acquired and built up a furniture business then

known as Courts Bros (Furnishers) Ltd, which later became Courts plc (“Courts”). By

the early 1960s Courts was already a valuable company.205 HAE206 was incorporated on

30 May 1960 to act as an executor or administrator of estates or as a trustee. Over the

years it was appointed as trustee of a number of Cohen family trusts and settlements,

including the Settlement.207 The settlor transferred the shares in Courts to HAE shortly

after the Settlement had been created, and on 30 November 2004 Courts went into

administration and its shares (and, with them, the property of the trust) became

worthless.208 The claimant209 sought to claim against the directors, not on the basis of a

directly-owed fiduciary or tortious duty, but by alleging that the directors were liable to

HAE for breach of their duty of care to HAE.210 The basis of the allegation was the failure

by the directors to review the investments of the Settlement and consider diversification

pursuant to their statutory obligation under section 4(2) of the Trustee Act, 2000.211 As

HAE could not be expected to sue, argued that she was able to sue as a beneficiary of

203 A settlor is a person who “makes a settlement”, ie, someone who puts or gives money or other assets in a

settlement. This is known as “settling” property and it can be done directly or indirectly. See

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/323655/hs270.pdf (accessed: 16/

08/2016). 204 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 459. 205 Ibid. 206 HAE took its name from the first initials of the three brothers, Henry, Alfred and Edwin – Gregson v HAE

Trustees Ltd and others [2008] EWHC 1006 459. 207 The original directors of HAE were Henry, Alfred and Edwin Cohen. Later others were appointed as directors,

mostly members of the Cohen family. The second to fifth defendants were sued as former directors of HAE (the

fourth defendant representing a former director of HAE) – Gregson v HAE Trustees Ltd and others [2008] EWHC

1006 459. 208 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 459. 209 The claimant, who was a member of the Cohen family, was a beneficiary of the Settlement under an

appointment made in 1991. Her share was 25.733% of the trust fund. Gregson v HAE Trustees Ltd and others

[2008] EWHC 1006 459. 210 Ibid. 211 Section 4(2) for the Trustee Act, 2000, states that a trustee must from time to time review the investments of

the trust and consider whether, having regard to the standard investment criteria, they should be varied. The Act

is available at http://www.legislation.gov.uk/ukpga/2000/29/section/4 (accessed: 17/08/2016).

122

the settlement.212 The court ruled that when the directors were appointed, they assumed

a number of duties to HAE including: the duty of care213 and the duty to exercise

reasonable care, skill, and diligence in the performance of their functions for the

company.214 In the court’s view, section 174 merely codified the existing common-law

position regarding directors’ duty of care.215 Although the court confirmed that the

directors owed a duty of care to the company, it held that the “dog-leg claim” did not

apply in this instance and dismissed the claim against the defendants.216

In the High Court decision in Lexi Holdings (in administration) v Luqman and others,217

the claimant company (“Lexi”) alleged that the first defendant (“Shaid”), its managing

director, had misappropriated in excess of £53m from the company and in addition had

caused further substantial loss by loans to and transactions with parties connected with

the directors.218 The second, third, and fourth defendants (Waheed, Monuza and Zaurian)

were respectively Shaid’s brother and sisters.219 Lexi’s case against Monuza and Zaurian

was not that they had actively authorised and permitted Shaid's misconduct, but that they

were liable by virtue of their extensive neglect in the performance of their duties.220 The

court ruled that the standard of care expected of directors in the discharge of their duties

212 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 at 459. Claims of this kind, based on the idea

that a corporate trustee's claims against its directors are held on trust for the trusts it administers, have become

known as “dog-leg claims”. 213 The duty of care was codified in s 174 of the Companies Act, 2006 (codifying the common law) – Gregson v

HAE Trustees Ltd and others [2008] EWHC 1006 462. 214 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 462 and 471. 215 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 471. 216 Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 478. See further at 471-474 for the reasons

supplied by the court as to why the dog-leg claim did not apply in this case. Dog-leg claims are claims brought

against the directors of corporate trustee companies who are accused of breaching their duties as directors. See

http://www.oxfordreference.com/view/10.1093/ oi/authority.20110803095724913 (accessed: 03/03/2018). 217 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 725. 218 Ibid. The principal activity of the company had been the provision of bridging loan finance to commercial

developers for the purpose of real estate acquisition. 219 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 725. Monuza and Zaurian were

non-executive directors of Lexi Holdings and Waheed was a shadow director. For a discussion of what a non-

executive director and shadow director are, see Ch 5 paras 5.3.1 and 5.3.2. 220 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 725.

http://www.oxfordreference.com/

123

is relatively well settled, and that section 214(4) of the Insolvency Act, 1986,

encapsulates – albeit only to establish wrongful trading liability – the standard of care

generally applicable to directors.221

The court further held that section 174(2) of the Companies Act, 2006, is modelled on

section 214(4) of the Insolvency Act which involves both an objective and subjective

test. 222 The objective test sets the basic standard. It is consequently no excuse for a

director to say that, in fact, she or he did not have the general knowledge, skill, or

experience reasonably expected of a person carrying out their appointed functions.223

The subjective test, on the other hand, potentially raises the standard by referring to any

greater general knowledge, skill, or experience that the particular director actually has.224

The court referred to the principle established in Re City Equitable Fire Insurance Co

Ltd,225 that, because of the essentially fiduciary nature of the office, a director is expected

to apply to the management and custodianship of the company's property the same degree

of care as she or he might reasonably be expected to apply in the management and

custodianship of his or her own property.226 The judge held that by reason of their total

inactivity while serving as directors, Monuza and Zaurian had breached their statutory

fiduciary duties and their duties of care owed to Lexi. They were, however, not liable for

the misappropriations by Shaid – save for the sums paid to them – because, in effect,

their inactivity as directors had not caused the misappropriations or any loss to Lexi

resulting from them.227

221 See discussion of s 214(4) in para 3.2.3. 222 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 (Ch) 738. 223 Ibid. 224 Ibid. 225 Re City Equitable Fire Insurance Co [1925] Ch 407 at 455. See discussion of the case in para 3.2.3. 226 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 (Ch) 738. 227 Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 766.

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In Brumder v Motornet Service and Repairs Ltd and another,228 the claimant was the

sole director and sole shareholder of a company. He suffered personal injury in an

accident at the company's workshop and brought a claim against the company.229 The

court of first instance held that the company had been in breach of its absolute obligation

under regulation 5(1)a of the Provision and Use of Work Equipment Regulations,

1998.230 However, the judge also held that the claimant, who had given no consideration

to health and safety matters in the workshop, including the need to comply with the 1998

Regulations, was responsible for the breach and fully negligent. The claimant

appealed.231

The Court of Appeal ruled that the appellant had a duty to the first respondent to exercise

reasonable care, skill, and diligence in relation to the first respondent’s statutory

obligations in terms of both section 174 of the Companies Act and those under the 1998

Regulations.232 It held that definition in section 174(2) of the Companies Act, 2006,

builds on the formulation in section 214(4) of the Insolvency Act, 1986, which Judge

Hoffmann found in Re D'Jan of London Ltd233 to be an accurate statement of the

common-law duty of care.234 The court held that the first part of section 174(2)(a)

provides that a director must exercise the care, skill, and diligence that would be

exercised by a reasonably diligent person with “the general knowledge, skill and

experience that may reasonably be expected of a person carrying out the functions carried

out by the director in relation to the company”. In this case, the director had paid no

228 Brumder v Motornet Service and Repairs Ltd and another [2013] 3 All ER 412. 229 Ibid. 230 Regulation 5(1) of the Provision and Use of Work Equipment Regulations, 1998, states: “Every employer shall

ensure that work equipment is maintained in an efficient state, in efficient working order and in good repair.” See

http://www.legislation.gov.uk/uksi/1998/2306/regulation/5/made (accessed: 17/08/2016). 231 Brumder v Motornet Service and Repairs Ltd and another [2013] 3 All ER 424. 232 Ibid. 233 Re D’Jan of London Ltd [1994] 1 BCLC 561 (Ch). See para 3.2.3. 234 Brumder v Motornet Service and Repairs Ltd and another [2013] 3 All ER 424.

125

attention whatsoever to health and safety issues, and had abrogated his responsibilities

as owner and director of the company. He was therefore in breach of his duty of care

under section 174(2)(a).235 The court further held that although the director was not a

mechanic or skilled in operating a workshop, and that there were other people who were

more closely involved in the setting up and day-to-day running of the workshop, this did

not absolve him from his duties under section 174.236 The court found the applicant

personally liable for his breach of the qualified duty to exercise reasonable care now

contained in section 174.237

In summary, to comply with the duty of care as set out in section 174, the director’s

performance must not fall below what a reasonably diligent and experienced person in

the same role might reasonably have been expected to do in the same circumstances. But

if that person has additional skills, the standard is raised to reflect those skills.238 The

standard applied by courts to determine whether directors breached their duty of care

will be an objective standard. The standard is defined with reference to the care exercised

by a prudent businessperson with the knowledge and expertise that can reasonably be

expected of a person in a comparable situation. However, the standard required is raised

to include a subjective standard, if the director in question possesses particular

knowledge or experience. In this case, the law expects the director to use his or her

abilities to the advantage of the company.239

235 Ibid. 236 Ibid. 237 See also the decision of Dawn v Bell [2016] EWCA Civ 96 para 210 where the court ruled that “the standard

of care owed by a director is that of a reasonably diligent person having both the general knowledge skill and

experience reasonably to be expected of a person carrying out the same functions as are carried out by that director

and the general knowledge, skill and experience that that director has (s 174 Companies Act 2006). I do not

consider that the claimant was in breach of that duty in not recommending a switch to a cheaper web host in the

summer of 2007 owed a duty of care under s 174 of the Companies Act 2006.” 238 Gerner-Beuerle et al Study on Directors’ Duties and Liability in the European Union 92. 239 Gerner-Beuerle et al Study on Directors’ Duties and Liability in the European Union 92.

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3.5 REASONS WHY THE UNITED KINGDOM OPTED NOT TO

INCLUDE A STATUTORY BUSINESS JUDGMENT RULE IN THE

COMPANIES ACT, 2006

During the company law review process, the Law Commission considered whether to

include a statutory business judgment rule in UK company law.240 In its Company

Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties

Report,241 the Law Commission took into consideration the position in the US,242

Australia,243 and South Africa244 regarding the incorporation of a statutory business

judgment rule.245 The Law Commission asked whether, if the director’s duty of care were

made statutory, the Companies Act should also include a business judgment rule. It

indicated that the courts already adopt a policy of not reviewing commercial decisions

240 Although the business judgment rule has not been codified in the United Kingdom, an approach similar to that

followed by the rule has been adopted in a broad range of cases. See Howard Smith v Ampol Petroleum [1974] 1

All ER 1126 at 835; Devlin v Slough Estates Ltd [1983] BCLC 497 503-504; and Birdi v Specsavers Optical

Group Ltd [2015] EWHC 2870 (Ch) para 246. For a detailed study on the business judgment rule from the United

King perspective see Keay & Loughrey 2018 White Rose University Consortium 1-45. 241 The Law Commission and the Scottish Law Commission’s Report of 1998: Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties. 242 The US does not have a statutory business judgment rule. See Ch 2 paras 2.4.4.1 and 2.4.4.2. 243 The Law Commission referred to the recommendations made in Australia relating to a statutory business

judgment rule. In its Report No 10, Company Directors and Officers: Indemnification, Relief and Insurance, the

Companies and Securities Law Review Committee (“CSLRC”) “it recommended the enactment of a statutory

business judgment rule on the ground that the rule would reinforce directors’ ability to make operational decisions

which would not be reviewable on their merits in the courts.” In 1989, in their Report on the Social and Fiduciary

Obligations of Company Directors (“Cooney Report”), the Australian Senate Standing Committee on Legal and

Constitutional Affairs also recommended “the introduction of a statutory business judgment rule. However, the

Australian government at the time of this Report rejected the need for a statutory business judgment rule. In 1992,

a Corporate Law Reform Bill was introduced which restated the duty of care owed by a director. The Explanatory

Memorandum to that Bill stated that the government considered that the development of a business judgment rule

was best left to the courts.” See the Law Commission and the Scottish Law Commission’s Report of 1998,

Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties para 15.35. 244 The Law Commission referred to the recommendations made in the King Reports regarding the statutory

business judgment rule. In South Africa, the King Committee has also recommended that there should be a

statutory business judgment rule. “It considered that, particularly in the case of non-executive directors, the duty

of care and skill was onerous, and that a director should not be liable for breach of the duty of care if he or she

exercised a business judgment in good faith, provided that the decision was an informed one based on all the

facts, was rational, and that the director had no self-interest. The King Committee considered that such an

approach would encourage the competitiveness of South African companies and therefore recommended that

consideration be given to amending the Companies Act so that the duty of skill and care was so limited.” See

King I para 3.33.5. See the discussion of the King Reports in Ch 5 para 5.4.2.2.2. The Law Commission and the

Scottish Law Commission’s Report of 1998 Company Directors: Regulating Conflicts of Interests and

Formulating a Statement of Duties para 15.40. 245 The Law Commission and the Scottish Law Commission Report 1998 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties paras 15.30 to 15.40.

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or judging directors with the wisdom of hindsight.246 The Law Commission thus hoped

that an empirical study would assist in answering the question whether a statutory

business judgment rule should be considered, and if so, whether it should be along the

lines proposed in Australia, or those identified by the American Law Institute, or in some

other way.247 Background interviews were conducted with legal advisors, bankers,

accountants and insolvency practitioners about the operation of the law relating to

directors’ duty of care, wrongful trading and disqualification of directors.248

Based on the outcome of the empirical study, the Law Commission recommended that

there was no need for a statutory business judgment rule. It was argued that the rule had

originated in the US and that the US itself had not codified the rule.249 A further argument

was that the business judgment rule is specific to the US and has no equivalent in

Commonwealth countries, although at the time Australia was contemplating including a

statutory business judgment rule in its legislation.250

246 The Law Commission and the Scottish Law Commission Report 1998 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties para 15.41. 247 The Law Commission and the Scottish Law Commission Report 1998 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties paras 15.41 and 16.6(3). Although similar in nature,

there are certain differences in the approach followed by Australia and the American Law Institutes’ versions of

the business judgment rule. Some comparisons are made in Ch 6 para 6.1. See also Ch 2 para 2.4.4.2 and Ch 4

para 4.5. The empirical study was conducted by the ESRC Centre of Business Research University of Cambridge

and the report was released in 1999. ESRC Centre of Business Research University of Cambridge Report 1999

Directors’ duties: Empirical Study 1999 para 7. 248 “Some of the comments made by the participants included: You can be diligent as a director, but still be very

unlucky and as a lending banker, you accept that you can do all the checks on the market, the financials, you have

a group of competent managers and it can still go wrong. So I would not want to see anything which meant that

if any company that got into serious difficulties that necessarily reflected on the professional competence of

managers. Sometimes it is just sheer bad luck. It happens. On the other hand, I do not think that the standards

which directors have to keep to have not been particularly onerous up to recently and I think it is absolutely right

that there should be hurdles which directors, both executive and non-executive, should reach (Banker).”: ESRC

Centre of Business Research University of Cambridge Report 1999 Directors’ duties: Empirical Study 1999 para

7. 249 ESRC Centre of Business Research University of Cambridge Report 1999 Directors’ duties: Empirical Study

1999 para 7. 250 Ibid.

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In Modern Company Law for a Competitive Economy: The Strategic Framework Report,

the Department of Trade and Industry did not discuss whether a statutory business

judgment rule should be included in UK company law in detail, but referred to the

discussion of this aspect in the Company Directors: Regulating Conflicts of Interests and

Formulating a Statement of Duties Report, 1998.251 Similarly, in the Strategic

Framework Report the Department made no recommendations regarding the business

judgment rule, but stated that it was not for the law to substitute the business judgments

involved but to provide optimal conditions for their proper exercise.252

In a further report by the Law Commission – the 1999 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties Report – the Commission

found that in relation to commercial decisions in general, the courts take the view that it

would be wrong “to substitute [their] opinion for that of the management, or indeed to

question the correctness of the management’s decision ... if bona fide arrived at”.253 The

Law Commission stated that the best argument for the statutory business judgment rule

would be if empirical research were to indicate that directors were concerned about a

statutory statement of the duty of care, or if there was evidence that such a rule would

help raise the standard of directors’ duties to a dual objective/subjective standard of

251 The Law Commission and the Scottish Law Commission’s Report 1998 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties. Department of Trade and Industry Modern Company

Law for a Competitive Economy: The Strategic Framework Report 1999 para 7.17. The purpose of the Report

was to review Part X of the Companies Act, 1985, with a view to considering how the provisions could be

simplified and modernised, and also the case for a statutory statement of the duties owed by directors to their

company under the general law, including their fiduciary duties and their duty of care. 252 Department of Trade and Industry Modern Company Law for a Competitive Economy: The Strategic

Framework Report 1999 para 4.11. 253 The Law Commission and the Scottish Law Commission’s Report 1998, Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties 1999 51 and 52. Howard Smith Ltd v Ampol

Petroleum Ltd [1974] AC 821 832; In Re Sam Weller & Sons Ltd [1990] Ch 682 694; Re Elgindata Ltd [1991]

BCLC 959; Re Tottenham Hotspur plc [1994] BCLC 655 660; Bruner Corporate Governance in the Common

Law World 68.

129

review.254 The empirical research did not, however, reveal particular concern among

directors about this.255 The Law Commission was of the view that the rule was

unnecessary and stated that British courts do not judge directors with the wisdom of

hindsight or “second-guess” them on commercial matters. There was nothing to suggest

that this long-established judicial approach would not continue to apply and thus the Law

Commission recommended against the inclusion of a statutory business judgment rule.256

For example, the Attorney-General, Lord Goldsmith, stated:

There is nothing in this Bill that says there is a need for a paper trail … I do not

agree that the effect of passing this Bill will be that directors will be subject to a

breach if they cannot demonstrate that they have considered every element. It will

be for the person who is asserting breach of duty to make that case good …

[Derivative claims] will be struck out if there is no decent basis for them.257

In Modern Company Law for a Competitive Economy: The Final Report, 2001, the

business judgment rule was not discussed but it was again reiterated that business

decisions on, for example, matters involving strategy and tactics, are for the directors to

make and are not subject to decisions by the courts if they were made in good faith.258

Another reason why it was not deemed necessary to include a statutory business

judgment rule in the Companies Act, 2006, was that shareholder litigation in the UK is

rare.259 Although the Companies Act, 2006, makes provision for derivative actions,260 it

254 The Law Commission and the Scottish Law Commission’s Report 1999 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties 1999 52; Dignam Cases and Materials on Company

Law 393. 255 The Law Commission and the Scottish Law Commission’s Report 1999 Company Directors: Regulating

Conflicts of Interests and Formulating a Statement of Duties 1999 53. 256 Ibid. Gerner-Beuerle et al Study on Directors’ Duties and Liability in the European Union 117. 257 Lord Goldsmith in the House of Lords 9 May 2006. 258 Department of Trade and Industry Final Report 2001 352. There was also no reference to the business

judgment rule in the House of Commons Trade and Industry Committee’s White Paper on Modernising Company

Law 2003. 259 Bruno & Ruggiero Public Companies 228. Bruner Corporate Governance in the Common Law World 103.

Certain South African commentators raised the same argument for South African law, but South Africa opted to

include the business judgment rule. See Ch 5 para 5.5.1. 260 Section 260 of the Companies Act 2006. This is the first time a derivative action was provided for by statute.

Previously only the rules of court made provision for derivative actions. By definition, a derivative action

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was argued that this would in all likelihood not lead to a notable increase in shareholder

litigation.261 Certain amendments were made by the legislature to the Companies Bill as

regards derivative actions in order to address concerns that they could make it too easy

for shareholders to bring frivolous claims against directors.262 These amendments were

welcomed by the United Kingdom Company Law Reform: Status Report, as they serve

to limit the scope for shareholders to bring legal action against directors without good

cause.263

A further remedy directors have against incurring liability for a breach of their duties, is

set out in section 1157 of the Companies Act, 2006.264 There are some similarities

between this clause and the relief provided by the business judgment rule.

Section 1157 allows courts to absolve a director from liability for a breach of his or her

duty if he or she has acted reasonably and honestly and took due account of all the

circumstances in the case.265 However, this section does not grant the court an unfettered

discretion to grant directors relief from liability for a breach of their duties. Three

requirements must be established by the courts in this regard. Firstly, the director must

presumes that the shareholder is willing to act as a “corporate interest plaintiff” in pursuit of a goal that will be

beneficial for the corporate body as a whole. Macmillan (ed) International Corporate Law 156. 261 Reisberg “Shadows of the past and back to the future: Part II of the Companies Act 2006” 219 available at

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1274268 (accessed: 23/03/2017). 262 These recommendations included, for example: “Introduce an additional hurdle in the procedure for bringing

a derivative claim. At the outset, the applicant would be required to show a prima facie case against the defendant;

the court may make costs or civil restraint orders against the applicant, etc. This is significant as the UK also does

not provide for contingency fees for attorneys who represent shareholders and this is seen as a deterrent for

shareholders to enter into a law suit with the directors of a company. A contingency fee agreement is an agreement

whereby the client pays no fees unless and until there is recovery in the lawsuit. Such fees are usually based on a

percentage.” See Hodder and Sacks “What is a contingency fee?” available at http://canadian-lawyers.ca/Legal-

Help-and-Resources/What-is-a-Contingency-Fee.html (accessed: 12/09/2016). See also Bruno & Ruggiero

Public Companies 228. In turn, a director may be covered by his Director and Officer Insurance Policy as regards

legal fees. Morris “Directors’ liability: Indemnifying against third party proceedings” available at

http://uk.practicallaw.com/6-200-2363?source=relatedcontent (accessed: 12/09/2016). 263 United Kingdom Company Law Reform: Status Report August 2006 4. 264 Section 1157 of the Companies Act, 2006, replaced s 727 of the Companies Act, 1985. 265 Section 1157(1) of the Companies Act, 2006.

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have acted honestly; secondly, the director must have acted reasonably; and thirdly, in

light of all the circumstances of the case, it would be fair to absolve the director of

liability. The burden of proof lies with the director to show that he or she acted reasonably

and ought in fairness to be absolved of liability.266 The court will generally assume that

the directors acted honestly unless the contrary is proved by the claimant.267

As regards directors’ negligence and breach of the duty of care, this section is somewhat

problematic. If a director in the UK has breached his or her duty of care, he or she has

necessarily acted unreasonably.268 One may therefore ask how a director can have

behaved unreasonably for purpose of a breach of the duty of care, but reasonably for

purpose of section 1157? Kershaw argues that the “reasonableness standard” in section

1157 is far lower than the “reasonableness standard” in section 174.269 In the case of

Madoff Securities International Limited (in liquidation) v Raven and Others,270 Judge

Popplewell held that:

1. It was apparent from the fact that the section is applicable to liability for

negligence that “reasonably” is a broad concept; 2. Relief is available even where a director has been in breach of the duty to

exercise reasonable care and skill;

3. A court should take into account factors such as loss to the company;

personal benefit; whether shareholder approval has been provided; the

degree of blameworthiness and proportionality.271

From this ruling it may be suggested that British judges may in future adopt a more

sympathetic approach to directors, particularly where they have acted honestly.

266 Kershaw Company Law in Context 453. 267 See, for example, Re Kirby Coaches Ltd [1991] BCC 130 at 131 where the court ruled that “it may be that

honesty would be assumed in his favour in the absence of evidence to the contrary, but it is for him to show that

he acted reasonably and ought fairly to be excused”. 268 Kershaw Company Law in Context 453. 269 Ibid. 270 Madoff Securities International Limited (in liquidation) v Raven and Others [2013] EWHC 3147. 271 Madoff Securities International Limited (in liquidation) v Raven and Others [2013] EWHC 3147 para 333.

132

It is argued that, directors in the UK, throughout history have been found liable for

omissions but not for commissions.272 They are thus found liable because they did not

take a certain action as opposed to acting.273 We saw in Chapter 2 that the business

judgment rule applies only when a business decision is made.274 If the breach of the

directors’ duty of care results from no business decisions having been taken, the business

judgment rule will in any event not apply.275 This may preclude the business judgment

rule from being applied in the UK and was another argument made against its

inclusion.276 This argument applies to both the Delaware and the ALI formulation of the

business judgment rule.277 This is illustrated by Brumder v Motornet Service and Repairs

Ltd and another. 278 In this case, the court ruled that the omission by the director to

comply with health and safety requirements rendered him personally liable under section

174 of the Companies Act.279 Here, even had there been a statutory business judgment

rule in UK law, it would not have applied as no business decision was made and no

business action was taken.

A further remedy a company has against directors who breach their duties is provided

in section 168 of the Act and states that a director may be removed from office by an

ordinary resolution at a general meeting.280 In the event of a director or directors not

272 See examples of English court’s ruling on the inactivity of directors in Re City Equitable Fire Insurance Co

Ltd [1925] 1 (Ch) 407 and Finch v Finch [2015] EWHC 2430 (Ch). In Lexi Holdings Plc v Luqman [2007]

EWHC 2652 (Ch) 224 the court ruled that complete inactivity as a director is by definition unreasonable. See also

Arsalidou Impact of Modern Influences 173. 273 Ibid. 274 See Ch 2 para 2.4.2.1. 275 See the important article by Keay & Loughrey (2018) 39 White Rose University Consortium 5-45, where the

notion of a business judgment is discussed as seen from the English and Welsh perspectives. 276 Giraldo & Bogota “Factors governing the application of the business judgment rule: An empirical study of the

US, UK, Australia and the EU” 135 available at

https://pdfs.semanticscholar.org/2ce2/04f94edd5a80e1bfe794c56122f7ddc58ebc.pdf (accessed: 22/ 02/2017). 277 Ibid. 278 Brumder v Motornet Service and Repairs Ltd and another [2013] 3 All ER 424. See para 3.4. 279 See para 3.4. 280 Section 168 of the Companies Act 2006: 168(1): “A company may by ordinary resolution at a meeting remove

a director before the expiration of his period of office, notwithstanding anything in any agreement between it and

133

acting in the best interests of the company, the shareholders have the right to remove and

replace him, her or them, however this is not always an easy task. This can be illustrated

by Bushell v Faith.281 In this case a private company consisted of three shareholders

(each held 100 shares in the company), a brother and his two sisters, of which only two

were directors.282 The company adopted Table A of the Companies Act 1948, as its

articles of association with certain modifications, of which one was contained in article

9 of its articles and read as follows:

In the event of a resolution being proposed at a general meeting of the company

for the removal from office of any director, any shares held by that director shall

be on a pole in respect of such resolution carry the right to three votes per share

and regulation 62 of Part 1 of Table A shall be construed accordingly.283

In November 1968, the appellant and her sister, being dissatisfied with the conduct to

the respondent, requisitioned a general meeting of the company, to consider and, if

sought fit, to pass a resolution for the removal of the respondent from office of director

in terms of section 184(1) of the Companies Act 1984 (the predecessor of section 168).284

Section 184(1) stated:

A company may by ordinary resolution remove a director before the expiration of

his period of office, notwithstanding anything in its articles.

him. (2) Special notice is required of a resolution to remove a director under this section or to appoint somebody

instead of a director so removed at the meeting at which he is removed. (3) A vacancy created by the removal of

a director under this section, if not filled at the meeting at which he is removed, may be filled as a casual vacancy.

(4) A person appointed director in place of a person removed under this section is treated, for the purpose of

determining the time at which he or any other director is to retire, as if he had become director on the day on

which the person in whose place he is appointed was last appointed a director. (5) This section is not to be taken

– (a) as depriving a person removed under it of compensation or damages payable to him in respect of the

termination of his appointment as director or of any appointment terminating with that as director, or (b ) as

derogating from any power to remove a director that may exist apart from this section.” See Roach Company Law

90. 281 Bushell v Faith [1970] AC 1099. 282 Geoffrey Leopold Faith (shareholder and director), Constance Anna Bushell (shareholder and director) and

Kathleen Bayne (shareholder). See Bushell v Faith [1970] AC 1099 1102. 283 Bushell v Faith [1970] AC 1099 1102. Table A of the Companies Act 1948 can be accessed at

http://www.legislation.gov.uk/ukpga/1948/38/schedules/enacted (accessed: 30/01/2020). 284 S 184(1) of the Companies Act 1984. Bushell v Faith [1970] AC 1099 1102.

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On the poll of the meeting, the appellant and her sister voted for the resolution and the

respondent voted against it. A dispute arose as to whether the resolution had been passed

of defeated.285 The appellant contended that the resolution was passed by 200 votes,

being that of herself and her sister.286 The responded however contended that in

accordance with article 9 his 100 shares carried 300 votes and that therefore the

resolution was defeated by 300 votes to 200.287

The court upheld the effectiveness of weighted voting rights conferred on a director by

a company's articles of association which had the effect that the director was always able

to defeat a resolution to remove him or her from office notwithstanding that the majority

of members supported the removal of the director from office.288 The court ruled:

Parliament has never sought to fetter the right of a company to issue a share with

such rights or restrictions as it may think fit. There is no fetter which compels the

company to make the voting rights or restrictions of general application and it

seems to me clear that such rights or restrictions can be attached to special

circumstances and to particular types of resolution. This makes no mockery of s

184, all that Parliament was seeking to do thereby was to make an ordinary

resolution sufficient to remove a director. Had a Parliament desired to go further

and enact that every share entitled to vote should be deprived of its special right

under the articles it should have said so in plain terms by making the vote on a poll

one vote one share.289

This ruling ties in with the agency cost problem regarding the conflict of shareholders

who possess the majority or controlling interest in the firm and, on the other hand, the

minority or non-controlling shareholders.290 An agency cost problem arises for example,

whenever the welfare of one party, termed the “principal” depends upon actions taken

285 Bushell v Faith [1970] AC 1099 1102. 286 Ibid. 287 Ibid. 288 Bushell v Faith [1970] AC 1099 1109. Weighted voting rights means: The granting of weighted voting rights

to any shareholder who votes against a specified resolution so that the shareholder can cast such number of

votes as is necessary to defeat the resolution. See https://uk.practicallaw.thomsonreuters.com/6-380-

9637?transitionType=Default&contextData=(sc.Default)&firstPage=true&bhcp=1 (accessed: 31/01/2020). 289 Bushell v Faith [1970] AC 1099 at 1102. 290 Kraakman & Hansmann The Anatomy of Corporate Law 22.

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by another party, termed the “agent”.291 Another agency cost problem involves the

conflict between the company’s shareholders and its hired management. Here the

shareholders are the principals and management are the agents.292 For decades, a

hallmark of UK corporate governance has been a separation of ownership and control.293

Most publicly traded companies in the UK, especially larger ones, have a dispersed

shareholding, also known as “dispersed ownership structure”.294 There is a lack of a

dominant shareholder and investors have typically taken a “hands off” approach to

corporate affairs.295 This arrangement has created risks that corporate executives will

exploit the discretion they have and impose a vertical agency cost problem for

shareholders.296 There is, however, protection for shareholders which alleviates the

agency cost problem. Shareholders in the UK have the right to ratify conduct by a

director amounting to negligence, default, breach of duty or breach of trust in relation to

the company.297 The decision of the company to ratify such conduct must be made by

resolution of the members of the company, which includes shareholders.298 Shareholders

therefore have the opportunity to either reject or approve conduct of a director who

breached his or her duties. In the UK the board of directors are responsible for the

governance of the company therefore they have the power to manage the company,

however shareholders have the power to appoint directors and auditors.299 They therefore

291 Kraakman & Hansmann The Anatomy of Corporate Law 21. 292 There is also another agency cost problem which involves the conflict between the company itself and other

stakeholders. See Kraakman The Anatomy of Corporate Law 22. 293 Cheffins (2013) 4 ECGI 504. 294 Cheffins (2013) 4 ECGI 504. Dispersed ownership normally has 100% small shareholders. The fraction of

the voting shares of one shareholder is below 5% of the whole company. See Strik The implication of dispersed

ownership structure vs large shareholders on company performance in the US 6. 295 Strik The implication of dispersed ownership structure vs large shareholders on company performance in the

US 6. 296 Ibid. 297 Section 239(1) of the Companies Act, 2006. 298 Section 239(2) of the Companies Act, 2006. 299 The Financial Reporting Council: The UK Corporate Governance Code, 2018 4.

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have the power to select the best candidates to become directors which also alleviates

the agency cost problem.

The UK follows the “shareholder primacy” model. The “shareholder primacy” model

holds that it is a director’s duty to maximise the wealth of a company for the benefit of

shareholder welfare.300 In recent years, the UK introduces a framework known as

“enlightened shareholders value” which sits somewhere between the shareholders’

primacy and the stakeholders’ primacy.301 Although the enlightened shareholders value

approach provides for the protection of shareholders, other stakeholders’ interests are

also considered, however their interest are secondary to those of the shareholders.302

Another form of protection can be found in section 232 of the Companies Act 2006. This

section prohibits a company from exempting a director from, or indemnifying him or her

against, liability in connection with negligence, default, or breach of the duty of trust by

him or her in relation to the company. Any provision, whether in the company’s articles

of association, a contract, or otherwise, attempting to exempt or indemnify directors from

liability, will be void.303 In the UK directors have received some protection from section

232 of the Companies Act, 2006, through the inclusion of section 233 which allows

companies to provide their directors with insurance policies.304 Section 233 permits a

company to purchase and maintain insurance for its directors, or the directors of an

associated company, against any liability attaching to them in connection with any

300 Cabrelli & Esser A rule-based comparison and analysis of the case studies 482. 301 Cabrelli & Esser A rule-based comparison and analysis of the case studies 482. 302 Ibid. South Africa also introduced an enlightened shareholder value approach. See Ch 5 para 5.4.1. 303 Section 232 of the Companies Act, 2006. Sheikh Guide to the Companies Act 2006 at 484. In the Companies

Act, 2006, there is thus no provision similar to that in the US in s 102(b)(7) of the Delaware General Corporation

Law, which allows directors to be released from liability for breaches of the duty of care. See Ch 2 para 2.3.2. 304 Section 232 of the Companies Act, 2006, prohibits a company from exempting a director from, or indemnifying

him against, any liability in connection with any negligence, default, breach of duty or breach of trust by him in

relation to the company.

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negligence, default, breach of duty, or breach of trust by them in relation to the company

of which they are a director.305 A director will, therefore, be protected from the

possibility of personal liability by way of an insurance contract, and it can therefore be

argued that the business judgment rule would serve no useful purpose.306

In conclusion, some of the reasons proffered for not including a statutory business

judgment rule are stronger than others. Taking into consideration the agency cost problem

regarding the conflict between shareholders and management it may be argued that a

statutory business judgment rule should be considered. It was, however, clear throughout

the company law review process, that the strongest argument against a statutory business

judgment rule was that historically courts have adopted the policy of not reviewing

commercial decisions or judging directors with the wisdom of hindsight, and that there

was no indication that the courts would change this policy.307 There was nothing to

suggest that this long-established judicial approach to not interfere would not apply and

it was accordingly recommended not to include a statutory business judgment rule.308 The

research indicates that no strong argument was made for the inclusion of the business

judgment rule in the UK.309

305 Section 233 of the Companies Act, 2006. 306 Giraldo & Bogota “Factors governing the application of the business judgment rule: An empirical study of

the US, UK, Australia and the EU” 135 available at

https://pdfs.semanticscholar.org/2ce2/04f94edd5a80e1bfe794c56122f7ddc58ebc.pdf (accessed: 22/ 02/2017). 307 See, for example, the Law Commission and the Scottish Law Commission’s 1998 Report Company Directors:

Regulating Conflicts of Interests and Formulating a Statement of Duties para 15.41; The Law Commission and

the Scottish Law Commission’s Report 1999 Company Directors: Regulating Conflicts of Interests and

Formulating a Statement of Duties 3 Gerner-Beuerle et al Directors’ Duties and Liability in the European Union

117. 308 The Law Commission and the Scottish Law Commission ibid at 53; Gerner-Beuerle et al Directors’ Duties

and Liability in the European Union 117. 309 Horrigan Corporate Social Responsibility 220; Kershaw Company Law in Context 474; Birds (2002) Reform

of the United Kingdom Law 174; and Keay Directors’ Duties 213.

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3.6 CONCLUSION

In this chapter it was shown that prior to the 1990’s the courts did not demand a high

standard of care from a director – he or she would only be held liable for a breach of the

duty of care which involved gross negligence.310 The English courts initially applied a

low standard of review for directors’ duty of care as emerged from case law.311 The duty

of directors was merely to act with such care and skill as might reasonably be expected

of them, having regard to their own knowledge and experience.312

In the case of Re City Equitable Fire Insurance Co,313 the court set out certain common-

law principles which applied to a director’s duty of care. This resulted in some confusion

as to how the case should be interpreted. On the one hand, it was believed that the court

followed a low subjective standard test, but on the other hand, some believed that the

court had used a dual subjective/objective standard.314 According to the decision in

Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical

Services Ltd315 and other cases, the courts held that in Re City Equitable Fire Insurance

Co316 the court intended applying the dual subjective/objective standard test to establish

whether a director had breached his or her duty of care.317

310 See para 3.2.3. For example, cases like Turquand v Marshall [1869] LR 4 Ch App 376 386; Grimwade v

Mutual Society [1885] 52 LT 409 415; and Overend & Gurney Co v Gibb [1872] LR 5 HL 480 all repeated the

same proposition – that in the absence of gross negligence the courts would not find directors to be in breach of

trust. 311 Re Brazillian Rubber Plantation and Estates Ltd [1911] 1 Ch 425. 312 Re Brazillian Rubber Plantation and Estates Ltd [1911] 1 Ch 425 437. 313 Re City Equitable Fire Insurance Co [1925] Ch 407 425. 314 See para 3.2.3. 315 Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] 2 All

ER 563. 316 Re City Equitable Fire Insurance Co [1925] Ch 407 425. 317 See para 3.2.3.

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Section 214(4) of the Insolvency Act, 1986, brought greater clarity by establishing a dual

objective/subjective standard of review for directors’ duty of care. This section refers to the

general knowledge, skill, and experience of a director which is subjective in nature.318

Relevant case law was discussed, followed by the company law review process.319 The

recommendations made during the review process by the CLRSE relating to the

codification of directors’ duties and the inclusion of the business judgment rule in UK

legislation, were highlighted.320 The CLRSE was in favour of the codification of

directors’ duties and proposed a dual subjective/objective standard of review. It was

shown that although the CLRSE was in favour of the codification of directors’ duties,

there was a school of thought which felt it would be impossible to define such duties

exhaustively, and that some omissions would be inevitable.321 Previous failed attempts

to codify directors’ duties were considered. The company law review process finally

culminated in the Companies Act, 2006, which now applies to the whole of the UK.322

Section 174(4) of the 2006 Act, fully codified directors’ duty of care and replaced the

common-law duties of a director.323 Although the common-law duties no longer apply,

the courts may still refer to them when interpreting the new codified duties.324 It was

seen that section 174(4) sets a dual subjective/objective standard of review of a director’s

duty of care.

318 Section 214(4)(a) of the Insolvency Act, 1986. 319 See paras 3.3.1.1 to 3.3.1.3. 320 See para 3.3.2. 321 See para 3.3.2; Board of Trade Report of the Company Law Committee 1962 para 87. 322 See para 3.3.2. 323 See s 170(3) of the Companies Act, 2006. 324 See para 3.4.

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Under the objective test in section 174(2)(a), a director’s performance is assessed against

what a reasonable, diligent, and experienced person in the same position might

reasonably have been expected to do in the same circumstances. The subjective test in

section 174(2)(b), requires a director to exercise the general knowledge, skill, and

experience that he or she actually has, if that exceeds the objective standard. It was

further established that a director will not be able to rely on the subjective level of

experience unless this is higher than would objectively be expected of a director.325 This

marks the final departure from the traditional subjective approach. Case law was

discussed in order to illustrate how courts in the UK have interpreted section 174(2).326

Why a statutory business judgment rule was not included in the Companies Act, 2006,

was also considered.327 During the company law review process consideration was given

to whether the business judgment rule should be included in UK company law. It was

concluded that the courts have already adopted the policy of not reviewing commercial

decisions or judgments of directors with the wisdom of hindsight. Empirical studies also

indicated that there was no need for a statutory business judgment rule in United

Kingdom law.328 A further argument was that although the US developed the business

judgment rule, it has failed to codify it. Other arguments include, for example:

shareholder litigation in the United Kingdom is not common;329 there are other remedies

in the Companies Act 2006 should the director not act in the best interests of the

company;330 and that historically British directors have, in the main, been found guilty

325 See para 3.4. 326 See, for example, Gregson v HAE Trustees Ltd and others [2008] EWHC 1006; Lexi Holdings (in

administration) v Luqman and others [2008] EWHC 1639; and Brumder v Motornet Service and Repairs Ltd and

another [2013] 3 All ER 412. See para 3.4. 327 See para 3.5. 328 Ibid. 329 Ibid. 330 See para 3.5 above for a discussion of ss 168, 232 and 1157 of the Companies Act, 2006.

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for a breach of their duties based on omissions and not commissions. The business

judgment rule will not apply in these instances as no business decisions have been taken.

It was also pointed out that there was nothing to suggest that there was ever a strong

argument made in the UK for the inclusion of the statutory business judgment rule. Some

of these considerations also apply in South Africa which will be discussed in chapter

5.331

331 See Ch 5 para 5.5.1.

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CHAPTER 4

AUSTRALIA

4.1 INTRODUCTION

This chapter examines directors’ duty of care before the enactment of section 180(1) of

the Australian Corporations Act, 2001.1 First, the common-law position is discussed,2

showing that directors’ duty of care was influenced by English law and, accordingly,

directors were only held liable in instances of gross negligence.3

The statutory duty of care prior to the important decision in AWA Ltd v Daniels t/a

Deloitte Haskins and Sells4 is then considered. It is shown that the same lenient approach

followed under common-law was carried over to the first statutory provisions. The

standard used to determine directors’ duty of care was, in the main, subjective.5 The

1980s saw a number of corporate collapses in Australia and this led to a reappraisal of

directors’ duties with a move towards a more stringent, objective standard in both

common law6 and legislation.7

The significant decision in AWA Ltd v Daniels t/a Deloitte Haskins and Sells,8 which was

then taken on appeal in Daniels v Anderson,9 illustrates this shift and is discussed

1 See para 4.3. 2 See para 4.3.1. 3 Ibid. 4 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759. 5 See, for example, s 116(2) of the Victorian Companies Act, 1896. See para 4.3.2 below. 6 Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946; AWA Ltd v Daniels t/a Deloitte Haskins and

Sells (1992) ACSR 759. 7 Corporations Act, 2001, s 180(1). 8 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759. 9 Daniels v Anderson (1995) 13 ACLC 614.

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separately to herald the new approach adopted in Australia on how the director's duty of

care had to be interpreted and applied.10

After the decision in Daniels v Anderson, the Corporate Law Reform Program

(“CLERP”) was launched. Its main aim was to reform key areas of corporate and business

regulation and it resulted in the CLERP Act, 1999. This reform is discussed as well

because section 180(1) of CLERP Act introduced a set of important objective standards

in Australian corporate law by which a director's obligation to act with care and diligence

was to be evaluated. 11 Subsequently the Federal Government, as part of the CLERP,

announced that corporation law should be amended to include a statutory business

judgment rule, which ultimately resulted in the inclusion of the rule in section 180(2) of

the Corporations Act, 2001.12

The CLERP Act was replaced by the Corporations Act, 2001. The Corporations Act,

2001 operates as a national Act throughout the states and territories of Australia. The

statutory duty of care under section 180(1) of the Corporations Act, 2001, which applies

to both directors and company officers, is discussed.13 The application of the statutory

directors’ duty of care is illustrated by discussing the leading case law. Coinciding with

the enactment of the Corporations Act, 2001, the Australian legislature also enacted the

Australian Securities and Investment Commission Act, 2001 (“ASIC Act”).14 The ASIC

Act provides for the Australian Securities and Investment Commission (“ASIC”) which

10 See para 4.3.3. 11 See para 4.3.4. 12 Corporate Law Economic Reform Program Directors’ Duties and Corporate Governance Paper No 3 (1997). 13 Ibid. 14 See para 4.4.

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is the regulator for corporate, financial and market services in Australia and is also

governed by the Corporations Act, 2001.15

Summarily, what emerges from the discussion is that the duties of directors incorporated

into the Corporations Act 2001 are only a partial codification and the implications of this

partial code are illustrated.16

Thereafter, the last part turns to examine the statutory business judgment rule in section

180(2) of the Corporations Act 2001. 17 The aim is to illustrate how the rule has been

interpreted and applied by courts since its inception.18

4.2 AUSTRALIAN CORPORATION LAW: HISTORICAL OVERVIEW

Australia was originally a colony of Great Britain.19 In colonial times the influence of

English law in Australia was undeniable.20 To illustrate, the Australian Courts Act, 1828

(UK), provided that all laws and statutes in force in the UK at the time, were to be applied

by courts in New South Wales.21 Australian corporation law was, however, not a mirror

of English law and incorporated some innovative features.22 One of these innovations

15 See para 4.4. 16 Ibid. 17 See para 4.5.1. Comparisons are drawn between the business judgment rule in the selected jurisdictions in Ch

6 para 6.3. 18 See para 4.5.2. 19 “At the time of the colonisation of Australia, the UK was in need of new land to accommodate its convicts.

After early sightings of Australia by James Cook, it was decided that Australia would become a new British colony

where convicts would be sent and used for labour to establish the colony. In 1788 the first fleet of ships landed in

Botany Bay and so began the colonisation of Australia”: Knight & Heazle Understanding Australia’s Neighbours

75. For a detailed discussion of the colonisation of Australia see Bennett Australian Discovery and Colonisation. 20 Various colonies followed the British model, for example the Joint Stock Companies Registration and

Regulation Act, 1844. Similarly, most Australian colonies adopted legislation based on the Companies Act, 1862.

Von Nessen (1999) 26 Syracuse Journal of International Law and Commerce 239. 21 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– introduction to Australian legal history” 13 available at

http://classic.austlii.edu.au/au/journals/NSWJSchol/2013/34.pdf (accessed: 08/06/2017). 22 Lipton “A history of company law in colonial Australia: Economic development and legal evolution” 806 available at http://www.austlii.edu.au/au/journals/MelbULawRw/2007/32.html (accessed: 14/06/2017).

147

was limited-liability partnerships which shared some of the characteristics of

corporations. These partnerships were introduced for mining enterprises in New South

Wales and Victoria in the early 1850s.23 These initial forms of limited-liability enterprise

were not often used and were subsequently repealed by the Companies Statute, 1864,

(Vic) and Companies Act, 1874, (NSW) which provided for the incorporation of

companies with limited liability.

Although the limited-liability partnership Acts were short-lived and not widely used, they

nevertheless reflected the disposition of colonial governments to depart from English law

and to adopt business forms more suited to the needs of certain sectors of the local

business community.24 Australia looked for a more indigenous approach which led to an

Australian version of the common law – one that was adapted to the country’s own

features and customs.25 This move away from English law meant that UK law was no

longer a binding source of law in Australia.26

Australia became an independent nation on 1 January 1901.27 Its six states followed a

federal government system, similar to that of the US. 28 From federation onwards, there

23 See the Act to Legalize Partnerships with Limited Liability, 1853 (NSW); and the Act to Legalize Partnerships

with Limited Liability, 1854 (Vic). See also Lipton “A history of company law in colonial Australia: Economic

development and legal evolution” 806. 24 Lipton “A history of company law in colonial Australia: Economic development and legal evolution” 812. 25 Tomasic, Bottomley & McQueen Corporations Law in Australia 17. 26 The judicial emancipation of the Australian courts was formally completed with the enactment of the Australia

Act, 1986 (Cth). This statute stopped a right of appeal from Australian cases to the Privy Council in London. See

Tomasic, Bottomley & McQueen Corporations Law in Australia 17. 27 Vanachter & Vranken Federalism and Labour Law 5l; Irvin Australian Federation 13. 28 New South Wales; Queensland; South Australia; Tasmania; Victoria & Western Australia (together known as

the Australian Commonwealth). See http://australia.gov.au/about-australia/our-government/state-and-territory-

government (accessed: 01/10/2013).

148

was a slow movement towards uniformity in corporate legislation in the different

jurisdictions.29

Shortly after becoming a federation, there was a move towards the enactment of a

Corporations Act by the Federal Government. However, doubts were raised by certain

states,30 owing to their concern over the loss of revenue that would result from the

Commonwealth gaining control over corporate affairs.31 It was particularly section

51(xx) of the Commonwealth Constitution that caused great controversy.32 Under section

51(xx), Federal Parliament had (subject to the Constitution):

power to make laws for the peace, order, and good government of the

Commonwealth with respect to foreign corporations, and trading or financial

corporations formed within the limits of the Commonwealth.33

In Huddart Parker v Moorehead,34 the High Court ruled certain sections of the

Commonwealth Industries Preservation Act, 1906, unconstitutional.35 The court

effectively limited the Commonwealth’s power over corporations under section 51(xx)

of the Constitution, holding that it did not confer the power on the Commonwealth to

29 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– introduction to Australian legal history” 16 available at

http://classic.austlii.edu.au/au/journals/NSWJSchol/2013/34.pdf (accessed: 08/06/ 2017). 30 These states include New South Wales, South Australia and Western Australia. Cassidy Concise Corporations

Law 13. 31 Cassidy Concise Corporations Law 13. 32 The states argued that “s 51(xx) of the Commonwealth of Australia Constitution Act, 1900 did not allow the

Commonwealth to: 1) regulate the incorporation of new companies; 2) prohibit the formation of ‘outsized

partnerships’, unless incorporated; and 3) prohibit trading corporations from incorporating under state corporation

law.” See Huddart Parker v Moorehead (1909) 8 CLR 330 at 393, which stated that s 51(xx) presupposed the

existence of corporations already incorporated under state law. Cassidy Concise Corporations Law 13. 33 See s 51(xx) of the Commonwealth of Australia Constitution Act, 1900. 34 Huddart Parker v Moorehead (1909) 8 CLR 330 393. 35 The Commonwealth Industries Preservation Act, 1906, aimed essentially at the protecting of commercial

competition through anti-monopoly provisions. The Act sought to prohibit monopolisation and other activities

which restrained interstate trade or damaged Australian industries by unfair competition. The Act is available at

http://www.austlii.edu.au/au/legis/cth/num_act/aipa19069o1906451/ (accessed: 11/04/2016).

149

incorporate corporations, or to regulate corporations lawfully engaged in domestic trade

within a state.36 This decision excluded the possibility of a federal Corporations Act.37

In 1959 the Federal and the Commonwealth Attorneys-General met to devise a plan to

bring uniformity to legislation.38 The result was the Australian Uniform Companies Act,

1961.39 This Act was based largely on the Victorian Companies Act, 1958, and by 1972

there was a move to adopt a uniform Companies Act for all the states.40 The Acts

implemented by the different states were, however, not uniform and for this reason the

intention to establish a uniform Companies Act failed to materialise. With subsequent

amendments to legislation in the different states, these variations were exacerbated.41

This inconsistency was criticised in the Senate Select Committee on Securities and

Exchange Report (“Rae Report”) of 1974.42 The Labour government43 acknowledged the

criticism expressed in the Rae Report and attempted to implement a national scheme for

the regulation of corporations. However, as had happened in the UK, the Labour

36 Huddart Parker v Moorehead (1909) 8 CLR 330 at 393. See further High Court of New South Wales v

Commonwealth of Australia (1990) 169 CLR 482. 37 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– introduction to Australian legal history” 17. 38 Tomasic, Bottomley & McQueen Corporations Law in Australia 21. At the time the Attorneys-General for

Australia were Sir Barwick (Federal), Downing (New South Wales), Everingham (Northern Territory), Munro

(Queensland), Hon Rowe (South Australia), Fagan (Tasmania), Rylah (Victoria), and Watts (Western Australia).

See http://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/Browse

_by_Topic/law/attorneysgeneral (accessed: 16/02/2017). 39 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– introduction to Australian legal history” 17. 40 Ibid. 41 Cassidy Concise Corporations Law 5. 42 Senate Select Committee on Securities and Exchange Report of 1974 (“Rae Report”). The Rae Committee met

between 1970 and 1974 and produced three interim reports and a final report in 1974. The Rae Report stated:

“The so-called uniform Companies Acts have never been entirely uniform for all States and Territories. In recent

years there have been serious departures from uniformity in, for example, their provisions on accounts, audit and

duties of directors” 15.22. The Rae Report is available at

https://trove.nla.gov.au/work/5913541?q&versionId=6862379 (accessed: 11/04/2016). See further Cassidy ibid

and Tomasic, Bottomley & McQueen Corporations Law in Australia 22. 43 The Labour Party was formed in the 1890s and was represented in the first Federal Parliament elected in 1901.

In December 1972, the Labour Party, led by Whitlam, came to power in Australian federal elections for the first

time in several decades. Von Nessen (1999) 26 Syracuse Journal of International Law and Commerce 241.

150

government fell to a Liberal government.44 The proposed Bills were consequently never

adopted.45 After taking office, the Liberal government negotiated with the states for a

uniform national company code and an agreement was reached which resulted in the

implementation of several disparate pieces of legislation. The most important of these

was the Companies Code, 1981, which was adopted by all states.46

While the Rae Committee was preparing its report, the High Court ruling in Strickland v

Rocla Concrete Pipes Limited47 overturned the decision in Huddart Parker v Moorehead,

and although the court did not expressly deal with the Commonwealth’s power under

section 51(xx), it nonetheless opened the door for the Federal government to push for

national legislation.48

In 1989, the Commonwealth again attempted to enact a federal law governing companies

without the need for state cooperation.49 This was, however, successfully challenged in

New South Wales v Commonwealth of Australia.50 Following the court’s decision, the

44 In 1944, the Liberal Party of Australia was founded after a three-day meeting held in a small hall not far from

Parliament House in Canberra. The meeting was called by the then Leader of the Opposition (United Australia

Party) Robert Menzies and was elected to government for 23 years from 1949 to 1972, and for another term of

more than seven years from 1975 to 1983. See https://www.liberal.org.au/our-history (accessed: 12/04/2016). 45 Corporations and Securities Industry Bill and the National Companies Bill. Cassidy Concise Corporations Law

5; Tomasic, Bottomley & McQueen Corporations Law in Australia 22 and Von Nessen (1999) 26 Syracuse

Journal of International Law and Commerce 241. 46 The agreement was known as the Formal Agreement of 22 December 1978, and was enacted as a schedule to

the National Companies and Securities Commission Act, 1979 (Austl). The agreement was amended three times:

24 February 1981; 30 December 1983; and 16 October 1986. In addition to the substantive companies’ legislation,

the scheme concurrently established a national administrative agency, namely, National Companies and Securities

Commission Act, 1979, Companies (Acquisition of Shares) Code, 1981 (Austl), Securities Industry Code, 1981

(Austl), and the Futures Industry Code, 1986 (Austl). Von Nessen (1999) 26 Syracuse Journal of International

Law and Commerce 241. 47 Strickland v Rocla Concrete Pipes Limited (1971) 124 CLR 468. 48 See para 5.2. Tomasic, Bottomley & McQueen Corporations Law in Australia 22. 49 Bathurst “The historical developments of corporations law: Francis Forbes society for Australian legal history

– introduction to Australian legal history” 18. 50 High Court in New South Wales v Commonwealth of Australia (1990) 169 CLR 482 pars 6 and 7. The court

held that the power in s 51(xx) to make laws in relation to “foreign corporations, and trading or financial

corporations formed within the limits of the Commonwealth” did not extend to allowing the Commonwealth to

make a law for the incorporation of trading and financial corporations, as opposed to regulating those that were

already incorporated. See also Huddart Parker v Moorehead (1909) 8 CLR 330, discussed above.

151

Commonwealth once again entered into discussions with the states for further uniform

legislation.51 An agreement with the Commonwealth was reached which led to the

enactment of the Corporations Act, 1989, (Cth). This Act was subsequently enacted by

each state in such a manner that state legislation would automatically include any future

amendments made to the Corporations Act by the Commonwealth.52

Australian corporate law underwent significant changes during the 1990s and early

2000s.53 During this time, a reform process was initiated by the Corporations Law

Simplification Program,54 which resulted in the First Corporate Law Simplification Act,

1995, the Company Law Review Act, 1998, and the Managed Investments Act, 1998.55

In 1996, the Corporations Law Simplification Program was succeeded by the Corporate

Law Economic Reform Program and resulted in the Corporate Law Economic Reform

Act, 1999 (“CLERP Act”).56

51 Ramsay (2000) 3 Journal of the Securities Institute of Australia 26; Tomasic, Bottomley & McQueen,

Corporations Law in Australia 27. 52 The national scheme replaced various Acts and Codes comprising the national co-operative scheme, which had

been in operation for approximately eight years. These Acts and Codes include: Companies Act, 1981, and codes;

Companies (Acquisition of Shares) Act, 1980, and codes; Securities Industry Act, 1980, and codes; Futures

Industry Act, 1986, and codes; National Companies and Securities Commission Act, 1979; and Companies and

Securities Act, 1980, and codes. Tomasic, Bottomley & McQueen, Corporations Law in Australia 27.; Bathurst

“The historical developments of corporations law: Francis Forbes society for Australian legal history –

introduction to Australian legal history” 18 available at

http://classic.austlii.edu.au/au/journals/NSWJSchol/2013/34.pdf (accessed: 08/06/2017); and Von Nessen (1999)

26 Syracuse Journal of International Law and Commerce 243. 52 Grantham (2015) 43 Federal Law Review 235; Tomasic, Bottomley & McQueen, Corporations Law in

Australia v. 53 Tomasic, Bottomley & McQueen, Corporations Law in Australia v. 54 The Corporations Law Simplification Program was initiated in 1993 by the then Commonwealth Labour

Attorney-General. Adams Essential Corporate Law 5. 55 Tomasic, Bottomley & McQueen Corporations Law in Australia 27. 56 Before the CLERP Act, 1999, there was, first, the enactment of the Company Law Review Act, 1998 (Cth)

(“Review Act”), which came into effect on 1 July 1998. The second was the Corporate Law Economic Reform

Program Bill, 1998 (Cth) (“CLERP Bill”) which was reintroduced into parliament on 3 December 1998. See

Tomasic, Bottomley & McQueen, Corporations Law in Australia v and Adams Essential Corporate Law 5.

152

One of the CLERP Act’s aims was to restore the imbalance which was perceived to have

been created by case law.57 These decisions appeared to have increased the responsibility

of directors and created a degree of uncertainty regarding their potential liability. This

resulted in concerns being expressed that the attention of directors was increasingly

focused on compliance issues rather than wealth creation for shareholders.58 The CLERP

Act was later replaced by the Corporations Act, 2001, which currently operates as a

national Act throughout all the Australian states and territories.59

In conjunction with the Corporations Act, 2001, the Commonwealth also enacted the

Australian Securities and Investments Commission Act, 2001, (“ASIC Act”)60 which

provided for the Australian Securities and Investments Commission (“ASIC”).61 The

ASIC is Australia’s corporate, markets, and financial services regulator also governed by

the Corporations Act, 2001.62 Australia therefore has a unique regulatory model for the

enforcement of directors’ duties. In the US, the UK, and South Africa, the primary means

57 See, for example, Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946; Group Four Industries

Pty Ltd v Brosnan (1991) 9 ACLC 1181, (1992) 10 ACLC 1437; Statewide Tobacco Services Ltd v Morley (1990)

8 ACLC 827, (1992) 10 ACLC 1233 which in turn spurred judicial reform of the duty of care. See AWA Ltd v

Daniels TIA Deloitte Haskins 6 Sells (1992) 10 ACLC 933; Daniels v Anderson (1995) 13 ACLC 614. 58 The Explanatory Memorandum to the Corporate Law Economic Reform Program Bill stated: “Doubts have

been expressed about the extent to which it is permissible for directors, non-executive directors in particular, to

delegate functions to, and rely on, advice and information provided by others. Uncertainty about the circumstances

in which it is appropriate for a director to delegate to, or place reliance on the advice of others could lead to an

overly conservative approach to management and could impede the decision-making processes within a company.

This is a less than optimal outcome and is not conducive to the development of sound corporate governance

practices such as putting in place appropriate board committee systems. To remedy this, it is proposed to provide

specific legislative authority for delegation and reliance by directors.” See Explanatory Memorandum to

Corporate Law Economic Reform Program Bill, 1998, para 6.8. 59 The Corporations Act, 2001 (Cth) is available at https://www.wipo.int/edocs/lexdocs/laws/en/au/au196en.pdf

(accessed: 20/04/2016). 60 Australian Securities and Investments Commission Act, 2001, is available at

https://www.legislation.gov.au/Details/C2018C00438 (accessed: 20/04/2016). 61 ASIC is regulated by the Australian Securities and Investment Commission Act, 2001. ASIC was first called

the National Companies and Securities Commission, and later the Australian Securities Commission. The Wallis

Report (released in April 1997) recommended several regulatory changes, including the establishment of ASIC.

Du Plessis et al Principles of Corporate Governance 137. 62 Gibson & Brown (2012) 35 University of New South Wales Law Journal 254.

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of enforcing directors’ duties is by way of private litigation, whereas in Australia the

regulatory system relies heavily on a public enforcement model.63

Under this model, ASIC operates as the principal enforcement mechanism for breaches

of directors’ duties under Australia’s civil penalty system.64 ASIC was formed as an

independent government body to act as regulator and to protect Australian consumers,

investors, and creditors against fraud and unfair practices in financial markets and

financial products.65 ASIC may apply to a court for a declaration that a director or other

officer has breached a duty imposed by the Corporations Act, 2001.66 If ASIC is

successful, civil penalties may be imposed or an order to pay compensation to the

company may be made against the director or officer.67 ASIC is further empowered to

disqualify a director for a short period without a court order, or to apply to a court for

longer periods of disqualification.68

The following section focuses on the law reform pertaining to a director’s duty of care

and the business judgment rule before the promulgation of the Corporations Act, 2001.69

63 Hill (2014) 13 Sydney Law School Research Paper 8. See also Armour et al “Private enforcement of corporate

law: An empirical comparison of the United Kingdom and the United States” 687 available at

https://pdfs.semanticscholar.org/728c/830de369e14eb95481cc2925016c0b843f4c.pdf (accessed 04/07/2017) and

Hill (2010) 10 Sydney Law School Research Paper 48. 64 Hill (2014) 13 Sydney Law School Research Paper 8. 65 See http://australia.gov.au/directories/australia/asic (accessed: 01/10/2013). 66 Section 206 of the Corporations Act, 2001; Loos Directors’ Liability: A Worldwide Review 269. 67 Corporations Act, 2001, s 1317J(1). 68 Under s 206D of the Corporations Act, 2001, the court may disqualify a director for a maximum of twenty years

(previously ten years until June 2004). 69 See para 4.3.

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4.3 AUSTRALIAN DIRECTORS’ DUTY OF CARE, SKILL, AND

DILIGENCE PRIOR TO THE PROMULGATION OF SECTION

180(1) OF THE CORPORATIONS ACT, 2001

4.3.1 Directors’ common-law duty of care

In chapter 3 it was extensively discussed that under English common law, it was accepted

that directors were not liable for breaches of their duty of care if they had merely acted

negligently.70 Because originally Australian law was considerably influenced by English

law, this historical aspect, as the lenient approach followed in the Re Denham & Co case

shows, will not be repeated in this chapter, but reference will be made to pertinent case

law.71

The Australian decision in Re Denham & Co72 followed this same lenient approach.73 In

this case one of the directors was absolved of liability for not detecting that the Chairman

of the board of directors had committed fraud by manipulating the accounts to show a

fictitious profit. The court described the innocent director as a “country gentleman and

not a skilled accountant”.74 The court found that the innocent director had neither checked

the accounts nor attended board meetings.75 Although the court found he had been guilty

of “considerable negligence”, it did not expect him to have realised the significance of

certain information in the financial accounts.76 As a consequence, he was found not to

have breached his duty of care.77

70 See Ch 3 para 3.2. 71 Ibid. See further, for example, Overend & Gurney Co v Gibb [1872] LR 5 HL 480 487-489, 493, 496 and 500

where it was held that directors are only liable for breach of their duty of care, skill, and diligence if they have

acted with gross negligence. This was confirmed in Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392.

See also Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 437; Re City Equitable Fire Insurance Co

[1925] Ch 407 428. See Ch 3 para 3.2. 72 Re Denham & Co (1883) 25 Ch D 752. 73 See, for example, Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 437; Re City Equitable Fire

Insurance Co [1925] Ch 407 428. See Ch 3 para 3.2. 74 Re Denham & Co (1883) 25 Ch D 767. 75 Re Denham & Co (1883) 25 Ch D 752. 76 Re Denham & Co (1883) 25 Ch D 766. 77 Ibid.

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4.3.2 Directors’ statutory duty of care before AWA Ltd v Daniels78

In 1896, the Victoria Companies Act laid down statutory duties of care, skill, and

diligence in section 116(2).79 Section 116(2) of this Act stated that every director was

under an obligation to the company to use reasonable care and prudence in the exercise

of his or her powers and duties, and would be liable to compensate the company for any

damage incurred by reason of culpable neglect to use such care and prudence.80

There was some debate surrounding the inclusion of section 116(2) in the Victoria

Companies Act, 1896. Individuals in support of the incorporation were concerned that

something needed to be done to protect the public, particularly in light of scandals that

had occurred. 81 Those against the incorporation felt that section 116(2) was too harsh

and would deter people from becoming directors.82 A further point of contention was the

incorporation of the word “culpable” in section 116(2). The wording of this section

appeared to be in line with the decision in Lagunas Nitrate Co v Lagunas Syndicate83

where the court held that directors are not liable for all the mistakes they make, and that

their negligence must be culpable or gross in a business sense.84 Although section 116(2)

78 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759. 79 Although there was vigorous parliamentary debate surrounding the introduction of the duty of care in 1896,

there appear to be no cases interpreting or applying this duty. It was also not re-enacted in the Victoria Companies

Act, 1910, which replaced the 1896 Act. Langford, Ramsay & Welsh (2015) 37 Sydney Law Review 490. 80 Section 116(2) of the Victoria Companies Act, 1896. 81 See Victoria, Parliamentary Debates, Legislative Assembly 4 March 1896 at 6237 where it was reported that

Hancock said: “Something must be done to protect the public. He believed there were thousands of pounds that

were now put by that would be invested in commerce and trading if there was some sort of guarantee that any

director not using proper care would be punished. He only regretted, as he had already said, that there was no

punishment of imprisonment, as he felt perfectly sure that when the evil time came the director proceeded against

would have filed his schedule and would not have a feather to fly with.” The debates are available at

https://www.parliament.nsw.gov.au/hansard/Documents/1990-91%20Index.pdf (accessed: 20/05/2016). 82 See, for example, Victoria, Parliamentary Debates, Legislative Assembly 4 March 1896 6232 where Zox said:

“Men would be afraid to become directors of public companies in face of such a drastic law, lest they should be

treated as criminals. Instead of getting the most honourable and straightforward men to become directors of public

companies, they would get men who were altogether unmindful of what became of themselves – men who had,

perhaps, no good reputation to lose. Men were not all blessed with the same amount of common sense, commercial

knowledge, or discretion.” 83 Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392. 84 Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 435. For a detailed discussion of s 116(2) see Langford,

Ramsay & Welsh (2015) 37 Sydney Law Review 492-497.

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provided that every director was under an obligation to use reasonable care and prudence,

the director was only liable to compensate the company for any damage incurred “by

reason of culpable neglect to use such care and prudence”.85

Sixty-two years later the Victoria Companies Act, 1896, was replaced by the Victoria

Companies Act, 1958. Section 107(1) of the 1958 Act dealt with directors’ duties and

formed the basis for the development of the current statutory directors’ duties.86 Section

107(1) introduced an objective standard of review for directors’ duties by inserting the

words “reasonable diligence”.87 A similar provision was introduced in 1961 by the

Australian Uniform Companies Act,88 section 124(1). 89 Section 124(1) reads:

A director shall at all times act honestly and use reasonable diligence in the

discharge of the duties of his office.

Both these sections included an objective standard of review. One court’s interpretation

of the statutory duty of “reasonable diligence” contained in section 107(1) of the

Victorian Companies Act, 1958 caused some concern among legislatures and

commentators. In Byrne v Baker90 the Victoria Supreme Court, tried to establish what

standards were expected of a director under sections 107(1) and 124(1), and interpreted

85 Langford, Ramsay & Welsh (2015) 37 Sydney Law Review 494. 86 Section 107 of the Victoria Companies Act, 1958, provided: “(1) A director shall at all times act honestly and

use reasonable diligence in the discharge of the duties of his office. (2) Any officer of a company shall not make

use of any information acquired by virtue of his position as an officer to gain an improper advantage for himself

or to cause detriment to the company. (3) Any officer who commits a breach of the foregoing provisions of this

section shall be guilty of an offence against this Act and shall be liable to a penalty of not more than Five hundred

pounds and shall in addition be liable to the company for any profit made by him or for any damage suffered by

the company as a result of the breach of any of such provisions. (4) Nothing in this section shall prejudice the

operation of any other enactment or rule of law relating to the duty or liability of directors or officers of a

company.” 87 In the Victoria Parliamentary Debates, Legislative Council, 29 October 1958 1299, Minister Feltham stated

that “it would not be a defence for the director to say that he did not know that this type of activity was being

practiced. The director would have to satisfy a court that he did in fact used reasonable diligence. If he ought to

have known what was happening, he will be deemed to have in fact known and to be responsible.” 88 Australian Uniform Companies Act, 1961. 89 Ibid. 90 Byrne v Baker (1964) VR 443. As s 107(1) of the Victoria Companies Act, 1958, and s 124(1) of the

Australian Uniform Companies Act, 1961, were virtually identical, the critique of Byrne v Baker applied

generally to the law in place at that stage. Du Plessis 2010 Acta Juridica 281.

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the provisions in the context of In re City Equitable Fire Insurance Company Ltd.91 The

court interpreted the statutory provision down to the lower case-law standards. The court

in Byrne v Baker held that the degree of diligence demanded of a director was that which

might reasonably be expected of the director in the circumstances.92 The court noted that

the omission of the word “skill” from sections 107(1) and 124(1) was significant and had

the effect that the legislature demanded only a reasonable degree of diligence from honest

directors.93 The court thus applied a lower objective standard than the already low

objective standard of review of gross negligence. According to Du Plessis,94 this raised

concern amongst legislators and commentators as it could surely not have been the

intention of the legislator to lower the already low standard of care expected of

directors.95

The 1980s saw a number of corporate collapses96 in Australia, which led to the review of

directors’ duties with a move towards a more stringent objective standard97 in both

common law98 and legislation.99 The ruling of Commonwealth Bank of Australia v

Friedrich100 illustrated that there was a growing expectation of a more stringent approach.

Judge Tadgell stated that the community expectations of directors had tended to escalate

91 Re City Equitable Fire Insurance Co [1925] Ch 407 428. Corkery,Directors’ Powers and Duties 140; Du Plessis

2010 Acta Juridica 280. 92 Byrne v Baker (1964) VR 443 450ff. 93 Byrne v Baker (1964) VR 443 450. 94 Du Plessis 2010 Acta Juridica 281. 95 See the discussion in Cooney Report para 3.19. 96 Some examples of the corporate collapses include Australia’s largest industrial group (Adelaide Steamship);

nearly half the brewing industry (Bond Brewing); all three major commercial television networks (Bond Media,

Qintex, Channel 10); Australia’s largest car renter (Budget); the second-largest newspaper group (Fairfax);

Victoria's largest building society (Pyramid); and Australia’s largest textile group (Linter). See Kirby “The

Australian Institute of company directors’ Tasmanian Division luncheon, Hobart, Tasmania 31 March 1998. 97 Mitchell et al Law, Corporate Governance and Partnerships at Work 36. See also Tomasic, Bottomley &

McQueen Corporations Law in Australia 316; and Butcher Directors’ Duties 43. 98 See Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 946; Daniels v Anderson (1995) 16 ACSR

607. 99 See the discussion of the Corporations Act, 2001, s 180(1) in para 4.4. 100 Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946.

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with the increasing complexity of commerce and that the stage had been reached where a

director was expected to be capable of understanding his or her company’s affairs to the

extent of actually reaching a reasonably informed opinion.101 In Metal Manufacturers Ltd

v Lewis,102 the court held that Australian corporate law required a higher level of attention

from directors to affairs of the company and its dealings with the outside world, than had

previously been the case, and that directors could not surround themselves with a shield

of immunity by washing their hands off the company’s affairs and leaving it to their co-

directors to deal with company matters.103 This sentiment was echoed by the

Tricontinental Royal Commission,104 which suggested that there should be an increase in

the standard of review of directors’ duties to a more objective standard.105

Section 124 was replaced by section 229 of the Australian Companies Act, 1981,

(Cth).106 Section 229(2) required a director of a corporation at all times to exercise a

reasonable degree of care and diligence in the exercise of his or her powers and the

discharge of his or her duties as opposed to just “reasonable diligence” which expands

on the standard expected of directors.107 According to the Cooney Report,108 the

101 Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 955-956. See also Metal Manufacturers Ltd v

Lewis (1988) 13 ACLR 357 and Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 35 432 which followed

the ruling of Metal Manufacturers where Judge Ormiston stated: “Directors are entitled to delegate to others the

preparation of books and accounts and the carrying on of day to day affairs of the company. What each director

is expected to do is to take an intelligent interest in the information either available to him or which he might with

fairness demand from the executives or other employees and agents of the company.” See further Hussein v Good

(1990) 1 ACSR 710; Heide Pty Ltd v Lester (1990) 3 ACSR 159; Group Four Industries Pty Ltd v Brosnan (1992)

59 SASR 22; Rema Industries and Services Pty Ltd v Coad (1992) 107 ALR 374; Deputy Commissioner of

Taxation v Clark (2003) 57 NSWLR 113. 102 Metal Manufacturers Ltd v Lewis (1988) 13 ACLR 357. 103 Metal Manufacturers Ltd v Lewis (1988) 13 ACLR 357 360. 104 The appointment of the Royal Commission on 7 September 1990 arose out of the collapse in 1989 of the

merchant banking business conducted by the Tricontinental Group of companies. This Group comprised the parent

company, Tricontinental Holdings Limited, and its wholly owned subsidiary companies. See First Report of the

Royal Commission of Inquiry into the Tricontinental Group of Companies, 1991, para 1.1. 105 Final Report of the Royal Commission of Inquiry into the Tricontinental Group of Companies, 1992, paras

19.53-19.56. 106 Companies Act, 1981 (Cth) s 229 available at https://www.legislation.gov.au/Details/C2004A02466

(accessed: 23/05/2016). 107 Companies Act, 1981 (Cth) s 229(2). 108 Cooney Report para 3.24.

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standards laid down however barely met the requirements of contemporary business and

fell far short of the standards required of other professions.109 The Cooney Report further

recommended the introduction of a statutory business judgment rule.110 It recommended

that the rule be coupled with an obligation on directors “to inform themselves of matters

relevant to the administration of the company”, and a requirement that they show that

they had exercised an “active discretion” or a “reasonable degree of care in the

circumstances”.111

While using the words “care and diligence”, section 232(4) did not refer to “skill” which,

according to Ramsey, could imply that there was no objective statutory standard of

skill.112 It was, however, argued that some parts of the Explanatory Memorandum to the

Corporate Law Reform Bill, 1992, appeared to assume that an extended objective

standard of skill had been achieved.113 Referring to the Explanatory Memorandum where

it was stated that in the governments’ view section 232(4) had not changed the law,

Ramsey considered it unlikely that section 232(4) extended the objective standard of

skill.114 A statutory business judgment rule was proposed when the Exposure Draft of the

Corporate Law Reform Bill, 1992, was released in February of that year. It was

recommended to add a new section 232(4AA) to the Corporations Law.115 The new

section would have required the court to have regard to a number of matters in

determining whether or not a director had contravened section 232(4).116 The final version

of the Bill did not, however, include such a provision since the government decided

109 Ibid. 110 Cooney Report para 3.35; Legg & Jordan (2013) 34 Adelaide Law Review 404; and Du Plessis (2011)

Company Lawyer (Part 2) 377. 111 Cooney Report para 3.35. 112 Ramsey (1999) 3 Company Financial and Insolvency Law Review 271. 113 Ibid; Du Plessis (2011) Company Lawyer (Part 2) 377. 114 Ramsey (1999) 3 Company Financial and Insolvency Law Review 271. 115 Berkahn (1999) 3 Southern Cross University Review 217. 116 Berkahn (1999) 3 Southern Cross University Review 217.

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against it as no state in the US had adopted a legislative statement of the business

judgment rule. Instead, the matter was left to the US courts to develop.117 Similarly, the

Australian government considered that the development of similar principles in Australia

was better left to the courts.118 The Explanatory Memorandum further indicated that there

was no need for a business judgment rule in Australia and suggested that the courts

generally would not second-guess decisions of directors where the directors had acted

reasonably and honestly.119

4.3.3 AWA Ltd v Daniels

The important decision of AWA Ltd v Daniels t/a Deloitte Haskins and Sells120 heralded

a new approach to the duty of care in Australian law. AWA Ltd was a listed company

engaged in foreign exchange dealings with hedge funds121 against the risk of foreign

currency fluctuations.122 These dealings were managed by a young employee who was

not properly supervised and who had very little experience.123 Initially, the company

made significant profits on these foreign exchange dealings, but in 1986 and 1987 the

company made substantial losses which were concealed by various methods.124 The

company was audited twice by its auditing firm,125 and the auditing partner warned the

company of internal control inadequacies, but the auditing partner failed to notify the

117 Explanatory Memorandum to the Corporate Law Reform Bill, 1992, para 86. 118 Ibid; Berkahn (1999) 3 Southern Cross University Review 217. 119 Explanatory Memorandum to the Corporate Law Reform Bill, 1992, para 86. See, for example, Harlowe’s

Nominees Pty Ltd v Woodside (Lake Entrance) Oil Co (1968) 121 CLR 483 493, where the court ruled that if a

business decision is exercised in good faith and not for irrelevant purposes, it is not open for review by the courts.

See, too, Howard Smith Ltd v Ampol Petroleum Ltd (1974) 1 NSWLR 68. 120 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759. 121 Hedge funds are a risk management strategy used in limiting or offsetting the probability of loss from

fluctuations in the prices of commodities, currencies, or securities. See

https://www.investopedia.com/terms/h/hedgefund.asp (accessed: 07/06/2016). 122 Farrar (2011) 23 Singapore Academy of Law Journal 752; Butcher Directors’ Duties 79. 123 Farrar (2011) 23 Singapore Academy of Law Journal 752. 124 One of the examples of the methods used was the making of unauthorised borrowings from a number of banks,

allegedly on behalf of AWA. See Farrar (2011) 23 Singapore Academy of Law Journal 752 and Tomasic,

Bottomley & McQueen Corporations Law in Australia 156. 125 Deloitte Haskins & Sells was the auditing firm for AWA Ltd at the time.

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board.126 During March 1987, the board of directors discovered the true position

regarding the losses the company had incurred, and on 28 October 1988 the company

sued the auditors for negligence, and the auditors in turn counterclaimed for contributory

negligence by the company.127

In the court of first instance, Rogers CJ held that the auditors had been negligent but that

the executive directors were also liable for contributory negligence.128 The judge stated

that the duty of care was measured by subjective standards, depending on the actual

knowledge and experience of the director, the nature and extent of the company’s

business, and the distribution of responsibilities in the company.129 Complete ignorance

was no longer a defence to a claim of negligence and directors are expected to be well

informed about the affairs of the company.130

The court held further that the directors of a company were obliged to take reasonable

steps to place themselves in a position to monitor the management of the company.

Rogers CJ also held that what is expected of a director of a particular company depends

on the actual knowledge and experience of the individual director, the nature and extent

of the corporation’s business, and the distribution of responsibilities in the particular

corporation.131 Like the reaction of directors in the US after the Smith v Van Gorkom132

126 Flint (1997) 9 Bond Law Review 199. 127 Farrar (2011) 23 Singapore Academy of Law Journal 752. 128 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 933. 129 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 864. See also Arsalidou Impact of Modern

Influences 134. 130 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 865. 131 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 865. Chief Justice Rogers observed: “Of

necessity, as the complexities of commercial life have intensified the community has come to expect more than

formerly from directors whose task is to govern the affairs of companies to which large sums of money are

committed by way of equity capital or loan. The affairs of a company with a large annual turnover, large stake in

assets and liabilities, the use of very substantial resources and hundreds, if not thousands of employees demands

an appreciable degree of diligent application by its directors if they are to attempt to do their duty.” 132 Smith v Van Gorkom 488 A 2d 858 (Del. 1985).

162

decision, the decision in AWA v Daniels generated considerable anxiety amongst directors

in Australia.133

Interestingly, while the executive directors were found to have been negligent, the non-

executive directors were found not to have been negligent.134 According to Rogers CJ,

non-executive directors are only expected to pronounce on matters of policy135 and they

may rely on management to inform them of important matters.136 The court ruled that

non-executive directors were expected to take reasonable steps to place themselves in a

position to guide and monitor the management of the company and to obtain a general

understanding of its business and of the effect that a changing economy may have on that

business.137 It was further held that non-executive directors had to bring an informed and

independent judgment to bear on the various matters that came to the board for decision,

and that they owed their company a common-law duty of care.138

In light of the decision in AWA Ltd v Daniels t/a Deloitte Haskins and Sells, section 232(4)

of the Corporations Act, 1989, was amended in an attempt to ensure a more objective

approach to directors’ duty of care.139 This was done by way of section 11 of the

Corporate Law Reform Act, 1992, amending section 232(4) as follows:

133 See Ch 2 para 2.3.2. 134 Du Plessis et al Contemporary Corporate Governance 77. See also Bottomley Constitutional Corporation 95;

and Butcher Directors’ Duties 79. 135 Chief Justice Rogers held that a non-executive director’s duties, as a member of a board of a large public

company, include setting goals for the corporation; appointing the corporation’s chief executive; overseeing the

plans of managers for the acquisition and organisation of financial and human resources towards attainment of

the corporation’s goals; and, reviewing at reasonable intervals the corporation’s progress towards attaining its

goals. See AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 865-866. 136 Butcher Directors’ Duties 79. 137 AWA Ltd v Daniels t/a Deloitte Haskins and Sells (1992) ACSR 759 864-865. 138 Ibid at 872-873. See also subsequent rulings that followed the approach in AWA Ltd v Daniels t/a Deloitte

Haskins and Sells, relating to non-executive directors’ duties, namely Australian Securities Commission v

Gallagher (1993) 10 ACSR 43; Vrisakis v Australian Securities and Investments Commission (1993) 11 ACSR

162. 139 Du Plessis 2010 Acta Juridica 283.

163

In the exercise of his or her powers and the discharge of his or her duties, an officer

of a corporation must exercise the degree of care and diligence that a reasonable

person in a like position in a corporation would exercise in the corporation’s

circumstances.

The Explanatory Memorandum of the Corporate Law Reform Act, 1992, indicated that

the amendment intended that the special background, qualifications, and management

responsibilities of the particular director be taken into account in evaluating his or her

compliance with the duty of care.140

The decision in AWA Ltd v Daniels t/a Deloitte Haskins and Sells was taken on appeal

in the New South Wales Court of Appeal in Daniels v Anderson.141 The Court of Appeal

drew upon case law in the US to describe what the duties of directors should be in

Australia.142 In particular, the court quoted from the judgment of Judge Pollock of the

Supreme Court of New Jersey in Francis v United Jersey Bank.143 Pollock J held that a

director should acquire at least a rudimentary understanding of the business of the

company and is under a continuing obligation to keep informed of the company’s

activities.144 He further ruled that a director has a responsibility to ensure that the nature

of the duty that he or she is called to perform is clearly understood.145 It is interesting to

observe that, much as the majority judgment of Judges Clarke and Sheller did not

overturn the orders made by Rogers CJ in AWA Ltd v Daniels t/a Deloitte Haskins and

Sells as regard non-executive directors,146 nevertheless, their observations went on to

140 Explanatory Memorandum to the Corporate Law Reform Act, 1992, 25. 141 Daniels v Anderson (1995) 13 ACLC 614; Keay Directors’ Duties 210. 142 For example, Francis v United Jersey Bank, 432 A.2d 814,824 (N.J. 1981); and Federal Deposit Insurance

Corporation v Stanley 770 F Supp 1281 (ND Ind. 1991). 143 Francis v United Jersey Bank 432 A.2d at 814, 824 (N.J. 1981). 144 Francis v United Jersey Bank 432 A.2d at 814, 824 (N.J. 1981)814, 821-822; Ramsey (1999) 3 Company

Financial and Insolvency Law Review 267; and Eisenberg “The duty of corporate directors and officers” 1951

available at https://scholarship.law.berkeley.edu/cgi/viewcontent.cgi?article=2150&context=facpubs (accessed:

07/07/2017). 145 Daniels v Anderson (1995) 13 ACLC 438 666. 146 Ibid.

164

impose a decidedly more rigorous standard of care on all company directors. Their final

determinations were that all directors, including non-executive directors, owed a

common-law duty to take reasonable care in the performance of their duties.147

Confirming the long-standing standard applied in Australian law, the Court of Appeal

held that duties of directors had been assessed subjectively in the court of first instance.

However, the Court went further to clarify that that subjective description of the law did

not “accurately state the extent of the duty of directors, whether non-executive or not, in

modern company law and the majority judgment was about giving recognition to this”

148

They noted that ignorance is no longer necessarily a defence to proceedings brought

against a director. In some respects, directors should at least inform themselves about the

affairs of a company.149 Moreover, they ruled that the duty involves becoming familiar

with the business of the company and how it is run, and ensuring that the board has

available means to audit the management of the company so that it can satisfy itself that

it is being properly run.150

The court in Daniels v Anderson also held that directors had a duty to display

entrepreneurial flair and accept commercial risks to produce a sufficient return on the

capital invested, and to make business judgments and business decisions in a spirit of

147 Daniels v Anderson (1995) 16 ACSR 607 505. See also Woolworths Ltd v Kelly (1991) 4 ACSR 431 (CA

NSW) which dealt with the responsibilities of company chairmen and held that such a company chairman has

greater practical responsibilities than other directors. 148 Byrne (2008) 22 Australian Journal of Corporate Law 242-243; Byrne (2008) 21 Australian Journal of

Corporate Law 242. 149 Daniels v Anderson (1995) 16 ACSR 607 664. 150 Ibid.

165

enterprise.151 Such comments suggest that the courts would afford some protection to

directors from liability for genuine commercial risk-taking behaviour.152

After the decision in Daniels v Anderson and the different interpretation followed in AWA

Ltd v Daniels t/a Deloitte Haskins and Sells, there was an increasing lack of confidence

in the courts’ ability to deliver judgments based on appropriate and consistent

principles.153 This led to a new movement to review directors’ duties and also to include

a statutory business judgment rule in Australian corporation law.154

4.3.4 Reform programme

The Corporate Law Economic Reform Program (“CLERP”) was established by the

Treasurer in 1997. Its main aim was to reform key areas of corporate and business

regulations.155 Comprehensive policy proposals on key areas156 were released during

1997 and developed in close consultation with the business community.157 The CLERP

specified certain reforms to provide directors and officers with greater certainty regarding

key aspects of their duties to companies.158 It further indicated that the existing duty to

exercise care and diligence in section 232(4), would be amended to make it clear that the

151 Daniels v Anderson (1995) 16 ACSR 607 658 and 664. 152 Berkahn (1999) 3 Southern Cross University Review 224. 153 Byrne (2008) 22 Australian Journal of Corporate Law 258; and Greenshow “The statutory business

judgment rule: Putting the wind into directors’ sails” 33 available at

https://www.academia.edu/20915111/The_Statutory_Business_Judgment_Rule_Putting_the_Wind_into_Directo

rs_Sails (accessed: 15/06/2018). 154 Byrne (2008) 22 Australian Journal of Corporate Law 258-259. 155 The Corporate Law Economic Reform Program: Policy Reforms 1998 at iii. See

http://archive.treasury.gov.au/documents/264/PDF/clerp.pdf#page=3&zoom=auto,-107,831 (accessed: 09/09/

2014). 156 The key areas included making access to capital easier for small business; the new business judgment rule;

greater commercial and international focus to the making of accounting standards; improving takeover regulation

to promote a more competitive market; adapting regulation to facilitate the more widespread use of electronic

commerce and building a world-class, leading-edge regulatory structure for financial markets: The Corporate Law

Economic Reform Program: Policy Reforms 1998 at iii & iv. 157 Ibid at iii. 158 The Corporate Law Economic Reform Program: Policy Reforms 1998 11.

166

standard of care required by the duty must be assessed by reference to the particular

circumstances of the officer concerned.159 Under the revised provision, a director or other

officer of a corporation would be required to exercise his or her powers and discharge his

or her duties with the degree of care and diligence that a reasonable person would have

exercised if they:

a) were a director or officer of a corporation in the corporation’s

circumstances;

b) occupied the office and had the same responsibilities within that

corporation as the director or officer; and

c) had the director or other officer’s experience. 160

The CLERP also expressly recognised the oversight role played by directors and their

reliance on delegates to manage their company’s day-to-day affairs.161 The programme

culminated in the Corporate Law Economic Reform Program Act, 1999, (“CLERP

Act”).162 Section 180(1) of the CLERP Act amended section 232(4) of the Corporations

Act, 1989. Section 180(1) provided:

(1) A director or other officer of a corporation must exercise their powers and

discharge their duties with the degree of care and diligence that a

reasonable person would exercise if they:

(a) were a director or officer of a corporation in the corporation’s

circumstances; and

(b) occupied the office held by, and had the same responsibilities

within the corporation as, the director or officer. 163

Section 180(1) implemented a set of objective standards by which a director’s obligation

to act with care and diligence should be evaluated.164

159 Ibid. 160 Ibid. 161 Ibid. 162 Corporate Law Economic Reform Program Act 1999 s 180(1). 163 Ibid. This is similar to par 8.30(a)(2) of the US’ Model Business Corporation Act which refers to “the degree

an ordinarily prudent person in a like position would exercise under similar circumstances.” See Ch 2 para 2.4.1. 164 Baxt Duties and Responsibilities of Directors and Officers 81.

167

As part of the CLERP, the Federal government also announced that the Corporate law

should be amended to include a statutory business judgment rule.165 The following form

of the rule was proposed:

(1) An officer of a corporation is taken to meet the requirements of sub-section

232(4) and the general law duty of care and diligence in respect of a

business judgment made by them if the officer:

(a) exercises their business judgment in good faith for a proper

purpose;

(b) does not have a material personal interest in the subject-matter of

the business judgment;

(c) informs themselves about the subject-matter of the business

judgment to the extent the officer reasonably believes to be

appropriate; and

(d) rationally believes that the business judgment is in the best

interests of the corporation.

(2) In this section ‘business judgment’ includes any decision to take or not to

take action in respect of a matter relevant to the business operations of the

corporation.

(3) Sub-section (1) does not operate in relation to any other provision of this

Law or any other Act or any Regulation under which an officer may be

liable to make payment in relation to any of their acts or omissions as an

officer.166

The Explanatory Memorandum to the CLERP Bill, 1998, stated that “the fundamental

purpose of the business judgment rule was to protect the authority of directors in the

exercise of their duties, not to insulate directors from liability”.167 The Memorandum

furthermore confirmed that the suggested statutory formulation of the business judgment

rule would clarify and confirm the common-law position that the courts will rarely

review bona fide business decisions.168 The Memorandum defined a “business judgment”

as “any decision to take action or not take action in respect of a matter relevant to the

business operations of the corporation”. This was designed to include only the “ordinary

165 CLERP Press Release no 28 of 17 March 1997. Greenshow “The statutory business judgment rule: Putting

wind into directors’ sails” 35 available at

https://www.academia.edu/20915111/The_Statutory_Business_Judgment_Rule_Putting_the_Wind_into_Directo

rs_Sails (accessed: 15/06/2018); Legg & Jordan (2013) 34 Adelaide Law Review 406. 166 Corporate Law Economic Reform Program Directors’ Duties and Corporate Governance Paper No 3 (1997). 167 See Explanatory Memorandum, Corporate Law Economic Reform Program Bill, 1998, Ch 17 para 6.3. Du

Plessis 2011 Company Lawyer (Part 2) 379. 168 Explanatory Memorandum, Corporate Law Economic Reform Program Bill, 1998, Ch 17 paras 6.4 and 6.9.

168

business operations” of the company, and did not apply to areas regulated by separate

liability regimes, such as decisions made in the context of insolvent trading, or in relation

to misstatements in registered prospectuses or takeover documents.169

Moreover, under the proposed CLERP legislation, should directors fulfil their

requirements, they would have an obvious safe harbour for any breach of their duty of

care, and the merits of their business judgments would not be the subject of review by

the courts.170 The business judgment rule would, therefore, act as a rebuttable

presumption in favour of directors which, if rebutted, would still require a plaintiff to

establish that the directors had breached their duty of care171 The CLERP Act was

replaced by the Corporations Act, 2001, which partially codified directors’ duty of care

in section 180(1) and included a statutory business judgment rule in section 180(2). We

turn now to these sections.172

4.4 THE STATUTORY DUTY OF CARE AND DILIGENCE UNDER

SECTION 180(1) OF THE AUSTRALIAN CORPORATIONS ACT,

2001

It is firstly noteworthy that the Corporations Act, 2001, still distinguishes between the

common-law duties of a director and his or her equitable fiduciary duties.173 Australia

has partially codified the duties of directors in section 180(1) of the Corporations Act,

169 Explanatory Memorandum, Corporate Law Economic Reform Program Bill, 1998, Ch 17 paras para 6.8. 170 Legg & Jordan (2013) 34 Adelaide Law Review 406; and Du Plessis 2011 Company Lawyer (Part 2) 379. 171 Explanatory Memorandum, Corporate Law Economic Reform Program Bill, 1998, Ch 17 para 6.9; Legg &

Jordan (2013) 34 Adelaide Law Review 406. The position in South Africa is different and is discussed in Ch 5

para 5.5.2.2.(e). 172 Section 180(1) and (2) of the Corporations Act, 2001. See paras 4.4 and 4.5. 173 Section 180(2) of the Corporations Act, 2001, containing the business judgment rule, provides that “[a] director

or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection

(1), and their equivalent duties at common law and in equity, in respect of the judgment if they …” and in the

concluding sentence of s 185 it is provided that s 185 “does not apply to subsections 180(2) and (3) to the extent

to which they operate on the duties at common law and in equity that are equivalent to the requirements of

subsection 180(1)”.

169

2001, and as a result there are similarities between judge-made rules (ie, the rules of

common-law and equity) and statutory rules.174 Section 180(1) reads:

A director or other officer of a corporation must exercise their powers and

discharge their duties with the degree of care and diligence that a reasonable person

would exercise if they:

(a) were a director or officer of a corporation in the corporation’s circumstances;

and

(b) occupied the office held by, and had the same responsibilities within the

corporation as, the director or officer.

The obligation under section 180(1)175 – that a director or officer must exercise his or

her powers in accordance with how a reasonable person would act – has imposed an

objective standard for the directors or company officers to satisfy.176 Australia has

excluded the subjective element from this section and a director can, therefore, no longer

rely on the fact that, subjectively, he or she lacked the knowledge or experience to

consider certain relevant matters which ought to have been considered.177 Note that

section 180(1) does not replace the common law duty of care.178 The duties of care

imposed by section 180(1) and by the common law are similar as the requirement of

“care and diligence” in section 180(1) also assumes or implies a need for skill.179 There

174 For example, the duties to act in good faith and for a proper purpose are reinforced in s 181 of the Corporations

Act, 2001. Sections 182 and 183 reinforce the duty to avoid conflicts of interest by prohibiting directors from

making improper use of their office and information. Section 180(1) reinforces the duty of care. The same

approach of partial codification of directors’ duties is followed in South Africa (see Ch 5 para 5.4.2.3). 175 Section 180(1) of the Corporations Act, 2001, states: “(1) A director or other officer of a corporation must

exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person

would exercise if they: (a) were a director or officer of a corporation in the corporation’s circumstances; and (b)

occupied the office held by, and had the same responsibilities within the corporation as, the director or officer”.

This is taken directly from s 180(1) of the CLERP Act. The Corporations Act, 2001, s 180(1). 176 Ciro & Symes Corporations Law: In Principle 252; Baxt Duties and Responsibilities of Directors and Officers

81. In South Africa s 76(3) of the Companies Act 71 of 2008 imposes both a subjective and an objective standard

of review. (See Ch 5 para 5.4.2.3.) 177 Du Plessis et al Contemporary Corporate Governance 244. 178 Section 180(2) makes it clear that directors will have to comply not only with the statutory duties but also their

common-law duties. Section 180(2) reads: “A director or other officer of a corporation who makes a business

judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in

equity, in respect of the judgment if they …”. 179 See, for example, Vrisakis v ASC (1993) 9 WAR 395 172; ASIC v Adler (2002) 168 FLR 253 372-375. In ASIC

v Rich (2009) 75 ACSR 236 FLR 40-43 and ASIC v Vines (2003) 48 ACSR 282 75 the court held that “the statutory

formulation adopts an objective standard of care, measured by reference to what a reasonable person of ordinary

prudence would do, enhanced where an appointment to the board of directors is based on the appointee having

some special skill, by an objective standard of skill referable to the circumstances.”

170

are nonetheless certain differences between the common-law and statutory requirements.

For example, at common law there must be evidence of a breach of the duty of care and

that the company suffered damage as a result of that breach. In terms of the statutory

duty of care, evidence of breach of the duties is sufficient.180

As mentioned earlier in this chapter, the ASIC Act was enacted alongside the

Corporations Act, 2001.181 The ASIC Act provides for a regulator – ASIC – which is

governed by the Corporations Act, 2001.182 Since its formation, ASIC has initiated

various court actions relating to directors’ duties of care, some of which will be discussed

in order to illustrate how the Australian courts interpret and apply section 180(1).183

In the case of ASIC v Adler & 4 Ors,184 ASIC sought declarations that various

contraventions of the Corporations Act, 2001, had been committed by three of the

directors of a collapsed insurance company, HIH Insurance Limited (“HIH”).185 The

three directors included Adler, a non-executive director and, through the Adler

Corporation Limited, a substantial shareholder of HIH, as well as186 Williams and

Fodera, both executive directors of HIH.187 The facts were that in June 2000, HIH

Casualty and General Insurance Ltd (“HIHC”) made an undocumented and unsecured

180 Vrisakis v ASC (1993) 9 WAR 395 252. 181 See para 4.3.4. 182 Ibid. 183 See, for example, ASIC v Adler (2002) NSWSC 171; ASIC v Vines (2006) NSWSC 760; ASIC v Rich (2009)

1229 NSWSC. For a summary of some of the key cases regarding breach of directors’ duties brought by ASIC in

recent years, see Gibson & Brown (2012) 35 University of New South Wales Law Journal 254. 184 ASIC v Adler & 4 Ors (2002) NSWSC 171. 185 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 1. 186 ASIC v Adler & 4 Ors (2002) NSWSC 171 paras 1 and 4. 187 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 1. Also joined as a defendant was Adler Corporation Pty

Limited (“Adler Corporation”) a company associated with the first defendant, Rodney Adler, against which

company accessory liability was claimed. Accessory liability was also claimed against the three directors based

on their alleged involvement in contraventions of the Corporations Act said to have been committed by HIH and

its subsidiary.

171

payment of $10 million in the form of a loan to Pacific Eagle Equity Pty Ltd (“PEE”).188

PEE was a company (controlled by Adler) and the trustee of Australian Equities Unit

Trust (“AEUT”). After receiving the loan PEE became a trustee of AEUT. The HIHC’s

$10 million loan to PEE was afterwards applied to HIHC’s subscription for $10 million

worth of AEUT units.189

PEE then bought $4 million worth of HIH shares on the stock market, but sold the HIH

shares at a $2 million loss.190 PEE then purchased HIH shares to give HIH’s investors

the false impression that the company was doing well. PEE also bought various unlisted

shares in technology and communication companies from Adler Corporation worth $4

million, and $2 million was given to Adler under the trust by AEUT. In court, it was

alleged that these were poor investments which resulted in a loss and which took place

without the knowledge of the board or the shareholders’ approval. 191

The court held that Adler had breached his duties as officer of HIH and HIHC on the

basis of all of these transactions.192 The court held that a reasonably careful and diligent

director or officer of HIH or HIHC in Adler’s position would not have caused or procured

the payment on 15 June 2000 of $10 million.193 In accordance with section 180(1), the

court applied the objective standard of review to determine whether Adler was in breach

of his duty of care.

188 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 4. 189 Ibid. 190 Ibid. 191 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 4. 192 Ibid. The court held that Adler had contravened the directors’ duties in the Corporations Act, 2001, specifically,

s 180 (duty to act with care and diligence), s 181 (duty to act in good faith and for proper purpose), s 182 (duty

not to improperly use position), and s 183 (duty not to improperly use information). ASIC v Adler & 4 Ors (2002)

NSWSC 171 para 775. 193 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 774(20)(a).

172

It was further held that Williams, the managing director of HIH and HIHC, had also

contravened section 180(1) as he had failed to ensure that there were proper safeguards

before HIHC made the loan to PEE.194 The court ruled that Williams was in breach of

section 180(1) by failing to exercise the degree of care and diligence that a reasonable

person would have exercised as a director in the circumstances and occupying the office

held by Williams.195

The court also found that Fodera, who was the financial director of HIH, had contravened

section 180 as he had failed to discuss a proposal to give the $10 million loan to PEE

with the HIH board or its investment committee.196 As the executive directors of the

company, both Fodera and Williams, in neglecting to inform the HIH board of their

intention, had failed to carry out their roles properly.197

In accordance with section 180(1) the court thus applied the objective standard of review

to determine whether the directors were in breach of their duty of care. The court did not

use a subjective standard of review by considering the experience and knowledge of each

particular director.

In ASIC v Macdonald,198 ASIC requested the court to determine whether the company

directors and officers of James Hardie Industries Ltd (“JHIL”) had breached their duties,

and in particular, the statutory duty of care in section 180(1) of the Corporations Act,

194 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 775. 195 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 774(22). 196 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 775. 197 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 775. The court decided to ban Adler from acting as a director

of a company for twenty years and Williams for ten years. It imposed the following penalties: Adler – $450 000;

the Adler Corporation – $450 000; Williams – $250 000; and Fodera – $5000. In addition, Adler, the Adler

Corporation, and Williams were ordered to pay a total compensation of $7 986 402 to HIHC. 198 ASIC v Macdonald (No 11) (2009) NSWSC 287.

173

2001. In 2001, the James Hardie group undertook a complex restructuring process

designed to contain potential liabilities arising from asbestos.199 The restructuring

included a “separation proposal” in terms of which the two affected subsidiaries would

be quarantined from the rest of the group.200 On 15 February 2001, a critical meeting was

held by JHIL’s board of directors at which the separation proposal was approved.201 The

proposal included the creation of a Foundation202 to manage and deal with claims relating

to asbestos, as well as to conduct medical research into asbestos-related diseases.203

Under the separation proposal the subsidiaries indemnified JHIL for asbestos-related

claims, and committed to make substantial payments to the Foundation.204

On 16 February 2001, JHIL issued a market announcement to the Australian Stock

Exchange stating that the Foundation was fully-funded and had “sufficient funds to meet

all future legitimate compensation claims”.205 Based on these statements, ASIC alleged

that the directors were in breach of section 180(1). It soon became clear that JHIL’s

guarantee regarding the adequacy of its funding was false.206 It was obvious that, far

from being “fully-funded”, the Foundation would in fact be unable to satisfy any claims

199 The restructuring plan was known as “Project Green”. Du Plessis et al Contemporary Corporate Governance

58. 200 Hill (2014) 13 Sydney Law School Research Paper 10. 201 Hill (2014) 13 Sydney Law School Research Paper 11. 202 The Foundation was a newly formed Australian company called the Medical Research and Compensation

Foundation. See Hill (2014) 13 Sydney Law School Research Paper 10. 203 Du Plessis et al Contemporary Corporate Governance 58. 204 Du Plessis et al Contemporary Corporate Governance 58. 205 ASIC v Macdonald (No 11) (2009) NSWSC 287 229-230. The minutes of the board meeting one day earlier,

recorded that JHIL’s directors had considered and approved a draft of this announcement, although the directors

later denied this – ASIC v Macdonald (No 11) (2009) NSWSC 287 239-244. 206 In October 2003, the Foundation announced a massive funding shortfall and that it would soon exhaust the

funds allocated to compensate victims. Hill (2014) 13 Sydney Law School Research Paper

11 (accessed: 17/07/2018).

174

beyond the first half of 2007.207 In 2007, ASIC announced that it had filed civil penalty

proceedings against former JHIL officers and directors.208

At first instance,209 the court held that JHIL’s non-executive directors, together with the

chief executive officer, chief financial officer, and the joint company secretary/general

counsel, had breached section 180(1) of the Corporations Act, 2001, and ordered the

individual defendants to pay pecuniary penalties and disqualified them from managing

corporations.210 The court ruled that JHIL’s issuing of the final Australian Stock

Exchange announcement to the effect that the Foundation was “fully-funded” was

misleading or deceptive, thereby contravening the Corporations Act.211 The non-

executive directors and the company secretary were found to have breached the statutory

duty of care under section 180(1) on the basis that they had known, or should have

known, that explicit public statements of this kind could result in legal liability, harm to

the company’s reputation, and market backlash.212 Based on this reasoning and the

application of the objective test under section 180(1), the court held that a reasonable

person with similar responsibilities would not have voted in favour of the resolution

which the company approved.213

207 Hill (2014) 13 Sydney Law School Research Paper 11; Du Plessis et al, Principles of Corporate Governance

60-61 for a discussion relating to the findings of the Jackson Report submitted by a special commission of enquiry

headed by David Jacson QC. 208 Hill (2014) 13 Sydney Law School Research Paper 11 (accessed: 17/07/2018). 209 ASIC v Macdonald (No 11) (2009) NSWSC 287. 210 ASIC v Macdonald (No 11) (2009) NSWSC 287 116. 211 ASIC v Macdonald (No 11) (2009) NSWSC 287 199. 212 ASIC v Macdonald (No 11) (2009) NSWSC 287 199. In Morley v ASIC (2010) 274 ALR 205, the New South

Wales Court of Appeal found that ASIC had failed to establish that the non-executive directors had approved the

draft Australian Stock Exchange announcement at the relevant board meeting, thereby rejecting a central finding

of fact at first instance. In 2012, the High Court of Australia considered the matter in ASIC v Hellicar (2012) 286

ALR 501 para 6. The court unanimously restored Judge Gzell’s first-instance decision that the non-executive

directors and company secretary/general counsel had breached their statutory duty of care and diligence by not

performing their duties with the reasonable care and diligence that a reasonable person in their position would

have exercised. 213 ASIC v Macdonald (No 11) (2009) NSWSC 287 261.

175

In this case the objective standard of review was applied to determine whether the

directors had breached their duties of care. What is of importance is that not only the

executive directors, but also the non-executive directors and the company secretary were

found to have been in breach of their duties.214 The court also used the same objective

standard of review for the non-executive directors and senior management. This decision

was, however, taken on appeal in Morley & others v ASIC (appeal by the non-executive

directors)215 and Shafron v ASIC216 (appeal by the company secretary). In these cases the

Court of Appeal overturned the ruling of the court of first instance as regards the non-

executive directors and the company secretary.217 The ruling was not overturned on the

basis that non-executive directors should have been immune from incurring liability in

that case. It was also not on the basis that non-executive directors and the company

secretary could not be judged based on the reasonable standard applied to all other

executive directors. Rather, the overturn was on the basis of a lack of evidence.

The decision of first instance in ASIC v Macdonald218 was reinstated in the High Court

of Australia’s decision in ASIC v Hellicar.219 The full bench of judges found

unanimously that the non-executive directors and the company secretary had breached

their statutory duties of care and diligence.220 The High Court ruled that the non-

executive directors and the company secretary had breached section 180(1) of the

214 In South Africa the Companies Act 71 of 2008 has extended the definition of “directors” for purpose of their

duties in section 1 of the Companies Act 71 of 2008. See Ch 5 para 5.3. 215 Morley v ASIC (2010) NSWCA 33. 216Shafron v ASIC (2012) HCA 612. 217 The Court of Appeal ruled that ASIC had failed to establish that the non-executive directors had approved the

draft Australian Stock Exchange announcement at the relevant board meeting, thereby rejecting a central finding

of fact at first instance. Morley & others v ASIC (2010) NSWCA 33 para 926 and Shafron v ASIC (2012) HCA

612 para 20. 218 ASIC v Macdonald (No 11) (2009) NSWSC 287. 219 ASIC v Hellicar (2012) 286 ALR 501. Hallicar was a further appeal to the cases of Macdonald, Morley and

Shafron. 220 ASIC v Hellicar (2012) 286 ALR 501 para 6.

176

Corporations Act, 2001, by failing to discharge their duties as non-executive directors

and as officers of the company with the degree of care and diligence that a reasonable

person in their positions would have done.221 The decision of the High Court is

commendable as compared to that of Morley and Shafron because in one’s view it is

consistent with the intentions of the legislators whose aim in drafting the provisions of

the Act was to broaden the scope of liability and include non-executive directors,

company secretaries and officers - in the breach of duties liability net - for having

breached their duties of care and diligence similarly to executive directors and officers.

Another example of a decision highlighting the dangers of potential liability of directors

for breach of the duty of care is ASIC v Healey.222 In this case, Judge Middleton held that

the defendants, including executive223 and non-executive directors,224 had breached their

duty of care in relation to financial reporting obligations during the global financial

crisis.225 ASIC sought declarations that each of the defendants had breached his or her

statutory duty of care owed to the Centro entities and had thereby contravened section

180(1) of the Corporations Act, 2001, by approving the consolidated financial accounts

221 Ibid. 222ASIC v Healey (2011) 196 FCR 291, also known as the Centro decision. 223 The two executives were the chief executive officer and managing director, Scott, and the chief financial officer

Nenna (who was the only defendant who was not a director). ASIC v Healey ibid. 224 The six non-executive directors were Healey (Chairperson), Cooper, Wilkinson, Kavourakis, Goldie, and Hall.

ASIC v Healey (2011) 196 FCR 291. 225 The global financial crisis (“GFC”) occurred between August 2007 and December 2008 and originated in the

US as a result of the sub-prime loan market collapsing during the summer of 2007. Sun, Stewart & Pollard

“Corporate governance and the global financial crisis: International perspectives” 193 available at

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1904672 (accessed: 31/01/2017); Hill (2012) 12/70

University of New South Wales Law Journal 342. See also Hill (2014) 13 Sydney Law School Research Paper

23.

177

for the Centro entities226 for the financial year ending 30 June 2007.227 The consolidated

financial statements incorrectly classified $1,5 billion in debt as non-current liabilities

(while they were in fact current liabilities) and failed to disclose US$1,75 billion in

guarantees (which was found to be a material event entered into after the balance date).228

The key question before the court was whether directors of substantial publicly-listed

entities are required to apply their own minds to, and carry out a careful review of, the

proposed financial statements and the directors’ proposed reports, to determine whether

the information they contain is consistent with the director’s own knowledge of the

company’s affairs, and that they do not omit material matters known to them, or material

matters that should be known to them.229 The court held that nothing in this case should

indicate that directors are required to have infinite knowledge or ability. Directors are

entitled to delegate the preparation of company books and accounts and the carrying on

of the day-to-day affairs of the company to others. What each director is expected to do

is to take a diligent and intelligent interest in the information available to him or her, to

understand that information, and to apply an enquiring mind to the responsibilities placed

upon him or her.230 Because of their nature and importance, the directors must understand

and focus upon the content of financial statements, and if necessary, make further

226 The Centro Group comprised Centro Properties Ltd (CPL), Centro Property Trust (CPT), and Centro Retail

Trust (“CRT”). In line with s 296(1) of the Corporations Act, 2001, the financial report of each of the Centro

companies, CPT and CRT, for the financial year ending on 30 June 2007 was required to comply with the

accounting standards set by the Australian Accounting Standards Board (“AASB”) pursuant to s 334 of the

Corporations Act, 2001. ASIC v Healey (2011) 196 FCR 291 paras 2 and 40. 227 The consolidated financial statements of the Centro Group were approved at a board meeting attended by the

defendant directors on 6 September 2007. ASIC v Healey (2011) 196 FCR 291 para 2. 228 ASIC v Healey (2011) 196 FCR 291 paras 85 and 86. See also Maiden “Centro to become a case study in crisis

management” available at http://www.smh.com.au/business/centro-to-become-a-case-study-in-crisis-

management-20091021-h96s.html (accessed: 12/01/2015). 229 ASIC v Healey (2011) 196 FCR 291 para 20. 230 ASIC v Healey (2011) 196 FCR 291 para 20. See also ASIC v Cassimatis (No 8) (2016) FCA 1023 para 833

where the court ruled that: “directors had breached their duties as directors in that a reasonable director with their

responsibilities and in the company’s circumstances should have been reasonably aware that the company was

likely to contravene the Corporations Act.”

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enquiries if matters revealed in these financial statements call for such enquiries.231 The

standard required is an objective duty of skill, competence, and diligence.232

The court ruled that the reading of financial statements by a director is important in order

to ensure, as far as reasonably possible, that the information they convey is accurate.233

These are the minimum steps that a director would and should take before participating

in the approval or adoption of the financial statements and his or her own director’s

reports.234 The court agreed with ASIC’s contention that the defendants had “failed to

take all reasonable steps required of them”, and had performed their duties without the

requisite degree of care and diligence.235

The decision in ASIC v Healey236 is similar to that in Smith v Van Gorkom, decided in

the US in 1985.237 As in Smith v Van Gorkom, “mere absence of bad faith”238 did not

save the Centro Group’s directors from breach of duty. Each of these judgments severely

condemned the board for effectively delegating all decision-making to management

when the directors should themselves have assessed information with “a critical eye”239

and “an inquiring mind”.240 Both cases were described as a “wake-up call for

directors”.241

231 ASIC v Healey (2011) 196 FCR 291 para 20. 232 ASIC v Healey (2011) 196 FCR 291 para 21. 233 ASIC v Healey (2011) 196 FCR 291 para 22. 234 Ibid. 235 ASIC v Healey (2011) 196 FCR 291 para 8. 236ASIC v Healey (2011) 196 FCR 291. 237 Smith v Van Gorkom 488 A2d 858 (Del) 1985. See Ch 2 para 2.3.2. 238 Smith v Van Gorkom 488 A2d 858 (Del) 1985 872. 239 Ibid. 240 ASIC v Healey (2011) 196 FCR 291 para 20. See also Hill (2014) 13 Sydney Law School Research Paper 28. 241 The Centro decision has been described as “a wake-up call from down under”. See Paolini Handbook on

Directors’ Duties 10. See also Katz “For directors’ a wake-up call from down under” available at

http://blogs.law.harvard.edu/corpgov/2011/10/04/for-directors-a-wake-up-call-from-down-under/ (accessed: 27/01/2015). Smith v Van Gorkom was once labelled a “wake-up call to passive boards”. See Elson &

Thompson “Van Gorkom’s legacy: The limits of judicially enforced constraints and the promise of proprietary

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Since ASIC v Healey, ASIC has been more active in articulating the standard of conduct

expected of directors by communicating their expectations through, for example,

regulatory guides and information sheets.242 Among these expectations are: that directors

must understand the business of the company; that they must understand the financial

position of the company; read the information provided; apply an enquiring mind; and

that their directors’ responsibilities should not be limited to their field of expertise.243

It was discussed that both in the US and in UK most publicly traded companies,

especially larger ones, have a dispersed shareholding, also known as “dispersed

ownership structure”.244 In Australia it is most common for publicly traded companies

to have controlling blockholders, known as a “blockholder system”.245 A blockholder is

the owner of a large block of a company's shares. In terms of shareholding, these owners

are often able to influence the company with the voting rights awarded with their

holdings.246 This can cause an agency problem which involves the conflict between, on

the one hand, shareholders who possess the majority controlling shares, and on the other

hand, the minority shareholders.247 The shareholders who hold a minority of the votes,

may have little, if any, influence over the direction and development of a company.

Minority shareholders in Australia do, however, have protection against oppression by

majority shareholders. Section 233 of the Corporations Act, 2001 provides for numerous

incentives” available at https://www.questia.com/library/journal/1P3-112297020/van-gorkom-s-legacy-the-

limits-of-judicially-enforced (accessed: 27/01/2015). 242 See, for example, RG 76 on related party transactions, and RG 228 on Prospectuses: Effective disclosure for

retail investors available at http://asic.gov.au/ (accessed: 29/06/2016). 243 WA Regional Commissioner Australian Securities & Investment Commission Director’s duties – The

Regulator’s View, 2012 26-28. 244 See Ch 2 para 2.4.3.3 and Ch 3 para 3.5. 245 Lamba and Stapledon The determinants of corporate ownership structure: Australian evidence at 10. 246 https://www.investopedia.com/terms/b/blockholder.asp (accessed: 06/02/2020). 247 Kraakman & Hansmann The anatomy of corporate Law 22.

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remedies which minority shareholders may rely on. The Court can, for example, make

any order under this section that it considers appropriate in relation to the company,

including an order: 1) regulating the conduct of the company's affairs in the future; 2)

for the purchase of any shares by any member or person to whom a share in the company

has been transmitted by will or by operation of law; 3) for the purchase of shares with an

appropriate reduction of the company's share capital etc.248 Blockholders can play an

important part in managing directors’ strategies. Blockholders can govern through “exit”

(“selling or threatening to sell shares”) and “voice” (“direct intervention in a firm’s

operations”).249 Blockholders therefore have more control over directors, which may

have promoted the existence of the statutory business judgment rule. Similar to the UK

and South Africa, Australia follows the “shareholder primacy” model.250 As discussed

in chapter 3, the “shareholder primacy” model holds that it is a director’s duty to

maximise the wealth of a company for the benefit of shareholder welfare.251 The legal

basis of shareholder primacy is deeply embedded in the corporate law model in Australia:

shareholders normally have the right to appoint directors,252 and in public companies

they in addition have the inalienable right to remove directors without cause.253 Thus,

shareholders have practical control over the board as a company organ. It is also the

shareholders who have the inalienable right to amend a company’s constitution (if one

was adopted),254 or to adopt one by way of a special resolution if the company did not

adopt one at incorporation.255

248 S 233 of the Companies Act, 2001. The Act can be accessed at

http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s233.html (accessed: 06/02/2020). 249 Edmans & Holderness “The role of blockholders in governance” at https://voxeu.org/article/role-blockholders-

governance (accessed: 06/02/2020). 250 See Ch 3 para 3.5 and Ch 5 para 5.4.1. 251 See Ch 3 para 3.5. 252 S 120G of the Corporations Act, 2001. 253 S 136(2) of the Corporations Act, 2001. 254 Ibid. 255 S 136(1)(b) of the Corporations Act, 2001 .

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Given the blockholders’ control over directors and the rights bestowed on Australian

shareholders, it may be argued that directors do not need protection from a business

judgment rule, seeing that the shareholders have control of the company where a

“blockholder” system is used.

4.5 THE STATUTORY BUSINESS JUDGMENT RULE

In the US, the business judgment rule has long been a common-law principle of

corporate governance.256 The common-law formulation of the business judgment

rule, simply stated, is 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 interests of the company.257 The policy underlying

a business judgment rule is said to be to recognise the need for directors to engage

in considered risk-taking and to protect the directors when those risks are part of an

informed business judgment.258 In Australia, the statutory business judgment rule

has been codified in section 180(2) of the Corporations Act, 2001, which is

discussed in the following section.259

4.5.1 Section 180(2) of the Corporations Act, 2001

The business judgment rule, anticipated by the CLERP,260 was included in the

Corporations Act, 2001, as section 180(2) and reads:

A director or other officer of a corporation who makes a business judgment is taken

to meet the requirements of subsection (1), and their equivalent duties at common

law and in equity, in respect of the judgment if they:

(a) make the judgment in good faith for a proper purpose; and

256 See Ch 2 para 2.2. See also Keller (2000) 4 Deakin Law Review 125. 257 Smith v Van Gorkom 488 A 2d 858 872 (Del Supr 1985). See Ch 2 para 2.3.2. 258 ASIC v Maxwell (2006) 59 ACSR 373; ASIC v Macdonald (2009) 256 ALR 199, 245 236; ASIC v Rich

(2009) 236 FLR 1 128–129. 259 See para 4.5.1. 260 See the discussion in para 4.3.4.

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(b) do not have a material personal interest in the subject matter of the

judgment; and

(c) inform themselves about the subject matter of the judgment to the extent

they reasonably believe to be appropriate; and

(d) rationally believe that the judgment is in the best interests of the

corporation. The director’s or officer’s belief that the judgment is in the

best interests of the corporation is a rational one unless the belief is one

that no reasonable person in their position would hold.

This version differs slightly from the CLERP version of the business judgment rule in so

far as it refers to officers and not to directors and other officers.261 A further variance was

the inclusion of the last sentence in section 180(2)(d) – “The director’s or officer’s……

position would hold” which was omitted from the CLERP version.262

The Australian business judgment rule requires that a business judgment must have been

made. Section 180(2) provides that: “A director or other officer of the corporation who

makes a ‘business decision’ is taken to meet the requirements…”.263 Australian directors

will accordingly only be protected by the business judgment rule if they made a business

decision. No other decisions will be considered under section 180(2). “Business decision”

is defined in section 180(3) of the Corporations Act, 2001. Section 180(3) provides that

“business judgment” means any decision to take or not take action in respect of a matter

relevant to the business operations of the corporation.264 In ASIC v Rich, the court found

that the phrase “relevant to the business operations of the corporation” in section 180(3)

was to be interpreted broadly265 and that in order to qualify as a business judgment, a

matter did not have to be a business operation matter in itself, but includes, for example,

the sale of a company to a third party.266 The important element, according to Judge

261 Corporate Law Economic Reform Program Directors’ Duties and Corporate Governance Paper No 3 (1997). 262 Ibid. 263 See para 4.5.1. 264 The Companies Act, 2008, contains no definition of a “business decision” equivalent to that in s 180(3) of the

Corporation Act, 2001. 265 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7276. 266 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7272.

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Austin, was the need for a conscious decision – that is to say, whether or not the directors

or officers in fact applied their minds to the matter.267 Some authors argue that the

Australian statutory business judgment rule should be enhanced to provide more

protection to directors from incurring liability. They argue that the current wording of

Section 180(2) should be amended to move away from “business judgement”, and the

replacement of the word “‘judgement” by “act”.268 Although the changes appear limited,

the authors argue that moving from “business judgement” would expand the protection

for directors and inserting “act” would mean that directors may have a stronger defence

if is it is proven that other directors would have acted in the same way, in the same or

similar circumstances.269

Section 180(2)(c) further provides that directors should inform themselves on the subject

matter of the judgment to an extent “they reasonably believe” to be appropriate. Again,

the test is whether directors themselves reasonably believed that they were adequately

informed as regards the subject matter of the decision. This is clearly a subjective

standard of review. The Australian business judgment rule also does not state that

directors should inform themselves of “material” information. Directors in Australia will

have to inform themselves of all information they reasonably believe to be appropriate

and not only material information.

267 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7277. See ASIC v Fortescue Metals Group Ltd (2011) 190 FCR

364 for an example of what would be construed not to be a business judgment. Here the court ruled that “the

decision not to disclose the true effect of the agreements cannot be described as ‘business judgment’ at all. A

decision not to make accurate disclosure of the terms of a major contract is not a decision related to the ‘business

operations’ of the corporation. Rather it is a decision related to compliance with the requirements of the Act.” 268 Du Plessis & Mathiopoulos “Defences and relief from liability for company directors: Widening protection to

stimulate innovation” 19. 269 Du Plessis & Mathiopoulos “Defences and relief from liability for company directors: Widening protection to

stimulate innovation” 19.

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Australia also applies the rationality standard of review which is objective but goes further

by including a reasonableness standard.270 Section 180(2)(d) of the Corporations Act,

2001, provides that directors should

rationally believe that the judgment is in the best interests of the

corporation. The director’s or officer’s belief that the judgment is in the

best interests of the corporation is a rational one unless the belief is one

that no reasonable person in their position would hold.

Section 180(2)(d) requires that the director “rationally believe that the judgment is in the

best interests of the corporation.” Section 180(2) further provides that a “belief that the

judgment is in the best interests of the corporation is a rational one unless the belief is

one that no reasonable person in position would hold.”271 The way in which the section

goes on to define a “rational” belief by reference to the “reasonable person” has caused

some confusion as to how it should be interpreted. It was suggested by Young that the

business judgment rule as codified in section 180(2), arguably offers nothing but window

dressing. As a defence to section 180(1), it offers a standard no less stringent than that

required by section 180(1).272

The Australian courts have, however, concluded that the rational belief required as an

element of the business judgment rule in section 180(2), does not have to be reasonable.

In other words, a director can invoke the business judgment rule if he or she can show

that he or she arrived at the business judgment after a reasoning process, “whether or not

the reasoning process was convincing to the judge and therefore reasonable in an

objective sense.”273 In ASIC v Rich,274 ASIC submitted that the rationality of a director’s

270 Section 180(2)(c) & (d) of the Corporations Act, 2001. 271 See s 180(2)(d) of the Corporations Act, 2001. 272 Young (2008) 26 Companies and Securities Law Journal 222. See s 180(1) of the Corporations Act 2001. 273 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. See also Legg & Jordan (2013) 34 Adelaide Law Review

415. For a detailed discussion of the reasonable-rational divide see Hooper (2011) 5 Bond University Electronic

Publications 1-13. 274 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289.

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belief is determined by whether it is reasonable.275 Judge Austin did not agree. He held

that as the duty of care in section 180(1) is based on reasonableness, there would be no

need for the business judgment rule if it applied only to reasonable decisions.276 He

further held that ASIC’s interpretation of the business judgment rule would distinguish

the Australian business judgment rule from that of the US, which had not been the

intention of the drafters of the Corporations Act, 2001.277 Judge Austin concluded that

the rational belief required as an element of the business judgment rule in section 180(2)

does not have to be reasonable. In other words, directors can invoke the rule if they can

show that they arrived at the business judgment after a reasoning process “whether or not


objective sense”.278 It is therefore unclear why the drafters of section 180(2) thought it

necessary to define an irrational belief as one which no reasonable person would hold.

Section 180(2)(b) provides that directors should not have a “material personal interest”

in the subject matter of the judgment.279 In my view, should directors in Australia have a

personal interest which is material, they will not be protected by section 180(2).280

However, should the personal interest not be material they will be protected.281 The

Australian business judgment rule further makes no provision for directors to receive

protection under the rule if they in fact disclosed the personal interest to the board.282

275 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7286. 276 Judge Austin ruled that: “The phrase ‘rationally believes’ is intended to permit a significantly wider range of

discretion than the term ‘reasonable’ and to give a director or officer a safe harbour from liability for business

judgments that might arguably fall outside the term ‘reasonable’ but are not so removed from the realm of reason

when made that liability should be incurred.” ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7286. 277 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7288. 278 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. See also Legg & Jordan (2013) 34 Adelaide Law Review


Publications 1-13. 279 See s 180(2)(b) of the Corporations Act, 2001. 280 Ibid. 281 Ibid. 282 Ibid.

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Even if Australian directors disclose their material personal interest to the board, they will

still not be protected by section 180(2).283

Section 180(2)(a) of the Corporations Act, 2001, stipulates that directors’ decisions must

have been made in good faith and for a proper purpose.284 Australia included the proper-

purpose requirement in addition to the provision that the decision must have been taken

in good faith. Australian directors must meet both requirements – as opposed to their

American counterparts who only need to show good faith.285

Section 180(2) makes it very clear that the business judgment rule will only apply to

directors’ duty of care in section 180(1) of the Corporations Act, 2001, and will not apply

to any fiduciary duties of whatever nature.286 In my view, this is a correct formulation of

the business judgment rule. By including only directors’ duty of care it limits the

application of that rule and will exclude any possible blurring between the directors’

fiduciary duties and the duty of care which are distinct concepts in Australia.287

Section 180(2) further clearly stipulates that the business judgment rule will apply to the

statutory directors’ duty of care as set out in section 180(1), but will also apply to their

equivalent duties at common law and in equity.288 Australia has limited the application

of the statutory business judgment rule to apply only to directors’ duty of care, but also

broadened it by including the equivalent duties in common law and equity.289

283 Ibid. In South Africa directors should not have any material financial personal interest in the subject matter.

See Ch 5 para 5.5.2.1(d). 284 Section 180(2)(a) of the Corporations Act, 2001. 285 See Ch 2 pars 2.4.2.1 and 2.4.2.2. The South African statutory business judgment rule has no provision that

the decision must have been made in good faith and for a proper purpose. See Ch 5 para 5.5.2.1.(d). 286 See ss 180(1) & 180(2) of the Corporations Act, 2001. 287 In South Africa the business judgment rule will apply only to statutory directors’ fiduciary duty to act in the

best interest of the company and statutory directors’ duty of care, skill, and diligence. See Ch 5 para 5.5.2. 288 Ss 180(1) & (2) of the Corporation Act 2001. 289 Ibid.

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Whether the business judgment rule applies to both directors and officers is clarified by

section 180(2). This section specifically provides that the business judgment rule applies

to both directors and “other officers” of the corporation.290 Any ambiguity as to whether

the business rule applies to company officers is thus eliminated. Section 180(2) does not

limit the application to only prescribed officers, but extends it to “other officers”. The

application of the Australian business judgment rule will accordingly not be limited to

prescribed officers, but will include any officer of the company.

In Australia, the statutory business judgment rule functions as a safe harbour as opposed

to a presumption and is applied as an immunity doctrine. In Delaware the business

judgment rule can be applied as both an abstention doctrine and standard-of- liability

test.291 On the other hand, New York’s version of the business judgment rule is applied

as an immunity doctrine.292 Should directors meet the requirements of section 180(2),

they will be immune from any liability and there will be no further examination into the

business decision or its merits. In this instance, the burden of proof lies with the directors

to establish that the requirements of section 180(2) have been met.293 Section 180(2)

provides:

A director or other officer of a corporation who makes a business judgment is

taken to meet the requirements of subsection (1), and their equivalent duties at

common law and in equity, in respect of the judgment if they:294

290 The South African business judgment rule also applies to both directors and officers. See Ch 5 para 5.5.2.2 (d). 291 See Ch 2 para 2.4.4.1. 292 See Ch 2 para 2.4.4.2. The South African business judgment rule is applied as an immunity doctrine. See Ch

5 para 5.5.2.3. 293 Section 180(2) of the Corporations Act, 2001. 294 Ibid.

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The phrases “taken to meet” and “if they” make it clear that if directors meet the

requirements in section 180(2)(a)-(d) they will have met the requirements under section

180(1) (statutory duty of care) and its equivalent in common law and equity. No further

enquiry will be undertaken, and directors will be immune from liability. It must,

however, again be noted that the Australian business judgment rule applies solely to

directors’ duty of care (both statutory and common-law).295

4.5.2 Application of the business judgment rule in case law

Case law is considered below to determine how the Australian courts interpret and apply

the business judgment rule.

In ASIC v Adler & 4 Ors,296 the court held that three directors had breached their statutory

duty of care as stated in section 180(1) and that they could not rely on the business

judgment rule as their defence.297 Judge Santow found that in order for the safe-harbour

“statutory business judgment rule” to be relied on, the director must first have made a

business judgment.298 The business judgment must then satisfy the following

requirements, it must have been made in good faith and for a proper purpose.299 The

director must have informed him- or herself as to the subject matter of the judgment to

an extent that he or she reasonably believed to be appropriate.300 The director must

furthermore not have had a material personal interest in the subject matter of the

judgment,301 and must rationally have believed that the judgment was in the best interests

295 See Ch 4 para 4.5.2. 296 ASIC v Adler & 4 Ors (2002) NSWSC 171. The facts of the case are discussed in para 4.4 above. 297 Williams, Adler, and Fodera were found to be in breach of s 180(1). See ASIC v Adler & 4 Ors (2002) NSWSC

171 paras 1 and 4. 298 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 15. 299 Section 180(2)(a) of the Corporations Act, 2001. 300 Section 180(2)(c) of the Corporations Act, 2001; ASIC v Adler & 4 Ors (2002) NSWSC 171 para 15. 301 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 15.

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of the corporation.302 The court further found that a director’s belief that his or her

judgment was in the best interests of the corporation must be a rational one, unless the

belief is one that no reasonable person in that position would make.303

It was found that both Williams and Adler had had material personal interests in

encouraging share purchasing in HIH shares by PEE via Adler.304 In the case of

Williams, Judge Santow found that he had failed to make a business judgment in good

faith and for a proper purpose.305 Taking this into consideration, Judge Santow concluded

that Williams was in breach of section 180(1) of the Corporations Act in failing to

exercise the degree of care and diligence that a reasonable person would have exercised

as a director in those circumstances, and that Williams could not invoke the business

judgment rule.306

In respect of Fodera, Judge Santow found that he had failed to exercise any business

judgment at all, as he had not brought the transaction to the attention of the other directors

of HIH or to the investment committee before it was implemented.307 Judge Santow

ruled that Adler had breached his obligation as a director to exercise the degree of care

and diligence required from a director by section 180(1) of the Corporations Act. He also

had a material personal interest in the subject matter308 and therefore could not rely on

any defence under the business judgment rule.309

302 Ibid. 303 Ibid. 304 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 406. 305 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 407. 306 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 412 & 453. 307 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 511. See also Baxt Duties and Responsibilities of Directors

and Officers 106. 308 See discussion of the facts of the case in para 4.4 above. 309 ASIC v Adler & 4 Ors (2002) NSWSC 171 para 577(a).

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This failure to successfully invoke the business judgment rule in ASIC v Adler & 4 Or,

led to criticism of the scope of the rule, most notably in the June 2007 submission to

Treasury by the Australian Institute of Company Directors (“AICD”).310 The basis of the

AICD’s argument was that senior, experienced and potential directors were becoming

ever more reluctant to fill board positions, especially in the listed environment311 as they

were concerned about personal liability, risks, and damaged reputations arising from

claims against them.312 The AICD observed that many directors had the perception that

there was no longer a fair balance between risk and reward.313 However, certain

commentators believed that there was no need for a more extensive business judgment

rule.314 They argued that more extensive business judgment rule would remain under-

utilised, taking into consideration that there are other remedies available to directors for

a breach of their duty of care.315 For example, Young noted that directors already have

recourse under section 1318 of the Corporations Act,316 which permits a court to excuse

a director from civil liability for negligence, default, breach of trust, or breach of duty, if

he or she shows the court that he or she acted honestly and should, in the circumstances,

in fairness to be excused.317

310 AICD, Submission to Corporations and Financial Services Division of the Treasury Review of Sanctions for

Breaches of Corporate Law (8 June 2007) 3. See also Australian Government Review of Sanctions in Corporate

Law (March 2007). 311 AICD, Submission to Corporations and Financial Services Division of the Treasury Review of Sanctions for

Breaches of Corporate Law (8 June 2007) 3. 312 AICD, Submission to Corporations and Financial Services Division of the Treasury Review of Sanctions for

Breaches of Corporate Law (8 June 2007) 3. See also Legg & Jordan (2013) 34 Adelaide Law Review 407. 313 AICD, Submission to Corporations and Financial Services Division of the Treasury Review of Sanctions for

Breaches of Corporate Law (8 June 2007) 3; See also Harris “Relief from liability for company directors: Recent

developments and their implications” available at

http://classic.austlii.edu.au/au/journals/UWSLawRw/2008/7.html (accessed: 02/02/2015). 314 Young (2008) 26 Companies and Securities Law Journal 216. 315 Ibid. 316 Section 1318 of the Corporations Act, 2001. 317 Young (2008) 26 Companies and Securities Law Journal 222-223.

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It was in this context that the decision by Judge Austin in ASIC v Rich318 was handed

down on 18 November 2009. This case arose out of the collapse in early 2001 of One.Tel

Ltd (“One.Tel”), an Australian telecommunication company, with Publishing and

Broadcasting Limited (“PBL”) and News Corporation (“News Corp”) as two of its major

shareholders.319 In late 2001, ASIC instituted civil-penalty proceedings against four

former One.Tel directors.320 ASIC’s principal allegation was that these directors had

breached their statutory duty of care under section 180(1) of the Corporations Act by

failing to keep the board of directors adequately informed of the company’s true financial

position.321

In ASIC v Rich, ASIC alleged that in the months leading up to administrators being

appointed to One.Tel, the defendants had breached their duties by failing, firstly,

properly to assess One.Tel’s financial position, secondly, to inform the board as to

One.Tel’s true financial position, and finally to ensure the existence of systems to

facilitate the flow of financial information to the board.322 In order to determine whether

the directors could claim protection under the business judgment rule, Judge Austin had

to rule on the following questions: Who bears the onus of proving the elements of the

business judgment rule? What is a business judgment? Was the judgment made “in good

faith for a proper purpose”323 and without a “material personal interest”?324 Did the

318 ASIC v Rich (2009) 75 ACSR 236 FLR 1. 319 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 1. See also Hill (2014) 13 Sydney Law School Research Paper

18-19 and Legg & Jordan (2013) 34 Adelaide Law Review 414. 320 The defendants to the suit were joint managing directors, Rich and Keeling, finance director, Silbermann, and

non-executive chairman, Greaves. See ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 1. Before the commencement

of proceedings, two of the defendants (Keeling and Greaves) entered into settlement agreements with the regulator

under which they accepted disqualification and compensation orders – ibid. 321 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 1. See also Hill (2014) 13 Sydney Law School Research Paper

19. 322 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7391. See also Hooper (2011) 5 Bond University Electronic

Publications 4. 323 Section 180(2)(a) of the Corporations Act, 2001. 324 Section 180(2)(b) of the Corporations Act, 2001.

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directors inform themselves as to the subject matter of the judgment to the extent they

reasonably believed to be appropriate?325 And finally, did the directors rationally believe

that the judgment was in the best interests of the corporation?326

As regards the first question, Judge Austin noted that the statutory provision327 itself does

not specifically indicate which party bears the onus of proving the applicability of the

business judgment rule, and that he could not extract any reliable indication from simply

reading the text.328 In order to answer the question, Judge Austin therefore considered

the US’ formulation of the business judgment rule329 upon which section 180(2) was, to

a large extent, modelled.330 There are, however, differences between the Australian

statutory business judgment rule, and its US equivalent. In Delaware, there is a strong

non-interventionist and the courts do not “second-guess” a director’s decision that was

made in good faith and for a proper purpose.331 The business judgment rule in Delaware

is thus a presumption “that in making a business decision the directors of a corporation

acted on an informed basis, in good faith and in the honest belief that the action taken

was in the best interests of the company”.332 In Australia, the business judgment rule is

a safe harbour, not a presumption, and this difference was noted by Judge Austin.333

While the burden of proof in Delaware falls to the plaintiff, Judge Austin considered that

if it had been the intention of the Australian Parliament to replicate that position, it would

325 Section 180(2)(c) of the Corporations Act, 2001. 326 Section 180(2)(d) of the Corporations Act, 2001. 327 Section 180(2) of the Corporations Act, 2001. 328 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7264. Judge Austin could also not find any significant assistance

from the statement of legislative policy considerations in the Explanatory Memorandum or Second Reading

Speech – ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7265. 329 See Ch 2 para 2.4.4.2 above for a discussion on the ALI business judgment rule. 330 See Legg & Jordan (2013) 34 Adelaide Law Review 418. 331 See Ch 2 para 2.4.4.1 for a discussion on the Delaware business judgment rule. 332 Aronson v Lewis 473 A.2d 805, 812 (Del. 1984). 333 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7266.

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have done so more clearly.334 The judge ultimately took the stance that whether the

plaintiff or defendant bears the burden of proof is an important one that will eventually

need to be resolved at the appellate level. However, despite having considered the

approach followed in the US, the judge held that section 180(2) places the onus on the

defendants.335 First, Judge Austin concluded that placing the onus on the plaintiffs would

be inconsistent with the objective expressed in the Explanatory Memorandum of the

Corporations Act, 2001, that there was to be no reduction in the statutory requirement.336

Second, he found that if the plaintiff was required to establish that the four criteria had

not been met, then as part of that obligation the plaintiff would have to show that the

defendant’s business judgment was not exercised in good faith for a proper purpose.337

Proving this would amount to requiring proof of a more serious contravention of the law

– a contravention of section 181 of the Corporations Act, 2001.338

The second question on which Judge Austin had to rule, was what constituted a “business

judgment” under section 180(2) of the Corporations Act, 2001. The court considered the

definition of “business judgment” in section 180(3),339 and found that the phrase

“relevant to the business operations of the corporation” in section 180(3) was to be

interpreted broadly.340 In order to qualify as a business judgment, a matter did not in

itself have to be a business-operation matter but would include, for example, the sale of

a company to a third party.341 The important element, according to Judge Austin, was the

334 Ibid. 335 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7266. 336 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7269. 337 Ibid. 338 Section 181 of the Corporations Act, 2001, states: “(1) A director or other officer of a corporation must exercise

their powers and discharge their duties: (a) in good faith in the best interests of the corporation; and (b) for a

proper purpose.” 339 Section 180(3) of the Corporations Act, 2001, provides a definition of “business judgment”. 340 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7276. 341 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7272.

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need for a conscious decision – that is to say, whether or not the directors or officers in

fact applied their minds to the matter.342 The judge found that, generally speaking, the

case before the court was not one where the defendant directors had failed to apply their

minds to decisions that ASIC alleged they should have taken. Rather, it was to a

substantial degree, a case where the defendants had considered the matters of which

ASIC complained, and had taken decisions with which ASIC disagreed. In those

circumstances, the decisions by the defendant directors taken in planning, budgeting, and

forecasting were eligible for protection under the Australian statutory business judgment

rule.343

The third question considered by Judge Austin was whether the judgment had been made

“in good faith for a proper purpose”,344 and whether the directors had any “material

personal interest”345 in the subject matter of the business judgment. ASIC alleged that

Rich and Silbermann could not establish the good faith precondition because they had

failed properly to supervise the drafting of budgets and board papers.346 Judge Austin did

not explore this issue in detail. He held that on the evidence, Rich and Silbermann had

made business judgments (as defined in s 180(3)). He further ruled that they had

exercised their business judgment in good faith for a proper purpose, namely, to get the

businesses to a cash-positive stage as forecast in the business plan approved by the

board.347 It was, further accepted by ASIC that the directors had no material personal

interest in the subject matter of the business judgment.348

342 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7277. 343 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7274. 344 Section 180(2)(a) of the Corporations Act, 2001. 345 Section 180(2)(b) of the Corporations Act, 2001. 346 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7281. 347 ASIC v Rich (2009) 75 ACSR 236 FLR 1 paras 3766 and 7281. 348 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7282.

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In the fourth place Austin J had to rule on whether the directors had informed themselves

about the subject matter of the judgment to an extent they reasonably believed to be

appropriate.349 ASIC submitted that regard should have been had not only to what the

directors knew, but also to what they should have known.350 This was rejected by Judge

Austin,351 who held that the qualifying words, “to the extent they reasonably believe to

be appropriate”, conveyed the idea that protection may be available even if the director

was unaware of available information material to the decision. If the director reasonably

believed that he or she had taken appropriate steps on the decision-making occasion to

inform him- or herself of the subject matter, he or she would be protected under the

business judgment rule.352 According to Hooper, the inclusion of the definition of

rational belief in the final paragraph of section 180(2)353 was unnecessary and caused the

problems of interpretation now wrestled with by judges and corporate lawyers.354 He

further argues that in applying rigour in the interpretation of the section, the definition

does not stand in the way of affording protection to directors. He also alludes to the fact

that the link back to reasonableness could perhaps be a deliberate attempt at compromise

or watering down the rule’s effectiveness.355 Regardless of the actual reason, if the

purpose of the statutory business judgment rule is to provide a genuine safe harbour for

directors, the words should, according to Hooper, be removed. A repeal of the definition

will achieve greater clarity and certainty for all concerned.356

349 Section 180(2)(c) of the Corporations Act, 2001. 350See ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7281. 351 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7284. 352 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7284. 353 Section 180(2)(d) of the Corporations Act, 2001, the last portion of which reads: “The director’s or officer’s

belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no

reasonable person in their position would hold.” 354 Hooper (2011) 5 Bond University Electronic Publications 11. 355 Ibid. 356 Hooper (2011) 5 Bond University Electronic Publications 11-12.

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Summarising the operation of the business judgment rule, Judge Austin held that the rule

will only operate where the directors made their decision after informing themselves on

the subject matter to the extent they believed appropriate.357 The court held further that

the directors’ belief as to the appropriate extent of information- gathering was reasonable

in terms of the practicalities of the information-gathering exercise.358 The last point

suggests that there is some objective requirement inherent in the information-gathering

process, but this conflicts with Judge Austin’s ruling that there is no objective element

as proposed by ASIC. Section 180(2) refers to the directors’ belief, suggesting a

subjective element. The requirement of reasonableness in section 180(2) suggests that

there also is an objective test.359

The fifth question in ASIC v Rich was whether the directors had rationally believed that

the judgment was in the best interests of the corporation.360 In Australia, the director’s

or officer’s belief that the judgment is in the best interests of the corporation is a rational

one, unless the belief is one that no reasonable person in his or her position could hold.361

ASIC submitted that the rationality of a director’s belief is determined by whether it is

reasonable.362 Judge Austin did not agree with this submission. He concluded that the

rational belief required as an element of the business judgment rule in section 180(2)

does not have to be reasonable. In other words, a director can invoke the business

judgment rule if he or she shows that he or she arrived at the business judgment after a

357 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7294. 358 Ibid. 359 Shafron v ASIC (2012) 286 ALR 612 617-618. 360 Section 180(2)(d) of the Corporations Act, 2001. 361 See ASIC v Fortescue Metals Group Ltd and Andrew Forrest (2011) 190 FCR 364 at 400; ASIC v Mariner

Corporation Limited (2015) FCA 589 483. 362 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7287.

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reasoning process “whether or not the reasoning process was convincing to the judge and

therefore reasonable in an objective sense”.363

In summary the following can be taken from this decision: In terms of this ruling the

onus of proof as to whether the business judgment rule will apply to protect directors

against liability for breach of their duties, rests on the defendants. Secondly, Judge Austin

ruled that the definition of a “business judgment” should be interpreted widely by the

courts, and that the important element of a business decision is whether the directors

have taken a conscious decision – that is to say, whether or not the directors or officers

in fact applied their minds to the matter. Judge Austin further held that if evidence shows

that the defendant believed that his or her judgment was in the best interests of the

corporation, and that belief was supported by a reasoning process sufficient to warrant

describing it as a rational belief, it will meet the requirement, irrespective of whether or

not the reasoning process was a convincing one objectively.

There is, however, some criticism of Austin J’s ruling in ASIC v Rich. Bainbridge and

Connor argue that, first, section 180(2) was introduced to clarify and confirm the courts’

existing approach to reviewing managerial decisions, not to lower the standard of care

expected of directors. Secondly, they argue that the provision should operate as a

rebuttable presumption with the plaintiff bearing the onus of proof, not as a defence.

Thirdly, they dispute the court’s argument that there can be no “degrees of

363 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. See also Legg & Jordan (2013) 34 Adelaide Law Review


Publications 1-13.

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reasonableness” and interpret section 180(2)(d) in light of corporate-law cases that

assume that possibility.364

Another case which addressed the Australian business judgment rule is ASIC v Mariner

Corporation Limited.365 The proceedings involved the lawfulness of the defendants’

conduct relating to an announcement on 25 June 2012 of an off-market takeover bid by

Mariner Corporation Limited (“Mariner”) for all of the issued capital of Austock Group

Limited (“Austock”) at 10,5 cents per share. By way of an originating application filed

on 2 April 2014, ASIC brought proceedings against Mariner and its three directors,

alleging contravention of section 180(1) of the Corporations Act, 2001, with regard to

the takeover announcement.366 Consistent with ASIC v Rich, the court ruled in ASIC v

Mariner Corporation Limited, that the defendants bore the burden of proving each

element of the business judgment rule.367 In terms of the first requirement of the rule

that there must be a “business judgment”, the court ruled that there must be a decision to

take or not to take action in respect of matters relevant to the business operations of the

corporation.368 In the present context, the relevant “business judgment” was the decision

to initiate a takeover bid for Austock, the necessary starting point for which was the

issuing of the 25 June announcement.369 The court held that having regard to the nature

of Mariner’s business and the evidence concerning the potential benefits to Mariner of

364 Bainbridge & Connor (2016) 34 Companies and Securities Law Journal 415; Jones & Welsh (2012) 45

Vanderbilt Journal of Transnational Law 375. 365ASIC v Mariner Corporation Limited (2015) FCA 589. 366 The three directors were Olney-Fraser, Christie, and Fletcher. ASIC v Mariner Corporation Limited (2015)

FCA 589 para 1. ASIC alleged that the directors breached s 180(1) because they contravened s 631(2)(b)(1) of

the Corporations Act, 2001, which states “that a person contravenes this subsection if either alone or with other

persons, he or she publicly proposes to make a takeover bid for securities in a company; and he or she does not

make offers for the securities under a takeover bid within two months after the proposal”. A further contravention

alleged by ASIC was under s 1041H of the Corporations Act, 2001 (misleading or deceptive conduct of directors

and officers). 367 ASIC v Mariner Corporation Limited (2015) FCA 589 para 485. See also ASIC v Fortescue Metals Group

Ltd (2011) 190 FCR 364 197, 541. 368 ASIC v Mariner Corporation Limited (2015) FCA 589 para 486. 369 Ibid.

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obtaining control over Austock, the decision to commence the takeover and make the 25

June announcement was a business judgment.370

The court further ruled that the second requirement – that the judgment be made in good

faith and for a proper purpose – had also been satisfied. The directors had decided to

support the takeover and make the 25 June announcement because of the potential for

Mariner to make a significant profit. The directors believed that the decision to make the

announcement and pursue a takeover bid for Austock was in the best interests of

Mariner.371 It was also found that the directors had not had any material personal interest

in the subject matter of the judgment and hence the third requirement had also been

met.372

As to the fourth requirement, to “inform themselves of the subject matter of the judgment

to the extent they reasonably believe to be appropriate”, the court referred to Austin J’s

decision in ASIC v Rich that protection under the business judgment rule may be

available even if the director was not aware of available information that was material to

the decision. If directors reasonably believed they had taken appropriate steps on the

decision-making occasion to inform themselves about the subject matter, they would

have met this requirement.373 The directors considered that they had been provided with

sufficient information to make an informed judgment to vote by holding various

meetings and discussions with Arena and others. In these circumstances, the court ruled

370 ASIC v Mariner Corporation Limited (2015) FCA 589 paras 486 and 543. 371 ASIC v Mariner Corporation Limited (2015) FCA 589 paras 488 and 544. 372 ASIC v Mariner Corporation Limited (2015) FCA 589 paras 489 and 545. 373 ASIC v Mariner Corporation Limited (2015) FCA 589 490; ASIC v Rich (2009) 75 ACSR 236 FLR 1 para

7284.

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that the directors had informed themselves to the extent that they believed appropriate

and therefore had satisfied this fourth requirement.374

As to the final requirement – that the director rationally believed that the judgment was

in the best interests of the corporation – the directors had been of the view that the

takeover bid and the 25 June announcement were in the best interests of Mariner. The

court again referred to ASIC v Rich, which stated that if evidence shows that the

defendant believed that his or her judgment was in the best interests of the corporation,

and that belief was supported by a reasoning process sufficient to warrant describing it

as a rational belief, it will meet the requirement.375 The directors’ view was not one that

no reasonable person in their position would have held. Accordingly, their belief was a

rational one.376 The court therefore held that the directors had satisfied the requisite

elements of the business judgment rule.377 This ruling shows no deviation from the ruling

in ASIC v Rich and supports the court’s approach in that case.


AUSTRALIAN BUSINESS JUDGMENT RULE

The table below provides a summary of the legal requirements and application of the

Australian statutory formulation of the business judgment rule and also indicates whether

the rule is classified as a presumption or a safe harbour.

374 ASIC v Mariner Corporation Limited (2015) FCA 589 paras 491-492. 375 Ibid para 494; ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7290. 376 ASIC v Mariner Corporation Limited (2015) FCA 589 paras 494 and 548. 377 Ibid paras 495, 549, and 561.

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Table 2:

Item Australian business judgment rule

Legal Requirements

Business judgment Section 180(2) of the Corporations Act 2001 requires that

a business decision must be made.378

Informed business

judgment

a) Section 180(2)(c) of the Corporations Act, 2001,

provides that directors should inform themselves

about the subject matter.379

b) Information is not limited to material information

only but extends to all information.380

c) A subjective standard of review is followed.381

Personal interest a) Directors should not have any material personal

interest in the subject matter.382

b) Interest is not limited to solely “financial personal

interest”.383

c) The personal interest must be “material”.384


corporation

Objective standard of review is followed.385

Application of the



purpose

The decision must have been made in good faith and for

a proper purpose.386

Director’s duties The business judgment rule only applies to directors’

duty of care.387

Common law The business judgment rule applies to common-law

duty of care.388

Directors and officers Yes – will apply to both.389

Burden of proof Directors bear the burden of proof.390

Safe harbour or

presumption

The business judgment rule is a safe harbour.391

Abstention-, immunity

doctrine, or standard of

liability test.

Business judgment rule is applied as an immunity

doctrine.392

378 Section 180(2) of the Corporations Act, 2001. See para 4.5.1. 379 See para 4.5.1. 380 Ibid. 381 Ibid. 382 Section 180(2)(b) of the Corporations Act, 2001. See para 4.5. 383 See para 4.5 384 Ibid. 385 Section 180(2)(d) of the Corporations Act, 2001. See para 4.5. 386 See para 4.5. 387 Ibid. 388 Ibid. 389 Ibid. 390 Ibid. 391 Ibid. 392 Ibid.

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4.7 CONCLUSION

This chapter has provided a historical overview of Australian corporate law.393 It observed

that traditionally Australia, like the other Commonwealth nations, followed the English

approach where directors were not held liable for breaches of their duty of care if they

had acted only negligently. In order for directors to incur any liability for a breach of their

duty of care their actions had to have been grossly negligent.394 This approach was also

reflected in the early statutory provisions discussed in this chapter.395

After a number of corporate collapses in Australia there was a move towards a more

stringent objective standard in both common law396 and legislation.397 This chapter

focused on the important decision of AWA Ltd v Daniels t/a Deloitte Haskins and Sells,

which heralded a new approach to directors’ duty of care in Australian law. Chief Justice

Rogers applied a subjective standard of review to determine whether the directors had

been in breach of their duty of care as set out in section 180(1). The court held that the

directors of a company are obliged to take reasonable steps to place themselves in a

position to monitor and manage the company. It further held that the directors’ actual

knowledge and experience should be considered, which implies a subjective standard of

review. Rogers CJ found that while the executive directors were in breach of their duty

of care, the non-executive directors had not been negligent and were therefore not in

breach of their duties.398

393 See para 4.2. 394 See para 4.3.1. Re Denham & Co (1883) 25 Ch D 752. 395 See para 4.3.2. 396 See, for example, Metal Manufacturers Ltd v Lewis (1988) 13 ACLR 357; Hussein v Good (1990) 1 ACSR

710; and Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946. 397 Corporations Act, 2001. See para 4.4. 398 See para 4.3.3.

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In the appeal decision in Daniels v Anderson,399 the court disagreed with the first-

instance decision on the following grounds. Firstly, the court ruled that Chief Justice

Rogers had applied a subjective standard of review and that this was not in line with

modern company law in Australia. Secondly, the Court of Appeal ruled that non-

executive and executive directors were subject to the same standards.400

After Daniels v Anderson, the CLERP determined that section 232(4) of the Corporations

Act, 1989, should be amended to make it clear that the standard of care required must be

assessed by reference to the particular circumstances of the director or officer

concerned.401 Under the revised provision, a director or officer of a corporation would

be required to exercise his or her powers and discharge his or her duties with the same

degree of care and diligence that a reasonable person would have exercised. Section

180(1) of the CLERP Act replaced section 232(4), and provided a set of objective

standards by which a director’s obligations to act with care and diligence should be

evaluated. The CLERP further announced that the corporation law should be amended

to include a statutory business judgment rule.402

The CLERP Act was replaced by the Corporations Act, 2001. Section 180(1) of the

Corporations Act, 2001, partially codified the duties of directors and imposed an

objective standard on directors and company officers. Australia has excluded the

subjective element from this section with the result that a director must now adhere to a

far higher standard of care and diligence than previously under Australian law.403

399 Daniels v Anderson (1995) 13 ACLC 607 was the appeal to AWA Ltd v Daniels t/a Deloitte Haskins and Sells

(1992) ACSR 759. 400 See para 4.3.3. 401 See para 4.3.4. 402 Ibid. 403 See para 4.4.

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Case law was discussed to illustrate the Australian courts’ interpretation of section

180(1).404 It is not expected of directors in Australia to have infinite knowledge or

ability.405 What is, however, expected is that a director should take a diligent and

intelligent interest in the information available to him or her, to understand that

information, and to apply an enquiring mind to the responsibilities placed upon him or

her.406 The standard required is an objective duty of skill, competence, and diligence407

and thus the mere absence of bad faith will not save directors in Australia from liability

for a breach of their duty of care.408 Information must be assessed with a critical eye and

an inquiring mind.409

The statutory business judgment rule, as recommended by the CLERP, was included in

the Corporations Act, 2001, by section 180(2).410 The Australian business judgment rule

provides protection for both directors and corporate officers with regard to breaches of

their duty of care in section 180(1) and its equivalent in common law and equity. The

Australian business judgment rule does not apply to the fiduciary duties of directors.411

The statutory business judgment rule in Australia is a safe harbour, and the following

requirements must be met before a director or officer may rely on the protection of the

rule for breaches of his or her duty of care: 1) There must be a business judgment; 2) the

business judgment must have been made in good faith and for a proper purpose; 3) the

directors or officers must not have a material personal interest in the business judgment

404 See para 4.4. ASIC v Adler & 4 Ors (2002) NSWSC 171; ASIC v Macdonald (No 11) (2009) NSWSC 287;

and ASIC v Healey (2011) 196 FCR 291. 405 ASIC v Healey (2011) 196 FCR 291 para 20. 406 Ibid. 407 ASIC v Healey (2011) 196 FCR 291 para 22. 408 ASIC v Healey (2011) 196 FCR 291 para 20. 409 Ibid. 410 See para 4.5. 411 See para 4.5.1.

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– I indicated that in my view this is a better formulation in terms of this subsection in

that it is not limited to purely financial interests; and 4) the directors or officers must

have a “rational belief” that the judgment is in the best interests of the company, unless

the belief is one that no “reasonable person” in their position would hold – as shown, this

subsection clearly follows both the reasonable and rational standards of review.412

In the discussion of the application of the business judgment rule in case law, some

interesting observations were made. First, it was established that courts see the business

judgment rule as a safe harbour for directors to protect them from liability for a breach

of their duties.413 Secondly, it was shown that section 180(2) places the burden of proof

on the defendants.414 Thirdly, when the courts should interpret the term “business

judgment” broadly and ensure that the directors or officers applied their minds to their

decision.415 Lastly, if evidence shows that the directors or officers believed that their

judgment was in the best interests of the company, and this belief was supported by a

reasoning process sufficient to warrant describing it as a “rational belief”, it will meet

the requirements for the application of the rule, whether or not the reasoning process was

objectively a convincing one.416 It was, however, indicated that not all commentators

agree with this interpretation of the statutory business judgment rule by Australian

courts. One would have to see how further decisions interpret the specific aspects in

contention.

412 See para 4.5.1. 413 See para 4.5.1. 414 Ibid. 415 See para 4.5.2. 416 Ibid.

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CHAPTER 5

SOUTH AFRICA

5.1 INTRODUCTION

This chapter provides an overview of the history of South African company law.1 It

includes a discussion on the different types of directors’,2 in the context of director's

duties having been partially codified in the Companies Act 71 of 2008 (“Companies Act,

2008”).3

The common-law duty of care, and the company-law review process leading up to its

partial codification in the Companies Act, 2008, under section 76(3)(c) are considered.4

This section includes recommendations from the various King Reports on Corporate

Governance for South Africa5 as well as the guidelines issued by the Department of Trade

and Industry.6

As a consequence of the company-law review process, the Companies Bill, 2007, which

provided for a partial codification of directors’ duties was released.7 This Bill was

1 See para 5.2. 2 See para 5.3. 3 Section 76(3) of the Companies Act 71 of 2008. See para 5.4.2.3. 4 See paras 5.4.2.1 and 5.4.2.2. 5 The Institute of Directors in South Africa The King Report on Corporate Governance for South Africa 1994

(“King I”); The Institute of Directors in South Africa The King Report on Corporate Governance for South Africa

2002 (“King II”); The Institute of Directors in South Africa The King Report on Corporate Governance for South

Africa 2009 (“King III”); The Institute of Directors in South Africa The King Report on Corporate Governance

for South Africa 2016 (“King IV”). See para 5.4.2.2.2. 6 Department of Trade and Industry Policy Paper South African Company Law for the 21st Century Guidelines

for Corporate Law Reform of 2004 (‘Policy Paper’). See para 5.4.2.2.3. 7 See para 5.4.2.3.

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replaced by the Companies Act, 2008, which followed suit by partially codifying

directors’ duties as well as including a statutory business judgment rule.8

Further the chapter focuses on the fiduciary duties of directors and directors’ duty of

care.9 In previous chapters only directors’ duty of care was discussed, but it is important

to include the fiduciary duties in this chapter as the South African statutory business

judgment rule applies not only to directors’ duty of care, but also to certain of their

fiduciary duties.10 It is shown that it is only when a director has discharged his or her

duties in the best interests of a company that that director may invoke the statutory

business judgment protection rule, and for this reason the chapter concentrates on this

particular fiduciary duty and the remaining fiduciary duties are not discussed.11

Primarily, the focus of this study is on the South African statutory business judgment

rule.12 Firstly, arguments for and against the rule are considered after which the statutory

business judgment rule is analysed in detail.13

An important part of this thesis is the comparisons drawn between the South African

statutory business judgment rule, and those of the other jurisdictions discussed in this

8 See paras 5.4.2.3 and 5.5. Section 76(3) of the Companies Act, 2008 (partial codification of directors’ duties)

and s 76(4) of Companies Act, 2008 (statutory business judgment rule). It must also be mentioned that on 21

September 2018 the Companies Amendment Bill, 2018 (the ‘Bill’) was released for public comment by the

Minister of Trade and Industry. The Bill, if introduced in its current form, proposes a number of changes to the

Companies Act, 2008, for example, limiting the scope of financial assistance under s 45. The Bill did not propose

any amendments to the business judgment rule. 9 See para 5.4. 10 See para 5.4.1. 11 Ibid. 12 See para 5.5. 13 See paras 5.5.1 and 5.5.2.

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thesis. Part of the latter discussion and the comparisons drawn are carried over to chapter

6.14

5.2 SOUTH AFRICAN COMPANY LAW: A HISTORICAL OVERVIEW

In 1600, a Charter was issued by the British Queen, Elizabeth I,15 to the Dutch East India

Company16 granting a fifteen-year trade monopoly covering all trade to and from Asia.17

In 1652, the Dutch East India Company sent a delegation to the Cape of Good Hope18 to

establish a refreshment post.19 With the Dutch came the application of Dutch law,

primarily the laws of Holland – the dominant Dutch province at that time – which were

applied under the legal authority of the Dutch Estates-General.20 The law used in Holland

was Roman-Dutch law and so, as a result of the Dutch colonisation of the Cape, Roman-

Dutch law was transplanted to the Cape and applied to all settlers.21

14 See Ch 6 para 6.2. 15 Elizabeth I, Queen of England and the last Tudor monarch, was born on 7 September 1533 to Henry VIII and

his second wife, Anne Boleyn. See https://www.historyextra.com/period/elizabethan/7-things-you-probably-

didnt-know-about-elizabeth-i/ (accessed: 09/03/2016). 16 “Founded in 1602, the Dutch East India Company (Verenigde Oost-Indische Compagnie or VOC) flourished

and survived for two centuries. The company, a combination of commercial organisations in various cities in

Holland and Zeeland, traded both in Asia and between Asia and Europe. It was the first public company to issue

negotiable shares and it developed into one of the biggest and most powerful trading and shipping concerns.” See

https://www.rijksmuseum.nl/en/explore-the-collection/timeline-dutch-history/1602-trade-with-the-east-voc

(accessed: 04/06/2015). 17 Samkin (2010) 15 University of Waikato Research Article 507. 18 In 1488, navigator Bartholomew Dias named the Cape Peninsula ‘Cabo Tormentoso’ or the Cape of Storms. It

was later renamed by King John II of Portugal ‘Cabo da Boa Esperanca’ – the Cape of Good Hope, because of

the great optimism engendered by opening a sea route to the East.” See https://www.sahistory.org.za/dated-

event/portuguese-navigator-bartholomew-dias-erects-first-stone-cross-south-african-coast (accessed: 04/06/

2015). 19 The official name of the Dutch parliament was the Staten-Generaal. In 1815, a bicameral parliamentary system

was introduced by amendment to the Constitution. From that time the State’s General consisted of the Senate

(Eerste Kamer der Staten-Generaal) and the House of Representatives (Tweede Kamer der Staten-Generaal).

Hare Shipping Law 3; and Heinrich (2012) 47 Azania: Archaeological Research in Africa 1. 20 Fagan “Roman-Dutch Law in its South African historical context” 33 available at

http://www.oxfordscholarship.com/view/10.1093/acprof:oso/9780198260875.001.0001/acprof-9780198260875-

chapter-2 (accessed: 04/03/2018); Hare ibid; and Doyle The Great Boer War 4. 21 The Dutch government was confronted with the existence of indigenous people on Cape soil whose customs

and usages were totally different from those to which it was accustomed, but there is no evidence that any

account was taken of these customs and usages. Rautenbach (2008) 12 Electronic Journal of Comparative Law

2-3; Blom-Cooper et al Judicial House of Lords 360; and Gibson South African Mercantile Company Law 1.

211

The Dutch occupation of the Cape continued for a century and a half before ending with

the second British occupation of 1806 (following the first British occupation of 1795 and

was interposed by three years of Dutch rule after the Napoleonic Wars).22 British rule

brought colonial status to the Cape in 1815, but Roman-Dutch law remained in place and

became the common law for the Boer Republics and the Natal Colony23 as European

settlement spread through what is today South Africa.24

There was, however, a strong influence of the law of England in certain areas of South

African law, for example procedural law, the law of trust, and of importance for this

thesis, commercial law.25 In 1861, the Joint Stock Companies Limited Act,26 based on

England’s Joint Stock Companies Act, 1844, and the Limited Liability Act, 1855, were

enacted in the Cape.27 In 1892, the Companies Act28 followed, which was later replaced

by the first national company law Act in South Africa, namely the Union Company Act,29

which was amended from time to time along the lines of the latest English legislation.30

The Union Companies Act was later repealed by the Companies Act, 1973, which also

followed the law applicable in England but with some deviations.31 Although English

22 Hare Shipping Law 3; Lenel “The history of South African law and its Roman-Dutch roots” 2 available at

http://www.lenel.ch/docs/history-of-sa-law-en.pdf (accessed: 03/03/2018). 23 See generally, Fremont-Barnes The Boer War 1899–1902 29; Wessels A Century of Postgraduate Anglo-Boer

War 32; Hare Shipping Law 4; Pretorius (2000) Scientia Militaria, South African Journal of Military Studies 111-

112. 24 Blom-Cooper et al Judicial House of Lords 360. 25 Hare Shipping Law 4; Lenel ibid; Pretorius (ed) Hahlo’s South African Company Law Through the Cases 2;

Van Der Sijde The Role of Good Faith 6. 26 Joint Stock Companies Limited Act, 1861 (C). 27 See Ch 3 para 3.2.1 for a discussion of the Joint Stock Companies Act, 1844 (UK). Abbey The Oppression

Remedy 24; Pretorius (ed) Hahlo’s South African Company Law Through the Cases 2. 28 Companies Act, 1892 (C). 29 Union Companies Act, 1926. 30 See Policy Paper 13. The policy document can be viewed at http://pmg-assets.s3-website-eu-west-

1.amazonaws.com/bills/040715companydraftpolicy.pdf (accessed: 05/06/2015). 31 Companies Act 61 of 1973. The deviation from the United Kingdom law could be explained by the

harmonisation of the company law of the United Kingdom with other member states of the European Union and

several amendments in the South African Companies Act. Havenga & Locke Corporations and Partnerships in

South Africa 16.

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company-law rules have been freely accepted in South African law, South African courts

have indicated that where England’s principles conflict with South African law they

should not be followed.32 It was argued by certain commentators, that English company

law has merely persuasive value and is not binding authority in South African law.33

In 2004, the Department of Trade and Industry published a policy paper, South African

Company Law for the 21st Century: Guidelines for Corporate Law Reform (“Policy

Paper”).34 The Policy Paper undertook the development of “clear, facilitating,

predictable and consistently enforced law” and to provide “a protective and fertile

environment for economic activity”.35 The Policy Paper promised an “overall review of

company law” to develop a legal framework based on the principles reflected in the

Companies Act, 1973, the Close Corporations Act,36 and the common law.37 This

resulted in the Companies Act, 1973, being replaced by the Companies Act, 2008, which

partially codified directors’ duties and included a statutory business judgment rule.

Proposed amendments to the Companies Act, 2008, were in turn made by the Companies

Act Amendment Bill, 2018.38 The Companies Amendment Bill, 2018, proposed no

amendments to directors’ duties or the statutory business judgment rule.

32 See, for example, Estate Wege v Strauss 1932 AD 76 80-81 and Ex parte Provisional Liquidator Hugo Franco

(Pty) Ltd 1958 (4) SA 397 (W) 399-400. 33 Botha “The role and duties of directors in the promotion of corporate governance: A South African perspective”

704 available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2873053 (accessed: 10/04/2017);

Havenga Fiduciary Duties of Company Directors 305; Havenga & Locke Corporations and Partnerships in South

Africa 16. 34 See para 5.4.2.2.3; Policy Paper. 35 Department of Trade and Industry Companies Bill, 2007, Explanatory Memorandum 3. 36 Close Corporation Act 69 of 1984. 37 Department of Trade and Industry Companies Bill, 2007, Explanatory Memorandum 3-4. 38 Companies Act Amendment Bill, 2018. The Companies Amendment Act 3 of 2011 had no proposed

amendments regarding the directors’ duties of the statutory business judgment rule.

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5.3 DIRECTORS IN SOUTH AFRICA

Directors need to know what their duties are and must be aware of what is expected of

them as the standards for directors’ conduct can have an impact on the profitability and

success of a company.39 In terms of section 66(1) of the Companies Act of 2008:

The business and affairs of a company must be managed by or under the direction

of its board, which has the authority to exercise all of the powers and perform any

of the functions of the company, except to the extent that this Act or the company’s

Memorandum of Incorporation provides otherwise. 40

This provision is important because for the first time in South Africa the Companies Act

has given the board of directors a legal duty and responsibility to manage the affairs of

the company.41 Previously, under the Companies Act, 1973, directors had no original

powers to manage the company’s business, meaning that the power to manage the

company’s affairs had to be delegated to the board of directors by the members in general

meeting, or as provided for in the constitution of the company.42 As will be discussed

later in this chapter, the Companies Act, 2008, partially codifies the duties of directors

in section 76. It is thus important to know who will qualify as a director and to whom

the duties will apply.43 The term “director” is defined in the Companies Act, 2008, as:

A member of the board of a company ... or an alternate director of a company and

includes any person occupying the position of director or alternate director, by

whatever name designated.44

39 Geach Paper for CIS Corporate Governance Conference 10. 40 Section 66(1) of the Companies Act 71 of 2008 available at http://www.justice.gov.za/legislation/acts/2008-

071amended.pdf (accessed: 09/06/2015). 41 Cassim et al Contemporary Company Law 375; Visser and Pretorius Essays in Honour of Frans Malan 84-92,

and Esser & Delport “Shareholder protection philosophy in terms of the Companies Act 71 of 2008” 9. 42 Esser & Delport “Shareholder protection philosophy in terms of the Companies Act 71 of 2008” 9. 43 See para 5.3. 44 Companies Act 71 of 2008 s 1. It is interesting to note that the definition of a director includes not only those

individuals who are appointed to the board of the company (as well as alternate directors), but also “any person

occupying the position of director or alternate director, by whatever name designated”. The effect of this wide

definition is that the provisions will apply not only to members of the board, but also to “de facto” directors. The

UK case of Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180, defines a de facto director as follows: “A de facto

director is a person who assumes to act as a director. He is held out as a director by the company, and claims and

purports to be a director, although never actually or validly appointed as such. To establish that a person is a de

facto director of a company, it is necessary to plead and prove that he undertook the functions in relation to the

company which could properly be discharged only by a director.” For a South African interpretation see R v Mall

and Others 1959 (4) SA 607 (N) at 622 where a de facto director was defined as “one who has been elected or

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When examining this definition, the word “includes” indicates that the definition of a

director is inclusive and not exclusive, and the meaning of “director” must be drawn from

the provisions of the Companies Act, 2008, as a whole.45 In Philips v Fieldstone Africa

(Pty) Ltd,46 the Supreme Court of Appeal ruled that in common law the standard of

conduct expected of a director extends to anyone who occupies a position of trust in

relation to the company.47 Any person who occupies the position of a director is a director

for the purposes of the Companies Act, 2008 – irrespective of whether or not he or she

is termed a director.48 In addition, section 66 includes ex officio directors49 and

prescribed officers.50 In Strut Ahead Natal (Pty) Limited v Burns,51 the defendant was

not a registered director of the company but performed all the duties of a director and,

accordingly, despite his attempts to distance himself from the company or its affairs, the

court held that he had acted as a director and managed the company in a reckless

manner.52 He was subsequently held personally liable under section 424(1) of the

Companies Act, 1973, for knowingly carrying on the company’s business recklessly.53

appointed a director, but in whose election or appointment, some defect or irregularity exists”. See also Otsile

Holdings (Pty) Ltd and Another v De Freitas 2009 1 BLR 487 HC citing R v Mills and Others. 45 Cassim et al Contemporary Company Law 375; Coetzee & Van Tonder 2014 Obiter 296. 46 Philips v Fieldstone Africa (Pty) Ltd 2004 2 All SA. 47 Philips v Fieldstone Africa (Pty) Ltd 2004 2 All SA 150. 48 Delport et al Henochsberg 22-23. See also Kaimowitz v Delahunt and Others 2016 (3) SA 201 (WCC) para 17. 49 See s 66(4)(a)(ii) of the Companies Act 71 of 2008 – an ex officio director refers to a person who is a director

of a company as a consequence of holding some other office, title, designation, or similar status. An ex officio

director has all the powers and functions of any other director or the company, except to the extent that these are

restricted by the MOI. See s 66(5)(b)(i) of the Companies Act 71 of 2008. 50 Delport et al Henochsberg 22; Coetzee & Van Tonder 2014 Obiter 297; and Schoeman “How the Companies

Act impacts on directors” 10 available at https://journals.co.za/content/jb_prej/13/6/EJC140779 (accessed:

11/11/2017). In Australia, the Australian Corporations Act, 2001, now includes “officers of the company” in s

9. See Ch 4 para 4.3. The UK definition of a director is not very clear. Section 250 of the Companies Act,

2006, states only that a “director includes any person occupying the position of director, by whatever name

called.” The courts will therefore look at the facts and circumstances of each situation and not at a person’s title

in order to determine whether he or she was obliged to comply with the duties of a director. The Companies

Act, 2006, also makes no distinction between executive and non-executive directors. See Ch 3 para 3.4. 51 Strut Ahead Natal (Pty) Limited v Burns 2007 3 All SA 190 (D). 52 Strut Ahead Natal (Pty) Limited v Burns 2007 3 All SA 190 (D) para 606. 53 Ibid. Section 424(1) of the Companies Act 61 of 1973. See s 77 of the Companies Act 71 of 2008 which

replaced s 424(1). Section 77(1)-(10) sets out the liability of the directors and prescribed officers of a company.

It also applies to alternate directors, members of the audit committee, or a committee of the board irrespective of

whether or not such persons are members of the board of directors of the company. Section 77 is supplemented

by s 218(4) of the 2008 Act, which states that any person who has contravened any provision of the Act is liable

to any other person for any loss or damage suffered by that person as a result of that contravention. See also

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In addition, the term “prescribed officers” is defined in section 1 of the Companies Act,

2008, as a person who performs any function within a company that has been designated

by the Minister under section 66(10).54 This definition is important because the

Companies Act, 2008, extends the obligations which directors owe to a company – and

so also the risk of liability – to prescribed officers.55 Section 76(1)(a) further specifically

states that directors’ duties, as set out in this section, will also apply to prescribed

officers. Section 76(1)(b) extends the definition further to include members of board and

audit committees. The result is that prescribed officers, although not directors, will now

have legal responsibility without any decision-making power. According to Cassim, the

general saying is “no power without responsibility” and with “greater power goes greater

responsibility”, but in this instance there is greater responsibility without greater power.56

Furthermore, section 1 of the Companies Act, 2008, also provides for alternate directors.

An “alternate director” is defined in section 1 as “a person elected or appointed to serve,

as the occasion requires, as a member of the board of a company in substitution for a

particular elected or appointed director of that company”. An alternate director may,

however, only be appointed if the Memorandum of Incorporation makes provision for a

Anderson and Others v Dickson and Another NNO (Intermenua (Pty) Ltd Intervening) 1985 (1) SA 93 (N) 110G

where Booysen J approved of the following passage in Delport et al Henochsberg 74: “The carrying on of any

business of a company recklessly means carrying it on by actions which evince a lack of any genuine concern for

its prosperity.” 54 Section 66(10) of the Companies Act 71 of 2008. This section provides that the Minister may make regulations

designating any specific function or functions within a company to constitute a prescribed officer for the purposes

of the Act. See also reg 38 of the Companies Act 71 of 2008, which sets out the definition of a prescribed officer

of a company (despite not being a director) for all purposes of the Act as follows: “if that person: a) exercises

general executive control over the management of the whole, or a significant portion, of the business and activities

of the company, or b) regularly participates to a material degree in the exercise of general effective control over,

and management of the whole, or a significant portion, of the business and activities of the company”. The

regulation applies to such a person irrespective of any specific title given by the company to the office held by

that person in the company or a function he or she performs for the company. See Boubaker & Nguyen Corporate

Governance in Emerging Markets 435; Delport et al Henochsberg 28; Havenga 2013 Tydskrif vir die Suid

Afrikaanse Reg 263; and Idensohn (2012) 129 South African Law Journal 721. 55 See ss 75, 76 and 77 of the Companies Act 71 of 2008. See further discussion of the directors’ duties in para

5.4. 56 Cassim et al Practitioner’s Guide 82. Idensohn (2012) 129 South African Law Journal 721.

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director to nominate an alternate director to act in his or her stead.57 Accordingly, the

definition of a director in section 1 is wide enough to include executive and non-

executive directors,58 de facto,59 shadow,60 de jure,61 and nominee directors.62 Other

directors also recognised include temporary directors,63 and puppet directors.64 Taking

into account the wide definition of a director in the Companies Act, 2008, and the fact

that the directors’ duties in section 76 apply to all of them, it is necessary briefly to

discuss the categories of director in South Africa.65 These directors, prescribed officers,

and members of board committees and the audit committee will also enjoy protection

under the South African business judgment rule, as is discussed later in this chapter.66

5.3.1 Executive and non-executive directors

An executive director is a director who is also an officer employed by the company;

while a non-executive director is any person who is a director of the company but who

is neither an officer nor an employee of the company.67 In Fisheries Development

Corporation of SA Ltd v Jorgensen,68 the court distinguished between an executive and

a non-executive director, holding that an executive director participates in the day-to-day

management of the company’s affairs and is a full-time, salaried employee of the

company.69 On the other hand, a non-executive director is a part-time director, is not

57 See s 66(4)(a)(iii) of the Companies Act 71 of 2008. 58 See para 5.3.1. 59 See para 5.3.2. 60 Ibid. 61 See para 5.3.3. 62 Ibid. 63 See para 5.3.4. 64 See para 5.3.5. 65 See para 5.3. 66 See para 5.5.2.2 (d). 67 Blackman Commentary on the Companies Act 8-13. 68 Fisheries Development Corporation of SA Ltd v Jorgensen; Fisheries Development Corporation of SA Ltd v

AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W) 534. 69 Ibid.

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involved in the day-to-day management, and is not required to give constant attention to

the affairs of the company.70 In Kaimowitz v Delahunt71 the court ruled:

What emerges from this dictum represents support for the concept of a non-

executive as opposed to an executive director. It also reveals that the involvement

of a director in the affairs of the company must be assessed in terms of enabling of

a director to perform those duties which are imposed upon him/her as a result of

his/her appointment as a director. This surely means that each director does not

have to be involved in the day-to-day running of a company nor that every director

must sit on every subcommittee which is constituted by a board.72

Unlike the King Reports, the Companies Act, 2008, does not differentiate between

executive and non-executive directors.73 According to the King Reports,74 an executive

director is a person who is involved in the day-to-day management of the company and/or

in the full-time salaried employment of the company or any of the company’s

subsidiaries. A non-executive director, on the other hand, is characterised by not being

involved in the day-to-day management of the company. He or she is also not in the full-

time, salaried employment of the company.75 Although there is no clear distinction in the

Companies Act, 2008, between these directors, it can be argued that the Companies Act

describes certain directors in a way which provides a distinct description similar to that

found in the King Reports.76

70 Fisheries Development Corporation of SA Ltd v Jorgensen; Fisheries Development Corporation of SA Ltd v

AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W) 534. See also Re City Equitable Fire Insurance Co Ltd 1925 Ch

407 (CA) 428–429. In Howard v Herrigel and Another1991 (2) SA 660 A 678, the court confirmed that once a

person consents to become a director, he or she becomes a fiduciary in relation to the company and is obliged to

display the utmost good faith towards the company and in his or her dealings on its behalf. See also Lindgren v

L&P Estates Ltd [1968] Ch 572 (CA) 596 where the court ruled that if the director has not formally been

appointed, the fiduciary relationship commences when he or she starts to act as director. 71 Kaimowitz v Delahunt and others 2016 (3) SA 201 (WCC). 72 Kaimowitz v Delahunt and others 2016 (3) SA 201 (WCC) para 26. See also Delport et al Henochsberg 23. 73 Cyberscene Ltd v i-Kiosk Internet and Information (Pty) Ltd 2000 3 SA 806 (C). 74 King I para 4; King II 54; King III at Annexures 1.2 and 1.3. King IV did not provide a further definition of or

distinction between executive and non-executive directors. 75 Joubert & Loubser 2016 De Jure 96. 76 For example, s 94 of the Companies Act, 2008, which regulates the composition of audit committees, explicitly

states that “a director who is elected to serve on the audit committee must not be involved in the day-to-day

management of the company or be in the full-time employment of the company.” This section clearly requires

that only non-executive directors be members of the audit committee. See also Joubert & Loubser 2016 De Jure

96. Another example is found in reg 43(4) of the Companies Act, 2008, where the composition of the Social and

Ethics Committee is prescribed. This regulation requires that at least one of the directors serving on this committee

must be a director “who is not involved in the day-to-day management of the company’s business”. Again, the

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5.3.2 De facto and shadow directors

The English Chancery Court in In Re Hydrodam (Corby) Ltd,77 ruled that a de facto

director is a person who assumes the role of and acts as a director.78 He or she is presented

as a company director, and claims and purports to be a director, although never actually

or validly having been appointed as such.79 According to Millet J, in order to establish

whether a person is a de facto director of a company, it is necessary to prove that he or

she undertook functions in relation to the company which could properly be discharged

only by a director. In the English case, Hollard v Revenue and Customs Commission and

Another80 the court held that:

Those who assumed to act as directors and who thereby exercised the

powers and discharged the functions of a director, whether validly

appointed or not, had to accept the responsibilities of the office.81

The test to be applied in determining whether a person is a de facto director, was recently

considered by the English Court of Appeal in Smithton Ltd v Guy Naggar & Others.82

Here the court held that a de facto director is a person who, either alone or with others,

has ultimate control of the management of any part of the company.83 The court upheld

the ruling of the Supreme Court in HMRC v Holland,84 where Judge Collins found that

there was no single definitive test for a de facto director. One option is to ask whether

the person is part of a corporate governance system and whether he or she has assumed

reference is to a non-executive director. It is clear, despite no express distinction between the various types of

director in the Companies Act, that the Act acknowledges that there is a difference. 77 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 (Ch) 161. 78 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 (Ch) 163. 79 Ibid. 80 Hollard v Revenue and Customs Commission and Another [2011] 1 All ER 430. 81 Hollard v Revenue and Customs Commission and Another [2011] 1 All ER 430 para 39. 82 Smithton Ltd v Guy Naggar & Others [2014] EWCA Civ 939 WLR (D) 306. 83 Ibid. 84 HMRC v Holland [2010] 1 WLR 2793.

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the status and functions of a director so as to make him- or herself responsible as if he or

she were in fact a director.85

The first official reference to a shadow director was made in the United Kingdom when

it extended the term “director” to include “any person in accordance with whose

directions or instructions the directors of a company are accustomed to act”.86 In Re

Hydrodam (Corby) Ltd87 the court ruled that, in order to establish whether a person is a

shadow director of a company, it is necessary to allege and prove the following:

1) Who are the directors of the company, whether de facto or de jure;

2) Did the defendant direct the appointed directors how to act in relation to the

company or that he was one of the persons who did so;

3) Did the appointed directors act in accordance with such directions; and

4) Are the appointed directors accustomed to act in accordance with such person’s

directions?88

85 HMRC v Holland [2010] 1 WLR 2793 para 42. The English Court of Appeal in Smithton Ltd v Guy Naggar &

Others [2014] EWCA Civ 939 WLR (D) 306 identified a number of points that provide a useful framework to

guide one in determining who qualifies as a de facto director. These points include: “1) The concepts of ‘de facto’

and ‘shadow’ directorships differ but there is some overlap. 2) A person may be a de facto director even if there

was no invalid appointment. The question is whether he or she has assumed responsibility to act as a director. 3)

Answering the question as to whether the person has assumed responsibility to act as a director may require a

determination of the precise capacity the person was acting in (as in Holland). 4) The corporate governance

structure of the company in general will also have to be determined in order to decide in relation to the company's

business whether the person’s acts were directorial in nature. 5) It is necessary to look beyond any job title given

to the person and to examine what the director actually did. 6) The fact that a person, in good faith, did not think

he or she was not acting as a director will not determine the issue: the question whether or not someone has acted

as a director is to be determined objectively and irrespective of his or her subjective motivation or belief. 7) The

cumulative effect of the activities relied on must be weighed: the circumstances should be considered ‘in the

round’ (see Secretary of State v Jones [1999] BCC 336 at 8). It is also important to look at the acts in their context.

A single act might in an exceptional case lead to a conclusion that the person is to be treated as having been a

director. 9) The fact that a person is consulted about directorial decisions or his or her approval does not in general

make him or her a director because he or she is not making the decision. 10) Acts outside the period in which he

or she is said to have been a de facto director may throw light on whether he was indeed a de facto director in the

relevant period”. 86 See s 3 of the Companies Act, 1917. Section 251(1) of the UK Companies Act, 2006, provides that “a shadow

director is a person in accordance with whose directions or instructions directors of the company are accustomed

to act”. There are two express exclusions from the general definition. Section 251(2) of the CA, 2006, provides

that “a person is not to be regarded as a shadow director by reason only that directors act on advice given by him

a professional capacity”. Section 251(3) provides that “a corporate entity is not to be regarded as a shadow director

of any of its subsidiary companies, for the purposes of certain of the Act’s shadow-director provisions, by reason

only that the directors of the subsidiary are accustomed to act in accordance with its directions or instructions.”

Section 170(5) of the CA provides that the general duties apply to a shadow director of a company where and to

the extent that they are capable of applying. See further Coetzee & Van Tonder 2014 Obiter 301; and Idensohn

(2010) 22 SA Merc LJ 327. 87 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 (Ch) 161. 88 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 (Ch) 162.

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The Companies Act, 2008, does not explicitly define a “shadow director”, but according

to certain commentators the definition of “director” in section 1 is wide enough to include

a shadow director under the phrase “occupying the position of a director”.89

The Companies Act, 2008, does, however, introduce the concept of a prescribed officer.90

According to Idensohn, it appears from the definition of a prescribed officer that it may

have been intended, at least in part, to include those who act in ways similar to shadow

directors.91 If the definition of a prescribed officer does include shadow directors, then

the duties of directors as set out in section 76 will apply to them. Those duties are not,

however, a complete statement of all the common-law fiduciary duties that fall to

directors.92 The question then is whether the common-law fiduciary duties that have no

equivalent in section 76, apply to shadow directors.93 According to Idensohn, the courts

are likely to follow the approach of the English courts and will generally refuse to

recognise shadow directors as subject to any primary fiduciary duties or liability.94

5.3.3 De jure and nominee directors

A de jure director is a person who has been validly and formally appointed to the position

of a company director and who has freely consented to that appointment.95 A nominee

director is a de jure director96 who owes his or her nomination as a director to a

89 Cassim et al Contemporary Company Law 381; and Coetzee & Van Tonder 2014 Obiter 301. Idensohn is of

the contrary view that there is still no formal recognition of the shadow director concept in South Africa. See

Idensohn (2010) 22 SA Merc LJ 339. The Companies Act, 2006, provided for a definition of “shadow director”

in s 251 which reads “ ‘shadow director’, in relation to a company, means a person in accordance with whose

directions or instructions the directors of the company are accustomed to act”. For further discussion on shadow

directors see Locke (2002) 14 SA Merc LJ 420-437. 90 Idensohn (2010) 22 SA Merc LJ 339. 91 Ibid. 92 See discussion on fiduciary duties in para 5.4.1. 93 Some examples are set out in Section 75 of the Companies Act, 2008 which describes conflicts of interest and

compels directors to disclose the nature and extent of the conflict of interest. 94 Idensohn (2010) 22 SA Merc LJ 327. 95 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 (Ch) 163. 96 See para 5.3.3.

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shareholder or other third party who controls sufficient voting power in the company to

represent his or her interests.97 In the English case of Boulting v Association of

Cinematograph Technicians,98 a nominee director was defined as standing apart from

his or her fellow directors by virtue of having been nominated by a shareholder or other

stakeholder of a company to represent the stakeholder’s particular interests.99 A nominee

director may be placed in a difficult position should there be a conflict of interest between

the company and the nominator.100 The nominee director owes a duty to act in the best

interest of the company to which he or she is appointed, but at the same time is expected

by his or her nominator to protect the interests of the nominator. In case law, the position

has, however, been clarified: in carrying out his or her duties and functions as a director,

a nominee director is in law obliged to serve the interest of the company to the exclusion

of the interest of any nominator, employer, or principal.101 In Fisheries Development

Corporation of SA Ltd v Jorgensen, Judge Margo ruled that the nominee director’s duty

is to observe the upmost good faith towards the company, and in discharging that duty

he or she is required to exercise an independent judgment and to take decisions in the

best interests of the company.102

5.3.4 Temporary director

In the Companies Act, 2008, provision is made for temporary directors. Sections 68(2)

and 68(3) provide that, unless the Memorandum of Incorporation of a profit company

provides otherwise, the board may appoint a person who satisfies the requirements for

97 S v Shaban 1965 (4) SA 646 (W) 651. 98 Boulting v Association of Cinematograph Technicians [1963] 2 QB 606 at 626. 99 Ibid. 100 Havenga (1997) 9 SA Merc LJ 323. 101 Fisheries Development Corporation of SA Ltd v Jorgensen, Fisheries Development Corporation of SA Ltd v

AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W) 163. 102 Ibid. See also Boulting v Association of Cinematograph Technicians [1963] 2 QB 606.

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election as a director to fill any vacancy and serve as a director of the company on a

temporary basis until the vacancy has been filled by election in terms of section 68(2).103

During this period any person so appointed has all the powers, functions, and duties of a

director. The person appointed will also be subject to all the liabilities applicable to any

other director of the company.

5.3.5 Puppet director

In the case of S v Shaban104 the court defined a puppet director as a person who has been

placed on the board of directors with the intention that he or she will blindly follow the

instructions of his or her controller.105 The puppet director cannot, however, escape

liability for a breach of his or her duties by shifting the blame onto his or her controller.106

Furthermore, a puppet director will also not escape liability on the ground that he or she

was not formally appointed. This was illustrated in S v De Jager,107 where the court held

that a director who had resigned and had secured the appointment of a puppet in his

place, was nevertheless still bound by his or her duties as a director.108

103 Section 68(2) of the Companies Act 71 of 2008. See also s 70(3) which provides that a vacancy on the board

other than as a result of an ex officio director, must be filled. Section 70(3) of the Companies Act 71 of 2008. 104 S v Shaban 1965 (4) SA 646 (W) 652 where the court held further that “[o]ur law does not know the complete

puppet who pretends to take part in the management of a company whilst having no idea what it is to which he

puts his signature. It is utterly foreign to the basic concepts of our law and the Courts will punish it as fraud.” See

also Sage Holdings Ltd v The Unisec Group Ltd 1982 (1) SA 337 (W) 354. 105 S v Shaban 1965 (4) SA 646 (W) 652. There is an overlap between a puppet- and nominee director and the

distinction it is not always clear. For commentary on the subject of puppet- and nominee directors see Du Plessis

(1995) 2 South African Law Journal 310-321. 106 S v Hepker & Another 1973 (1) SA 472 (W) 484. See also Fisheries Development Corporation of SA Ltd v

Jorgensen, Fisheries Development Corporation of SA Ltd v AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W) 163

where Judge Margo held that the puppet director may not be indifferent or a mere dummy – there is no difference

between the duties of “puppet” and ordinary directors. 107 S v De Jager 1964 (2) SA 616 (A). 108 Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555, [1968] 2 All ER 1073; S v Hepker

& another 1973 (1) SA 472 (W); and Cassim et al Contemporary Company Law 379. In Australia and the UK

there were recent cases involving puppet directors. A Port Macquarie (Town in Australia) man has been convicted

of managing a company while bankrupt and fined $1100 in a local court, after his daughter was found to have

been taking instructions from him on how to run the business. Grant John Hives pleaded guilty to making business

decisions while being a disqualified director. After filing for bankruptcy, Hives nominated his 18-year-old

daughter as the sole director of the company. A subsequent investigation by the ASIC found Hives had

communicated instructions or wishes to his daughter knowing that she would act in accordance with them. Hives

was convicted and fined by the Commonwealth Director of Public Prosecutions for $1,100.00. See

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Lastly, with the possible exception of shadow directors, all directors and prescribed

officers discussed above are obliged to comply with directors’ common-law duties and

the duties of directors as set out in section 76 of the Companies Act, 2008.109 In addition,

these directors and prescribed officers also enjoy the protection offered by the business

judgment rule.110

5.4 DIRECTORS’ DUTIES IN SOUTH AFRICA

Before the Companies Act, 2008,111 South African directors’ rights and duties were

derived mainly from contracts entered into with the company,112 the memorandum and

articles of association,113 the Companies Act of 1973,114 and the common law.115 The

common law in South Africa imposes both a fiduciary duty and a duty of care on

directors.116 One of the significant innovations in the Companies Act, 2008, is that for

the first time in South African company history, the fiduciary duties of directors and the

https://asic.gov.au/about-asic/news-centre/find-a-media-release/2015-releases/15-153mr-port-macquarie-man-

convicted-and-fined-for-managing-a-company-while-bankrupt/ (accessed: 19/05/2021). In the UK, Pauline

Muldowney, more commonly known as Pauline Gopee, was disqualified for 12 years at the High Court of Justice.

Muldowney was the sole formally appointed director of Pangold Investments Limited in 2016 and just over a year

later on 27 April 2017, a winding-up order was made against Pangold Investments. Yet just four days before the

company was going to be shut down by the courts, Muldowney caused Pangold Investments to transfer property

assets, with an estimated value of more than £2.5 million, to her father-in-law Dharam Prakash Gopee for just £1.

See https://www.gov.uk/government/news/southend-director-banned-for-transferring-assets-to-father-in-law

(accessed: 10/02/2020). 109 See para 5.4. 110 See the discussion of the business judgment rule in para 5.5.2. 111 In the Companies Act, 2008, the duties of directors are set out in ss 75-76. Section 75 deals with the director’s

personal financial interest, s 76 deals with the standards of a director’s conduct. 112 For example, the employment contract that the director entered into with the company can set out duties the

director must fulfil: Moyo South African Principles of Corporate Governance 38. 113 The previous Memorandum and Articles of Association are now defined in the Companies Act, 2008, as the

Memorandum of Incorporation, which is described as: “the document, as amended from time to time that sets out

rights, duties and responsibilities of shareholders, directors and others within and in relation to a company.” 114 See ss 243-251 of the Companies Act, 1973. There is also other legislation that provides for directors’ duties,

for example, the Labour Relations Act 66 of 1995 and the Income Tax Act, 1997.These other forms of legislation

that impose duties on directors are not discussed in this thesis. 115 The common-law duties of directors are discussed later in this chapter. See para 5.4.2.1; Bouwman (2009) 21

SA Merc LJ 509; Esser Recognition of various stakeholder interests in company management 208 and Moyo

South African Principles of Corporate Governance 18. 116 Bouwman (2009) 21 SA Merc LJ 509; Moyo South African Principles of Corporate Governance 18.

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duty to exercise reasonable care and skill have been partially codified.117 The fiduciary

duties of directors were not discussed in the earlier chapters of this thesis, but in this

chapter the fiduciary duty to act in the best interest of the company is considered because

the business judgment rule, as codified in the Companies Act 2008, may be invoked by

a director in the event that an allegation is made against the director that he or she

breached this duty118 and the duty of care.119 The duty to act in the best interest of the

company which is the overarching fiduciary obligation is discussed next. The specific

categorisations o this duty are not discussed in detail.120

5.4.1 Directors’ fiduciary duty to act in the best interests of the company

The fiduciary duty as a legal principle, originated in UK rules of equity.121 Directors’

fiduciary duties require of them to exercise their powers in good faith and for the benefit

117 See also ss 75 and 76 of the Companies Act 71 of 2008. Avenant Director’s Duties to Comply 34; Bouwman

ibid; Cassim (2008) 125 South African Law Journal 732; Delport et al Henochsberg 290; Esser & Delport (2011)

74 THRHR 453; Geach Paper for CIS Corporate Governance Conference 8; Von Dürckheim Does South Africa

Need a Statutory Business Judgment Rule? 36. 118 See s 76(4) of the Companies Act 71 of 2008. 119 Cassim et al Contemporary Company Law 461; Pretorius et al Hahlo’s South African Company Law

Through the Cases 278; Cantante & Ertner “Duties and responsibilities of company directors in South Africa” 2

available at http://www.into-sa.com/uploads/download/file/363/INTO_SA_eINFO_-

_Duties_and_Responsabilities_of_Company_Directors__2014_.pdf (accessed: 10/04/2017). In the US, the

duty of care forms part of the fiduciary duties, unlike South Africa, Australia and the UK where directors’

fiduciary duties and the duty of care and skill are separate duties. See Ch 2 para 2.3. 120 Other fiduciary duties include: 1) that a director must act for a proper purpose; 2) within the limits of powers

conferred upon the particular director; and 3) without a conflict of interest. On these duties generally, see Cassim

et al Contemporary Company Law 475 and Delport et al Henochsberg 298. Section 76(3)(a) and (b) of the

Companies Act 71 of 2008 partially codify the fiduciary duties of directors. Only the duty to act in good faith and

for a proper purpose (s 76(3)(a)) and the duty to act in the best interests of the company (s 76(3)(b)) were codified.

It may, however, be argued that because these two duties are the overarching duties from which all the other

fiduciary duties flow, further categorisation of the fiduciary duties are by implication included within the scope

of s 76(3)(a) and (b). 121 Botha “The role and duties of directors in the promotion of corporate governance: A South African

perspective” 704 available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2873053 (accessed:

16/04/2017); Esser Stakeholder Interests in Company Management 50.

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of the company.122 These fiduciary123 duties are based on the general principle that a

“person standing in a fiduciary relationship to another commits a breach of trust if he or

she acts for his or her own benefit or to the prejudice of the other”.124 The position of

directors as fiduciaries, is often compared to that of trustees or agents, but although there

are similarities between these fiduciary positions, a director is neither a trustee nor an

agent.125 In Cohen NO v Segal,126 Judge Boshoff ruled that:

Directors are from time to time spoken of as agents, trustees or managing partners

of a company, but such expression are not used as exhaustive of the powers and

responsibilities of those persons, but only as indicating useful points of view from

which they may for the moment and for particular purpose be considered. 127

A director’s fiduciary duty to the company arises from the nature of his or her position in

relation to the company and the company’s position in relation to him or her.128 The

relationship arises from the purpose for which directors are entrusted with powers to

manage the business and affairs of the company, that is, to relinquish their own self-

interest and act exclusively on behalf of and in the interests of the company.129

122 Cyberscene & others v i-Kiosk Internet and Information (Pty) Ltd 2000 (3) SA 806 (C); Da Silva v CH

Chemicals (Pty) Ltd 2008 (6) SA 620 (SCA) para 13, 627B; Fisheries Development Corporation of SA Ltd v

Jorgensen, Fisheries Development Corporation of SA Ltd v AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W) 165;

Glenrand MIB Financial Services (Pty) Ltd v Van Heerden NO [2013] 1 All SA 511 (SCA) 16 para 37; Robinson

v Randfontein Estates Gold Mining Co 1921 AD 168; S v de Jager & another 1965 (2) SA 616 (A); Sibex

Construction (SA) (Pty) Ltd v Injectaseal 1988 (2) SA 54 (T) 65; Swanee’s Boerdery (Edms) Bpk (in Liquidation)

v Trust Bank of Africa Ltd 1986 (2) SA 850 (A) 854; and Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd

and Others 2014 (5) SA 179 (WCC). See further Botha “The role and duties of directors in the promotion of

corporate governance: A South African perspective” 706; Esser & Dekker (2008) 3 Journal of International

Commercial Law and Technology 159; and Havenga (1996) 8 SA Merc LJ 366. 123 The word “fiduciary” is derived from the Latin word fiduciarius, meaning “holding in trust” from fides,

meaning “faith” and fiducia, meaning “trust”. See Coetzee & Van Tonder 2014 Obiter 286; Dharmaratne “A

consideration of whether directors should stand in a fiduciary relationship with the company’s related and inter-

related companies” 1 available at http://www.cgblaw.co.za/fiduciary-relationship.pdf (accessed: 18/04/2017). 124 Robinson v Randfontein Estates Gold Mining Co Ltd 1921 AD 168 242; Cilliers et al Corporate Law 141. 125 In Bristol and West Building Society v Mothew [1996] 4 All ER (CA) 698 711-712 Judge Millet held that a

fiduciary is someone who undertakes to act for or on behalf of another in circumstances that give rise to a

relationship of trust and confidence between the parties. See also Robinson v Randfontein Estates Gold Mining

Co 1921 AD 168 242; Esser Recognition of Stakeholder Interests 50. 126 Cohen NO v Segal 1970 (3) SA 702 (W) 706. 127 Ibid. 128 Cyberscene Ltd v i-Kiosk Internet and Information 2000 (1) SA 806 (C) 820; Robinson v Randfontein Estates

Gold Mining Co Ltd 1921 AD 177-178; Sibex Construction (SA) (Pty) Ltd v Injectaseal CC 1988 (2) SA 54 (T)

65. 129 See ss 66(1) and 76 of the Companies Act 71 of 2008. As set out in Phillips v Fieldstone Africa (Pty) Ltd

[2004] 1 All SA 150 (SCA) 159, these three elements appear to be the absolute minimum required for the

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The relationship between a director and a company is best seen as sui generis.130 In

Derbigum Manufacturing (Pty) Ltd v Callegaro & Others,131 Judge Windell reaffirmed

the position in Robinson v Randfontein Estates Gold Mining Co Ltd132 and Du Plessis v

Phelps,133 where the courts ruled:

In my judgment it is correct to state that a breach of fiduciary duties does not

necessarily involve fault. For example, if a director were to obtain a secret profit,

the company could claim such profit from him without alleging fault. An action

of that kind could be described as sui generis. The claim would arise merely by

virtue of the fact that the director, in breach of his fiduciary duty, obtained for

himself a secret profit which he should have obtained for the company. 134

Directors’ fiduciary duties in South Africa now derive from both the Companies Act,

2008, and the common law.135 Section 76(3)(a) and (b)136 states that, subject to section

76(4) and (5),137 directors of a company acting in that capacity, must exercise the powers

and perform the functions of a director: 1) in good faith and for a proper purpose; and 2)

in the best interests of the company. In addition, section 75 states that directors have a

existence of a fiduciary relationship: (i) scope for the exercise of some discretion or power; (ii) that power or

discretion can be used unilaterally so as to effect the beneficiary’s legal or practical interests; and (iii) a peculiar

vulnerability to the exercise of that discretion or power. 130 Robinson v Randfontein Estates Gold Mining Co Ltd 1921 AD 168; Du Plessis NO v Phelps 1995 (4) SA 165

(C). 131 Derbigum Manufacturing (Pty) Ltd v Callegaro & Others 2013 ZAGP JHC 322. 132 Robinson v Randfontein Estates Gold Mining Co Ltd 1921 AD 168 at 242. Judge Solomon ruled: “The action

indeed is, as the Judges in the Court below held, one sui generis.” 133 Du Plessis v Phelps 1995(4) SA 165 (C) 171. 134 Du Plessis v Phelps 1995(4) SA 165 (C) 170, for example, where South African courts used the actio legis

Aquiliae for breach of a director’s duty of care. See also Havenga Fiduciary Duties of Company Directors 315. 135 Section 77(2) of the Companies Act provides as follows: “A director of a company may be held liable– (a) in

accordance with the principles of the common law relating to breach of a fiduciary duty, for any loss, damages or

costs sustained by the company as a consequence of any breach by the director of a duty contemplated in section

75 [the duty to disclose a personal financial interest in board matters or an agreement or other matter in which the

company has a material interest], 76(2) (the duty not to use the position of a director or information obtained

while acting in the capacity of a director to gain an advantage or to cause harm to the company and the duty to

communicate corporate information to the board of directors) or 76(3)(a) (the duty to act in good faith and for a

proper purpose); or (b) (the duty to act in the best interests of the company).” See, eg, Bellairs v Hodnett &

Another 1978 (1) SA 1109 (A) 1128. 136 Section 76(3)(a) & (b) of the Companies Act 71 of 2008. Section 76(3)(c) includes the director’s duty of care,

skill and diligence. 137 Section 76(4) codifies the business judgment rule and sets out the steps that the director must adhere to in order

to comply with s 76(3) (b) & (c). Section 76(5) sets out on whom the director could rely when making a decision

– for example, legal counsel, accountants, other professional persons, certain employees and some board

committees of which the director is not a member.

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duty to disclose a personal financial interest in board matters or an agreement or other

matter in which the company has a material interest.138

Section 76(2) places a further duty on directors not to use their position or information

obtained while acting in the capacity of a director, to gain an advantage or to cause harm

to the company. It also places a duty on directors to communicate corporate information

to the board of directors.139

In common law, the overarching fiduciary duty of directors from which all the other

fiduciary duties flow, is the duty to act in good faith and in the best interests of the

company.140

The common-law principle that directors must act in the best interests of the company is

codified in section 76(3)(b) of the Companies Act, 2008, which states that directors of a

company when acting in that capacity, must exercise the powers and perform the

functions of directors in the best interests of the company.141 Accordingly, the section

makes it clear that company directors owe their duty to the company and the company

alone.142 The question can be raised as to what the word “company” means? The

Companies Act, 2008, does not assist in defining the word company for purposes of

138 Section 75 of the Companies Act 71 of 2008. There are certain exclusions set out in s 75(2). These are decisions

that may generally affect all the directors of the company in their capacity as directors; or class of persons, despite

the fact that the director is one member of the class of persons (unless the only member of the class is the director

or person related or interrelated to the director). 139 See ss 75 and 76(2) of the Companies Act 71 of 2008. A case in point is S v Gardiner and Another 2011 (4)

SA 79 (SCA) where two chief executive officers were held to have breached their duty to disclose personal

financial interests in certain contracts with the company by failing to disclose those interests to the board of the

company. The court held that the two accused had deliberately and fraudulently withheld information from the

board of directors and convicted them of fraud. 140 Cassim et al Contemporary Company Law 475; Delport et al Henochsberg 298. 141 See para 5.5.2. 142 Cassim et al Contemporary Company Law 467.

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section 76(3)(b),143 but historically it was held that directors owed their fiduciary duties

to the company as a whole, and this has been interpreted as to the shareholders

collectively, and not to any third parties directly.144

The Companies Act, 2008, has thus not provided formal recognition for the interests of

stakeholders other than the interests of the collective shareholders. There has, however,

been an on-going debate as to whether a company should be seen as an integral part of

society or as just another business entity.145 The debate surrounding this question

concerns the “stakeholder” versus “shareholder” approach.146 In its most basic form, the

debate is that powers granted to a company or its management may be exercised only for

the benefit of the shareholders of the company. In accordance with this view, the sole

object or function of a company is to make a profit for its shareholders.147 In terms of the

competing view, a company has responsibilities to the community and corporate

managers who control the business should voluntarily manage a company in such a way

as to fulfil these responsibilities.148

In terms of the “shareholder” approach, the primary role of the directors is to promote the

success of the company for the benefit of the company as a whole, and to generate

maximum value for shareholders. Other stakeholders are considered, but their interests

143 Section 1 of the Companies Act 71 of 2008 states that a company is a juristic person incorporated in terms of

the Act. 144 Blackman Commentary on the Companies Act 8-51; Cassim et al Contemporary Company Law 467; Coetzee

& Van Tonder 2014 Obiter 305; Esser Recognition of Stakeholder Interests 51; Muswaka International Business

and Social Sciences Research Conference 2013 3. 145 Cassim et al Contemporary Company Law 470; Esser & Du Plessis (2007) 19 SA Merc LJ 350. 146 Also known as the Berle-Dodd debate – a debate between Professors Berle and Dodd Jnr conducted in the

1930s and which still remains important today. Dodd (1932) 45 Harvard Law Journal 1145 and Berle (1932) 45

Harvard Law Review 1365; Havenga (1997) 9 SA Merc LJ 314; Lombard & Joubert “The legislative response

to the shareholders v stakeholders debate” 1 available at

https://www.tandfonline.com/doi/abs/10.5235/14735970.14.1.211 (accessed: 15/06/2017); Kerr (2007) 29

Cardozo Law Review 660. 147 This is the view of Professor Berle. See Berle (1932) 45 Harvard Law Review 1049. 148 This is the view of Professor Dodd Jnr. See Dodd (1932) 45 Harvard Law Journal 1145-1163.

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are secondary to those of the shareholders. Ultimately, profit maximisation is the main

goal of the directors.149 The “stakeholder” approach, by contrast, requires companies to

promote stakeholder interests independently of, not subordinate to, the interests of their

shareholders.150

Although, as stated above, stakeholder interest has not received formal legal recognition

under the Companies Act, 2008, and shareholders’ interests are traditionally conferred

primacy in the management of a company, there have been a shift in public opinion.151

Public opinion dictates that consideration should be given to a variety of interests

extending beyond those of the shareholders alone.152 The wider variety of interests

include environmental concerns and the interests of the following stakeholders: investors,

employees, consumers, and the general public.153

This approach is also known as the triple-bottom-line approach.154 According to Esser

and Du Plessis, the triple-bottom-line approach has the effect that requiring directors to

act in good faith in the interest of the company cannot today mean anything other than a

blending of all these interests, but first and foremost directors must act in the best interest

of the company as a separate legal entity.155 They argue further that courts will be in a

position to give a different weight to the degree of interest.156 It will also be appropriate

149 See Cassim et al Contemporary Company Law 471; Esser & Dekker (2008) 3 Journal of International

Commercial Law and Technology 159; and Esser (2009) 21 SA Merc LJ 193. 150 Cassim et al Contemporary Company Law 472. 151 Esser (2009) 21 SA Merc LJ 191. 152 Ibid. 153 Ibid. See also Recycling and Economic Development Initiative of South Africa NPC v Minister of

Environmental Affairs 2019 (3) SA 251 (SCA). 154 The triple-bottom line approach is an accounting framework that incorporates three dimensions of

performance: social, environmental, and financial. For a detailed discussion. See Henriques & Richardson The

Triple Bottom Line 1-179. 155 Esser & Du Plessis (2007) 19 SA Merc LJ 358 and King IV 26. 156 Ibid.

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for a court to consider any other remedies under other legislation before it allows a

particular interest group to rely on particular company law remedies.157 It may happen

that a specific interest group has already been catered for under separate legislation. Esser

and Du Plessis compare this on-going process to a merry-go-round. They state:

Just like a merry-go-round, there are sometimes brief stops to let some participants

get off and take some participants on board, but then the motion continues with the

participants (interests) constantly moving up and down without any finishing line.

The speed of rotation may even vary, until it comes to a permanent standstill when

the company is liquidated. But even then it will require of the courts to weigh up

various interests of at least creditors, shareholders and employees. During the

existence of the company the directors will focus on the interests of the company

(the merry-go-round), but they are not only allowed, but are in actual fact required,

to observe the various other interests, moving up and down just like those who are

enjoying the ride on the merry-go-round, very carefully when they act. After all it

is required of them to act in good faith and in the best interest of the company as

represented by the various interests in the company. 158

The “stakeholder” and “shareholder” approaches are based on various theories. Examples

of these are the contractual, concessionary, and communitaire theories. These theories

are discussed only briefly for completeness. In terms of the contractual theory – also

known as the agency theory – the company is a web of contractual relationships. All

relationships within the company are therefore contractual in nature; each of the various

stakeholders contributes certain inputs in exchange for certain rights to the company

output.159 Stakeholders will, in accordance with this theory, be able to structure their

particular relationship as they deem fit. The concession theory holds that a company’s

existence and operation is a concession granted by the state to use this corporate tool.160

This theory is not clear on who the beneficiaries of directors’ fiduciary duties should be,

but does nonetheless acknowledge that the beneficiaries include a wider variety of

157 Esser & Du Plessis (2007) 19 SA Merc LJ 358 and King IV 26. 158 Ibid. 159 Esser Recognition of Stakeholder Interest 27. 160 Ibid. See also Sheehy (2005) 14 University of Miami Business Law Review 232.

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interests than the contractual theory.161 According to the communitaire theory, a company

is regarded as an instrument of the state and not a mere concession. In terms of this theory

the aims of the company reflect the aims of society. The company does not have a strong

commercial character, but has become a tool used by the state to give effect to its goals.

According to this theory the stakeholders are vulnerable to abuse and should be protected.

Within this theory the goal is the long-term viability of the company.162 The company

will consider the interests of the stakeholders if it will derive a long-term benefit from

doing so.163 The theory is, however, unclear as to how this goal will be achieved.164

There are some provisions which allow for a wider consideration of stakeholder interests.

Sections 7(a) and 7(d) of the Companies Act, 2008 are examples of such provisions which

provide that the purpose of the Companies Act is to promote compliance with the Bill of

Rights as provided for in the Constitution165 and to reaffirm the concept of the company

as a means of achieving economic and social benefits.166 Section 7(a) implies that human-

rights concerns must be placed at the centre of policy making within a company, and

should be embedded in its holistic functioning.167 Regarding section 7(d), some

commentators argue that this section should be interpreted to read that directors of a

company must pay attention to the interests of stakeholders, but that it does not provide

stakeholders with direct rights.168 Every state-owned company, listed public company,

161 Esser Recognition of Stakeholder Interest 27; Sheehy (2005) 14 University of Miami Business Law Review

193-240. 162 Esser Recognition of Stakeholder Interest 31. 163 Ibid. 164 Ibid. 165 Ch 2 of the Constitution of the Republic of South Africa, 1996. 166 Sections 7(a) and 7(d) of the Companies Act 71 of 2008. For further discussion on the Social and Ethics

Committee see Delport et al Henochsberg 282; Stoop (2013) 24 Stellenbosch Law Review 562-582; Esser &

Delport (2016) 79 THRHR 1-29; Esser & Delport (2017) 7 De Jure 97-110; Esser & Delport (2017) 16 De Jure

221-240. 167 Katzew (2011) 128 South African Law Journal 686-687. 168 Esser (2011) 23 SA Merc LJ 317.

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and any other company that has a significant public interest (companies with more than

500 employees or more than R500 million turnover) is obliged in terms of section 72(4)

and regulation 43 of the Companies Act, 2008, to establish and maintain a Social and

Ethics Committee which must perform the functions as set out in regulation 43(5).169 In

providing for a Social and Ethics Committee, the Companies Act, 2008, has

acknowledged that directors must also consider other stakeholders’ interests.

Reading the Companies Act, 2008, as a whole, it is clear that there is a definite move

away from the “shareholder” approach towards a “stakeholder” approach. It is argued by

some commentators that the South African legislature adopted an approach “which lies

somewhere between the ‘stakeholder’ and the ‘shareholder’ approach”.170 Mongalo

suggests that the South African Companies Act “directly provides a clear framework for

the empowerment of stakeholders and includes a directive that companies operate to

enhance not only shareholder profits but also social welfare”.171

Furthermore, King III172 advocated a stakeholder-oriented corporate governance

approach. King III recommended that the best interests of the company should be

interpreted within the parameters of the company as a sustainable enterprise and a good

corporate citizen.173 The Report promoted the inclusive stakeholder approach which

169 Regulation 26(2) of the Companies Act 71 of 2008, sets out the criteria for determining the “public interest

score”. Regulation 43(5) of the Companies Act 71 of 2008 reads: “The functions of the social and ethics

committee are: a) To monitor the company’s activities with regard to – (i) social and economic development; (ii)

good corporate citizenship; (iii) the environment, health and public safety; (iv) consumer relationships;(v) labour

and employment; (b) to draw matters within its mandate to the attention of the Board...; and (c) to report...to the

shareholders...on the matters within its mandate.” 170 Cassim & Cassim (2005) 16 International Company and Commercial Law Review 411-412. 171 Mongalo Modern Company Law 220. It should also be noted that there is other legislation that specifically

provides for the protection of stakeholders’ interests, for example, the Labour Relations Act 66 of 1995 (ss 78-

94); the Broad Based Black Economic Empowerment Act 53 of 2003; and the Consumer Protection Act 68 of

2008. 172 King III. 173 King III 28-29; Bouwman (2012) 12 Without Prejudice 28-29.

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considered, weighed, and promoted the interests of all the company’s stakeholders and

so ensured the cooperation and support of all stakeholders the company depends on for

its sustainable success.174 The board’s principal responsibility is to create value for its

shareholders. However, in so doing, directors need to take the interests of other

stakeholders into account.175 Although the board is responsible to the company, it should

take account of the legitimate expectations of all the company’s stakeholders.176 The main

reason for the existence of a company is to create value. This has, however, evolved into

the notion of value in terms of the triple-bottom line. It is specifically held in principle

1.7 of King III that the board and its directors should act in the best interests of the

company.177 The board is responsible not only for the company’s financial bottom line,

but also for the company’s performance in respect of its triple-bottom line.178 When the

triple-bottom line approach is followed, the economic value and reputation of the

company will increase.179

King IV states that as part of the governing body’s decision-making in the best interests

of the company, it should ensure that the stakeholder-inclusive approach is adopted which

takes account of and balances its legitimate and reasonable needs, interests, and

expectations.180 The stakeholder-inclusive approach implies that companies should allow

stakeholders a right to be heard while at the same time accepting its responsibility to

account to them.181 Stakeholder interests should, therefore, be considered when deciding

174 King III 13. 175 King III Ch 1 para 3. 176 King III para 5. 177 Ibid. See also Esser (2009) 21 SA Merc LJ 197. 178 Esser (2009) 21 SA Merc LJ 197. 179 Ibid. 180 Principle 5.1 of King IV. The term ‘stakeholder’ appears 150 times in the report which shows how important

the concept has become. 181 Slabbert (2015) 34 Communicare: Journal of Communication Sciences in South Africa 7.

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on the best interests of the company.182 It must, however, be stated that King IV is not a

mandatory code but rather voluntary, and, according to Cassim, the promotion of

stakeholder interests therefore remains discretionary.183 Although this is true as regards

unlisted companies, listed companies must comply with the King Code. In terms of the

Johannesburg Stock Exchange’s listing rules, compliance with the King Code is

mandatory. The listing rules require companies to implement specific corporate

governance practices and also to disclose their compliance in their annual reports. The

effect of incorporating certain practices from the King Code in the listings rules is to

make their implementation mandatory, this notwithstanding that application of the

corporate-governance practices in the King Code is generally voluntary.184

It was discussed that both the UK and Australia follow the shareholders primacy model

whereas the US follows a director primacy model.185 It was further discussed that in both

the US and UK the majority of companies follow a dispersed ownership structure, whilst

in Australia the majority of companies follow a blockholder system.186 In South Africa,

due to historical factors, such as exchange control, the flow of capital internationally was

limited and this resulted in concentrated shareholding.187 Due to the lack of dispersed

shareholding, South Africa, similar to Australia, follows a blockholder system.188 South

Africa therefore also faces the agency cost problem regarding the conflict between

182 Slabbert (2015) 34 Communicare: Journal of Communication Sciences in South Africa 7. 183 Cassim et al Contemporary Company Law 473. 184 See the Johannesburg Stock Exchange listing rules para 3.84 available at https://www.jse.co.za (accessed:

10/04/2019). 185 Ch 2 para 2.4.3.3, Ch 3 para 3.5 and Ch 4 para 4.4. In the US, the obligation of the board is to maximize the

profit of the corporation for the benefit of the shareholders, which is known as the directors’ primacy model. 186 Ch 2 para 2.4.3.3, Ch 3 para 3.5 and Ch 4 para 4.4. 187 Esser & Delport (2016) 79 THRHR 7. 188 Ch 4 para 4.4.

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majority- and minority shareholders. Section 163 of the Companies Act, 2008, however,

does provide relief for prejudiced minority shareholders.189 Section 163 provides that:

(1) A shareholder or a director of a company may apply to a court for relief if –

(a) any act or omission of the company, or a related person, has had a result that is

oppressive or unfairly prejudicial to, or that unfairly disregards the interests of, the

applicant;

(b) the business of the company, or a related person, is being or has been carried

on or conducted in a manner that is oppressive or unfairly prejudicial to, or that

unfairly disregards the interests of, the applicant; or

(c) the powers of a director or prescribed officer of the company, or a person related

to the company, are being or have been exercised in a manner that is oppressive or

unfairly prejudicial to, or that unfairly disregards the interests of, the applicant.190

Another agency cost problem is the conflict between shareholders and the board of

directors. As discussed in the Australian chapter, blockholders can play an important

part in managing directors. Blockholders can govern through “exit” and “voice”.191

Blockholders, therefore, have more control over directors. In Australia shareholders

have control of the company.192 In South Africa the situation differs. Shareholders no

longer have an original decision making power.193 Section 66(1) of the Companies Act,

2008 provides that the business and affairs of the company must be managed by or under

the direction of its board of directors, which has the authority to exercise all of the powers

and perform all of the functions of the company, except to the extent that the Companies

Act, 2008, or the company’s Memorandum of Incorporation provides otherwise.194 The

power to manage the company therefore lies with the board and not the shareholders.195

This is of significance since shareholders will not have the right at common law to ratify

189 Section 163 of the Companies Act 71 of 2008 applies to both shareholders and directors. Interestingly s 163

does not state that it must be a minority shareholder who may apply, but rather that any shareholder may make

use of s 163. There is a similar provision in section 233 of the Australian Corporations Act, 2001. It, however,

applies only to shareholders and not directors. See Ch 4 para 4.4. 190 Section 163 of the Companies Act 71 of 2008. 191 Edmans & Holderness “The Role of Blockholders in Governance” https://voxeu.org/article/role-blockholders-

governance (accessed: 06/02/2020). 192 Ch 4 para 4.4. 193 Previously the Companies Act 61 of 1978 stated that directors acted as functionaries (organs or agents) of

the company. 194 Section 66(1) of the Companies Act 71 of 2008. 195 Esser & Delport (2016) 79 THRHR 9; Delport et al Henochsberg 250.

236

any actions of the board, unlike their UK counterparts, beyond their authority, except to

the extent that it is permitted by the Companies Act, 2008, or the Memorandum of

Incorporation explicitly provides otherwise.196 Section 66(1) may be problematic for

companies with dispersed shareholding as the board of directors will have ultimate

control and other rights and remedies provided for in the Companies Act, 2008, will not

necessarily apply to them.197 It was argued that given the blockholders’ control over

directors and the rights bestowed on Australian shareholders, there may not be a need

for protection from a business judgment rule.198 Although South Africa also follows the

blockholder system, the ultimate control of the company vests in the board.

5.4.2 Directors’ duty of care, skill, and diligence

5.4.2.1 Common-law duty of care and skill

Directors were required not only to exercise their powers in good faith and for the benefit

of the company, but were also required to act with the required degree of care and skill.199

The South African principles of directors’ common-law duty of care originated from

English case law.200 English law did not originally make the duty of care particularly

onerous for directors and they were initially held liable for a breach of the duty of care

only if their actions were grossly negligent.201 The South African common-law position

196 See discussion in ch 3 para 3.5 on the right of shareholders to ratify actions of the board of directors. 197 Some of these remedies and rights included in the Companies Act 71 of 2008 are: s 20 (right of shareholders

to claim for damages against directors); s 162 (declaration as delinquent director); s 163 (oppression of directors

or shareholders) etc. See Esser & Delport (2016) 79 THRHR 20-22. 198 Ch 4 para 4.4. 199 Bouwman (2009) 21 SA Merc LJ 510; Carciumaru “An assessment of the impact of corporate governance

codes and legislation on directors and officers liability insurance in South Africa” 64 available at

http://insurancegeteway.co.za (accessed: 15/09/2018); and Cilliers et al Corporate Law 141. 200 See discussion of the duty of care, skill and diligence in the UK in Ch 3 para 3.2.3. See, for example, Lagunas

Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392 (CA); Overend & Gurney Co v Gibb [1872] LR 5 HL 480 (HL);

Re Cardiff Saving Banks [1892] 2 Ch 100; Re National Bank of Wales Ltd [1899] 2 Ch 629 (CA); Sheffield and

South Yorkshire Permanent Building Society v Aizlewood [1889] 44 ChD 412; and Turquand v Marshall [1869]

LR Ch 4 App 376. 201 This is illustrated in cases such as Overend & Gurney Co v Gibb LR 5 HL 480 (HL) 1872; Re Cardiff Saving

Banks 2 Ch 100 (ChD) 1892; Re National Bank of Wales Ltd 2 Ch 626 1899; Turquand v Marshall LR 4 App

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can be illustrated with reference to Fisheries Development Corporation of SA Ltd v

Jorgensen & Another; Fisheries Development Corporation of SA Ltd v AWJ Investments

(Pty) Ltd & Others,202 which was influenced by the English cases of In re Brazilian

Rubber Plantation and Estates Ltd203 and In re City Equitable Fire Insurance Co Ltd.204

The following principles were summarised by Judge Margo:

(a) The extent of a director’s duty of care and skill depends to a considerable

degree on the nature of the company’s business and on any particular

obligations assumed by or assigned to him. There is a difference between

the full-time or executive director, who participates in the day to day

management of the company’s affairs and the non-executive director

who has not undertaken any special obligation. The latter is not bound

to give continuous attention to the affairs of the company. His duties are

of an intermittent nature, to be performed at periodical board meetings

and at any other meetings which may require his attention. He is not,

however, bound to attend all such meetings, though he ought to

whenever he is reasonably able to do so.205

(b) A director is not required to have special business acumen or expertise,

or singular ability or intelligence or even experience in the business of

the company. He is, however, expected to exercise the care which can

reasonably be expected of a person with his knowledge and experience.

A director is not liable for mere errors of judgment.206

(c) In respect of all duties that may properly be left to some other official, a

director is, in the absence of specific grounds for suspicion, justified in

trusting that official to perform such duties honestly. He is entitled to

accept and rely on the judgment, information and advice of the

management, unless there are proper reasons for questioning such.207

Obviously, a director exercising reasonable care would not accept

information and advice blindly. He would accept it, and he would be

entitled to rely on it, but he would give it due consideration and exercise

his own judgment accordingly.208

376 (ChD) 1869. All these cases confirmed that in the absence of gross negligence a mere error of judgment was

not sufficient to find a director liable. 202 Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries Development Corporation of

SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W) 156. 203 In re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 425. For further discussion see Ch 3 para 3.2.3. 204 In re City Equitable Fire Insurance Co Ltd [1925] 1 Ch 407. For a further discussion see Ch 3 para 3.2.3. 205 In re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 429. 206 In re Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch 425 437; In re City Equitable Fire Insurance

Co Ltd [1925] 1 Ch 407 at 437. 207 In re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 429-430. 208 Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries Development Corporation of

SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W) 156. Cassim Practitioner’s Guide 90;

Carciumaru “An assessment of the impact of corporate governance codes and legislation on directors and officers

liability insurance in South Africa” 67 available at http://insurancegeteway.co.za (accessed: 15/09/2018); Cilliers

et al Corporate Law 141; Du Plessis 2010 Acta Juridica 246-247.

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The first principle distinguishes between an executive and non-executive director. A less

stringent obligation is placed on a non-executive director continuously to give attention

to the affairs of the company.209 Secondly, there is no expectation that directors should

have any special business acumen or expertise in the business of the company.210 Finally,

directors may rely on information and advice supplied by management, but must still give

it due consideration and should not blindly accept the information and advice.211

The court consequently formulated a subjective test focusing on directors’ intelligence

and experience.212 The result was that a very lenient standard of care was required of

directors.213 Howard v Herrigel & Another,214 however, heralded a more stringent

approach. In this case Goldstone J held that contrary to Fisheries215 there should be no

distinction between the duties to the company expected of executive and non-executive

directors.216 Goldstone J further held that the general rule was that once a person accepts

the position as a director of a company, he or she becomes a fiduciary in relation to the

company and the application of the rule depends on the facts of each case.217 Thus, it may

be argued that the approach to compliance by directors with their duty of care under South

209 Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries Development Corporation of

SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W) 165F-166D, 156; Carciumaru “An assessment

of the impact of corporate governance codes and legislation on directors and officers liability insurance in South

Africa” 67. See also Louw and Others v Long 1990 (3) SA 45 E 56D which stated that there can be no negligence

if there is no duty of care. 210 Re Brazilian Rubber Plantations & Estates Ltd [1911] 1 Ch 425 437 which states that: “He [ie, the director]

is, I think, not bound to bring any special qualifications to his office. He may undertake the management of a

rubber company in complete ignorance of everything connected with rubber, without incurring any responsibility

for the mistakes that may have been caused by his ignorance.” 211 Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries Development Corporation of

SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W) 156; Bekink (2008) 20 SA Merc LJ 100. 212 Bouwman (2009) 21 SA Merc LJ 511; Carciumaru “An assessment of the impact of corporate governance

codes and legislation on directors and officers liability insurance in South Africa” 67. 213 Bouwman (2009) 21 SA Merc LJ 511; Cassim et al Contemporary Company Law 505. 214 Howard v Herrigel & Another NNO 1991 (2) SA 660 (A). 215 Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries Development Corporation of

SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W). 216 Howard v Herrigel & Another NNO 1991 (2) SA 660 (A) 678A. 217 Howard v Herrigel & Another NNO 1991 (2) SA 660 (A) 672E; Carciumaru “An assessment of the impact of

corporate governance codes and legislation on directors and officers liability insurance in South Africa” 68-69

available at http://insurancegeteway.co.za (accessed: 15/09/2018); Bekink (2008) 20 SA Merc LJ 100.

239

African common law, had overtime, become stringent as was also the case in the UK and

Australia.218

In Philotex (Pty) Ltd & Others v Snyman & Others219 the court agreed with the decision

in Howard v Herrigel & Another.220 The court in Philotex held that the test for

recklessness was an objective one as directors’ conduct must be measured against that of

a reasonable person.221 The court confirmed the view held in S v Van As,222 where the

Supreme Court ruled:

The test for recklessness is objective insofar as the defendant’s actions are

measured against the standard of conduct of the notional reasonable person and it

is subjective insofar as one has to postulate that notional being as belonging to the

same group or class as the defendant, moving in the same spheres and having the

same knowledge or means to knowledge.223

The court further held that although the standard by which a director’s conduct is

measured was an objective one, the subjective considerations referred to also require that

courts should have regard to any additional knowledge, experience, or qualifications of

the directors.224

218 See para 5.4.1; Ch 3 para 3.2.3 and Ch 4 para 4.3. 219 Philotex (Pty) Ltd & Others v Snyman & Others 1998 (2) SA 138 (SCA). 220 Howard v Herrigel & Another NNO 1991 (2) SA 660 (A). 221 Philotex (Pty) Ltd & Others v Snyman & Others 1998 (2) SA 138 (SCA) 25. 222 S v Van As 1976 (2) SA 921. 223 S v Van As 1976 (2) SA 921 928C-928E. See also S v Van Zyl 1969 (1) SA 553 (A) 559D-559G arriving at the

conclusion that the ordinary meaning of “recklessly” includes gross negligence, with or without consciousness of

risk-taking; S v Dhlamini 1988 (2) SA 302 (A) 308D-308E which states that gross negligence was described as

including an attitude or state of mind characterised by “an entire failure to give consideration to the consequences

of one's actions, in other words, an attitude of reckless disregard of such consequences”. 224 Philotex (Pty) Ltd & Others v Snyman & Others 1998 (2) SA 138 (SCA) 9.

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In Du Plessis NO v Phelps,225 the court concurred with the decisions in Howard226 and

Philotex227 that the test for negligence is both objective and subjective.228 Directors would

have acted negligently and have breached their duty of care had they failed to do

something which a reasonable person would have done under the same circumstances, or

if they did something that a reasonable person would not have done under the same

circumstances.229 The court held that although the standard by which a director’s conduct

is measured, is an objective one, the subjective considerations referred to require that

regard also be had to any additional knowledge, experience, or qualifications the director

has.230

Directors who fail to observe their duty of care may be held liable in delict to the company

for any loss suffered as a result of such failure.231 In order for directors to incur liability,

the general elements of the law of delict will have to be met.232 These elements are now

briefly considered.233

The first element is that of conduct, which may be an omission or a positive act.234 The

second element is wrongfulness, which entails that an act is unlawful if it is performed in

225 Du Plessis NO v Phelps 1995 (4) SA 164. 226 Howard v Herrigel & Another NNO 1991 (2) SA 660 (A). 227 Philotex (Pty) Ltd & Others v Snyman & Others 1998 (2) SA 138 (SCA). 228 Du Plessis NO v Phelps 1995 (4) SA 164 170 where the court held that “[a]part from their statutory duties,

directors owe fiduciary duties to the company as well as a common law duty to take reasonable care in the

management of the company’s affairs. Liability in the event of a director failing to take reasonable care in the

management of the company affairs is based on the principles of the Lex Aquilia. The basic requisite for liability

under the Lex Aquilia is fault, ie dolus or culpa, which results in loss to the plaintiff.” 229 Bekink (2008) 20 SA Merc LJ 101-102. 230 Ibid at 102; Havenga (1996) 8 SA Merc LJ 366; Moyo South African Principles of Corporate Governance 33;

Philotex (Pty) Ltd & Others v Snyman & Others 1998 (2) SA 138 (SCA) 9. 231 Re Brazilian Rubber Plantations & Estates Ltd [1911] 1 Ch 425. See also In re City Equitable Fire Insurance

Co Ltd [1925] 1 Ch 407 and Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries

Development Corporation of SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W). 232 Perlman v Zoutendyk 1934 CPD 151. See further Neethling, Potgieter & Visser Deliktereg 28; Kennedy-Good

& Coetzee (Part 2) (2006) 27 Obiter 281. 233 For a detailed discussion see Neethling, Potgieter & Visser Deliktereg. 234 Brand (2014) 25 Stellenbosch Law Review 451; Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 281.

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breach of a legal duty and results in the infringement of another individual’s interests.235

The principle to be applied is one of objective reasonableness and the court will thus

inquire into whether or not the defendant’s conduct is socially acceptable.236 These legal

convictions of the community are influenced by ethical, moral, and religious convictions.

The question is whether society condemns the particular conduct as unreasonable and

improper.237 In Loureiro and Others v Imvula Quality Protection (Pty) Ltd238 the court

ruled that the wrongfulness enquiry focuses on the harm-causing conduct and goes to

whether the policy and legal convictions of the community, constitutionally understood,

regard it as acceptable.239 Havenga argues that the test for wrongfulness is, therefore,

open-ended and it may be difficult to establish this requirement.240

There are various criteria used to establish wrongfulness, one of which is the breach of a

legal duty – for example, instances of liability resulting from an omission or causing pure

economic loss.241 In Minister of Forestry v Quathlamba (Pty) Ltd,242 the defendant made

no attempt to extinguish a fire on his property, which subsequently spread and damaged

the plaintiff’s property. The court held that the defendant had been aware that a fire had

broken out on his property and should have foreseen, or ought reasonably to have

foreseen, the likelihood that if not controlled or extinguished it might spread and cause

damage to another’s property. He had therefore acted wrongfully. The defendant should

have taken reasonable steps to control or extinguish the fire.243

235 Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 281. 236 Ibid. 237 Havenga (1996) 8 SA Merc LJ 373; Havenga Fiduciary Duties of Company Directors 321-324. 238 Loureiro and Others v Imvula Quality Protection (Pty) Ltd 2014 (3) SA 394 (CC). 239 Loureiro and Others v Imvula Quality Protection (Pty) Ltd 2014 (3) SA 394 (CC) para 55; Country Cloud

Trading CC v MEC, Department of Infrastructure Development 2015 (1) SA 1 (CC). See further Neethling 2015

Journal of South African Law 188-197 for a detailed discussion on the Country Cloud Trading case. 240 Havenga (1996) 8 SA Merc LJ 373. 241 Ibid. 242 Minister of Forestry v Quathlamba (Pty) Ltd 1973 (3) SA 69 (A). 243 Minister of Forestry v Quathlamba (Pty) Ltd 1973 (3) SA 69 (A) 81G-82A.

242

The third element of delict is that of fault, which can take two forms: intention or

negligence. There are two main components of intention: direction of the will; and the

consciousness of wrongfulness.244 Not all wrongful acts are intentional.245 The test used

by our courts to establish negligence has been authoritatively stated in Kruger v

Coetzee246 as that negligence is established if a reasonable person in the position of the

defendant would foresee the reasonable possibility of his or her conduct injuring another

and would take reasonable steps to guard against such occurrence, and the defendant

failed to take such steps.247 In the instance of directors, the test may be adapted. Directors

may be viewed as experts; therefore, the court may have regard to the general skill

exercised by the particular profession to which the directors belong and so demand a

higher standard of care. Even though the standard is higher, it could still be argued that

the director’s liability may be limited.248

The fourth element of delict is that of damage. The purpose of a claim for damages is to

compensate the plaintiff victim in money terms for the loss suffered.249 A plaintiff must

allege and prove the quantum of damages suffered because of the defendant’s wrongful

act.250 If it is not possible to establish how much of the damage sustained was caused by

each of a number of co-defendants, and it is clear that all the available evidence has been

244 Dantex Investment Holdings (Pty) Ltd v Brenner & Others NNO 1989 (1) SA 390 (A) 396E – 396G. There are

three forms of intent: dolus directus (direct intent) – see Bytes Technology Group South Africa (Pty) Ltd v Michael

2014 JDR 2491 (GP) 90; dolus indirectus (indirect intent) – see Majolica Pottery (Venda) (Pty) Ltd v Barrow &

Coetzee and Others 1999 (1) SA 1166 (C) 1178; and dolus eventualus (when the possibility of a particular

consequence or circumstance is foreseen but there is a reckless disregard as to whether it ensues or not) – see S v

Humphreys 2015 (1) SA 491 (SCA) and Neethling & Potgieter Law of Delict 748-847. 245 Country Cloud Trading CC v MEC, Department of Infrastructure Development 2015 (1) SA 1 (CC) para 42. 246 Kruger v Coetzee 1966 2 (SA) 428 (A) 430E. 247 Ibid. See also Premier, Western Cape v Faircape Property Developers (Pty) Ltd 2003 (6) SA 13 (SCA) paras

41-42 stating that the test rests on two bases: reasonable foreseeability, and the reasonable preventability of

damage. See further Jacobs and Another v Transnet Ltd t/a Metrorail and Another 2015 (1) SA 139 (SCA) para

6. 248 Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 283. 249 Delport et al Henochsberg 144. 250 Ibid.

243

led on the point, it is the court’s duty to do the best it can. This may lead to a finding that

each defendant is liable to pay a proportion of the loss suffered.251 A plaintiff claiming

prospective loss (damage or loss which has not yet materialised) need not prove on a

preponderance of probability that such a loss will occur or arise; instead, a contingency

allowance for the possibility of the loss is made.252 In general, a plaintiff must claim in

one action all damages flowing from one cause of action, whether already sustained or

prospective (also known as the “once and for all rule”).253

5.4.2.2 The duty of care, skill and diligence before the Companies Act, 2008

5.4.2.2.1The Companies Act 61 of 1973

The 1973 Companies Act did not codify the duty to act with the necessary degree of skill

and care and this was therefore measured against the common law254 and the company’s

Memorandum and Articles of Association.255 The 1973 Companies Act did, however,

include some statutory provisions placing certain restraints on and setting requirements

for directors.256 For example, sections 423 to 426 of the 1973 Act provided for the

personal liability of directors and others for reckless and fraudulent conduct of company

business.257 Sections 234 to 241 of the 1973 Companies Act dealt with directors’

251 Delport et al Henochsberg 144. 252 Ibid. 253 Ibid. See also Evins v Shield Insurance Co Ltd 1980 (2) SA 814 (A) 835. 254 See para 5.4.2.1. 255 “The Memorandum of Association determined the external range of the company’s objects and powers, while

the Articles of Association were internal rules by which a company was governed. The Memorandum and Articles

of Association were replaced by the Memorandum of Incorporation in the 2008 Act. The Memorandum of

Incorporation is the founding document of the company and sets out the rights, duties, and responsibilities of the

shareholders, directors, and others within and in relation to the company:” Cassim et al Contemporary Company

Law 117. 256 These provisions included, for example, ss 221-227 (restrictions on the issuing of share capital by directors)

and ss 234-246 (interests of directors and officers regarding contracts) of the 1973 Act. Esser & Delport (2011)

74 THRHR 346. 257 See Companies Act 61 of 1973, ss 423-426. These provisions still apply in respect of insolvency in terms of

transitional arrangements of Companies Act 71 of 2008. See schedule 5 of the Companies Act 71 of 2008.

244

obligation to declare all direct or indirect material interests they had in any contract

already concluded by the company.258

In addition to the above, section 248 of the 1973 Companies Act259 provided that directors

may be excused from liability if they took reasonable and diligent steps to become

informed about the matter, had no financial interest in the matter or had properly

disclosed such interest, and made a business decision rationally in the belief that it was

in the best interests of the company.260 Section 248 clearly resembled the business

judgment rule,261 but special circumstances had to exist before directors were granted the

relief envisaged by the section.262 In Ex parte Lebowa Development Corporation Ltd,263

it was held that section 248 did not apply in circumstances in which a third party lodged

a claim against directors for damages he had suffered as a result of the directors’

negligence.264 Therefore, the only relief that the section permitted was relief from liability

to the company in question and from criminal liability. Given the fact that section 248

258 These provisions are similar to s 75 of the Companies Act 71 of 2008. See para 5.4.2.2. 259 The origin of this provision is to be found in a recommendation of the UK Company Law Amendment

Committee (“Reid Committee Report”) 1906. In para 24 the Committee warned that “the provisions of the

Companies Act should not be used as engines of oppression for honest and prudent men.” See AWA Ltd v Daniels

(1992) 7 ACSR 759 855 SC (NSW) and Blackman et al Commentary on the Companies Act Ch 8 363; Fourie

(1991) 339 Stellenbosch Law Review 339; Edmunds & Lowry (2003) 66 Modern Law Review 195 where, in

reviewing the position in the UK, the authors argue that the underlying rationale for this type of provision would

be better met if the test for relief were to be based solely on the court’s determination of fairness. 260 Section 248(1) of the Companies Act 61 of 1973. Jooste The Old and the New Companies Act 383. 261 See para 5.5 below for a more detailed discussion of the business judgment rule. 262 Section 248 of the 1973 Act was amended by cl 93 (4) and (5) of the Companies Bill, 2007, and later replaced

by s 77(9) of the Companies Act 71 of 2008. Section 77(9) is in several respects similar to s 248, but there are

some differences, eg, s 77(9) makes no provision for auditors and is not confined to legal proceedings against

directors for negligence, default, breach of duty, and breach of trust. Cassim et al Contemporary Company Law

579. Furthermore, s 22 of the Companies Act 71 of 2008 should also be considered as it must be read with s 77.

Section 22(1) states that a company must not carry on its business recklessly, with gross negligence, with intent

to defraud any person, or for any fraudulent purpose. See also Ch 3 para 3.5 above for a discussion of s 1157 of

the UK Companies Act, 2006, which is similar to s 77(9). In PNC Telecom plc v Thomas [2008] 2 BCLC 95

(ChD) 94 the court ruled that a director may act reasonably even though he or she was negligent. It is therefore

argued that the same will apply to s 77(9). 263Ex parte Lebowa Development Corporation Ltd 1989 (3) SA 71 (T). 264 Ex parte Lebowa Development Corporation Ltd 1989 (3) SA 71 (T) 103G-103I. Pressma Services (Pty) Ltd v

Schuttler and Another 1990 (2) SA 411 (C).

245

could not be invoked against a claim instituted by a third party, its application was

severely limited.265

Section 424 of the 1973 Act266 also imposed personal liability on directors if it appeared

that the business of the company was conducted recklessly or with the intention of

defrauding creditors of the company. The court could have declared that any person who

was knowingly a party to conducting the business in this way could be held personally

liable without any limitation for all debts and/or liabilities of the company.267 An

important distinction between section 424 and the common-law remedy was that the

common law required a causal connection between the wrongful conduct and the

damages claimed, whereas under section 424 an individual may be held liable without

proof of a causal connection.268 In order to have obtained an order in terms of section

265 Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 284. 266 The origins of s 424 can be traced back to a recommendation of the Greene Committee (Report of Company

Law Amendment Committee Cmd 2657 (1925–26)) in the United Kingdom. The recommendations made by the

Greene Committee resulted in the introduction of s 275 in the English 1929 Companies Act. That section provided

that “if in the course of the winding up of a company it appeared that any business of the company had been

carried on with the intention to defraud creditors of the company, or creditors of any other person, or for any

fraudulent purpose, the court, on the application of the official receiver or the liquidator or any creditor or

contributory of the company, might, if it thought proper to do so, declare any of the directors, whether past or

present, who were knowingly parties to the carrying on of the business in the manner aforesaid, personally

responsible without limitation of liability, for all or any of the debts or other liabilities of the company as the court

might direct. It also contained provisions empowering the court to make the liability a charge, and it rendered

such persons criminally liable.” See Blackman et al Commentary on the Companies Act Ch 14 523. See also

Report of Company Law Amendment Committee Cmd 2657 (1925-26) para 61. 267 Schedule 5 to the Companies Act 71 of 2008 deals with the transitional arrangements between the Companies

Act 71 of 2008 and the 1973 Act. That is, those provisions of the 1973 Act which continue to apply despite the

repeal of the 1973 Act. Item 9 of Schedule 5 to the Companies Act 71 of 2008 provides that despite the repeal of

the 1973 Act, Ch 14 of the 1973 Act continues to apply with respect to the winding-up and liquidation of

companies under the Act. In light of item 9(1) of Schedule 5, it would appear that ss 423 and 424 of the 1973 Act

(which are part of Ch 14) will continue to be used by aggrieved creditors (whose claims arose either before or

after 1 May 2011) against directors of companies in circumstances where the companies have been wound up or

liquidated with resultant losses to creditors. Whether or not the reference to “winding-up and liquidation” in item

9 is limited to purely procedural aspects of this process, and thus not to related matters, is something that will

need to be considered by our courts. See Levenstein & Van Vuuren “Claims against directors in terms of the

Companies Act 71 of 2008” available at http://www.werksmans.com/legal-briefs-view/claims-against-directors-

in-terms-of-the-companies-act-2008/ (accessed: 27/08/2015). Cassim Practitioners Guide 99. 268 Howard v Herrigel and Another NNO 1991 (2) SA 660 (A) 672C-672E; Philotex (Pty) Ltd and Others v

Snyman and Others; Braitex (Pty) Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA) 142G-142I

which expressly laid down the general principle that s 424 does not require proof of a causal link between the

relevant conduct and the company’s inability to pay the debt. See also Fourie v Firstrand Bank Ltd and Another

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424, the applicant must have proven, on a balance of probabilities, that the person sought

to be held accountable had knowledge of the facts, from which a conclusion can be drawn

that the business was being carried on recklessly or with intent to defraud creditors of the

company.269

It was not necessary to prove that the individual had actual knowledge of the

consequences of those facts.270 In Howard271 the court held that:

At common law a director of a company who is knowingly a party to a fraud on

the part of his company would be liable in damages for any loss suffered by any

person in consequence of the fraud and that in order to fix the liability of such a

director it would be necessary to establish a causal connection between the fraud

of the company and the damages claimed from the director.272

In Philotex, the Supreme Court of Appeal found the directors concerned liable under

section 424.273 The court held that the test for “recklessness” was objective to the extent

that the defendant’s actions are measured against the standard of conduct of a reasonable

person, but was subjective to the extent that the knowledge of the defendant could be

attributed to the reasonable person.274 One may argue that although it was unnecessary

NO 2013 (1) SA 204 (SCA) 215G-215I; Tsung and Another v Industrial Development Corporation of South

Africa Ltd and Another 2013 (3) SA 468 (SCA). 269 Pressma Services (Pty) Ltd v Schuttler & Another 1990 (2) SA 411 (C). 270 Howard v Herrigel and Another NNO 1991 (2) SA 660 (A) 674. 271 Ibid. 272 Howard v Herrigel and Another NNO 1991 (2) SA 660 (A) 674 672. 273Braitex (Pty) Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA); Philotex (Pty) Ltd and Others v

Snyman and Others 1998 (2) SA 138 (SCA). 274 Philotex (Pty) Ltd and Others v Snyman and Others; Braitex (Pty) Ltd and Others v Snyman and Others 1998

(2) SA 138 (SCA) 144. See also Mafikeng Mail (Pty) Ltd v Centner 1995 (4) SA 607 (W); Kalinko v Nisbet &

Others 2002 (5) SA 766 (W) 774 where the court confirmed that a court should give s 424(1) a wide interpretation

to provide an effective remedy against the abuses contemplated by Parliament. See also Bellini v Paulsen 2012

JDR 2301 (WCC); Tsung and Another v Industrial Development Corporation of South Africa Ltd and Another

2013 (3) SA 468 (SCA) para 31, where the court held that it is clear, then, that if the plaintiff can show (and of

course he or she bears the burden of proof) on the probabilities that the defendants acted recklessly or fraudulently

in conducting the business of the company, and that the company was unable to pay its debts, the defendants

would be liable under s 424. See further Delport et al Henochsberg 916(1)-916(2) who opines that the carrying

on of the business of a company recklessly means “carrying it on by conduct which evinces a lack of any genuine

concern for its prosperity”. See also Blackman et al Commentary on the Companies Act Ch 14 para 535; Havenga

“Knowledge of directors and agents imputed to principal corporations” 116 available at

http://journals.co.za/docserver/fulltext/ju_jbl/12/2/ju_jbl_v12_n2_a10.pdf?expires=1514897838&id=id&accna

me=guest&checksum=5A2B755AB0EAE8A748EBC72165314897 (accessed: 13/07/2018).

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to prove a causal link between the relevant conduct and the debts or liabilities for which

there was a declaration of personal liability in terms of section 424, the absence of such

a proven link must have been taken into consideration by the court in the exercise of its

discretion and in order to decide whether such a declaration was, in all the circumstances,

just and equitable.275

It could consequently have been argued that although directors’ duties were not codified

in the Companies Act, 1973, in concurrence with the common law,276 provision was made

for directors to desist from conducting the affairs of companies recklessly and with intent

to defraud. In the event that this was found to be the case, again provisions provided for

personal liability to be incurred by company directors.

5.4.2.2.2 The King Reports

a) King I

The King Report on Corporate Governance for South Africa 1994277 was released in

November 1994 under the auspices of the Institute of Directors in South Africa, with the

assistance of the Johannesburg Stock Exchange278 and the South African Chamber of

Business.279 It dealt with a number of fundamental concepts of corporate governance, and

275 In Saincic and Others v Industro-Clean (Pty) Ltd and Another 2009 (1) SA 538 (SCA) para 20, Harms JA

“took the example of company A that incurs liability towards creditor B for debt C while the business of A was

conducted in a fraudulent manner. The fraud did not affect the solvency of the company and debt C was paid.

Thereafter, A incurs debt D at a time when the business was properly conducted but owing to other circumstances

A cannot pay this amount to B. In these circumstances, there can be little doubt that B would not be entitled to

rely on s 424(1).” This example illustrates that the provision could not have intended that causation plays no role

– at least not as far as creditors are concerned. 276 King I and all other relevant statutes (eg, the Security Services Act 36 of 2004; the Promotion of Access to

Information Act 54 of 2002; and the Basic Conditions of Employment Act 7 of 2018 (“the BCEA Act”)); and the

JSE Securities Exchange Rules for listed companies which jointly encapsulated the principles and provisions of

good corporate governance. See para 5.4.2.2.2 for a discussion of the King Reports. 277 King I. 278 Now the JSE Limited. See Esser & Delport (2011) 74 THRHR 449. See also Bekink (2008) 20 SA Merc LJ

107; and Cassim et al Contemporary Company Law 433. 279 Esser & Delport (2011) 74 THRHR 449; Naidoo Corporate Governance 11.

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culminated in a set of recommendations encapsulated in the Code of Corporate Practices

and Conduct (the “Code”).280 Companies affected by King I were required to state in their

financial statements whether or not they complied with the Code and to identify and

explain areas of non-compliance, although the adoption of King I was not mandatory for

a non-affected company.281 King I was similar to the Cadbury Report,282 but the King

Committee’s terms of reference were far wider than those of the Cadbury Committee,

having regard to circumstances unique to the South African business environment.283

Conforming to good corporate governance standards may result in constraints on

management, therefore the key challenge for the drafters of King I was to seek principles

signalling an appropriate balance between the freedom to manage, accountability, and the

interests of stakeholders.284 Consequently, directors had to ensure that they acted with the

necessary care and skill in performing their duties and responsibilities. In order to ensure

proper performance by directors, King I recommended a codification of the duty of care

as a possible solution. This set the stage for future legal and regulatory development.285

Furthermore, King I stated that a director should not be accountable for breaches of the

duty of care if his or her decision was an informed, rational one based on all the facts of

280 Hereafter the “Code”. The Code applied to companies listed on the JSE, large public entities as defined in the

Public Entities Act, banks, financial and insurance institutions, and large unlisted public corporations with equity

of over R50 million. See Naidoo Corporate Governance 11; See also Carciumaru “An assessment of the impact

of corporate governance codes and legislation on directors and officers liability insurance in South Africa” 116

available at http://insurancegeteway.co.za (accessed: 15/09/2018). 281 Naidoo Corporate Governance 11. 282 Cadbury Committee on Financial Aspects of Corporate Governance, Final Report and Code of Best Practice

1992. See Ch 3 para 3.3.1.1 for a discussion of the Cadbury Report. 283 King I included a Code of Ethical Practice for business enterprises in South Africa. Further, the undertaking

was complicated as the special circumstances in South Africa had to be considered, especially those of previously

disadvantaged communities. See Carciumaru “An assessment of the impact of corporate governance codes and

legislation on directors and officers liability insurance in South Africa” 116. 284 Bekink (2008) 20 SA Merc LJ 108. 285 King I paras 3.4 and 3.5. See also Bekink (2008) 20 SA Merc LJ 108.

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a particular case, and taken without self-interest – requirements closely related to those

of the business judgment rule.286

King I recommended that the Companies Act, 1973, be amended to provide for a statutory

limitation on directors’ duty of care.287 Reasons for the recommendation included: 1) the

“onerous” standard of the duty of care, especially in relation to non-executive directors;

2) the encouragement of commercial ventures and the appointment of persons of skill and

repute; and 3) the promotion of higher standards of corporate governance.288 It was,

however, argued that the reasons based on the onerous standard of the duty of care and

skill, and that directors were immersed in litigation were incorrect. It was further stated

that the common-law duty of care was in fact disappointingly low and that, contrary to

King I, the duty should be made more onerous.289 It was further argued that directors had

never been held accountable for mere errors in judgment,290 therefore the reason supplied

by King I that the business judgment rule recognises that business decisions frequently

entail risk and uncertainty, and thus encourage directors to engage in ventures which have

potential for greater profit but may entail some risk, was not justified.291 King I’s

contention that limiting directors’ duty of care could contribute to a higher standard of

corporate governance was also criticised by Jones, who contended that it was far more

286 King I para 5.4.2.2. King II also proposed an inclusive approach which recognises that stakeholders such as

the community in which the company operates, its customers, its employees and its suppliers need to be

considered when developing the strategy of a company. See para 5.4.2.2.2 (b). 287 King I para 3.5. 288 King I para 3.3. See also Jones “Directors’ duties: Negligence and the business judgment rule” 332 available

at https://repository.up.ac.za/handle/2263/3893 (accessed: 11/09/2018). 289 Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 288. Jones “Directors’ duties: Negligence and the business

judgment rule” 333; and Botha & Jooste (1997) 114 South African Law Journal 67 where it is noted that Niagra

Ltd (in liquidation) v Langerman & Others 1931 WLD 188 is the only reported case in South African law in

which a director has been held liable for breach of his duty of care. 290 See, eg, Levin v Feld and Tweeds Ltd 1951(2) SA 401 (A) 402C-D where it was held that it is not the duty of

the court to usurp the functions of the directors and to consider what is best for the companies from the business

point of view. See also Mafikeng Mail (Pty) Ltd v Centner (No 2) 1996 (4) SA 607 (WLD) 613G-H and Ben-

Tovim v Ben-Tovim and Others 2001 (3) SA 1074 (CPD). 291 Botha & Jooste (1997) 114 South African Law Journal 67 and Jones “Directors’ duties: Negligence and the

business judgment rule” 333 available at https://repository.up.ac.za/handle/2263/3893 (accessed: 11/09/2018).

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likely that it would contribute to a higher degree of corporate misconduct, and that the

existing law adequately protected directors who acted honestly and reasonably.292 King I

was reviewed in 2002 by the Institute of Directors in South Africa and this resulted in

King II.293

b) King II

King II sought to identify key areas of good corporate governance practice which would

be voluntarily and effectively applied by companies and directors.294 It also focused on

the central role of the board in ensuring good corporate governance, and identified seven

fundamental characteristics of good corporate governance. These were: discipline,295

transparency,296 independence,297 accountability,298 responsibility,299 fairness,300 and

social responsibility.301

King II also drew a distinction between the role of executive and non-executive

directors.302 While both types of directors are bound by the duty of care, the non-

executive director performs this duty occasionally and has less regular access to the books

292 Jones “Directors’ duties: Negligence and the business judgment rule” 333. 293 King II. 294 King II para 3 which states that there has always been the perception that voluntary adoption of governance

codes is preferable to legislated solutions. 295 King II para 18.1: “Corporate discipline is a commitment by a company’s senior management to adhere to

behaviour that is universally recognised and accepted to be correct and proper.” 296 King II para 18.2: “Transparency is the ease with which an outsider is able to make meaningful analysis of a

company’s actions, its economic fundamentals and the non-financial aspects pertinent to that business.” 297 King II para 18.3: “Independence is the extent to which mechanisms have been put in place to minimise or

avoid potential conflicts of interest that may exist, such as dominance by a strong chief executive or large

shareowner.” 298 King II para 18.4: “Accountability means individuals or groups in a company, who make decisions and take

actions on specific issues, need to be accountable for their decisions and actions.” 299 King II para 18.5: “With regard to management, responsibility pertains to behaviour that allows for corrective

action and for penalising mismanagement.” 300 King II para 18.6: “Fairness is the systems that exist within the company must be balanced in taking into

account all those that have an interest in the company and its future.” 301 King II para 18.7: “Social Responsibility is where a well-managed company will be aware of, and respond to,

social issues, placing a high priority on ethical standards.” 302 Bouwman (2009) 21 SA Merc LJ 518.

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and records of the company than executive directors.303 King II, however, stated that non-

executive directors “should be judicious in the number of directorships they accept, in

order to ensure that they do full justice to their onerous and demanding

responsibilities”.304 Compliance with King II was not compulsory, but it could have

resulted in secondary liability.305 In the case of Stilfontein Minister of Water Affairs and

Forestry v Stilfontein Gold Mining Co Ltd,306 Judge Hussain showed that secondary

liability is possible. In the case, the Judge referred to and used King II307 to determine

whether the directors had breached both their fiduciary duties and their duty of care. This

could have an influential effect especially in terms of the Companies Act, 2008, which is

discussed below.308

Before his decision, Hussain J noted the guidelines set out by King II for company

directors when performing their duty of care. It laid down certain requirements for the

acquisition of knowledge, expertise, and an understanding of the company affairs:

Directors must, in line with modern trends worldwide, not only exhibit the degree

of skill and care as may be reasonably expected from persons of their skill and

experience (which is the traditional legal formulation), but must also:

a) exercise both the care and skill any reasonable persons would be expected to

show in looking after their own affairs as well as having regard to their actual

knowledge and experience; and

b) qualify themselves on a continuous basis with a sufficient (at least a

general) understanding of the company’s business and the effect of the

303 Bouwman (2009) 21 SA Merc LJ 518. 304 Bouwman (2009) 21 SA Merc LJ s 1 Ch 4. 305 For example, JSE Limited sanctions may be imposed. See the JSE Listing Requirements paras 1.20–1.22. The

Listing Requirements are available at https://www.jse.co.za (accessed: 12/01/2016). 306 Stilfontein Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W). 307 King I para 18.7 cited in Stilfontein Minister of Water Affairs and Forestry ibid at 16.7. Judge Hussain stated:

“A well-managed company will be aware of, and respond to, social issues, placing a high priority on ethical

standards. A good corporate citizen is increasingly seen as one that is non-discriminatory, non-exploitative, and

responsible with regard to environmental and human rights issues. A company is likely to experience indirect

economic benefits, such as improved productivity and corporate reputation by taking those factors into

consideration.” 308 See discussion of King III below at para 5.4.2.2.2 (c) and the discussion of the Companies Act, 2008, in para

5.4.2.3. Esser & Delport (2011) 74 THRHR 452.

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economy so as to discharge their duties properly, including where

necessary relying on expert advice.309

Hussain J further noted that King II referred to the business judgment rule. He observed

that King II noted that in South Africa common law directors are liable to the company

for negligence in so far as they have a duty of care, but are not liable for mere errors in

judgment.310 It went on to explain that the business judgment rule means that

shareholders should not be entitled to damages by reason of judgement calls made by

directors, unless the directors have failed to exercise their business judgment on an

informed basis, with no conflict of interest, and on a basis of the decision being

rational.311 In respect of non-executive directors, it was particularly contended that the

appointment of directors is onerous in light of the present tests for a breach of the duty

of care.312 Taking this into consideration, King II recommended that the Standing

Advisory Committee on Company Law313 investigate whether there was a need for the

business judgment rule in South Africa.314

In Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd,315 the court

ruled that by not complying with King II, directors had not acted with the necessary care

and skill.316 It could therefore be argued that if the same principle applies to King IV, the

309 Esser & Delport (2011) 74 THRHR 452. 310 King III below at para Ch 9 para 3. See also Levin v Feld and Tweeds Ltd 1951 2 SA 401 (A) 414 cited by

King II where it was stated that it was not part of the business of a court to determine the wisdom of a course

adopted by a company in the management of its own affairs. 311 King I Ch 9 para 4. 312 King I para 3.3. 313 The Standard Advisory Committee was established by s 18 of the Companies Act, 1973, and consisted of a

judge, a retired judge, or a senior advocate of the Supreme Court (later the High Court) of South Africa as

chairperson. The Committee made recommendations regarding amendments to company law from time to time.

See http://thornton.co.za/resources/gg32832_nn1664i_pg168-187.pdf (accessed: 21/01/2014). 314 King I Ch 9. 315 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) available at

http://www.saflii.org/za/cases/ZAGPHC/2006/47.html (accessed: 30/01/2017). 316 Du Plessis et al Contemporary Corporate Governance 402; Esser & Delport (2011) 74 THRHR 454; Luiz &

Taljaard (2009) 21 SA Merc LJ 423-425.

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Report may be considered by courts to test whether directors have complied with their

duties. In this case the applicant was the Minister of Water Affairs and Forestry, who

issued directives317 against Stilfontein Gold Mining Co Ltd (“Stilfontein Gold”).318

The mining activities of Stilfontein Gold resulted in a situation where underground water

would, if not raised to the surface and treated appropriately, become polluted and in turn

pollute valuable water resources.319 The directives issued by the Minister of Water

Affairs and Forestry required the company to supply the Minister with certain

information and to make interim contributions to the costs of pumping and treating the

water.320 The company failed to comply with these directives and the Minister obtained

a court order after which the company’s directors resigned on mass.321 The two issues of

concern in the case were, firstly, whether directors had breached their duties to the

company by resigning simultaneously; and secondly, the issue of social responsibility

and to whom directors owe their duties.322

As regards the simultaneous resignation of the directors, Hussain J stated in his ruling

that he had been unable to find a case in South African corporate history in which all the

directors of a listed company had resigned simultaneously; nor could he find case law

which dealt with this situation.323 He further stated that the manner and timing of the

resignations should equally have been criticised.324 The court held that a listed company

can only function through its board of directors and that directors at all material times

317 Directives were issued in terms of s 19 of the National Water Act 36 of 1998. See Minister of Water Affairs

and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. 318 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. 2. 319 Ibid. 320 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. 3. 321 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. 6. 322 Esser & Delport (2011) 74 THRHR 451. 323 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) para 16.1. 324 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. para 16.4.

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were under a duty to act bona fide and in the interests of the company.325 The court ruled

that the directors had not acted in good faith and on reasonable grounds when they took

the decision to resign.326

The court based its judgment on the directors’ breach of their fiduciary duties by

resigning simultaneously, but also commented, when discussing the application of King

II, that the directors should adhere to the recommendations of King II and should be held

liable should they fail to do so.327 The judge stated that the directors had acted against

recommendations made in King II and that they had acted irresponsibly by simply

abandoning the company. He referred to the relevant recommendation in King II which

dealt with social responsibility, and quoted as follows from the Report:

A well-managed company will be aware of, and respond to, social issues, placing

a high priority on ethical standards. A good corporate citizen is increasingly seen

as one that is non-discriminatory, non-exploitative, and responsible with regard to

environmental and human rights issues. A company is likely to experience indirect

economic benefits, such as improved productivity and corporate reputation, by

taking those factors into consideration.328

According to Esser and Delport, it is therefore clear that Judge Hussain used King II to

determine whether or not the directors had breached their fiduciary duties, and the duty

of care owed to the company, and that this could have far-reaching consequences, as

discussed below.329

325 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. paras 16.5

and 16.6. 326 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W) 13.2. para 16.6. 327 Esser & Delport (2011) 74 THRHR 452. 328 King I para 18.7. 329 Esser & Delport (2011) 74 THRHR 452.

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c) King III

King III330 replaced King II in March 2010, in anticipation of the Companies Act, 2008,

coming into operation, and unlike its predecessors, applied to all entities regardless of

their nature, size, or form of incorporation or establishment.331 King III moved away from

the “comply and explain”332 approach, advocated in King I and King II, towards a

principle-based “apply or explain” approach. 333 The King III committee considered the

word “apply” more appropriate than “comply” because:

[t]he ‘comply or explain’ approach could denote a mindless response to the King Code

and its recommendations whereas the ‘apply or explain’ regime shows an appreciation

for the fact that it is often not a case of whether to comply or not, but rather to consider

how the principles and recommendations can be applied.334

The “apply or explain” principle, therefore, requires an explanation of how the principles

and recommendations have been applied, or if they have not, an explanation of the

reasons for not applying them.335 In applying a recommended practice a board may,

therefore, conclude that the practice will not be in the best interests of the company and

apply a different practice provided that it explains the practice adopted and its reasons

for doing so.336

330 King III. 331 See Visser “Ansie Ramalho appointed project leader on update of King reports” available at

http://www.bdlive.co.za/companies/2014/07/18/ansie-ramalho-appointed-project-leader-on-update-of-king-

reports (accessed: 13/01/2016), indicating that King III will be revised in order to assist smaller entities and to

keep up to date with new legislation and international developments. See also Visser “Revision of King III to help

smaller entities” available at http://www.bdlive.co.za/companies/2014/06/02/revision-of-king-iii-report-to-help-

smaller-entities (accessed: 13/01/2016). The Institute of Directors in South Africa Draft King IV Report on

Corporate Governance for South Africa 2016 (“Draft King IV”) para 6 follows the comply-and-explain approach. 332 The “comply-or-explain” principle requires companies to state their compliance with the principles and then

explain if there is non-compliance with any of the detailed provisions supporting the principle. See

https://www.businesstimes.com.sg/hub/boardroom-matters/comply-or-explain-20-what%E2%80%99s-the-

difference (accessed: 13/01/2016). 333 King II para 3. Bouwman (2009) 21 SA Merc LJ 520. 334 King II para 3. 335 Bouwman (2009) 21 SA Merc LJ 520 and Leach Avoiding the American Mistakes 49. 336 Moyo South African Principles of Corporate Governance 44.

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Reference was made in King III to the statement of the common-law duties in the

Companies Act, 2008, which confirmed that the standard of directors’ duties is defined

by reference to common-law principles.337 The guidelines in the King Reports could be

used as a test to determine whether a director acted with at least the necessary care and

skill, as explained below:

As far as the body of legislation that applies to a company is concerned, corporate

governance mainly involves the establishment of structures and processes, with

appropriate checks and balances that enable directors to discharge their legal

responsibilities and oversee compliance with legislation. In addition to compliance

with legislation, the criteria of good governance, governance codes and guidelines

will be relevant to determine what is regarded as an appropriate standard of

conduct for directors. The more established certain governance practices become,

the more likely a court would regard conduct that conforms with these practices

as meeting the required standard of care. Corporate governance practices, codes

and guidelines therefore lift the bar of what are regarded as appropriate standards

of conduct. Consequently, any failure to meet a recognised standard of

governance, albeit not legislated, may render a board or individual director liable

at law.338

There is thus always a link between good governance and compliance with the law.339

Good governance is not something that exists separately from the law and it is entirely

inappropriate to delink governance from the law.340

King III gave further guidance on the standard of care and skill by stating that in

exercising their duty of care, directors should attempt to resolve disputes expeditiously,

efficiently, and effectively, and to ensure that prudent and reasonable steps have been

taken in regard to information-technology governance.341 Directors are also required to

inform themselves adequately on the content of applicable laws, rules, codes, and

337 King II para 4. See also Bouwman (2009) 21 SA Merc LJ 520. 338 King II para 4; Esser & Delport (2011) 74 THRHR 452. 339 King II para 4. 340 Ibid. See also Muskwaka (2013) 3 International Journal of Humanities and Social Science 94. 341 Bouwman (2009) 21 SA Merc LJ 520. Information-technology governance is a formal framework that provides

a structure for organisations to ensure that Information-technology investments support business objectives. See

https://www.techopedia.com/definition/19641/information-technology-governance-it-governance (accessed 07/

17/2019). Esser & Delport (2018) 39 Company Lawyer 378-384.

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standards generally so that they are adequately able to discharge their fiduciary duties

and duty of care.342 King III made no mention of the inclusion of a statutory business

judgment rule.

d) King IV

King IV343 replaced King III in 2016 and does not deal with directors’ duties in any great

detail.344 It does, however, state that company governance includes that directors should

adhere to: 1) their duty to act with due care, skill, and diligence; and 2) their duty to act

in good faith in the best interests of the company.345 King IV, like its predecessors, is a

set of voluntary principles and good practices.346 King IV does, however, state that good

governance is not something that exists separately from the law and a court will consider

all relevant circumstances, including what is regarded as the accepted practice in a

particular situation.347 Should there be a conflict between the Report and legislation, the

legislation will prevail.348

In terms of the findings in Minister of Water Affairs and Forestry v Stilfontein Gold

Mining Co Ltd, it can be argued that adherence to King II was in fact mandatory for

directors, and that those who failed to do so could be held accountable for not acting

with the necessary care and skill.349 This case was, however, based on King II which

applied only to listed companies.350 Should the argument in Minister of Water Affairs

342 King II para 4; Bouwman (2009) 21 SA Merc LJ 520-521. 343 King IV. 344 This was because King IV anticipated the new Companies Act which contained very specific sections on these

duties. 345 King IV 4. 346 While King III called on companies to apply or explain, King IV para 6 assumes application of all principles,

and requires entities to explain how the principles are applied – thus, apply and explain. 347 King IV 29. 348 Ibid. 349 King IV 455. See para 5.4.2.2.2 (b). 350 King IV.

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and Forestry v Stilfontein Gold Mining Co Ltd be followed it could lead to a situation in

which directors can be held accountable under King IV which applies to all companies

and not listed companies only. What is important here, is that directors will have no

protection under the business judgment rule should they breach their duties under King

IV. This is discussed later in this chapter.351

5.4.2.2.3 The Department of Trade and Industry’s Guidelines for Corporate Law Reform

In 2004, the Department of Trade and Industry published a policy paper, South African

Company Law for the 21st Century: Guidelines for Corporate Law Reform (“Policy

Paper”).352 The Policy Paper promised an “overall review of company law” to develop

a legal framework based on the principles reflected in the Companies Act, 1973, the Close

Corporations Act,353 and the common law.354 The purpose of the review was to ensure

that South African company law was in line with a constitutional democracy.355 The

Policy Paper stated that while company law should be comprehensive, it should not

burden companies with unnecessary rules.356 It further recognised that there was a need

to codify both directors’ fiduciary duties and duty of care. It also stated that the benefits

of such a statutory standard of conduct would need to be evaluated against the constraints

it would place on the development of the common law.357

351 See para 5.5.2.2 (c). 352 Department of Trade and Industry Policy Paper available at https://www.gov.za/documents/other-documents

(accessed: 13/01/2016). 353 Close Corporation Act 69 of 1984. 354 Republic of South Africa, Department of Trade and Industry, Companies Bill, 2007, Explanatory

Memorandum 3-4. 355 Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 288. 356 Department of Trade and Industry Policy Paper 29. 357 Department of Trade and Industry Policy Paper 40.

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The Policy Paper further declared that because South Africa is not a litigious society, it

was unnecessary to indemnify directors against liability.358 By implication, it could

therefore be argued that the Policy Paper indicated that it was not necessary to include a

statutory business judgment rule in South African legislation.359

The Policy Paper was, however, somewhat contradictory. First, it stated that the law at

the time was lacking in that it did not provide effective means for the enforcement of

directors’ duties.360 On the other hand, it stated that because South Africans are not

unduly litigious it was unnecessary to indemnify directors against liability.361

Consequently, some found the credibility of the report questionable.362

5.4.2.3 The duty of care, skill, and diligence in the Companies Act, 2008

As a consequence of the company law review process as discussed above, the Companies

Bill was released for public comment in February 2007.363 When drafting the Companies

Bill, the legislature took into consideration certain of the proposals made by the relevant

King Committees364 and allowed for the partial codification of directors’ duties.365 This

included both fiduciary duties and a duty of care. On 30 May 2008, the amended

provisions for the proposed reform of the Companies Act were published in the

Companies Bill, 2007, and in May 2011 the Companies Act, 2008, came into effect.366

358 Department of Trade and Industry Policy Paper 40. 359 Von Dürkheim Does South Africa need a Statutory Business Judgment Rule? 33; Kennedy-Good & Coetzee

(Part 2) (2006) 27 Obiter 290. 360 Policy Paper 18. 361 Department of Trade and Industry Policy Paper 40. 362 Von Dürkheim Does South Africa need a Statutory Business Judgment Rule? at 33; Kennedy-Good & Coetzee

(Part 2) (2006) 27 Obiter 290. 363 See para 5.4.2.2. Esser (2007) 32 South African Yearbook of International Law 409. 364 See para 5.4.2.2.2. 365 Bekink (2008) 20 SA Merc LJ 10. 366 The Companies Act 71 of 2008 available at https://www.gov.za/documents/companies-act (accessed:

15/01/2016). The Companies Bill, 2007, available at http://www.companylaw.uct.ac.za/usr/companylaw/

downloads/legislation/Companies_Bill_2007.pdf (accessed: 27/01/2014). The director’s duties in the

http://www.companylaw.uct.ac.za/usr/companylaw/

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The Companies Act of 2008, like the Companies Bill, partially codified the common-

law duty of care in section 76.367 There are both advantages and disadvantages to a

complete codification versus a partial codification.368

The advantages of a full codification, include that it will improve clarity, simplicity, and

legal certainty, which would make the law more accessible to directors and other

stakeholders.369 Arguments against a complete codification include that the codification

of a mass of developed common law is impractical. Moreover, it would be a difficult

task because the common-law duty of care has been developed through case law over a

considerable period. The possibility therefore exists that the wealth of the common law

would be lost in the attempt to codify it.370

A partial codification, on the other hand, will not hinder the growth of the duty of care

in common law. The flexibility of the common law is not compromised, and if the

statutory duties are silent on a certain aspect, the common law can still be called into

service.371 Arguments against a partial codification include the risk that directors,

Companies Bill, 2007, were partially codified in cl 76, which included both the director’s fiduciary duties and a

duty of reasonable care. 367 See ss 75 and 76 of the Companies Act 71 of 2008. Bouwman (2009) 21 SA Merc LJ 513; Esser & Delport

(2011) 74 THRHR 453; Von Dürkheim Does South Africa need a Statutory Business Judgment Rule? 36 ; Du

Plessis 2010 Acta Juridica 263; Geach Paper for CIS Corporate Governance Conference 8; Grove “Company

directors: Fiduciary duties and the duty of care and skill” 15 available at https://repository

.up.ac.za/handle/2263/26667 (accessed: 05/09/2016); Leach Avoiding American Mistakes 11; Matsimela (2011)

1 Company Law Hub Journal of Student Research 5; Ncube “Transparency and accountability under the new

company law” 68 available at http://www.companylaw.uct.ac.za/clh/research/journal/cnube2 (accessed:

11/11/2016); and Stein & Westbrook “Directors and officers liability insurance” 6 available at

http://services.bowman.co.za/Brochures/DutiesAndLiabilities/DutiesAndLiabilitiesBrochure-lr.pdf (accessed:

15/01/2017). The UK opted to have a full codification of directors’ duties. See Ch 3 para 3.4. 368 Australia opted partially to codify the directors’ duty of care and skill, while the UK fully codified directors’

duties and replaced the common-law duties. The common-law duties are only used to assist in the interpretation

of directors’ duties. See Ch 3 para 3.4 and Ch 4 para 4.4. 369 Other examples include that directors’ duties need to be aligned with modern economies. This is because the

common law has been developed over many years and some of its rules are outdated and need to be aligned with

modern requirements. It is also important to have a statement that clearly sets out directors’ duties – directors will

then know what is expected of them. Maharaj Duty of Care, Skill and Diligence 36. 370 Ibid. 371 Maharaj Duty of Care, Skill and Diligence 38.

https://repository/

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shareholders, and other stakeholders may be uncertain as regards their positions, and that

problems surrounding clarity, simplicity, and accessibility will not be resolved.372

Despite these arguments for a complete codification and the arguments against a partial

codification, the legislature opted to codify directors’ duty of care only partially in

section 76(3)(c) of the Companies Act, 2008. The section reads:

A director of a company, when acting in that capacity, must exercise the powers

and perform the functions of director –

…

(c) with the degree of care, skill and diligence that may reasonably be expected of

a person –

(i) carrying out the same functions in relation to the company as those

carried out by that director; and

(ii) having the general knowledge, skill and experience of that director.

Examining the wording of this section, it is clear that the codification of the common-

law duty of care in the Companies Act, 2008, preserved both the subjective and objective

elements of the common law.373 This approach was also followed in the United

Kingdom.374 Australia, on the other hand, opted to follow an objective standard by which

a director’s obligation to act with care and diligence is evaluated without any subjective

element.375

In section 76(3)(c),376 the objective element is contained in the first leg of the test and

sets a minimum standard which all directors must meet.377 The subjective element,

contained in the second leg of the test, sets a standard for directors who are more skilled

372 Ibid. See also Esser & Coetzee (2004) 12 Juta’s Business Law 29. 373 See para 5.4.2.1 above for the discussion of the common-law duty of care and skill. This approach is also

followed in the UK. Section 174(2) in the Companies Act, 2006, codified the directors’ duty of care and provides

for both the subjective (s 174(2)(b)) and objective standard (s 174(2)(a)). See Ch 3 para 3.4. 374 See Ch 3 para 3.4. See also the UK Companies Act, 2006, s 174 and the Australian Corporations Act, 2001, s

180(1). See Ch 4 para 4.4. 375 See s 180(1) of the Corporations Act, 2001. See Ch 4 para 4.4. 376 Section 76(3)(c) of the Companies Act 71 of 2008. 377 Bouwman (2009) 21 SA Merc LJ 513; Kanamugire & Chimuka (2014) 5 Mediterranean Journal of Social

Sciences 73; and McLennan “Duties of care and skill of company directors and their liability for negligence”

101 available at http://heinonline.org/HOL/LandingPage?handle=hein.journals/safrmerlj8&div=13&id

=&page (accessed: 13/01/2017).

262

or experienced than expected in terms of the objective standard.378 Those directors then

must meet both the objective and the subjective requirements.379 This position resembles

the one established in section 174(2)(i) of the UK’s Companies Act, 2006. The first part

of the test in section 174 is objective and sets a minimum standard of care expected of

all directors by the reference to their function in the particular company.380 The second

part of section 174(2)(ii) is subjective and, as in section 76(3)(c) of the South African

Companies Act, 2008, raises the standard for review.381

Although the standard for review corresponds to the common-law duty of care, it goes

beyond the common law, not only in respect of the content of the duties, but also as

regards the level of compliance.382 The more skilled, knowledgeable, and experienced

directors are, the higher the level of skill they need to exercise.383 This higher standard

placed on directors could be one of the reasons why the legislature included a statutory

business judgment rule in the Companies Act, 2008.384 It is, however, interesting to note

that the UK also has raised the standard expected of directors in section 174 of the

Companies Act, 2006, but it still opted not to include a statutory business judgment

rule.385

378 Section 76(3)(c)(i) of the Companies Act 71 of 2008. Bouwman (2009) 21 SA Merc LJ 514; Kanamugire &

Chimuka (2014) 5 Mediterranean Journal of Social Sciences 73. 379 Bouwman (2009) 21 SA Merc LJ 514; Conradie (2008) 8 Without Prejudice 14; and Von Dürckheim Does

South Africa need a Statutory Business Judgment Rule? 37. 380 Section 174(2)(i) of the Companies Act, 2006. This means the care, skill, and diligence that would be exercised

by a reasonably diligent person, with the general knowledge, skill and experience that may reasonably be expected

of a person carrying out the functions of the director in relation to the company. See Ch 3 para 3.4. 381 Section 174(2)(ii) means the care, skill, and diligence that would be exercised by a reasonably diligent person,

with the general knowledge, skill, and experience that the director has. The objective standard is always the

minimum standard, therefore the subjective standard element cannot lower the standard. See Ch 3 para 3.4. 382 See the discussion of the common-law duty of care and skill in para 5.4.2.1. See further Esser & Delport (2011)

74 THRHR 453. 383 Cassim et al Contemporary Company Law 509. See also King The Corporate Citizen 30. 384 See para 5.5.1 below for arguments for and against the business judgment rule. 385 See Ch 3 para 3.5 for a discussion of why the UK opted not to include a statutory business judgment rule.

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A comparison between section 180(1) of the Australian Corporations Act, 2001, and

section 76(3) reveals some interesting aspects. First, the word “skill” has been retained

in section 76(3), while section 180(1) of the Australian Corporations Act excludes it.

Secondly, section 76(3) of the Companies Act, 2008, explicitly retains subjective

elements – “having the general knowledge, skill, and experience” of that director –

whereas Australia allows for an objective element only.386

It is important to note that section 76 does not exclude the common law, which means

that the common-law duties not expressly amended by the section will still apply.387 This

approach is also followed in Australia.388 Australia takes the view that the statutory

statement of directors’ duties applies together with the common-law and equity

principles.389 In contrast, the UK opted for a full codification of directors’ duties. The

statutory duties in the UK legislation are based on, but replace, the common-law rules

and equitable principles, but replace them.390 Courts may, however, refer to these duties

for purposes of interpretation.

386 See Ch 4 para 4.4. See further Du Plessis 2010 Acta Juridica 269-270. 387 See s 77(2) of the Companies Act 71 of 2008: “A director of a company may be held liable (a) in accordance

with the principles of the common law relating to breach of a fiduciary duty, for any loss, damages or costs

sustained by the company as a consequence of any breach by the director of a duty contemplated in ss 75, 76(2)

or 76(3)(a) or (b); or (b) in accordance with the principles of the common law relating to delict for any loss,

damages or costs sustained by the company as a consequence of any breach by the director of— (i) a duty

contemplated in s 76(3)(c); (ii) any provision of this Act not otherwise mentioned in this section; or (iii) any

provision of the company’s Memorandum of Incorporation.” See further Esser & Du Plessis (2007) 19 SA Merc

LJ 347; and Ncube “Transparency and accountability under the new company law” 68 available at

http://www.companylaw.uct.ac.za/clh/research/journal/cnube2 (accessed: 11/11/2016). 388 See Ch 4 para 4.4. See also s 170(3) of the Companies Act, 2006, read with the Explanatory Notes to the

Companies Act 57 para 305; Esser & Du Plessis (2007) 19 SA Merc LJ 347; Ncube “Transparency and

accountability under the new company law” 68. 389 See s 180(1) of the Australian Corportions Act, 2001. 390 See Ch 3 para 3.4. The US has not codified directors’ duty of care and same is still governed by common law.

See the discussion in Ch 2 para 2.3.

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Section 218(2) of the Companies Act, 2008, is significant in that it means that directors

will not only be liable to the company, but now may be held liable by any third party for

a contravention of any provision of the Companies Act, 2008. Section 218(2) provides:

Any person who contravenes any provision of this Act is liable to any other person

for any loss or damage suffered by that person as a result of that contravention.

It is not always clear what would constitute a “contravention”. In Rabinowitz v Van

Graan,391 the court accepted the proposition that conduct by directors which constitutes

an offence under the Companies Act, 2008, can lead to their incurring personal liability

under section 218(2).392 It was submitted on behalf of the plaintiff that a person who is

guilty of an offence in terms of the Companies Act, 2008, must therefore be found to

have “contravened” a “provision” of the Companies Act, 2008.393 If, therefore, for

example, a director is guilty of the offence created by section 214 of the Companies Act,

2008 (director knowingly defrauds a creditor or employee of the company) such director

must therefore be found to have contravened a provision of the Companies Act, 2008,

for purposes of section 218 (2).394 The court agreed with this proposition. It held that to

hold otherwise would result in a finding that a director can be guilty of an offence in

terms of the Companies Act, 2008 without having contravened any provision thereof.395

The court also accepted the argument that a third party can hold directors personally

liable in terms of the Companies Act, 2008.396 This effectively gives a statutory right of

391 Rabinowitz v Van Graan 2013 (5) SA 315 (GSJ). 392 Rabinowitz v Van Graan 2013 (5) SA 315 (GSJ) para 17. 393 Ibid. 394 Ibid. 395 Ibid. In Henochsberg it is argued that “contravene here would obviously mean any offence in terms of the Act,

but, it is submitted it would also include any non-compliance with the provisions of the Companies Act, 2008,

that may not be an offence (e.g. s 22 conduct).” Delport et al Henochsberg 642. 396 Delport et al Henochsberg 642.

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action to anyone to sue directors for loss occasioned by their breach of any of their

common-law and statutory duties.397

Chemfit Fine Chemicals (Pty) Ltd v Maake398 ruled that section 218(2) provides a

general remedy to any person, which could include the company, shareholders, creditors,

etc, to hold any provision that contravenes any provision of the Companies Act, 2008

liable for any loss or damage suffered as a result of the contravention.399 Chemfit Fine

Chemicals (Pty) Ltd v Maake was overturned by the court of appeal in Maake v Chemfit

Fine Chemicals (Pty) Ltd.400 The court ruled that section 218(2) does provide a general

remedy to any person who suffers a loss or damage due to the contravention of a

provision of the Companies Act, 2008.401 However, it does not specify which

contravention the person may sue for.402 A creditor for example may sue a director of a

company in his/her personal capacity for the loss or damage it has suffered as a result of

that director’s actions.403 Since the section does not specify which actions may be

regarded as a contravention of the Companies Act, 2008, it follows that a creditor who

sues must specify which contravention were attributed to the director and the exact losses

or damages with sufficient particulars. Sufficient facts should be pleaded to enable the

director to defend the case.404

397 Roodt “The new Companies Act explicitly requires a director to act with care, skill and diligence” available at

http://www.roodtinc.com/newsletter95.asp (accessed: 19/01/2016). 398 Chemfit Fine Chemicals (Pty) Ltd v Maake 2017 JDR 1473 (LP). 399 Chemfit Fine Chemicals (Pty) Ltd v Maake 2017 JDR 1473 (LP) para 30. 400 Maake v Chemfit Fine Chemicals (Pty) Ltd (5772/2016/HCAA04/2018) [2018]. 401 Maake v Chemfit Fine Chemicals (Pty) Ltd (5772/2016/HCAA04/2018) [2018] para 28. 402 Ibid. 403 Ibid. 404 Ibid.

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5.5 THE BUSINESS JUDGMENT RULE

As discussed earlier in this thesis, the business judgment rule was developed in the US

alongside a director’s duty of care.405 It was shown that in order for directors to receive

protection under the business judgment rule, a decision must have been made.406 It was

further established that directors who make a decision in good faith,407 with care, and on

an informed basis408 which they reasonably believe is in the interests of the company,409

will not incur liability as a result of that decision.410 In South African law there were some

arguments and recommendations in favour of a statutory business rule and some

arguments against. They are discussed below.

5.5.1 Arguments for and against the statutory business judgment rule

The rationales for a business judgment rule were discussed in Chapter 2 and are not

repeated in this chapter. The emphasis is rather placed on arguments raised by South

African commentators, the majority of whom agree that there was no need for South

African law to adopt the business judgment rule.411 On the other hand, it has been

submitted by others that the proposed introduction of the business judgment rule in South

African law was perfectly justifiable given the wider form of protection required for

directors in modern company legislation in light of the standard for review used to

405 See Ch 2 para 2.4. 406 Ibid. See also Aronson v Lewis 473 A2d 805, 813 (Del 1984). 407 See Ch 2 para 2.4.2. 408 Ibid. 409 Ibid. 410 See the full discussion in Ch 2 para 2.4. 411 See Ch 2 para 2.4.3.1 (encouraging directors to serve and take risks). See also para 2.4.3.2 (avoiding judicial

infringement on business decisions) and para 2.3.3.3 (preserving the board’s governance role). Botha & Jooste

(1997) 114 South African Law Journal 76; Bouwman (2009) 21 SA Merc LJ 4; Havenga (2004) 16 SA Merc LJ

78; Jones “Directors’ duties: Negligence and the business judgment rule” 336 available at

https://repository.up.ac.za/handle/2263/3893 (accessed: 11/09/2018); Loubser (2001) 22 Juta’s Business Law

135; and McLennan “Duties of care and skill of company directors and their liability for negligence” 100 available

at http://heinonline.org/HOL/LandingPage?handle=hein.journals/safrmerlj8&div=13&id=&page (accessed:

13/01/2017).

267

establish whether directors’ have complied with their duty of care having been raised

from the standard applied historically.412

King I and King II recommended that a business judgment rule be incorporated into

legislation on the basis of, among other things, the demanding nature of directors’ duties

in the South African context.413 These reasons were criticised by Jooste and Botha, who

argued that the degree of care and skill in South Africa was disappointingly low, contrary

to what King I and King II reported.414 Bouwman further argued that “directors are

seldom found to be in breach of their duty of care and skill, therefore mechanisms should

rather be introduced to enhance the enforcement of the degree of care and skill required,

rather than to introduce another defence against breach of the duty of care and skill”.415

This view was supported in the UK where the common-law principles governing this

duty in the English common law prior to the enactment of the UK Companies Act, 2006

are the foundation of the South African common law principles of the duty of care.416 It

was further argued that directors have never been held accountable for mere errors in

judgment.417 This means that the argument in King I that the business judgment rule

recognises that business decisions frequently entail risk and uncertainty, and so

encourages directors to engage in ventures which have potential for greater profit but may

entail some risk, does not hold water.418 King I’s contention that limiting a director’s duty

412 Du Plessis (Part 2) 2011 Company Lawyer 380. 413 See para 5.4.2.2.2. See also Loubser (2001) 22 Juta’s Business Law 135. 414 Botha & Jooste (1997) 114 South African Law Journal 76. According to Botha and Jooste there is only one

reported case, namely, Niagara Ltd (in liquidation) v Langerman & Others 1913 WLD 188 where a director was

held liable for breach of his or her duty of care. This view is supported by Kennedy-Good & Coetzee (Part 2)

(2006) 27 Obiter 288. 415 Bouwman (2009) 21 SA Merc LJ 529. 416 See Ch 3 para 3.3. 417 See, for example, Levin v Feld and Tweeds Ltd 1951(2) SA 401 (A) 402C-D where it was held that it is not

the duty of the court to usurp the functions of the directors and to consider what was best for the companies from

the business point of view. See also Mafikeng Mail (Pty) Ltd v Centner (No 2) 1996 (4) SA 607 (WLD) 613G-H

and Ben-Tovim v Ben-Tovim and Others 2001 (3) SA 1074 (CPD). 418 Botha & Jooste (1997) 114 South African Law Journal 67; Hippert (1997) 5 Juta’s Business Law 19; and Jones

“Directors’ duties: Negligence and the business judgment rule” 333..

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of care could contribute to a higher standard of corporate governance, was also criticised

by Jones, who contended that it was far more likely to contribute to a higher degree of

corporate misconduct, and that the existing law adequately protects directors who act

honestly and reasonably.419

Further arguments against the recommendations of the King Reports are that King II

failed to mention the provisions of section 248 of the Companies Act, 1973, which are

similar to the provisions of the business judgment rule.420 It should be noted that section

248421 could only be invoked in certain circumstances, and did not protect directors from

claims by third parties. Consequently, an argument could have been made that the

business judgment rule should be incorporated into South African law to provide for a

situation in which a third person claims damages from directors. However, according to

Bouwman, if the third party were to hold directors liable in delict, the delictual principles

(in particular the tests for wrongfulness, negligence, and legal causation)422 would

adequately limit the directors’ liability.423

A further argument for the inclusion of the business judgment rule relates to section 424

of the Companies Act, 1973.424 This section provides for action on behalf of the creditors

of the company. The court could have declared directors of a company personally liable

for the company’s debts or liabilities if it could be shown that the directors carried on the

business of the company recklessly, with intent to defraud its creditors or creditors or any

419 Jones “Directors’ duties: Negligence and the business judgment rule” 333. 420 See para 5.4.2.1 above were the resemblance between s 248 and the business judgment rule is noted; Botha &

Jooste (1997) 114 South African Law Journal 76. See also Bouwman (2009) 21 SA Merc LJ 529 and Jones

“Director’s duties: Negligence and the business judgment rule” 33. 421 For a discussion of s 248 see para 5.4.2.1. 422 See para 5.4.2.2 above where the elements of a delict are discussed. 423 Bouwman (2009) 21 SA Merc LJ 530. 424 See para 5.4.2.2 above for a detailed discussion of s 424 of the Companies Act 61 of 1973 and the limitation

on its applicability under the Companies Act, 2008.

269

other person, or for any fraudulent purpose.425 It is important to note that the business

judgment rule could not be invoked in relation to section 424 where directors’ actions

were fraudulent.426 This is primarily because the business judgment rule aims to protect

honest directors from being held liable for errors of judgement and can therefore not be

used as a shield against liability where the directors have acted fraudulently.427

It was also contended that a statutory business judgment rule blurs the distinction between

the duty of care and directors’ fiduciary duty of good faith.428 These two duties differ in

their practical application, and should not be confused429 as this may allow directors to

escape liability for a breach of their duties.430

A further consideration is that although the US developed the business judgment rule, it

has never been codified in the US despite two unsuccessful attempts.431 In addition, the

fact that the US courts attach different interpretations to the rule, did not instil confidence

in its adoption into South African law amongst commentators.432

425 See http://www.werksmans.com/legal-briefs-view/claims-against-directors-in-terms-of-the-companies-act-

2008/ (accessed: 17/02/2016). 426 Ex parte Lebowa Development Corporation Limited 1989 (3) SA 71 (T) 107D-E. 427 Bouwman (2009) 21 SA Merc LJ 530; Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 286. 428 Bouwman (2009) 21 SA Merc LJ 531; Jones Directors’ duties: Negligence and the business judgment rule 336

available at https://repository.up.ac.za/handle/2263/3893 (accessed: 11/09/2018) and Lombard “Importation of

the business judgment rule into South African company law: Yes or no?” 614-627. 429 Lombard “Importation of the business judgment rule into South African company law: Yes or no?” 614-627. 430 Lombard “Importation of the business judgment rule into South African company law: Yes or no?” 531. 431 See Ch 2 para 2.4.4.2. The first attempt at codification was by the Committee on Corporate Laws of the Section

of Business Law of the American Bar Association (ABA) and the second attempt was made by the American

Law Institute (ALI). 432 See Ch 2 para 2.4.4.1 for a discussion of the Delaware approach and para 2.4.4.2 on the American Law

Institute’s formulation of the business judgment rule. Kennedy-Good & Coetzee (Part 2) (2006) 27 Obiter 291.

270

5.5.2 The South African statutory business judgment rule

Despite all the arguments against433 the inclusion of the statutory business judgment rule,

section 76(4) of the Companies Act, 2008, introduced a statutory business judgment rule

into South African law.434 Section 76(4) applies to all directors and officers of a

company.435 Section 76(4)(a), reads:

In respect of any particular matter arising in the exercise of the powers or the

performance of the functions of a director, a particular director of a company will

have satisfied the obligations of exercising his or her powers and functions as a

director in the best interests of the company and with a degree of care, skill and

diligence reasonably expected of a person (as specified in Section 76(3)(b) and

(c)) if: (i) the director has taken reasonably diligent steps to become informed about the

matter;

(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; or

(bb) the director complied with the requirements of section 75

(Disclosure of personal financial interest) with respect to any interest

contemplated in subparagraph (aa); and

(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. 436

433 See para 5.5.1. 434 Avenant Director’s Duties to Comply 37; Bouwman (2009) 21 SA Merc LJ 528; and Delport et al Henochsberg

299. The Companies Bill, 2007, was the first attempt to introduce the business judgment rule. Section 91(2)

provided: “A director’s judgment that an action or decision is in the best interests of, or for the benefit of, the

company is reasonable if – (a) the director –(i) has taken reasonably diligent steps to become informed about the

subject matter of the judgment, having regard to subsections (4) and (5); and (ii) does not have a personal financial

interest in the subject matter of the judgment; and (b) it is a judgment that a reasonable individual in a similar

position could hold in comparable circumstances”. Taking this into consideration, the conclusion can be drawn

that the business judgment rule in the context of the Companies Bill seemingly would not have afforded protection

for a director for a breach of his or her duty of care and skill, in that it referred only to the director’s fiduciary

duties. On the other hand, with the formulation in s 76 of the 2008 Companies Act it has become apparent that

the drafters intended to bring the business judgment rule’s application into account once matters arise concerning

a director’s duty of care and skill. 435 The same applies in the US and in Australia. In recent times, however, certain states have ruled that the business

judgment rule will not apply to officers (see, eg, California). See Ch 2 para 2.4.4 and Ch 4 para 4.5. 436 Although this is not discussed in detail it is important to note that ss 76(4)(b) and 76(5) of the Companies Act

71 of 2008 make provision for directors now to rely on the performance of an employee, a professional person,

an expert, or a board committee, provided that they reasonably believe that that person is reliable and competent

or merits confidence. Directors may also rely on a person to whom the board has reasonably delegated the

authority or duty to perform a delegable function of the board. Should ss 76(4)(b) and 76(5) be complied with,

the director is entitled to rely on the performance of such a person, as well as information, opinions,

recommendations, reports, or statements prepared by him or her. Cassim et al Contemporary Company Law 511;

and Matsimela (2011) 1 Company Law Hub Journal of Student Research 6.

271

In order to compare the business judgment rule as applied in different jurisdictions, this

chapter analyses the South African business judgment rule. The discussion that follows

compares the application and interpretation of the South African business judgment rule

to its application in the other jurisdictions considered in this study.

5.5.2.1 Legal requirements

a) Business judgment

As discussed earlier in this thesis, both the US and Australian versions of the business

judgment rule arguably only protect business judgments as opposed to non-business

judgments.437 In South Africa, section 76(4)(a) does not specifically refer to a business

judgment but to “any particular matter arising in the exercise of the powers or the

performance of the functions of a director”. All that is required under the Companies

Act, 2008, is a decision by directors or their support for a decision of a committee or the

board. The result is that section 76(4)(a) possibly has a wider application than the US or

Australian business judgment rule.438 By expanding the application of the South African

business judgment rule to “any particular matter” the legislator may have caused some

problems in the practical application of the rule.

There is no justification for directors to enjoy wider protection under the business

judgment rule than the protection afforded other professions such as doctors and

437 See Ch 2 para 2.5 and Ch 4 para 4.5. 438 Cassim et al Contemporary Company Law 514-515. See further Du Plessis (Part 2) 2011 Company Lawyer

380-381. Du Plessis is in favour of the implementation of the statutory business judgment rule in South Africa

and regards this wider form of protection sensible and justifiable. See also Cassidy “Models of reform: The

director’s duty of care in a modern commercial world” 375 for a different approach available at

http://www.companylaw.uct.ac.za/clh/research/journal/cassidy (accessed: 17/07/2018); and Grove “Company

directors: Fiduciary duties and the duty of care and skill” 37 available at

https://repository.up.ac.za/handle/2263/26667 (accessed: 05/09/2016).

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attorneys.439 This is not in line with the fundamental reason for the business judgment

rule – ie, to protect directors from incurring liability for business decisions that were

made in good faith, without a conflict of interest, and in the best interests of the company.

The name in itself indicates that the rule applies to “business” decisions and it is therefore

unclear why the legislator opted to broaden the scope of the rule. Neither the US nor

Australia has deemed it necessary to broaden the application of the business judgment

rule to such an extent.440 In both these jurisdictions the business judgment rule applies

only to business decisions. Some recommendations in this regard are made in Chapter

6.441

This wider application of the rule will, however, not protect directors against wilful

misconduct or a wilful breach of trust. Section 77(9) reads: 442

In any proceedings against a director, other than for wilful misconduct or wilful

breach of trust, the court may relieve the director, either wholly or partly, from any

liability set out in this section, on any terms the court considers just if it appears to

the court that—

(a) the director is or may be liable, but has acted honestly and reasonably; or

(b) having regard to all the circumstances of the case, including those connected

with the appointment of the director, it would be fair to excuse the director.

This section adds the vital qualifier that no fraudulent conduct will be protected by the

rule or sanctioned by the courts.443 There have been a number of rulings in which South

African courts have had to establish what constitutes wilful misconduct or a wilful breach

of trust.444 In the case of Companies and Intellectual Property Commission v Cresswell

439 Doctors are governed by the Health Profession Council of South Africa and attorneys by the Law Society of

South Africa. 440 See Ch 2 para 2.4 and Ch 4 para 4.5. 441 See Ch 6 para 6.3.1.1. 442 Section 77(9)(a) of the Companies Act 71 of 2008. 443 Leach Avoiding American Mistakes 57. 444 See, eg, Cape Empowerment Trust Limited v Druker and others (2016) JOL 36987 (WCC); KLM Royal Dutch

Airlines v Hamman 2002 (2) SA 818 (W); and Rustenburg Platinum Mines ltd v South African Airways and Pan

American World Airways Inc 1977 (1) Lloyds LR 19 (QB (Com Ct)) 564. In Ex Parte Lebowa Development Corp

Ltd 1989 (3) SA 71 (T) the court ruled that willful breach of trust or willful misconduct means that the director

did not act “honestly”. In Henochsberg the argument was made that it is not clear why willful misconduct or

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and Others445 an application was brought to declare a director delinquent. The applicant

relied on section 162(5)(c)(iv)(aa) of the Companies Act, 2008, which provides that a

court must make an order declaring a person a delinquent director if that person has acted

in a manner which amounts to gross negligence, wilful misconduct, or breach of trust in

relation to the performance of the director’s function within and duties to the company.446

The judge referred with approval to the case of Rustenburg Platinum Mines Ltd v South

African Airways and Pan American World Airways Inc447 where Acker J held:448

It is common ground that ‘wilful misconduct’ goes far beyond negligence, even

gross or culpable negligence, and involves a person doing or omitting to do that

which is not only negligence, and involves a person doing or omitting to do that

which sir not only negligent but which he knows and appreciates is wrong, and is

done or omitted regardless of the consequences, not caring what the result of his

carelessness may be.

This dictum was also approved and adopted in South African law in KLM Royal Dutch

Airlines v Hamman.449 If a director knew what he or she did or omitted to do was not only

negligent but wrong, and he or she carried on regardless of the consequences, it will be

viewed as wilful misconduct. Directors will under these circumstances not have

protection under the business judgment rule.

b) Informed business judgment

In order to comply with this requirement of the business judgment rule, directors need to

inform themselves of the subject matter before making a decision.450 Directors should

follow the due care process requirement in terms of which they must consider matters

willful breach of trust had to be specifically excluded as they would have been excluded by the definition in Ex

Parte Lebowa in any event. Delport et al Henochsberg 308. I agree with the argument made in Henochsberg. 445 Companies and Intellectual Property Commission v Cresswell and Others (2017) ZAWCHC 38 [1]. 446 Companies and Intellectual Property Commission v Cresswell and Others (2017) ZAWCHC 38 [1] para 15. 447 Rustenburg Platinum Mines ltd v South African Airways and Pan American World Airways Inc 1977 (1) Lloyds

LR 19 (QB (Com Ct)) 564. 448 Rustenburg Platinum Mines ltd v South African Airways and Pan American World Airways Inc 1977 (1) Lloyds

LR 19 (QB (Com Ct)) 569. 449 KLM Royal Dutch Airlines v Hamman 2002 (2) SA 818 (W) para 17. 450 Section 76(4)(a)(i) of the Companies Act 71 of 2008.

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carefully, including close scrutiny of alternatives.451 In the US ruling, Smith v Van

Gorkom the court, for example, considered directors to have been grossly negligent

because they had not informed themselves of all relevant information before making

important corporate decisions.452 They were found to be in breach of their duty of care

for not making an informed business decision and therefore could not rely on the business

judgment rule as a defence. The court held: “Under the business judgment rule there is

no protection for directors who have made an unintelligent or unadvised judgment.”453

Uninformed South African directors will also not be protected by the business judgment

rule but the standard of review is lower than its counterpart in the United States of

America and Australia. This is discussed in Chapter 6.454

Section 76(4)(a)(i) provides that the business judgment rule will apply if directors have

taken “reasonably diligent steps” to inform themselves of the subject matter of the

decision.455 The subsection follows an objective standard of review456 which is

synonymous with the reasonable person standard. The court will not base its decision on

whether directors reasonably believed their decision to be appropriate – a subjective

standard of review – but on whether directors had taken reasonable steps to become

informed, which is clearly objective. Section 76(4)(a)(i) should be compared with section

76(4)(a)(iii) which states that directors must have a rational basis for believing that the

decision was in the best interests of the company.457 The test for rationality is also

objective. There is consequently no subjective element in section 76(4)(a). This

451 Section 76(4)(a)(i) of the Companies Act 71 of 2008. 452 Smith v Van Gorkom 488 A.2d (Del 1985) 877. 453 Smith v Van Gorkom 488 A.2d (Del 1985) 877 872. 454 See Ch 6 para 6.3.1.2. 455 Section 76(4)(c)(i) of the Companies Act 71 of 2008. 456 Ibid. 457 See the discussion in para 5.5.2.1(c).

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contradicts section 76(3) which embodies a dual objective/subjective standard of

review.458

Whether or not directors have taken reasonably diligent steps to become informed of the

matter on which they are required to decide, should therefore be aligned with the general

principles of the South African law of delict by applying the wrongfulness test.459 The

test for wrongfulness is that of the boni mores, or legal convictions of the community.460

The legal convictions of the community are gauged by an objective test based on

reasonableness. The basic question is whether, in terms of the legal convictions of the

community and in the light of all the circumstances of the case, the defendant infringed

the interests of the plaintiff in a reasonable or unreasonable manner.461

In assessing whether directors acted wrongfully various factors must be considered.462

These include whether the directors held full-time positions or not, what access they had

to relevant information, specific experience and skills they undertook to bring to the

company, functions delegated by or assigned to them, and the nature of the company.463

Muswaka argues that this shows a subjective orientation to what constitutes “taking

reasonably diligent steps to become informed”.464 The test, however, remains an

458 Section 76(3) of the Companies Act 71 of 2008. See para 5.4.2.3. 459 See the discussion of delict in para 5.4.2.1. 460 Neethling, Potgieter & Visser Deliktereg 5. 461 Marais v Richard 1981 1 SA 1157 (A) 1168. See also Muswaka “Shielding directors against liability

imputations: The business judgment rule and good corporate governance” 30 available at

http://www.saflii.org/za/journals/SPECJU/2013/2.htm (accessed: 06/10/2018); Neethling, Potgieter & Visser

Deliktereg 6. 462 Muswaka “Shielding directors against liability imputations: The business judgment rule and good corporate

governance” 30. 463 Ibid. 464 Ibid.

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objective one in the sense that due regard must be had to what would be expected from a

person in that situation in terms of the convictions of the community.465

The South African business judgment rule is based largely on the ALI’s variant of the

rule.466 As will be recalled, that version of the business judgment rule follows both an

objective and subjective standard of review, which also corresponds to the Australian

version.467 It is unclear why the legislator deviated from ALI’s version in this instance to

not include a subjective standard of review. The US is deemed to be a litigious society,

and in Australia ASIC has instituted a number of actions against corporations. South

Africa, on the other hand, has a regulator, namely the Companies and Intellectual

Property Commission (“CIPC”) but it has very limited control over the corporate

environment and furthermore South Africa is also not regarded as a litigious society.468

This was one of the arguments against the incorporation of the statutory business

judgment rule.469 Why, if a South African director has a far lower risk of incurring

personal liability than his or her US and Australian counterpart, would the legislator make

the rule more accessible as a defence for directors by lowering the standard of review?

Recommendations for the refinement of the formulation are made in Chapter 6.470

465 Ibid. 466 See Ch 2 para 2.4.4.2. 467 See Ch 4 para 4.5. 468 See Ch 4 para 4.4. See, eg, ASIC v Adler (2002) 168 FLR 253; ASIC v Rich (2009) 75 ACSR 236 FLR; and

ASIC v Vines (2003) 48 ACSR 282. The US is among the top five litigious societies in the world; number one is

Germany. See https://www.clements.com/resources/articles/The-Most-Litigious-Countries-in-the-World

(accessed: 12/09/2018). Although companies have to comply with an administrative process to inform the CIPC

of its decisions (for example the appointment of directors, changing of auditors, change of year end, amendment

of the Memorandum of Incorporation), none of these decisions are dependent on the approval of the CIPC. In

most instances, the company’s decision is effective immediately and it merely needs to inform the CIPC of

decisions or actions. Sections 185 to 192 of the Companies Act 71 of 2008 deals with the functions and powers

of the CIPC. 469 See para 5.5.1. 470 See Ch 6 para 6.2.

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Directors whose knowledge is limited may consult with experts and secure expert

guidance in order to make an informed decision. Section 76(4)(b) states that directors are

entitled to rely on any person referred to in section 76(5).471 Section 76(5) reads:

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.472

Directors will consequently not be able to use a lack of knowledge as an excuse for not

becoming reasonably informed concerning the subject matter of the decision. The

Companies Act, 2008, defines “knowing”, “knowingly”, and “knows”, when used with

respect of a person and in relation to a matter, to mean that the person either:

a) had actual knowledge of the matter; or b) was in a position in which the person

reasonably ought to have had actual knowledge; or investigated the matter to an extend

that would have provided the person with actual knowledge; or taken other measures

which, if taken, would reasonably be expected to have provided the person with actual

knowledge of the matter.473

To “know” directors must take “reasonable diligent steps” to become informed on the

subject matter in order to obtain actual knowledge of it. It is interesting to note that the

term “actual knowledge” is repeated four times in the definition. It could thus be argued

that directors will not enjoy protection under the business judgment rule if they do not

have actual knowledge of the subject matter. This does not, however, imply that directors

are expected to be experts but rather that they should adequately “interrogate the

471 Sections 76(4)(b) and 76(5) of the Companies Act 71 of 2008. 472 Sections 76(4)(b) and 76(5) of the Companies Act 71 of 2008. 473 Section 1 of the Companies Act 71 of 2008.

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matter”.474 If directors lack specific expertise in the subject matter they are expected to

obtain guidance from a third party who has the knowledge to assist them in making an

informed decision. For example, if directors are faced with a decision that requires legal

knowledge, they may request the guidance of their internal legal counsel or an attorney

to guide them in making a legally sound informed business decision.

c) Decision made in the best interests of the company

Section 76(4)(a)(iii) states that directors must make decisions, or must have supported

the decision of a committee with regard to the matter, and directors must have a rational

basis for believing, and did in fact believe, that the decision was in the best interests of

the company.475 Is the standard of review for “rationality” objective or subjective, and

does the “reasonableness test” correspond to the “rationality test”? According to Cassidy,

the test for rationality has reduced the standard of review by requiring that directors

merely have a “rational” basis for believing that their decisions are in the best interests

of the company.476 She goes on to state that the difference between “reasonableness” and

“rationality” might at first glance appear more apparent than real. The standard of review

for both reasonableness and rationality is objective. However, the adoption of the latter

as the standard of review means that directors may make unreasonable or even unwise

decisions provided that their decisions or judgment is not entirely irrational.477 In

Cassidy’s view mere rationality is an inappropriate standard of review in the modern

474 Shuttleworth v Cox Brothers & Co (Maidenhead) Ltd 1927 2 KB 9 (CA) 23-24. 475 Section 76(4)(a)(iii) of the Companies Act 71 of 2008. 476 Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 400 available at

http://www.companylaw.uct.ac.za/clh/research/journal/cassidy (accessed: 17/07/2018). Nethavhani Business

Judgment Rule: Undue Erosion 23. 477 Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 400.

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world of corporate governance.478 Eisenberg is also of the opinion that the test for

“rationality” is lower than that for “reasonableness”. He states that

this rationality standard of review is and is intended to be very easy for a director

or officer to satisfy, and, in particular, much easier to satisfy than a reasonability

standard. Perhaps the most obvious type of a decision that lacks rationality is one

that cannot be explained coherently.479

As regards this requirement, it was held in Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus

(Pty) Ltd480 that directors should believe subjectively that their decision is in the best

interests of the company and this belief must have a rational basis.481 Rogers J ruled

that section 76(4) makes it clear that the duty imposed by section 76(3)(b) to act in the

best interests of the company is not an objective one in the sense of entitling a court, if

a board decision is challenged, to determine what is, objectively speaking, in the best

interests of the company. What is required is that the directors, having taken reasonably

diligent steps to become informed, must subjectively have believed that their decision

was in the best interests of the company and this belief must have had a rational basis.482

The court held that although the rational criterion in section 76 is an objective one, its

threshold is quite different from, and more easily met than, a determination as to

whether the decision was objectively in the interests of the company.483

In Pharmaceutical Manufacturers Association of SA & Another484 it was held that:

The setting of this standard [rationality] does not mean that the Courts can or

should substitute their own opinions as to what is appropriate for the opinions of

those in whom the power has been vested. As long as the purpose sought to be

achieved by the exercise of public power is within the authority of the functionary,

and as long as the functionary’s decision, viewed objectively, is rational, a Court

478 Ibid. 479 Eisenberg (1993) 48 The Business Lawyer 1282. 480 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC). 481 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC) para 74. 482 Ibid. 483 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC) para 76. 484 Pharmaceutical Manufacturers Association of SA & Another: In re Ex parte President of the Republic of South

Africa & Others 2000 (2) SA 674 (CC).

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cannot interfere with the decision simply because it disagrees with it or considers

that the power was exercised inappropriately. A decision that is objectively

irrational is likely to be made only rarely but, if this does occur, a Court has the

power to intervene and set aside the irrational decision.485

And in Minister of Defence and Military Veterans v Motau and Others486 the court ruled

that it is well established that the test for rationality is an objective one and distinct from

that for reasonableness.487 From these authorities it can be deduced that the test for

rationality is objective, and further that rationality and reasonableness are two distinct

concepts. It is further argued that were it to be accepted that the rationality and

reasonableness tests are synonymous, it would render section 76(4) redundant. The test

for reasonableness is stricter than that for rationality. Section 76(4)(a)(iii) consequently

lowers the standard of review for directors to a mere rational belief which makes it far

easier for them to meet this requirement than the reasonableness test. Recommendations

in this regard are made in Chapter 6.488

d) Personal interest

The South African business judgment rule also requires that directors have no material,

personal, financial interest – or that they make due and proper disclosure of that interest

in accordance with section 75.489 Section 75(5) requires directors to disclose the nature

and extent of any such financial interest in a matter before the board. Section 75(4) allows

directors to disclose a financial interest in advance, and this standing notice will suffice

for the purposes of section 75, unless there has been a change in the nature and extent of

the financial interest. This, however, relates only to companies where the individual

485 Pharmaceutical Manufacturers Association of SA & Another: In re Ex parte President of the Republic of South

Africa & Others 2000 (2) SA 674 (CC) para 90. 486 Minister of Defence and Military Veterans v Motau and Others 2014 (5) SA 69 (CC). 487 Minister of Defence and Military Veterans v Motau and Others 2014 (5) SA 69 (CC) para 69. 488 See Ch 6 para 6.3. 489 See s 76(4)(a)(i) and (ii) of the Companies Act 71 of 2008. See also s 75 of the Companies Act 71 of 2008.

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concerned is the sole director and does not hold all the beneficial interests of all the issued

securities of the company.490 This could pose a problem in so far as directors may appeal

to the South African business judgment rule even though they had a financial interest in

a decision and had not formally declared that conflict of interest during the relevant board

meeting. It is argued that a historical notice of a financial conflict of interests should not

suffice under any business judgment rule, and that the directors should inform the

shareholders when the decision is to be made.491

Section 75(5), however, provides that if directors of a company – other than a company

contemplated in subsection (2)(b) or (3) – have a personal financial interest in a matter to

be considered at a meeting of the board, or know that a related person has a personal

financial interest in the matter, the directors must disclose that interest and its general

nature before the matter is considered by the meeting.492 This, in my view, is correct and

directors of companies as contemplated in section 75(5), must disclose their material

personal financial interests at the relevant meeting in order to qualify for protection under

the business judgment rule. They will not be protected under section 76(4) if the

disclosure has only been made in the past.

Section 76(4)(a)(ii) also appears to include the standard requirement that directors should

not have a material personal “financial” interest in the subject matter of the decision. It

is clear from the wording that this section is confined to a director’s own personal

financial interest. This is a major error in the drafting of this section as it makes no

490 Section 75(3) of the Companies Act 71 of 2008. 491 See Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 399 available at

http://www.companylaw.uct.ac.za/clh/research/journal/cassidy (accessed: 17/07/2018). This approach was not

followed by the US or Australia. See Ch 2 para 2.5 and Ch 4 para 4.5. 492 Section 75(5) of the Companies Act 71 of 2008. Section 75(2)(b) states that s 75 will not apply to companies

with only one director who holds all the beneficial interest of all the issued securities of the company.

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provision for other instances where directors may compromise their independence for

reasons other than personal “financial” interests.493 The Companies Act, 2008 defines

“personal financial interest” as a direct material interest of that person, of a financial,

monetary or economic nature, or to which a monetary value may be attributed.494 Thus,

if directors do not have a “financial interest” but do have “other interests” in the subject

matter they will have met this requirement. A director may, for example, have a conflict

of interest in making a decision to employ a family member in a high-level position in

preference to a more suitable candidate. Should the family member cause any harm to

the company, the director would still have met this element of the business judgment rule

since he or she had no “financial” interest in the decision that was made. This is not ideal

and recommendations are made in Chapter 6.495

Section 76(4)(a)(ii) is limited in its application as discussed above, but it does extend the

application not only to a director’s reasonable knowledge of any personal financial

interests he or she may have, but also to the personal financial interests of a “related

person”. Again, I submit that this is correct. Directors must therefore disclose any

personal financial interests of a person related to them. It is, however, again limited to

financial interest only and not any other interest that the related person may have.

493 See Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC) para 74 as an illustration

of the way the court applies s 76(4). See Cassidy available at http://www.companylaw.uct.ac.za/

clh/research/journal/cassidy (accessed: 17/07/2018). 494 Companies Act 71 of 2008. 495 See Ch 6 para 6.3.

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Section 1 of the Companies Act 71 of 2008 defines “related” when used in respect of two

persons, as any person/s who are connected to one another in any manner contemplated

in section 2(1)(a) to (c). Section 2(1)(a) to (c) provides:496

(1) For all purposes of this Act-

(a) an individual is related to another individual if they-

(i) are married, or live together in a relationship similar to a marriage; or

(ii)are separated by no more than two degrees of natural or adopted consanguinity

or affinity;

(b) an individual is related to a juristic person if the individual directly or indirectly

controls the juristic person, as determined in accordance with subsection (2); and

(c) a juristic person is related to another juristic person if-

(i) either of them directly or indirectly controls the other, or the business

of the other, as determined in accordance with subsection (2);

(ii) either is a subsidiary of the other; or

(iii) a person directly or indirectly controls each of them, or the business

of each of them, as determined in accordance with subsection (2).

If a person falls within this definition of a “related” person, directors must disclose any

personal financial interest which the related person may have in the subject matter of the

decision. This poses a problem in so far as the word “material” is omitted in relation to

related persons. For directors themselves the interest must be “material” in order to lose

protection under section 76(4), but when it comes to related persons, directors will lose

protection under section 76(4) if the related persons has any personal financial interest –

whether material or not. There is a higher burden for related persons than directors, which

in my view is strange. If a director has a personal financial interest which does not qualify

as material, he or she will have met this requirement of the business judgment rule; there

is no reason why this should not also apply to related persons.

As noted above, section 76(4)(ii)(aa) provides that the personal financial interest in the

subject matter of the decision must be material. Should directors’ personal financial

496 Section 2(1)(a)-(c) of the Companies Act 71 of 2008. See also s 2(a) of the Companies Act 71 of 2008 which

details who will control a juristic person either directly or indirectly.

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interest in the subject matter not be material, they will enjoy protection under the business

judgment rule. It has already been pointed out that section 248 of the Companies Act,

1973, closely resembled the business judgment rule in that it provided that directors may

be excused from liability if they had no “financial interest” in the subject matter – in that

section no mention was made of the interest also being “material”. 497

Section 1 of the Companies Act, 2008, defines “material” to mean significant in the

circumstances, and an interest which may reasonably affect a person’s judgment or

decision-making in the matter. It may be argued that the current formulation in section

76(4) leaves a gap for directors with a personal financial interest to be protected by the

business judgment rule if the interest is not material. In my view, however, this is not in

fact a problem. If directors have a non-material interest in the subject matter the

probability of its significantly impacting their judgment or decision is considerably less

likely than where their interest is “material”. The inclusion of “material” in section 76(4)

would appear to have no particular significance.

5.5.2.2 Application of the rule

a) Good faith and proper purpose

The South African business judgment rule does not require that the decision be made in

good faith and for a proper purpose.498 In respect of fiduciary duties, the scope of the

business judgment rule under section 76(4)(a) has been clearly defined to apply only to

section 76(3)(b) – the fiduciary duty to act in the best interests of the company rather than

all the fiduciary duties.499 It could be argued that whilst the fiduciary duty to act in the

497 See para 5.4.2.2.1; s 248 of the Companies Act 61 of 1976. 498 Section 180(2)(a) of the Corporations Act, 2001. Cassidy ibid at 398. See also Ch 2 para 2.5 and Ch 4 para

4.5. 499 See the discussion of the fiduciary duty to act in the best interests of the company in para 5.4.1.

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best interest of the company is the overarching fiduciary duty, it includes the fiduciary

duties to act in good faith and for proper purpose. It is however contended that if it was

the intention of the legislator to include these two fiduciary duties, section 76(4)(a) would

not have specifically excluded it.

As we have seen, one of the arguments against a statutory business judgment rule was

the blurring between the duty of care and the fiduciary duties which are two distinct

concepts.500 Omitting good faith and proper purpose from section 76(4) is, in my view, a

step in the right direction to resolve the issue of keeping directors’ duty of care and the

fiduciary duties distinct concepts in law. The omission will not absolve directors of

compliance with these duties, but they will not enjoy protection under the business

judgment rule as regards the decision-making process. As we shall see, section 76(4)

includes the fiduciary duty to act in the best interest of the company. Does this hold the

possibility of creating US-type uncertainty regarding the relationship between the

fiduciary duties, the statutory duty of care, and the business judgment rule? And if so,

how can this problem be resolved? It is to this that the discussion turns.501

b) Directors’ duties

As indicated, section 76(4) applies to only one of the directors’ fiduciary duties – the duty

to act in the best interests of the company (s 76(3)(b)) – and the duty to act with the

necessary care, skill, and diligence (s 76(3)(c)). Concern has been raised that section

76(4) blurs the distinction between fiduciary duties, and the duty of directors to exercise

500 See para 5.5.1. 501 See para 5.5.2.2 (b).

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reasonable care, skill, and diligence.502 This begs the question as to whether the codified

business judgment rule has in fact blurred this distinction, and whether this will cause the

same uncertainty as in the US.503 To answer this question, the cause of action for each of

these duties must first be established.

The cause of action in a case where the breach of a director’s fiduciary duty is alleged is

sui generis.504 In contrast, the cause of action for a breach of the duty of care lies within

the law of delict.505 Under the Companies Act, 2008, a breach of the fiduciary duty leads

to liability under section 77(2)(a),506 which allows for liability to include any loss,

damages, or costs sustained by the company as a consequence of any breach in

accordance with the common-law principles regarding the breach of fiduciary duties. On

the other hand, a breach of the statutory duty of care, under section 76(3)(c), leads to

liability under section 77(2)(b)(i),507 which states that directors who are in breach of the

duty will incur liability in accordance with the common-law of delict.508 Liability for the

breach of fiduciary duties is thus not delictual in nature and is therefore distinct from the

duty of care.509

502 See para 5.5.1. See also Bouwman (2009) 21 SA Merc LJ 531; Cassim et al Contemporary Company Law 515;

and Jones “Director’s duties: Negligence and the business judgment rule” 336 available at

https://repository.up.ac.za/handle/2263/3893 (accessed: 11/09/2018). 503 See Ch 2 para 2.3. 504 See para 5.4.1; Cohen NO v Segal 1970 (3) SA 702 (W) 706; and Havenga (2004) 16 SA Merc LJ 286. 505 See para 5.4.2; Brazilian Rubber Plantations & Estates Ltd [1911] 1 Ch 425; In Re City Equitable Fire

Insurance Co Ltd [1925] 1 Ch 407; and Pinandi v Manyepedza 2007 (3) BLR 141 (HC). 506 Section 77(2)(a) of the Companies Act 71 of 2008 reads: “A director of a company may be held liable— (a)

in accordance with the principles of the common law relating to breach of a fiduciary duty, for any loss, damages

or costs sustained by the company as a consequence of any breach by the director of a duty contemplated in

section 75, 76(2) or 76(3)(a) or (b).” 507 See s 77(2)(b)(i) of the Companies Act 71 of 2008 reads: “A director of a company may be held liable— (b)

in accordance with the principles of the common law relating to delict for any loss, damages or costs sustained

by the company as a consequence of any breach by the director of—(i) a duty contemplated in section 76(3)(c).” 508 See the discussion on the requirements for a delict in para 5.4.2.1. See also Muswaka (2013) 3 International

Journal of Humanities and Social Science 91-92. 509 See Du Plessis NO v Phelps [1995] 2 All SA 469 (C) 473 where the court ruled that liability in the event of a

director failing to take reasonable care in the management of the company’s affairs is based on the lex Aquilla.

The basic requisite for liability under the lex Aquilla is fault, ie, dolus or culpa. Liability for a breach of director’s

fiduciary duties, on the other hand, does not necessarily involve dolus or culpa.

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According to Leach, section 77(2) of the Companies Act, 2008, preserves the distinction

between the fiduciary duties and the duty of care.510 He argues that although the business

judgment rule applies to the fiduciary duty to act in the best interests of the company and

the duty of care, there remains a clear distinction between these duties and there should

accordingly not be problems similar to those that have beset the US on this point.511

Although Leach’s argument is valid, I propose that the business judgment rule should

have limited application which avoids the uncertainty and overreaching nature of the US’

common-law business judgment rule. I recommend that the legislature remove the

fiduciary duty to act in the best interest of the company from section 76(4).512 This will

limit the application of the business judgment rule to directors’ duties of care, skill, and

diligence and will avoid any uncertainty as to the application of section 76(4). This is

further discussed in Chapter 6.513

c) Common law

The South African business judgment rule does not apply to the common-law duties of

directors, save for those now codified.514 Section 76(4) provides that the business

judgment rule will only apply to the statutory duty to act in the best interests of the

company as set out in section 76(3)(b), and directors’ duty of care in section 76(3)(c).

Should directors breach any of their common-law duties they will have no protection

under the statutory business judgment rule. This is important taking into consideration

the ruling in Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd

where the court found that the King Reports must be considered to determine whether

510 Leach Avoiding the American Mistakes 26. 511 Leach Avoiding the American Mistakes 27. 512 See Ch 6 para 6.3.1.3. 513 Ibid. 514 Section 76(3)(b) and (c) of the Companies Act 71 of 2008.

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directors have breached both their fiduciary duties and their duty of care.515 Directors will

not only have to comply with the duties as set out in the Companies Act, 2008, but also

the duties as per King IV. In addition, at common-law directors will also not be able to

rely on protection under the business judgment rule should they breach the duties imposed

by King IV.516 The South African business judgment rule, therefore, has only limited

application in this regard.517 In my view the legislature was correct to limit the

application of the business judgment rule to exclude the common law. This will ensure

that South Africa will not experience the same difficulties as experienced in the US.518

The exclusion of common-law duties from the protection of section 76(4) will not mean

that directors will be without protection should they breach, for example, a common- law

duty of care. The elements of delict will still have to be present and proven before

directors will be held liable for a breach of their duty of care. It will have to be proven

that there was conduct (commission or omission), wrongfulness, fault (negligence or

intent), causation, and damage.519 If these elements cannot be proved directors will not

be liable. It is accordingly argued that directors should have sufficient protection for

breach of their common-law duties even though they are excluded from protection under


515 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W). 516 See also s 5(1) read with s 7(b)(iii) of the Companies Act 71 of 2008 which provides grounds for justification

for reliance on the corporate governance codes by the courts. 517 Interestingly, the Australian business judgment rule under s 180(2) of the Corporations Act, makes provision

for the rule to operate as a defence to both the common-law and statutory duty of care and skill. See Ch 4 para

4.5. 518 Ch 2 para 2.5. 519 See para 5.4.2.1 where the elements are discussed.

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d) Directors and officers

In South Africa, section 76(1)(a) of the Companies Act, 2008, specifically states that

directors’ duties, as set out in this section, will also apply to prescribed officers and a

person who is a member of the board or a board committee or the audit committee, and

not only to directors. In addition, a prescribed officer is defined in section 1 of the

Companies Act, 2008, as a person who performs any function within a company that has

been designated by the Minister in terms of section 66(10).520 This definition is important

because the Companies Act, 2008, extends the obligations and so also the risk of liability

which directors owe to a company.521

e) Safe harbour or presumption

The court will presume that in making a business decision, the company directors acted

on an informed basis, in good faith, and with a rational belief that the action or omission,

was taken in the best interests of the company.522 Secondly, unless it can be shown that

the board of directors did not act within these parameters, it will incur no liability as a

result of its decision. The court will not disturb the decision itself provided that it can be

attributed to a rational business purpose.523 This creates a safe harbour for directors and

indicates that the business judgment rule functions as both a procedural rule and a

520 See para 5.3. Section 66(10) of the Companies Act 71 of 2008. This section provides that the Minister may

make regulations designating any specific function or functions within a company a prescribed function and the

person performing that function, a prescribed officer for the purposes of the Act. See also reg 38 of the Companies

Act 71 of 2008 which defines a prescribed officer of a company (despite not being a director) for all purposes of

the Act as follows: “if that person: – a) exercises general executive control over the management of the whole, or

a significant portion, of the business and activities of the company, or b) regularly participates to a material degree

in the exercise of general effective control over, and management of the whole, or a significant portion, of the

business and activities of the company. The regulation applies to such a person irrespective of any particular title

given by the company to an office held by that person in the company or a function performed by the person for

the company. Delport et al Henochsberg 28; and Havenga (2013) 2 Journal of South African Law 263; Idensohn

(2010) 22 SA Merc LJ 721. 521 See ss 75, 76 and 77 of the Companies Act 71 of 2008. See further the discussion on the director’s duties in

paras 5.4.1 and 5.4.2. 522 See s 76(4) of the Companies Act 71 of 2008. See further Van Tonder (2015) 36 Obiter 722. 523 See s 76(4)(a)(i)-(iii) of the Companies Act 71 of 2008. See also Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus

(Pty) Ltd 2014 (5) SA 179 (WCC) para 87; and Van Tonder (2015) 36 Obiter 722.

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substantive rule of law.524 In Chapter 1 it was pointed out that a safe harbour provision is

a provision in a statute or a regulation that reduces or eliminates a party’s liability under

law provided that the person acting did so in good faith or in compliance with the defined

standards.525 The South African business judgment rule as a safe harbour presumes that

directors acted in “good faith” whilst making a business decision which complies with

the definition of a safe harbour. Furthermore the defined standards include that the court

will presume that directors acted on an “informed basis” and with a “rational belief” that

the action or omission, was taken in the best interests of the company.526

The South African business judgment rule not only reduces directors’ liability, but

eliminates it – unless the requirements of the business judgment rules are not met. The

rule states that directors are safe from liability if they meet the requirements in section

76(4). This section provides:


performance of the functions of a director, a particular director of a company will

have satisfied the obligations of exercising his or her powers and functions as a

director in the best interests of the company and with a degree of care, skill and

diligence reasonably expected of a person (as specified in Section 76(3)(b) and (c))

if:…

The words “will have satisfied” and “if” clearly provide that if the directors meet the

requirements of section 76(4) they will have satisfied their obligations and will not incur

liability. This is in line with a safe-harbour provision discussed in Chapter 1. If the

directors satisfy the requirements of the South African business judgment rule, there will

524 Masethla v President of the Republic of South Africa 2008 1 BCLR 1 (CC) para 184, where the procedural and

substantive rule of law was defined by Judge Ngcobo as: “Rationality deals with the substantive component, the

requirement that the decision must be rationally related to the purpose for which the power was given and the

existence of a lawful reason for the action taken. The procedural component is concerned with the manner in

which the decision was taken. It imposes an obligation on the decision-maker to act fairly. To hold otherwise

would result in executive decisions which have been arrived at by a procedure which was clearly unfair being

immune for review”. 525 See Ch 1 para 1.3. 526 See s 76(4) of the Companies Act 71 of 2008. See further Van Tonder (2015) 36 Obiter 722.

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be no further enquiry into the decision or the merits of the matter. This corresponds to

the ALI and Australian business judgment rules, which also institute a safe harbour.527

However, it is in contrast to the Delaware rule which takes the form of a presumption.528

This is discussed further in chapter 6.529

On the procedural level, the business judgment rule creates a presumption of an informed

business decision, taken in good faith, and with a rational belief that it is in the best

interests of the company.530 The substantive aspect of the rule requires the court to defer

to a business judgment made by directors, provided their decision is not completely

irrational. Judicial review of the merits of the decision is prevented and the decision

cannot be challenged.531 The criterion used to determine rationality is an objective one

and the threshold differs from, and is more easily satisfied than, a determination as to

whether the decision was objectively in the best interests of the company.532 Directors

must act in a way which they conceive to be for the benefit of the company as a whole.533

Although the enquiry goes to the subjective intentions of directors, it is an investigation

which must be conducted objectively by the court. The court must decide whether to

accept or discount the assertions directors made about their motives and purposes.534

Therefore, the test is not entirely subjective. Even if directors believed that they were

acting in the best interests of the company, they may still be found to be in breach of their

duties if there are no grounds on which a reasonable person could come to the same

conclusion.535

527 See Ch 2 para 2.4.4.2 and Ch 4 para 4.5. 528 See Ch 2 para 2.4.4.1. 529 See Ch 6 para 6.1. 530 See s 76(4)(a)(iii) of the Companies Act 71 of 2008. 531 Van Tonder (2015) 36 Obiter 723. 532 Ibid. 533 Blackman et al Commentary on the Companies Act Ch 8 67; Van Tonder ibid. 534 Blackman et al Commentary on the Companies Act Ch 8 61. 535 Blackman et al Commentary on the Companies Act Ch 8 67.

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In the decision of Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd,536 reference was

made to the statutory business judgment rule as regards the fiduciary duty of directors to

act in the best interests of the company.537 According to Roger J, section 76(4) makes it

clear that the duty imposed by section 76(3)(b) to act in the best interests of the company

is not an objective one538 in the sense of entitling a court, if a board decision is challenged,

to determine what is objectively speaking in the best interests of the company.539 What is

required is that directors should have taken reasonably diligent steps to inform

themselves, and should have believed subjectively that their decision was in the best

interests of the company. This belief must further have had a “rational basis”.540 The court

went on to state that section 76541 requires the bona fide assessment by the directors to

have a rational underpinning. Roger J, was further of the view that this requirement has

been articulated less frequently in the conventional statement of directors’ duties but is

not necessarily an innovation.542 Section 76(4)(a)(iii) thus lowers the standard of review

to rationality rather than reasonableness by requiring that directors merely have a rational

basis for believing that their decision is in the company’s best interests.543

5.5.2.3 Abstention, the immunity doctrine, and the standard-of-liability test

In Chapter 2 it was indicated that the business judgment rule can be applied in three

different ways.544 First, under Delaware law the business judgment rule can be applied as

536 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC). 537 See ss 76(4) and 76(3)(b) of the Companies Act 71 of 2008. 538 See also Pharmaceutical Manufacturers Association of SA & Another: In re Ex parte President of the Republic

of South Africa & Others 2000 (2) SA 674 (CC) para 90. 539 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC) para 74. 540 Ibid. 541 Section 76 of the Companies Act 71 of 2008. 542 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC) para 75. 543 See Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 399 available at

http://www.companylaw.uct.ac.za/clh/research/journal/cassidy (accessed: 17/07/2018). The safe harbour

application is further discussed under the immunity doctrine below. See para 5.5.2.3. 544 See Ch 2 para 2.5.

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an abstention doctrine where the court would review the process the board followed in

reaching a decision rather than the decision itself.545 Under the abstention doctrine, the

court refrains from reviewing the substantive merits of a director’s conduct unless the

plaintiff can rebut the business judgment rule’s presumption of good faith.546 We saw

earlier in this chapter that the South African business judgment rule is a safe harbour and

not a presumption.547 The Delaware courts formulate the business judgment rule as a

presumption that in making a business decision directors of a corporation act on an

informed basis, in good faith, and in the honest belief that the specific action taken is in

the best interests of the corporation.548 When a court assesses the presumption of the

business judgment rule it evaluates director conduct not by looking at the result of a given

decision, but instead at the process the board followed in reaching the decision.549 It is

argued that provided that directors act in good faith and on a reasonable basis, their

business decisions should not be second-guessed.550

In Chapter 2 the study considered whether, because the court recognises a presumption

in favour of directors through the business judgment rule, the challenging party must

carry the burden of proving that directors violated their duty in some way.551 The burden

of proof will, however, shift if a plaintiff shows that a majority of directors have a

personal interest in the transaction.552 Consequently, when the burden of proof shifts to

545 Ibid. See also Paramount Communications Inc v QVC Network Inc 637 A.2d 34, 45 n.17 (Del 1994). 546 Brehm v Eisner 746 A.2d 244, 264 n.66 (Del 2000). 547 See para 5.5.2.2 (e). 548 In Aronson v Lewis 473 A.2d (Del. 1984) at 812. See Ch 2 para 2.4.4.1. 549 In Paramount Communications Inc v QVC Network Inc 637 A.2d (Del 1994) 45. 550 Unocal Corp v Mesa Petroleum Co 493 A.2d (Del. 1985) 954. 551 Aronson v Lewis 473 A.2d 805, 812 (Del 1984). 552 In Guth v Loft Inc 5 A.2d 503, 510 (1939) 510 the court held that “the rule that requires an undivided and

unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest.”

Johnston (1990) 40 Catholic University Law Review 160; Aydin Due Care Liability in Delaware 87.

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the directors, they must show that the transaction was fair.553 To shift the burden of proof

to directors, a plaintiff must show self-interest on the side of director(s), as opposed to a

benefit which devolves upon the corporation or all shareholders generally.554 This

presumption against judicial review of the duty of care is known as the abstention

doctrine.555 Under the abstention doctrine the court refrains from reviewing the

substantive merits of director’s conduct unless the plaintiff can rebut the business

judgment rule’s presumption of good faith.556

The South African business judgment rule is not applied as an abstention doctrine for the

following reasons: It has already been established that section 76(4) is a safe harbour

provision and not a presumption. In essence, the abstention doctrine is a presumption and

being a safe harbour the South African business judgment rule cannot be applied as an

abstention doctrine. Secondly, under the abstention doctrine the burden of proof falls to

the plaintiff shareholder whereas under the South African business judgment rule the

burden to prove that they are entitled to protection under section 76(4) falls to the

directors. If the directors can prove that they complied with the elements in section 76(4)

they will incur no liability for a breach of sections 76(3)(b) and (c). This conflicts with

the abstention doctrine. The onus, whether the company must prove the absence of the

elements of the business judgment rule (sub-s (4) (a) and (b)) or whether the person held

accountable must prove the presence of all the elements (conjunctively) is not certain.557

553 In AC Acquisitions Corp v Anderson, Clayton & Co 519 A.2d 103, 111 (Del Ch 1986) 111 the court stated that

“courts’ unwillingness to assess the ... [fairness] of business decisions ends when a transaction is one involving a

predominantly interested board with a financial interest in the transaction adverse to the corporation”. 554 See Sinclair Oil Corp v Levien 280 A.2d 717, 720 (Del 1971). See also Aronson v Lewis 473 A.2d 805, 812

(Del 1984). 555 See Schlensky v Wrigley 237 NE2d 776 (Ill. App. 1968) for an illustration of the business judgment rule as an

abstention doctrine. See also Bainbridge (2003) 03-18 Law & Economics Research Paper 7; McMillan (2013) 4

William & Mary Business Law Review 529; and Kamin v American Express Co 383 NYS 2d 807 (NY Sup 1976). 556 See Brehm v Eisner 746 A.2d 244, 264 n.66 (Del. 2000) 264. 557 Delport et al Henochsberg 298.

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Henochsberg refers to the Australian ruling in ASIC v Rich558 where it was said that the

“statutory language is profoundly ambiguous” but the court eventually concluded” that:

with some hesitation in light of the US approach, I have reached the conclusion

that the Australian statute casts the onus of proving the four criteria in s 180 (2) on

the defendants.559

The second application can also be found in Delaware law, namely, the standard-of-

liability test.560 This test requires some objective review of the merits of the board’s

decision and thus the plaintiff will be able to shift the burden of proof if he or she can

establish the existence of certain conditions – eg, fraud, illegality, self-dealing, or lack of

decision by the board.561 The wording of section 76(4) does not suggest that there will be

any enquiry into the merits of the business decision, and it is clear that directors will not

incur personal liability should they meet the requirements of section 76(4)(a)(i)-(iii).

For the reasons identified under the abstention doctrine, the South African statutory

business judgment rule does not operate as a standard for liability. Cassim states that in

the sphere of ordinary commercial decisions, the merits and wisdom of directors’

decisions fall outside the scope of judicial review when the formal requirements of the

business judgment rule in section 76(4) of the Companies Act, 2008, have been met.562

Thirdly, the business judgment rule is applied as an immunity doctrine which insulates

directors from liability resulting from bad decisions provided certain requirements are

met.563 It was shown earlier that the South African business judgment rule is largely based

558 Australian Securities and Investment Commission v Rich [2009] NSWSC 122 para 7264. See discussion in Ch

4 para 4.5.2. 559 Australian Securities and Investment Commission v Rich [2009] NSWSC 122 para 7269. 560 See Ch 2 para 2.5. 561 Ibid. See further Cede & Co v Technicolor Inc 632 A.2d 361 (Del. 1993); and McMillan (2013) 4 William &

Mary Business Law Review 529. 562 Cassim (2013) 25 SA Merc LJ (Part 2) 310. 563 See Ch 2 para 2.5.

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on the ALI business judgment rule which applies the rule as an immunity doctrine. The

immunity doctrine is applied as a safe harbour and not a presumption. In accordance with

the safe harbour application, the business judgment rule will protect directors from

liability if they make a business decision which meets the requirements of the business

judgment rule.564 If the conditions for the safe harbour are met in a particular business

decision, the standard of conduct will have been satisfied without further judicial inquiry,

and directors will be safe from liability. The immunity doctrine entails no examination

into the merits of the decision – as does the standard-of-liability doctrine – and also no

consideration of whether directors have breached their duties. There is not even an

examination into good faith.

The South African business judgment rule resembles the immunity doctrine for the

following reasons: First, given the wording of the business judgment rule in the

Companies Act, 2008,565 it can be inferred that if the requirements listed in section

76(4)(a)(i)-(iii) are met directors will be immune from personal liability – they will have

a safe harbour from liability. This resembles the ALI formulation which applies as an

immunity doctrine. Secondly, although not clearly indicated in section 76(4) it would

seem that directors will bear the burden of proof that they have met the elements of

section 76(4), which similarly corresponds to the ALI formulation. In practice, the

operation of the business judgment rule under section 76(4) would certainly be to insulate

directors from liability for their business-related decisions, provided that the

requirements of section 76(4)(a) have been met.566

564 See Ch 2 para 2.4.4.2. 565 Section 76(4)(a) of the Companies Act 71 of 2008. 566 Leach Avoiding the American Mistakes 45.

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There is no examination of the merits of the decision as with the standard of liability

doctrine, nor whether directors have breached their duties in section 76(3)(b) and (c).567

In my view the immunity doctrine is the correct approach to follow. The core aim of the

business judgment rule is to protect directors from incurring liability when they legally

comply with their duties because the law will regard them as having complied with the

requirements underpinning compliance with the rule.

As discussed earlier, section 76(4) is not clear as to whether the burden of proof lies with

the directors of the company. I agree with Leach that directors should bear the burden of

proof – it is they who should be required to prove their entitlement to protection under

the business judgment rule.568 This will create awareness amongst directors as to what

their duties and obligations are under sections 77(3)(b)-(c) and 76(4)(a). Unlike their

counterparts in the US and Australia, South African directors are not often confronted

with their duties and obligations in a litigious environment. As a consequence not all

directors in South Africa are aware of what these duties entail, and more importantly, of

the possible consequences of non-adherence.

In Chapter 6, I offer some recommendations as regards section 76(4) which are aimed,

in the main, at limiting the application of the business judgment rule.569 The rule is new

to South African law and has not been tested as intensely as in the US. In order for the

rule to be applied as effectively as possible by our courts, a limited application is

proposed. Section 76(4) without doubt has sound elements which are to be welcomed,

567 Ibid. 568 Leach Avoiding the American Mistakes 53. 569 See Ch 6 para 6.3.

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but there are also elements which can be improved. This I attempt to highlight when I

submit recommendations in Chapter 6 informed by comparisons made in this chapter.570


SOUTH AFRICAN BUSINESS JUDGMENT RULE

The table below provides a summary of the legal requirements and application of the

South African statutory formulation of the business judgment rule.

Table 3:

Legal Requirements Companies Act 71 of 2008, section 76(4)

Business judgment The rule will not only apply to business judgments, but

to any particular matter arising in the exercise of the

powers or the performance of the functions of

directors.571

Informed business

judgment

Directors must take “reasonably diligent steps” to

become informed.572



company

Directors must have a “rational basis” for believing

that the decision was in the best interest of the

company.574


Personal interest Limited to personal “financial” interest of directors or

“related persons”.576

Alternatively, provision is made for disclosure of the

personal “financial” interest under section 75(5).577 No

need for disclosure when the decision is made unless

the interest has changed. In accordance with section

75(4) historical disclosure is in order.578

570 Ibid. 571 See para 5.5.2.1 (a). Section 76(4)(a) of the Companies Act 71 of 2008. 572 See para 5.5.2.1 (b). Section 76(4)(a)(i) of the Companies Act 71 of 2008. 573 See para 5.5.2.1 (b). 574 See para 5.5.2.1 (c). Section 76(4)(a)(iii) of the Companies Act 71 of 2008. 575 See para 5.5.2.1 (c). 576 See para 5.5.2.1 (d). Section 76(4)(a)(ii) of the Companies Act 71 of 2008. 577 See para 5.5.2.1 (d). Section 75(5) of the Companies Act 71 of 2008. 578 See para 5.5.2.1 (d). Section 75(4) of the Companies Act 71 of 2008.

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The personal financial interest must be “material”579

Application of the



purpose

Section 76(4) does not apply to the fiduciary duties to

act in good faith and for a proper purpose.580

Director’s duties Section 76(4) only applies to the fiduciary duty to act

in the best interest of the company and the duty of

care.581

Common law Section 76(4) does not apply to common-law duties of

directors.582

Directors and officers Section 76(4) applies to both directors and prescribed

officers.583

Safe harbour or

presumption

Section 76(4) applies as a safe harbour.584

Burden of proof In in not clear-cut but it seems that directors bear the

burden of proving that they have met the requirements

of section 76(4).585

Abstention, immunity

doctrine and standard of

review.

Abstention doctrine Section 76(4) is not applied as an abstention

doctrine.586

Immunity doctrine Section 76(4) is applied as a safe harbour which is

integral to immunity doctrine.587

Standard-of-liability test Section 76(4) is not applied as a standard-of-liability

test.588

5.7 CONCLUSION

This chapter has presented an overview of the history of South African company law.589

The different types of directors were discussed taking into account the fact that directors’

579 See para 5.5.2.1 (d). 580 See para 5.5.2.2 (a). Section 76(4)(a) of the Companies Act 71 of 2008. 581 See para 5.5.2.2 (b). Section 76(4)(a) of the Companies Act 71 of 2008. Section 76(3)(b) and (c) of the

Companies Act 71 of 2008. 582 See para 5.5.2.2 (c). Section 76(4) of the Companies Act 71 of 2008. 583 See para 5.5.2.2 (d). 584 See para 5.5.2.2 (e). 585 See para 5.5.2.3. 586 Ibid. 587 Ibid. 588 Ibid. 589 See para 5.2.

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duties have been partially codified by the Companies Act 71 of 2008.590 A discussion of

the fiduciary duty to act in the best interest of the company was included as, with the

duty of care, it is included under the application of section 76(4) in its current form.591

It was established that directors’ duties in South Africa currently derive from the

common law and their partial codification in section 76(3) of the Companies Act,

2008.592 It was also shown that additional duties are placed on directors by sections 75

(disclosure of personal financial interest) and 76(2) (not to use information gained to

gain a personal advantage or cause harm to the company).593 It emerged that the

Companies Act, 2008, does not formally recognise the interests of stakeholders other

than those of the collective shareholders.594 It was, however, shown that there are certain

provisions in the Companies Act, 2008, which allow for a wider consideration of

interests.595

The common-law duty of care was examined.596 Initially, South Africa followed the

same lenient approach as the UK pre-1990.597 Directors were only liable for a breach of

their duty of care if they had been grossly negligent. It was shown that the South African

courts originally followed the subjective standard in determining whether directors had

breached their duty of care.598 In later years, however, there was a shift away from the

590 See para 5.3. S 76(3) of the Companies Act 71 of 2008. See para 5.4.2.3. 591 See para 5.4. 592 Ibid. 593 See ss 75 and 76(2) of the Companies Act 71 of 2008. See para 5.4.1. 594 See para 5.4.1. The debate is between the “stakeholder approach” and the “enlightened shareholder value

approach”. 595 See para 5.4.2.3; s 7(a) and (b) in Ch 2 of the Constitution of the Republic of South Africa, 1996; and ss 163

and 165 of the Companies Act 71 of 2008. 596 See para 5.4.2.1. 597 Ibid. See also Ch 3 para 3.3. 598 See para 5.4.2.1. See also Fisheries Development Corporation of SA Ltd v Jorgensen & Another; Fisheries

Development Corporation of SA Ltd v AWJ Investments (Pty) Ltd & Others 1980 (4) SA 156 (W).

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subjective approach to a dual objective/subjective standard for review. This move was

illustrated with reference to case law.599 Directors who failed to observe their duty of

care could be held liable to the company in delict for any loss suffered as a result of their

failure.

It was shown that sections 423 to 426 of the Companies Act, 1973, placed certain

restraints and requirements on directors.600 These were briefly discussed.601

The recommendations emanating from the King Reports as regards the codification of

directors’ duties and the inclusion of a statutory business judgment rule were then

examined.602 King I recommended the codification of directors’ duties and also made

certain recommendations closely related to the business judgment rule.603 King II

provided guidelines for directors in performing their duties of care, skill, and diligence

and laid down certain requirements for the acquisition of knowledge, expertise, and an

understanding of the company affairs.604 King II further stated that directors should not

be held liable for mere errors in judgment and explained that the business judgment rule

meant that shareholders should not be entitled to damages by reason of judgment calls,

unless they had failed to exercise business judgment on an informed basis, with no

conflict of interest, and their decision was rational.605 King III made no recommendations

regarding the business judgment rule, but provided some guidance on the standard of

care and skill required of directors.606 Subsequently, King IV having regard to the

599 See para 5.4.2.1. See also Howard v Herrigel & Another NNO 1991 (2) SA 660 (A); Philotex (Pty) Ltd &

Others v Snyman & Others 1998 (2) SA 138 (SCA); and S v Van As 1976 (2) SA 921. 600 See para 5.4.2.2.1. 601Ibid. 602 See para 5.4.2.2.2. 603 See para 5.4.2.2.2 (a). 604 See para 5.4.2.2.2 (b). 605 Ibid. 606 See para 5.4.2.2.2 (c). See also King III para 4.

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anticipated partial codification of directors’ duties and inclusion of the rule in the

Companies Act, 2008, also made no recommendations on the business judgment rule,

nor did it address directors’ duties in any detail. It did, however, state that company

governance includes that directors should act with due care, skill, and diligence, in good

faith, and in the best interests of the company.607

The case of Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd608

was discussed and special emphasis was placed on its potential consequences for

directors’ duties. It was argued that this case could lead to a situation in which directors

could find themselves liable for a breach of duty under King IV. This is significant in that

King IV applies to all companies and not only to listed companies. In addition, the

business judgment rule does not apply to common-law duties, thus directors will have

no protection for breaches of their common-law duties not included in the Companies

Act, 2008, which will include obligations and duties placed on the by King Reports.609

The guidelines provided by the Department of Trade and Industry were then considered.

The Policy Paper recommended the codification of directors’ fiduciary duties and the

duty of care. It further implied that there was no need for a statutory business judgment

rule as South Africa is not a litigious society.610

The Companies Act, 2008, partially codified directors’ duties and included a statutory

business judgment rule.611 The codified directors’ duty of care preserve both the

607 See para 5.4.2.2.2 (d). See also King IV para 29. 608 Minister of Water Affairs and Forestry v Stilfontein Gold Mining Co Ltd 2006 (5) SA 333 (W). 609 See para 5.4.2.2.2 (c). 610 See para 5.4.2.2.3. Policy Paper 40. 611 See paras 5.4.2.3 and 5.5. Sections 76(3) (partial codification of directors’ duties) and 76(4) (statutory business

judgment rule) of the Companies Act 71 of 2008.

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subjective and objective elements of the common law.612 It was argued that, in contrast

to the common law the statutory position would set a minimum objective standard in

addition to a subjective standard, which could raise the standard of care and skill required

of directors.613 Some comparisons were then drawn between the duty of care in the

different jurisdictions.614

The chapter then discussed, the business judgment rule.615 First, some arguments for and

against a statutory business judgment rule were examined.616

The statutory business judgment rule was then analysed under different headings. First

the legal requirements for the rule were discussed and its application was illustrated.617

It was indicated that the South African business judgment rule applies not only to

business decisions but to any matter arising in the exercise of the powers or the

performance of the functions of directors – all that is required under section 76(4) is a

decision by directors or the support of a decision by a committee of the board.618 As a

result, the South African business judgment rule possibly has a wider application than

the equivalent rules in the US and Australia, which is not ideal.

In order to comply with the requirements for the business judgment rule, directors need

to inform themselves on the subject matter before taking a decision.619 They must further

take reasonably diligent steps to become informed. A reasonable-person test is applied

612 See para 5.4.2.3. 613 Ibid. 614 Ibid. 615 See para 5.5. 616 See para 5.5.1. 617 See paras 5.5.2.1 and 5.5.2.3. 618 See para 5.5.2.1 (a). Section 76(4) of the Companies Act 71 of 2008. 619 See para 5.5.2.1 (b). Section 76(4)(a)(i) of the Companies Act 71 of 2008.

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as the standard of review under section 76(4)(a)(i).620 This section determines that the

business judgment rule will apply if directors have taken “reasonably diligent steps” to

become informed about the subject matter of the decision – an objective standard of

review.621

Section 76(4)(a)(iii) establishes that directors must have a rational basis for believing

that the decision they took was in the best interests of the company.622 The test for

rationality is objective. It was consequently submitted that there is no subjective standard

of review in section 76(4), in contrast to section 76(3).623 Section 76(3) has both a

subjective and objective standard of review. It was pointed out that the South African

business judgment rule was based largely on the ALI business judgment rule which

follows both an objective/subjective standard of review. It was further argued that the

South African rule requires a lower standard of review than the ALI and the rule in

Australia.624 It was queried why the legislature would deviate from the ALI version by

lowering the standard of review. An argument was made that lowering the standard of

review was unnecessary as South Africa – as opposed to the US – is not a litigious

society. It was discussed that South Africa has a regulator, namely the CIPC, but that it

has very limited control over the corporate environment as opposed to the powers

afforded to ASIC in Australia.625

The last legal requirement for the South African business judgment rule is that directors

must not have any material personal financial interest in the subject matter, or in the

620 See para 5.5.2.1 (b). 621 Ibid. 622 See para 5.5.2.1 (c). Section 76(4)(a)(iii) of the Companies Act 71 of 2008. 623 See para 5.5.2.1 (c). Section 76(3) of the Companies Act 71 of 2008. 624 See para 5.5.2.1 (c). 625 Ibid.

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alternative, should disclose their personal financial interests as required by section 75.626

Section 75(4) allows directors to disclose a financial interest in advance.627 This could

pose a problem in so far as directors may appeal to section 76(4) even though they had a

financial interest in a decision, but they had not formally declared that conflict of interest

at the relevant board meeting where the decision was taken.628 It was shown that section

76(4)(a)(ii) only provides that directors should disclose personal “financial” interests in

the subject matter of the decision, which is a concern.629 No “other” interest in the subject

matter would thus be included under this requirement.630 Although section 76(4)(a)(ii)

is limited in its application, it does extend the application not only to directors’ personal

financial interests, but also to their knowledge of a related persons’ personal financial

interests.631 In respect of the latter, the personal financial interests must be material.

Should the personal financial interest be classified as not material, directors would still

be protected under the business judgment rule.

The chapter then turned to a discussion of how the South African business judgment rule

is applied.632 The South African business judgment rule does not require that the decision

must have been made in good faith and for a proper purpose. The scope of section 76(4)

has been clearly defined to apply only to section 76(3)(b) – the fiduciary duty to act in

the best interest of the company – and not to all fiduciary duties.633 Directors will only

enjoy the protection of the business judgment rule for a breach of their fiduciary duty to

act in the best interest of the company and their duty of care. Omitting good faith and

626 See para 5.5.2.1 (d). Section 75 of the Companies Act 71 of 2008. 627 Section 75(4) of the Companies Act 71 of 2008. 628 Ibid. 629 Section 76(4)(a)(ii) of the Companies Act 71 of 2008. 630 See para 5.5.2.1 (d). 631 Ibid. 632 See para 5.5.2.2. 633 Section 76(3)(b) of the Companies Act 71 of 2008.

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proper purpose from section 76(4) is in my view, a step in the right direction in resolving

the issue of maintaining directors’ duty of care and the fiduciary duties as two separate

concepts in law.634

One posed the question whether the inclusion of section 76(3)(b) would blur the

distinction between these concepts in law. It was argued that each concept has a different

cause of action. On the one hand, the cause of action for a breach of directors’ fiduciary

duties is a claim for breach of trust. In contrast, the cause of action for a breach of the

duty of care lies within the law of delict.635 In terms of the Companies Act, 2008, a breach

of the fiduciary duty may lead to liability under section 77(2)(a), while a breach of

section 76(3)(c) may lead to liability under section 77(2)(b)(i).636 It could therefore be

argued that these two concepts remain distinct. Although an argument can be made that

the distinction between these concepts has not been blurred by section 76(4), it remains

my view that the business judgment rule should have limited application, and it was

recommended that the legislature remove the fiduciary duty to act in the best interests of

the company from section 76(4).637

It was submitted that the South African business judgment rule does not apply to the

common-law duties of directors, save for those that are now codified.638 Section 76(4)

therefore has limited application in this regard which, in my view, is correct. This will

634 See para 5.5.2.2 (a). 635 See para 5.5.2.2 (b). 636 Section 77(2)(a) of the Companies Act 71 of 2008 allows for liability to include any loss, damage or costs

sustained by the company as a result of any breach in accordance with common-law principles regarding the

breach of fiduciary duties. Section 77(2)(b)(i) of the Companies Act 71 of 2008 states that a breach of section

76(3)(c) will lead to liability for a director in accordance with the common-law of delict. 637 See para 5.5.2.2 (a). 638 See para 5.5.2.2 (c). Section 76(3)(b) & (c) of the Companies Act 71 of 2008.

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ensure that South Africa will not experience the difficulties that faced the US with the

application of the business judgment rule.639

The Companies Act, 2008, imposes the same obligations on prescribed officers as on

directors.640 Both directors and prescribed officers will also have protection under the

statutory business judgment rule.

It was further indicated that the South African business judgment rule functions as a safe

harbour as opposed to a presumption.641 The court will presume that in making a business

decision, directors of a company acted on an informed basis, in good faith, and with a

rational basis, and that the act or omission was in the best interests of the company.642

The court will not disturb the decision itself, provided that it can be attributed to a rational

business purpose. Is it therefore not a presumption in favour of directors but rather

creates a safe harbour for directors.643 The substantive aspect of the rule requires the

court to defer to a business judgment made by directors, provided that their decision is

not completely irrational. Judicial review of the merits of the decision is prevented and

the decision cannot be challenged.644 The criterion used to determine rationality is an

objective one, and the threshold differs from, and is more easily satisfied than, a

determination as to whether the decision was objectively in the best interests of the

company.645 Section 76(4)(a)(iii) thus reduces the standard of review to rationality rather

639 See para 5.5.2.2 (c). See Ch 2 paras 2.4 and 2.5. 640 Section 76(1)(a) of the Companies Act 71 of 2008. 641 See para 5.5.2.2 (e). 642 See para 5.5.2.2 (e). Section 76(4) of the Companies Act 71 of 2008. 643 See para 5.5.2.2 (e). 644 Ibid. 645 Ibid. Van Tonder (2015) 36 Obiter 723.

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than reasonableness by requiring directors merely to have a rational basis for believing

that their decision is in the best interests of the company.646

The business judgment rule can be applied in three different ways. First, as an abstention

doctrine, where the challenging party must carry the burden of proving that the directors

violated their duty in some way.647 The burden of proof will however shift if a plaintiff

shows that a majority of the directors have a personal interest in the transaction.648 It was

argued that the South African business judgment rule is not applied as an abstention

doctrine for various reasons.649

The second application, is the standard-of-liability test.650 This test requires some

objective review of the merits of the board’s decision and consequently the plaintiffs will

be able to shift the burden of proof if they can establish the existence of certain

conditions, such as fraud, illegality, self-dealing, or lack of decision by the board.651 The

wording of section 76(4) does not require an enquiry into the merits of the business

decision. Based upon this and the other reasons discussed, it was argued that the South

African business judgment rule does not apply as a standard-of-liability test.652

Thirdly, the business judgment rule can be applied as an immunity doctrine which

insulates directors from liability resulting from bad decisions provided that the

prescribed requirements are met.653 The immunity doctrine is applied as a safe harbour

646 See para 5.5.2.2 (e). 647 See para 5.5.2.3. 648 Ibid. 649 Ibid. 650 Ibid. 651 Ibid. 652 Ibid. 653 Ibid.

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and not a presumption.654 The business judgment rule, in accordance with the safe

harbour application, will protect directors from liability if they make a business decision

whilst meeting the requirements of the business judgment rule. If the conditions for a

safe harbour are met, the standard of conduct will have been satisfied without further

judicial inquiry and directors will be safe from liability.655 The immunity doctrine

requires no examination into the merits of the decision as under the standard-of-liability

test, and also not whether the directors breached their duties. It was argued that the South

African business judgment rule resembles the immunity doctrine and reasons were

provided.656

In Chapter 6, some important comparisons will be made between the business judgment

rule in the different jurisdictions, and a number of recommendations will be made in an

attempt to improve the application of the rule in South Africa.657

654 See Ch 1 paras 3 and 5.5.2.2 (e). 655 See para 5.5.2.3. 656 Ibid. 657 See Ch 6 para 6.3.

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CHAPTER 6

CONCLUSION AND RECOMMENDATIONS

__________________________________________________

6.1 INTRODUCTION

This chapter draws on a comparison of the business judgment rule between the US,

Australia and South Africa. As has been confirmed in the study, the US has two versions

of the rule. These will form the foundation of the comparison between and among the

other jurisdictions.1 The comparisons drawn reveal both differences and similarities

between the versions of the business judgment rule in the three jurisdictions.2 It is argued

that although there is definite room for improvement of section 76(4) of the Companies

Act, 2008, the latter section also has positive elements.3

Before comparisons are drawn regarding the different elements of the business judgment

rule, comparisons will be made of the different ownership structures of the jurisdiction

and whether they have followed the shareholder primacy, director primacy or the

stakeholder primacy models.4 The agency cost problems that the different jurisdictions

are faced with due to the type of ownership structure used, will also be compared.5 This

is relevant in order to comprehensively determine the relevance of the business judgment

rule in the different jurisdictions. Although the UK did not include a statutory business

judgment rule in the Companies Act, 2006, and there are no comparisons that can be

1 See Ch 2 paras 2.4.4.1 and 2.4.4.2; Ch 4 para 4.5; and Ch 5 para 5.5. 2 See para 6.3. 3 Section 76(4) of the Companies Act 71 of 2008. 4 Ch 2 para 2.4.3.2, Ch 3 para 3.5, Ch 4 para 4.4, Ch 5 para 5.4.1. 5 Ch 2 ibid, Ch 3 ibid, Ch 4 ibid, Ch 5 ibid.

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drawn regarding the rule, it is still significant to compare the UK model relating to the

different ownership structures, shareholder models and agency cost problems.6

The chapter will then move to compare the elements of the business judgment rule in the

different jurisdictions. First, the legal requirements set for the rule will be compared

(business judgment, informed business decision, best interests of the company, and

personal interest).7 These legal requirements must be met before directors can receive

protection from the business judgment rule. There are some similarities and differences

in the different jurisdictions regarding the requirements of the business judgment rule.

These similarities and differences will be compared below.8 The traditional business

judgment rule is often described as a presumption that in making a business decision the

directors of a corporation act on an informed basis, in good faith, and in the honest belief

that the action taken is in the best interests of the company.9

Second, the application of the business judgment rule will be compared (good faith and

proper purpose, directors’ duties, the common law, directors and officers, and safe

harbour or presumption).10 To ensure a comprehensive comparison between the different

jurisdictions it is important to know how the business judgment rule is applied. Each

different jurisdiction has different applications of the business judgment rule. Some

jurisdictions, for example, include good faith and proper purpose in their application of

the business judgment rule whilst others partially or completely omit it.11 Another

example is that the business judgment rule does not apply to all director’s duties in all of

6 Ch 3 para 3.5. 7 See para 6.3.1. 8 Ibid. 9 See Ch 2 para 2.4.4.1. 10 See para 6.3.2. 11 Ch 2 para 2.4.4.1 and 2.4.4.24, Ch 4 para 4.5 and Ch 5 para 5.5.2.2 (a).

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the jurisdictions considered. In some jurisdictions the business judgment rule will apply

to both directors’ fiduciary duties and their duty of care whilst others will only apply to

directors’ duty of care.12

The main aim of this chapter is to make recommendations in an attempt to improve/refine

the formulation of the current section 76(4).13 These recommendations are based on the

comparisons drawn between the jurisdictions examined. I have endeavoured to draw

guidance from the other jurisdictions’ formulation of the business judgment rule.

Necessarily, the purpose of the comparison is to find an easier way to determine whether

or not directors are protected by the rule against liability where they breach their duty to

act in the best interests of a company (s 76(3)(b)) and their duty of care (s 76(3)(c)).14

The recommendations are also aimed at pre-empting problems similar to those

experienced in the US in distinguishing between directors’ fiduciary duties and their duty

of care. This is of importance because the South African business judgment rule applies

to both the directors’ statutory fiduciary duty to act in the best interest of the company,

and the statutory directors’ duty of care.15 This new section 76(4) will limit the

application of the business judgment rule and clarify how the South African business

judgment rule is to be applied by courts. In so doing, I submit, have realised the purpose

of this study as outlined in Chapter 1.

A summary of the comparisons drawn between the business judgment rule in the different

jurisdictions is provided in the form of a table, for ease of reference.16

12 Ch 2 ibid, Ch 4 ibid; Ch 5 para 5.5.2.2 (b). 13 See para 6.3. 14 Sections 76(3)(b) and (c) of the Companies Act 71 of 2008. 15 Ch 5 paras 5.4.1 and 5.4.2.3. 16 See para 6.4.

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6.2 COMPARISON OF THE OWNERSHIP STRUCTURES,

SHAREHOLDER MODELS AND AGENCY COST PROBLEMS

Most publicly traded companies in the US, especially larger ones, have a dispersed

shareholding, also known as “dispersed ownership structure”.17 There is a lack of a

dominant shareholder and investors have typically taken a “hands off” approach to

corporate affairs.18 This arrangement has created risks that corporate executives will

exploit the discretion they have and impose a vertical agency cost problem for

shareholders.19 This agency cost problem involves, the conflict between the company’s

shareholders and its hired management.20 Here the shareholders are the principals and

management are the agents.21 In the US, the obligation of the board is to maximise the

profit of the corporation for the benefit of the shareholders. This is known as the

shareholder primacy model.22 Shareholders essentially have no power to initiate

corporate actions and are entitled to approve or disapprove only a very few board

actions.23 In Delaware for example, shareholder voting rights are essentially limited to

the election of directors, mergers, sale of substantially all the assets of the corporation,

voluntary dissolution, and approval of charter or bylaw amendments.24 This is in contrast

to the shareholder primacy model followed by the UK, Australia, and South Africa.25

The shareholder primacy model encompasses the shareholder wealth maximisation

norm, but adds to its control claims.26 Shareholder primacy contends not only that

17 Ch 2 para 2.4.3.2. 18 Ibid. 19 Ibid. An agency cost problem arises for example, whenever the welfare of one party, termed the “principal”

depends upon actions taken by another party, termed the “agent”. See Kraakman Anatomy of Corporate Law 21. 20 See Ch 2 para 2.4.3.2. 21 Ibid. 22 Bainbridge “Director v. Shareholder Primacy in the Corporate Debate” 47. 23 Ibid. 24 Ibid. 25 See Ch 2 para 2.4.3.2, Ch 3 para 3.5, Ch 4 para 4.4 and Ch 5 para 5.4.1. 26 Bainbridge “Director v Shareholder Primacy in the Corporate Debate” 47.

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shareholders are the principals on whose behalf corporate governance is organised, but

also that shareholders exercise unlimited control of the corporate enterprise.27 Hence, for

example, shareholder primacy assumes shareholder voting rights are both exclusive and

strong.28 It may therefore be argued that the need for a business judgment rule in the US

is stronger due to the power, and ultimately the risk, vested in US directors.

It has been shown that for decades, the separation of ownership and control has been a

hallmark of UK corporate governance.29 Most publicly traded companies in the UK,

especially larger ones, have a dispersed shareholding, also known as “dispersed

ownership structure”.30 As in the US, there is a lack of a dominant shareholder, and

investors have typically taken a “hands off” approach to corporate affairs.31 This

arrangement has created risks that corporate executives will exploit the discretion they

have and create a vertical agency cost problem for shareholders.32 There is, however,

protection for shareholders which can alleviate the agency cost problem. Shareholders in

the UK have the right to ratify conduct by a director amounting to negligence, default,

breach of duty, or breach of trust in relation to the company.33 The decision of the

company to ratify such conduct must be made by resolution of the members of the

company, which includes the shareholders.34 Shareholders, therefore, have an

opportunity to either reject or approve conduct of a director who has breached his or her

duties. This allows some measure of power for shareholders to control the company. In

the UK the board of directors is responsible for the governance of the company and it

27 Bainbridge “Director v Shareholder Primacy in the Corporate Debate” 47. 28 Ibid. 29 Ch 3 para 3.5. 30 Ibid. 31 Ibid. 32 Ibid. 33 Ibid. Section 239(1) of the Companies Act, 2006. 34 Section 239(1) of the Companies Act, 2006.

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therefore has the power to manage the company. However, shareholders have the power

to appoint directors and auditors.35 Shareholders therefore have the power to select the

best candidates to become directors which further alleviates the agency cost problem.

The UK follows the “shareholder primacy” model. This model holds that it is a director’s

duty to maximise the wealth of a company for the benefit of shareholder welfare.36 In

recent years, the UK has introduced a framework known as “enlightened shareholder

value” which sits somewhere between shareholder primacy and stakeholder primacy.37

Although the enlightened shareholder value approach provides for the protection of

shareholders, other stakeholders’ interests are also considered – although they remain

subordinate to those of the shareholders.38

Taking into consideration the agency cost problem regarding the conflict between

shareholders and management, it can be argued that a statutory business judgment rule

should be considered. It was, however, clear throughout the company law review process,

that the strongest argument against a statutory business judgment rule was that

historically courts have adopted a policy of not reviewing commercial decisions or

judging directors with the wisdom of hindsight, and that there was no indication that the

courts would change this policy.39 There was nothing to suggest that this long-established

judicial approach of non-interference would not continue and the recommendation was

accordingly not to include a statutory business judgment rule.40 The research indicates

35 Section 239(1) of the Companies Act, 2006. The Financial Reporting Council: The UK Corporate

Governance Code, 2018 4. 36 See Ch 3 para 3.5. 37 Ibid. 38 Ibid. 39 Ch 4 para 4.4. 40 The Law Commission and the Scottish Law Commission 53.

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that no strong argument was made for the inclusion of the business judgment rule in the

UK.41

In Australia it is most common for publicly traded companies to have controlling

blockholders, known as a “blockholder system”.42 The “blockholder system” can give

rise to the agency problem which involves the conflict between, on the one hand,

shareholders who hold the majority controlling shares, and on the other hand, minority

shareholders.43 The shareholders holding the minority of the votes, may have little, if

any, control and/or influence over the direction and development of a company. Minority

shareholders in Australia are, however, protected against oppression by majority

shareholders. Section 233 of the Corporations Act, 2001, provides for numerous

remedies on which minority shareholders may rely.44 The court can, for example, issue

any order under this section which it considers appropriate in relation to the company,

including an order: 1) regulating the conduct of the company's affairs in the future; 2)

for the purchase of any shares by any member or person to whom a share in the company

has been transmitted by will or by operation of law; 3) for the purchase of shares with

an appropriate reduction of the company's share capital, etcetera.45 Blockholders can

play an important part in managing directors. Blockholders can govern through “exit”

(“selling or threatening to sell shares”) and “voice” (“direct intervention in a firm’s

operations”).46 Blockholders, therefore, have more control over directors, which may

have promoted the existence of the statutory business judgment rule.47 As in the UK and

41 Horrigan Corporate Social Responsibility 220; Kershaw Company Law in Context 474; Birds (2002) Reform

of the United Kingdom Law 174; and Keay Directors’ Duties 213. 42 See Ch 4 para 4.4. 43 Kraakman Anatomy of Corporate Law 22. 44 Ibid. 45 Kraakman Anatomy of Corporate Law 22; Section 233 of the Companies Act, 2001. 46 Kraakman Anatomy of Corporate Law 22; Edmans & Holderness “The Role of Blockholders in Governance”

https://voxeu.org/article/role-blockholders-governance (accessed: 06/02/2020). 47 Ibid.

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South Africa, Australia follows the “shareholder primacy” model.48 As discussed in

Chapter 3, the “shareholder primacy” model holds that it is a director’s duty to maximise

the wealth of a company for the benefit of shareholder welfare.49 The legal basis of

shareholder primacy is deeply embedded in our corporate law model. Australian

shareholders normally have the right to appoint directors,50 and in public companies they

have the inalienable right to remove the directors without cause.51 Thus, they have

practical control over the board as a company organ. It is also the shareholders who have

the inalienable right to amend a company’s constitution (if one was adopted),52 or to

adopt one by way of a special resolution if the company did not adopt one on

incorporation.53 Given the blockholders’ control over directors and the rights bestowed

on Australian shareholders, it may be argued that directors will not necessarily have

protection under the business judgment rule, especially taking into consideration the

right shareholders have to remove directors without cause.54

Due to the lack of dispersed shareholding, South Africa, like Australia, follows a

blockholder system.55 South Africa therefore also faces the agency cost problem

regarding the conflict between majority and minority shareholders. Section 163 of the

Companies Act, 2008, provides relief for prejudiced minority shareholders.56

48 See Ch 3 para 3.5 and Ch 5 para 5.4.1. 49 See Ch 3 para 3.5. 50 Ch 4 para 4.4. S 120G of the Corporations Act, 2001. 51 The Corporations Act, 2001 s 203G. 52 The Corporations Act, 2001 s 136(2). 53 The Corporations Act, 2001 s 136(1)(b). 54 Ch 4 para 4.4. 55 Ch 5 para 5.4.1. 56 Ch 5 para 5.4.1; Section 163 of the Companies Act 71 of 2008 applies to both shareholders and directors.

Interestingly s 163 does not state that it must be a minority shareholder who may apply, but rather that any

shareholder may make use of s 163. There is a similar provision in s 233 of the Corporations Act, 2001. It

however applies only to shareholders and not directors. See Ch 4 para 4.4.

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Another agency cost problem is the conflict between shareholders and the board of

directors. As discussed in the Australian chapter, blockholders can play an important

part in managing directors. Blockholders can govern through “exit” and “voice”.57

Blockholders therefore have considerable control over directors. In Australia,

shareholders have control of the company.58 In South Africa the situation differs.

Shareholders no longer have original decision making power.59

Section 66(1) of the Companies Act, 2008, provides that the business and affairs of the

company must be managed by or under the direction of its board of directors, which has

the authority to exercise all of the powers and perform all of the functions of the

company, except to the extent that the Companies Act, 2008, or the company’s

Memorandum of Incorporation provides otherwise.60 The power to manage the company

therefore lies with the board and not the shareholders.61 This is of significance since

shareholders will not have the right at common law to ratify any actions of the board,

unlike their UK counterparts, beyond their authority, except to the extent that it is

permitted by the Companies Act, 2008, or the Memorandum of Incorporation explicitly

provides otherwise.62 Section 66(1) may be problematic for companies with dispersed

shareholding as the board of directors will have ultimate control and other rights and

remedies provided for in the Companies Act, 2008, will not necessarily apply to them.63

It was argued that given the blockholders’ control over directors and the rights bestowed

on Australian shareholders, there may not be a need for protection from a business

57 Ch 4 4.4. 58 Ibid. 59 Ch 5 para 5.4.1. 60 S 66(1) of the Companies Act 71 of 2008. 61 Ch 5 para 5.4.1. 62 Ch 3 para 3.5 and Ch 5 para 5.4.1. Section 20(1) of the Companies Act 71 of 2008. 63 Ch 5 para 5.4.1.

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judgment rule. Although South Africa also follows the blockholder system, the ultimate

control and risk of the company vests in the board of directors. Because the “control of

the company rests with the board” an argument which favours the incorporation of the

business judgment rule in the South African context, as opposed to the position in

Australia, finds support. It thus makes sense to have included the rule in the Companies

Act 2008 due to the increased risks directors have statutorily been made to face.64

6.3 JURISDICTIONAL COMPARISONS OF THE PROTECTION THE

BUSINESS JUDGMENT RULE OFFERS AND

RECOMMENDATIONS

Certain legal requirements must be met before directors can enjoy the protection of the

business judgment rule. This part summarises both the similarities and differences set out

in each chapter discussion of the countries forming part of this study. It dissects the

different requirements these countries have judicially determined to satisfy the rule.

These similarities and differences are compared below.

6.3.1 Legal requirements

6.3.1.1 Business judgement

In Chapter 2 we saw that the US has two formulations of the business judgment rule65 –

the Delaware; and the ALI formulations.66 Both these formulations specifically require

that a “business decision” be made in order for the rule to apply.67 In Aronson v Lewis68

the Delaware business judgment rule69 was formulated as a presumption that, in making

a “business decision”, the directors of a corporation act on an informed basis, in good

64 See discussion of the statutory business judgment rule in ch 5 para 5.5. 65 See Ch 2 paras 2.4.4.1 and 2.4.4.2. 66 Ibid. 67 Ibid. 68 Aronson v Lewis 473 A2d 805, 813 (Del 1984). 69 Aronson v Lewis 473 A2d 805, 813 (Del 1984) 813. See Ch 2 para 2.4.4.1.

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faith, and in the honest belief that the specific action is in the best interests of the

corporation.70 The ALI’s formulation of the business judgment rule is found in section

4.01(c) of the ALI Principles.71 Section 4.01(c) provides that: “A director who makes a

‘business judgment’ in good faith….” meets the requirements of the rule.72 In the US

directors will not be protected by the business judgment rule unless an actual or a

conscious business decision has been made.73

In Australia the business judgment rule is codified in section 180(2) of the Corporations

Act, 2001.74 Section 180(2) provides that: “A director or other officer of the corporation

who makes a ‘business decision’ is taken to meet the requirements…”.75 Australian

directors are accordingly only protected by the rule if they make a business decision. A

“business decision” is defined in section 180(3) of the Corporations Act, 2001. Section

180(3) provides that “business judgment” means any decision to take or not take action

in respect of a matter relevant to the business operations of the corporation.76 In ASIC v

Rich, the court found that the phrase “relevant to the business operations of the

corporation” in section 180(3) must be interpreted broadly77 and that in order to qualify

as a business judgment, a “matter” need not be limited to a business-specific issue in

itself, but includes, for example, the sale of a company to a third party.78 The important

70 Aronson v Lewis 473 A2d 805, 813 (Del 1984) 813. 71 See Ch 2 para 2.4.4.2. Section 4.01(c) of the American Law Institute Principles of Corporate Governance:

Analysis and Recommendations, 1992. 72 Section 4.01(c) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations, 1992. 73 See Ch 2 para 2.5. See also Aronson v Lewis 473 A2d 805, 813 (Del 1984); TW Service Incorporated v SWT

Acquisition Corporation CA No 10427 (Del Ch 1989); and American Law Institute Principles of Corporate

Governance: Analysis and Recommendations, 1992, s 4.0 (c). 74 See Ch 4 para 4.5.1. Section 180(2) of the Corporations Act, 2001. 75 Section 180(2) of the Corporations Act, 2001. 76 There is no definition of a “business decision” in the South African Companies Act, 2008, similar to s 180(3)

of the Australian Corporation Act, 2001. See Ch 4 para 4.5.2. 77 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7276. 78 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7272.

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element, according to Judge Austin, is the need for a conscious decision – that is to say,

whether or not the directors or officers in fact applied their minds to the matter.79

The South African version of the business judgment rule in section 76(4) of the

Companies Act, 2008, has a wider application of the legal requirement of the rule that a

business decision must have been made than the US and Australia.80 Section 76(4)

provides that the rule will apply: “In respect of ‘any particular matter’ arising in the

exercise of the powers…”.81 Therefore, when it comes to the type of decisions made,

South African directors enjoy wider protection under the rule than their counterparts in

the US and Australia.

Section 76(4) makes no mention of a “business decision”, electing instead to refer to

“any particular matter arising”. The words have an implied connotation that directors

need not make a decision at all. However, in my view, this is not what the legislator

intended. There are a number of references to “decision” in section 76(4): section

76(4)(a)(ii)(aa) refers to “subject matter of the decision”; section 76(4)(a)(iii) refers to a

director who “made a decision” or “supported a decision” of a committee or the board

with regard to that matter; and also that the director had a rational basis for believing, and

did believe, that “the decision” was in the best interests of the company. The word

“decision” also appears in section 76(4)(a) and it can consequently be argued that it was

the intention of the legislator that a decision must have been made, related to the business

or any particular matter arising in the exercise of the director’s powers or in the

performance of the director’s’ functions.82

79 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7277. 80 See Ch 5 para 5.5. Section 76(4) of the Companies Act 71 of 2008. 81 Ch 5 para 5.5. 82 Ch 5 para 5.5.2.1 (a).

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It is unclear why the legislature extended the application of the rule to “any particular

matter”; there is no justification for so extensive an expansion. This is one of the reasons

why it is argued that the legislature intended to make it fairly easy for directors to meet

certain of the requirements of the rule. Directors in the US and Australia will only be

protected under the business judgment rule if they have made a business decision; in my

view, this is correct and corresponds to the purpose of the rule, which is to protect

directors from incurring liability for a breach of their duties when making business

decisions in good faith, without a conflict of interest, and in the best interests of the

company. The name in itself indicates that the rule applies to “business” decisions and it

is therefore unclear why the legislator opted to broaden the scope of the rule.83 Neither

the US nor Australia has deemed it necessary to broaden the application of the business

judgment rule to such an extent.84 South African directors, on the other hand, enjoy far

wider protection and will be protected for any action or decision whilst performing their

functions as directors.85

It is recommended that our courts take court rulings in the other jurisdictions into

consideration when interpreting the business judgment rule, and also apply the definition

of a “business decision” broadly to include all business operations. Section 5(2) of the

Companies Act, 2008, provides that to the extent appropriate, a court interpreting or

applying the Companies Act may consider foreign company law. There is consequently

no need to expand the application of the rule to the extent provided for in section

76(4)(a). It is therefore recommended that the section be amended to apply only to

“business decisions”. The first recommendation is that the section should be amended as

83 Ch 5 para 5.5.2.1 (a). 84 See Ch 2 para 2.4 and Ch 4 para 4.5. 85 See para 5.5.2.1 (a). Section 74(4)(a) of the Companies Act 71 of 2008.

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follows: the phrase “particular matter arising in the exercise of the powers or the

performance of the functions of a director” be deleted and the term “business judgment”

be inserted in its place. This will ensure a limited application of the business judgment

rule and align it with the intention of the legislature and purpose of the rule.86

6.3.1.2 Informed business judgment

The Delaware Supreme Court explained in Aronson v Lewis, that “directors have a duty

to inform themselves, prior to making a business decision, of all material information

reasonably available to them”.87 An objective standard of review is followed to establish

whether directors informed themselves of the subject matter of a decision. There is no

subjective element in this legal requirement of the Delaware rule.88 Although the

objective standard of review is a lower standard as opposed to the subjective standard,

the requirement remains that directors must inform themselves of the subject matter.89 If

directors do not do so, they forfeit protection under the business judgment rule.90

Directors need only inform themselves of all “material” information which is

“reasonably” available to them. If directors do not inform themselves of any non-material

information or material which was not “reasonably” at their disposal, they will be

protected under the Delaware business judgment rule. It should accordingly not be

difficult for directors to meet this requirement of the rule.91

86 See Ch 2 para 2.4.3 for a discussion of the rationales behind the business judgment rule. 87 Aronson v Lewis 473 A.2d 805, 812 (Del 1984) 812. See Ch 2 para 2.4.4.1. 88 Ch 2 para 2.4.4.1. 89 Ibid. 90 Ibid. See Smith v Van Gorkom 488 A 2d 858, 874-93 (Del 1985) for an example where the directors were found

personally liable for breach of their duties as they did not inform themselves of the subject matter of the decision. 91 Ch 2 para 2.4.4.1.

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The ALI formulation of the business judgment rule also requires directors to be informed

regarding the subject matter of the decision.92 The ALI rule, however, differs from the

Delaware rule in that a subjective, as opposed to an objective, standard of review is

followed.93 Section 4.01(c)(2) provides that directors must inform themselves of the

business judgment to the extent that “the director reasonably believes” to be appropriate

under the circumstances.94 This clearly embodies a subjective element as the test is

whether the directors themselves “reasonably believed” that they were adequately

informed on the subject matter. This is a higher standard of review than the purely

objective Delaware standard.95

Furthermore, the ALI formulation does not require directors to inform themselves only

of “material” information. In terms of the ALI formulation directors must inform

themselves of all information and not merely that which is “material”. Where the ALI

formulation of the business judgment rule is applied, it will be more difficult for directors

to meet this requirement than directors in Delaware.96

Section 180(2)(c) of the Australian Corporations Act, 2001, corresponds to the ALI

version of the business judgment rule in section 4.01(c)(2).97 Section 180(2)(c) provides

that directors should inform themselves about the subject matter of the judgment to the

extent that “they reasonably believe” to be appropriate. Again the test is whether directors

themselves reasonably believe that they are informed. The Australian business judgment

92 Section 4.01(c) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. See Ch 2 para 2.4.4.2. 93 Ch 2 para 2.4.4.2. 94 Section 4.01(c)(2) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. See Ch 2 para 2.4.4.2. 95 Ch 2 para 2.4.4.2. 96 Ch 2 paras 2.4.4.1 and 2.4.4.2. 97 Ibid. See Ch 4 para 4.5.1. Section 180(2)(c) of the Corporations Act, 2001.

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rule does not state that directors must inform themselves of “material” information.98

Directors in Australia will have to inform themselves of all information which they

reasonably believe to be appropriate and not “material” information only. Australian

directors will have the same level of difficulty in meeting this requirement as directors

under the ALI formulation.99

We saw in Chapter 5 that the South African business judgment rule is based largely on

the ALI formulation.100 The legislature, however, deviated from the ALI version in

section 76(4)(a)(i).101 The section provides that directors should take “reasonable diligent

steps” to become informed about the subject matter.102 Unlike the ALI and Australian

versions of the business judgment rule, an objective standard of review is followed as

opposed to a subjective test.103 It is unclear why the legislature decided to deviate from

the ALI formulation in this instance and adopt an approach similar to that of the Delaware

rule.104 The result, however, is that South African directors are more likely to meet this

requirement than directors in Australia or where the ALI formulation applies.105 This is

not ideal, taking into consideration that South African directors are not exposed to a

litigious society and there would appear to be no need to lower the standard of review to

facilitate their access to protection under the business judgment rule.

Section 76(4)(a)(i) does not, however, limit the information required to “material”

information. In this regard it corresponds to the Australian and ALI versions of the

98 Ch 4 para 4.5.1. 99 Ch 2 para 2.4.4.2 and Ch 4 para 4.5. 100 See Ch 5 para 5.5.2. 101 Section 76(4)(a)(i) of the Companies Act 71 of 2008. 102 Ch 5 para 5.5.2. 103 Ch 2 para 2.4.4.2, Ch 4 para 4.5 and Ch 5 para 5.5.2. 104 Ch 2 para 2.4.4.1 for a discussion of the Delaware rule. 105 Ch 2 para 2.4.4.2, Ch 4 para 4.5 and Ch 5 para 5.5.2.

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business judgment rule.106 South African directors will have to take reasonably diligent

steps to inform themselves on the subject matter relevant to the decision, whether the

information is material or not.107 Although the lower standard of review is used in

establishing whether or not directors have met this requirement, the requirement is

extended slightly by not limiting it solely to material information. Although this is a

sound formulation, there is still some room for improvement as regards the objective

standard of review section 76(4) prescribes for determining whether directors indeed

made an informed decision.

The second recommendation is that this portion of section 76(4) should be amended to

include a subjective standard of review as opposed to the current purely objective

standard. This will be in line with the heightened standard expected of directors in section

76(3)(c).108

It is recommended that section 76(4)(a)(i) be amended as follows: The phrase “the

director has taken reasonably diligent steps to become informed about the matter” should

be deleted and replaced by the phrase “the director must inform him- or herself on the

subject matter of the judgment to the extent he or she reasonably believes to be

appropriate”.109 This corresponds to the ALI and Australian versions which in my view

reflect the correct formulation.110 Directors will have to inform “themselves” of the

subject matter – a subjective enquiry – and not merely take reasonably diligent steps to

become informed on the subject matter. Amending section 76(4)(a)(i) to include a

106 Ch 2 para 2.4.4.2; Ch 4 para 4.5.1 and Ch 5 para 5.5.2.1 (b). 107 Ch 5 5.5.2.1 (b). 108 Section 76(3)(c) of the Companies Act 71 of 2008. 109 Section 76(4)(a)(i) of the Companies Act 71 of 2008. 110 Ibid.

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subjective standard of review will introduce a subjective element to section 76(4) which

in its current form provides only for an objective standard of review.111 This will address

the concern that it is relatively easy for South African directors to meet the requirements

of the business judgment rule under section 76(4).

6.3.1.3 Best interests of the company

In Delaware directors will meet this requirement – to act in the best interests of the

company – if they hold an honest belief that the specific action taken is in the best

interests of the corporation.112 There is no subjective element and the standard of review

is purely objective. Courts will not second-guess directors’ decisions when the process

followed was rational.113

The ALI in section 4.01(c)(3) states that the director must “rationally believe” that the

business judgment is in the best interests of the company.114 Section 4.01(c)(4)

distinguishes between “rationality” and “reasonableness” in that the phrase “rationally

believes” is intended to permit a significantly wider range of discretion than the term

“reasonable”.115

The ALI formulates a standard of reasonable belief regarding the process directors use to

reach their decisions.116 This would appear to be consistent with the norm of ordinary

negligence. However, when it comes to the substance of the directors’ decision, the ALI’s

111 Section 76(4)(a)(i) of the Companies Act 71 of 2008. 112 In Aronson v Lewis 473 A.2d (Del. 1984) at 812. See Ch 2 para 2.4.4.1. 113 Ch 2 para 2.4.4.1. 114 Section 1.04(c)(3) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. 115 Ibid. 116 Ch 2 para 2.4.4.2.

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version of the business judgment rule lowers the standard of care to a rational belief.117

The ALI’s comments suggest that directors will not be held liable for mere negligence

but only if they acted with gross negligence.118 The rationality standard of review is very

easy for a director to satisfy and, in particular, far easier to satisfy than a reasonableness

standard.119

The ALI formulates a standard of reasonable belief regarding the process the directors

use to reach their decision.120 The ALI’s equation of “rationally believes” with the

Delaware “gross negligence” standard, also suggests an objective element in that the

negligence test is objective. Although this rationality standard is far less stringent than a

reasonableness standard, it does involve some, albeit limited, objective review of the

quality of the decision. The ALI further notes that a “rational” basis is already

considerably wider than a “reasonableness” test and provides adequate protection for

directors;121 there is no need to protect irrational business decisions which are completely

removed from the realm of reason.122

Australia similarly applies the rationality standard of review which is objective but goes

further by including a reasonableness standard.123 Section 180(2)(d) of the Corporations

Act, 2001, states that directors should:

[R]ationally believe that the judgment is in the best interests of the corporation.

The director’s or officer’s belief that the judgment is in the best interests of the

corporation is a rational one unless the belief is one that no reasonable person

in their position would hold.

117 Ch 2 para 2.4.4.2. 118 Ibid. 119 Ibid. 120 Ibid. 121 American Law Institute Principles of Corporate Governance: Analysis and Recommendations,1992, 181 n 1. 122 Ibid. 123 Section 180(2)(c) & (d) of the Corporations Act, 2001. See Ch 4 para 4.5.1.

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Section 180(2)(d), requires that the director “rationally believe that the judgment is in

the best interests of the corporation”. Section 180(2) further provides that a “belief that

the judgment is in the best interests of the corporation is a rational one unless the belief

is one that no reasonable person in their position would hold”.124 The way in which the

section goes on to define a “rational” belief by reference to the “reasonable person”, has

caused some confusion as to how it should be interpreted.

The Australian courts have, however, concluded that the rational belief required as an

element of the business judgment rule in section 180(2) does not have to be reasonable.

In other words, a director can invoke the business judgment rule if he or she can show

that he or she arrived at the business judgment after a reasoning process, “whether or not


objective sense”.125 In ASIC v Rich126 the ASIC submitted that the rationality of a

director’s belief is determined by whether it is reasonable.127 Judge Austin concluded

that the rational belief required as an element of the business judgment rule in section

180(2) does not have to be reasonable.128

It is therefore unclear why the drafters of section 180(2) felt it necessary to define an

irrational belief as one which no reasonable person would hold. I do not recommend that

South Africa follow the Australian approach in this instance.

124 See s 180(2)(d) of the Corporations Act, 2001. 125 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. See also Legg & Jordan (2013) 34 Adelaide Law Review


Publications 1-13. See Ch 4 para 4.5.2. 126 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. 127 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7286. 128 ASIC v Rich (2009) 75 ACSR 236 FLR 1 para 7289. See also Legg & Jordan (2013) 34 Adelaide Law Review


Publications 1-13.

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Section 76(4)(a)(iii) of the Companies Act, 2008, states that directors must make

decisions, or must have supported the decision of a committee, with regard to the matter,

and directors must have a rational basis for believing, and did in fact believe, that the

decision was in the best interests of the company.129 In Chapter 5 it was submitted that

the standard of review for reasonableness and rationality is objective, but that the

rationality test allows for a much wider discretion than the term “reasonable”.130 The

adoption of rationality as the standard of review means that directors may make

unreasonable or even unwise decisions provided that their judgment is not wholly

irrational.131 It is far easier for directors to meet the rationality requirement than the

reasonableness requirement. This corresponds to the Delaware, ALI, and Australian

formulations of this requirement of the business judgment rule. All of these jurisdictions

require a rational rather than a reasonable belief. The Australian drafting caused some

confusion as to how this requirement of the business judgment rule in section 180(2)

should be interpreted.132 Here, too, it is recommended that South Africa not follow the

Australian example.

I propose that section 76(4)(a)(iii) be left unchanged as regards the use of an objective

standard of review, but subject to the amendment of section 76(4)(a)(i) as proposed.133

My fifth recommendation is to propose the amendment of section 76(4)(a)(i) to provide

for section 76(4) to have a dual subjective/objective standard of review which will

correspond to the standard of review followed for directors’ duty of care in section

129 Section 76(4)(a)(iii) of the Companies Act 71 0f 2008. 130 See Ch 5 para 5.5.2.1(c). Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd 2014 (5) SA 179 (WCC).

Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 400 available at

http://www.companylaw.uct.ac.za/clh/research/journal/cassidy (accessed: 17/07/2018). 131 Cassidy “Models of reform: The director’s duty of care in a modern commercial world” 400. 132 See Ch 4 para 4.5. 133 See para 6.3.1.3.

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76(3)(c).134 This will obviate the watering-down of directors’ duties and the higher

standard set in 76(3)(c) will prevail.135 Section 76(3)(c) provides for both a

subjective/objective standard of review which is a higher standard than is used currently

in section 76(4).136

One may ask whether South Africa should replace the rationality test with the

reasonability standard. The criterion used to determine rationality and reasonability is

objective.137 These concepts, however, remain distinct from each other.138 It is

recommended that we should not deviate from the ALI version of the business judgment

rule in this regard. If the rationality test were to be replaced with the reasonableness test

it could influence the current safe harbour created by section 76(4)(a). This rationality

standard is far less stringent than a standard of reasonableness, but nevertheless does

involve some, albeit limited, objective review of the quality of the decision. This should

be sufficient, bearing in mind the recommendation made for section 76(4)(a)(i).

6.3.1.4 Personal interest

The Delaware business judgment rule does not require directors to have an interest –

whether personal or financial – in the subject matter of the decision.139 Directors in

Delaware will accordingly be protected under the business judgment rule even if they

have a personal interest in the subject matter of the decision. This will, however, have an

impact on who bears the burden of proof. As the court recognises a presumption in favour

of directors through the business judgment rule, the alleging party must carry the burden

134 Section 76(3)(c) of the Companies Act 71 of 2008. 135 See discussion in Ch 5 para 5.5.2.1 (c). 136 Ibid. 137 Ibid. 138 Ibid. 139 See Ch 2 para 2.4.4.1.

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of proving that the directors violated their duty in some way.140 The burden of proof will

shift if a plaintiff shows that a majority of the directors had a personal interest in the

transaction.141

Section 4.01(c) of the ALI Principles states that directors should not be “interested” in

the subject matter.142 No specific distinction is made as to whether this interest should be

financial or personal. Directors will not be protected by the ALI business judgment rule

if they are personally or financially “interested”143 In this regard, the Delaware rule has a

wider application than its ALI counterpart. In Delaware the rule will apply whether

directors have an interest in the subject matter or not, whereas the ALI formulation

excludes protection for directors under the business judgment rule should they have an

interest in the subject matter of the decision.144 The ALI formulation further does not

state that the interest must be “material” and any interest will therefore suffice. Should

directors have any interest in the subject matter of the decision they will not be protected

under the rule. There is also no provision that should directors disclose such interest in

the subject matter, they will receive protection under the business judgment rule.145 In

terms of the ALI formulation, directors will consequently have no protection under the

business judgment rule even if they disclose their interest to the board.

In Australia, section 180(2)(b) provides that directors should not have a “material

personal interest” in the subject matter of the judgment.146 The interest is not limited to

140 See Ch 2 para 2.4.4.1. 141 Ibid. See also Guth v Loft Inc 5 A 2d 503, 510 (1939) 510. 142Section 4.01(c)(1) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. See Ch 2 para 2.4.4.2. 143 See Ch 2 para 2.4.4.1. 144 See Ch 2 para 2.4.4.2. 145 See Ch 5 para 5.5.2.1 (d). 146 See s 180(2)(b) of the Corporations Act, 2001. See Ch 4 para 4.5.1.

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financial interests. Should directors in Australia have a personal interest which is material

they will not be protected by section 180(2);147 but should the personal interest not be

material they will be protected.148 Furthermore, the Australian business judgment rule, as

with the ALI business judgment rule, does not provide for directors to be protected under

the rule if they have disclosed the personal interest to the board.149 Even if Australian

directors disclose such material personal interests to the board they will still not be

protected under section 180(2).150

The South African business judgment rule has a wider application than the ALI or

Australian business judgment rules when it comes to the legal requirement that directors

may not have a personal interest in the subject matter.151 Its application is not as wide as

its Delaware equivalent which protects directors under the business judgment rule

whether they had an interest in the subject matter or not.152 Section 76(4)(a)(ii)(aa) states:

(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; or (bb) the director complied

with the requirements of section 75 (Disclosure of personal financial interest)

with respect to any interest contemplated in subparagraph (aa).153

If South African directors have a material personal interest in the subject matter they

will be protected by the rule provided that the interest is not a material personal

“financial” interest.154 The ALI business judgment rule excludes any interest, while the

Australian version of the rule excludes any material personal interest.155

147 See Ch 4 para 4.5.1. 148 Ibid. 149 Ibid. 150 Ibid. 151 See Ch 2 para 2.4.4.2; Ch 4 para 4.5; and Ch 5 para 5.5.2.1(d). 152 See Ch 2 para 2.4.4.1; Ch 5 para 5.5.2.1 (d). 153 Section 76(4)(a)(ii)(aa) of the Companies Act 71 of 2008. See Ch 5 para 5.5.2.1(d). 154 See Ch 5 para 5.5.2.1 (d). 155 See Ch 2 para 2.4.4.2 and Ch 4 para 4.5.

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The South African business judgment rule extends the material personal financial interest

not only to directors’ themselves but also to any related person who has a personal

financial interest in the matter.156 As there is no equivalent provision in either of the other

jurisdictions, in this regard section 76(4) has a broader application than its equivalent in

other jurisdictions.157 It is unclear why the legislature opted for “personal financial

interest” in the case of related parties, as opposed to “material” personal financial

interests as in the case of directors. This implies that directors may not be protected by

the rule should any related person have a “personal financial interest” as opposed to a

“material personal financial interest”. Related persons are therefore subject to a more

stringent obligation. This is not ideal and should be corrected.

In addition, section 76(4)(a)(ii)(aa) provides that even if directors and related persons

have a material personal financial interest (directors), or a personal financial interest

(related persons), they will be protected under the business judgment rule if they disclose

that interest as required by section 75. Section 75(5) requires directors to disclose the

nature of any such financial interest in a matter before the board. Section 75(4) allows

directors to disclose a financial interest in advance, and this standing notice suffices for

purposes of section 75 – unless there has been a change in the nature of the financial

interest since disclosure. However, this relates only to companies where a person is the

sole director of the company but does not hold all of the beneficial interests or all of the

issued securities of the company.158 It was argued in Chapter 5 that an historical notice

of a financial conflict of interests should not suffice under any business judgment rule,

156 Section 76(4)(a)(ii)(aa) of the Companies Act 71 of 2008. See Ch 5 para 5.5.2.1 (d). 157 See Ch 2 paras 2.4.4.1 and 2.4.4.2; Ch 4 para 4.5. 158 Ch 5 para 5.5.2.1 (d).

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and that directors should inform the shareholders at the time at which the decision is

made, even if they have informed them “historically”.159

Section 75(5), however, provides that if directors of a company – other than a company

contemplated in subsections (2)(b) or (3) – have a personal financial interest in a matter

to be considered at a meeting of the board, or know that a related person has a personal

financial interest in the matter, the directors must disclose the interest and its general

nature before the matter is considered at the meeting.160 This is correct and directors of

companies, as contemplated in section 75(5), are obliged to disclose their material

personal financial interests at the relevant meeting in order to ensure protection under


It is problematic that only material personal “financial” interests are included under

section 76(4)(a)(ii)(aa). Should directors have any interest other than a material personal

financial interest, they would meet this requirement and will be protected under the

business judgment rule. It is therefore recommended that the word “financial” be deleted

from this section. All material personal interests should be excluded from protection

under the business judgment rule and not solely financial interests. None of the other

jurisdictions studied has limited directors’ personal interests to the purely “financial”. I

consequently propose that we follow the Australian example in this instance by

extending this section to include all material personal interests of directors.161

159 Ch 5 para 5.5.2.1 (d). 160 Ibid. 161 Ch 4 para 4.5.

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Section 76(4)(a)(ii)(aa) does, however, have a positive element in so far as it not only

includes the interests of directors but also those of related parties. What is confusing is

that directors will not be protected under section 76(4) if they have a “material” personal

financial interest, or have knowledge that a related person has a personal financial

interest in the subject matter, unless they disclose that interest as set out in section 75.

As regards directors, the interest must be “material”, but related persons are not subject

to the same requirement.

6.3.2 Application of the business judgment rule

6.3.2.1 Good faith and proper purpose

The Delaware business judgment rule creates a presumption that directors acted in good

faith when making a business judgment, but is silent as regards “a proper purpose”.162

Section 4.01(c) of the ALI provides that the decision must be made in good faith, but

again there is no mention that it must be made for a proper purpose.163 If directors meet

the good faith requirement they will be protected by the business judgment rule even if

the decision was not made for a proper purpose.164

Section 180(2)(a) of the Australian Corporations Act, 2001, provides that the decision

must have been made in good faith and for a proper purpose.165 Australia has therefore

included the proper purpose requirement in addition to the requirement that the decision

must be made in good faith. Australian directors must satisfy both requirements, while

directors in the US need only meet the requirement of good faith.

162 Ch 5 para 5.5.2.2 (a). 163 Ibid. Section 4.01(c)(1) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. See Ch 2 para 2.4.4.2. 164 Ch 5 para 5.5.2.2 (a). 165 Section 180(2)(a) of the Corporations Act, 2001. See Ch 4 para 4.5.

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In South Africa, section 76(4) does not require that directors’ decisions be made either in

good faith or for a proper purpose. Neither of these requirements need be met in order for

the business judgment rule to be invoked by South African directors. In this regard, the

Australian approach is more stringent than that in the US or South Africa.166 South Africa

has the least onerous requirement; while the US lies somewhere in the middle.167 This

does not, however, mean that South African directors need not act in good faith and for

a proper purpose when performing their duties. South African directors are still required

to comply with their fiduciary duties as codified in section 76(3)(a) which include acting

in good faith and for a proper purpose, but these are not set as preconditions for accessing

protection under the business judgment rule in section 76(4)(a).168 Directors stand in a

fiduciary relationship to their company and are duty-bound to act in good faith towards

the company.169

I agree that good faith and proper purpose should not be set as requirements for the South

African business judgment rule. By including fiduciary duties in section 76(4), South

Africa may be confronted with the same difficulties facing the US where the distinction

between fiduciary duties and the duty of care have been blurred by the business judgment

rule. By omitting fiduciary duties from the South African business judgment rule this

problem is resolved. Following this reasoning, I propose that directors’ fiduciary duty to

act in the best interest of the company also be excluded from section 76(4). Although the

drafters omitted the good faith and proper purpose requirements from section 76(4)(a),

166 See Ch 2 paras 2.4.4.1 & 2.4.4.2 and Ch 4 para 4.5. 167 See Ch 5 para 5.5.2.2 (a). See also Ch 2 paras 2.4.4.1 and 2.4.4.2. 168 Ch 5 para 5.5.2.2 (a). Sections 76(3)(a) and 76(4)(a) of the Companies Act 71 of 2008. 169 Ch 5 para 5.5.2.2 (a).

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they nonetheless apply in that directors must always act in good faith and for a proper

purpose when conducting the affairs of the company.170

6.3.2.2 Directors’ duties

We have seen that in the US the fiduciary duties of directors and the duty of care are not

distinct concepts as in Australia and South Africa.171 The business judgment rule in both

Delaware and the ALI will consequently apply to both directors’ fiduciary duties and

their duty of care.172 In the US this has caused major concerns in that the business

judgment rule has blurred the distinction between these duties.

In Australia, section 180(2) provides that the business judgment rule only applies to

directors’ duty of care and not to any fiduciary duties.173 This is a correct formulation of

the business judgment rule. By including only directors’ duty of care, the application of

the rule will be limited which resolves any possible blurring between the fiduciary duties

and the duty of care.

In South Africa, section 76(4) only applies to the fiduciary duty to act in the best interest

of the company (s 76(3)(b)) and directors’ duty of care (s 76(3)(c)).174 This omission of

good faith and proper purpose does not imply that directors are not required to adhere to

these duties, they are merely not set as requirements for protection under the business

judgment rule. When compared to the jurisdictions studied, the business judgment rule

in the US has wider application than the South African rule, but, in turn, the South African

170 Ch 5 para 5.5.2.2 (a). 171 See Ch 2 para 2.3. 172 See Ch 2 paras 2.4.4.1 and 2.4.4.2. 173 See ss 180(1) and 180(2) of the Corporations Act, 2001. See Ch 4 paras 4.4 and 4.5. 174 Sections 76(3)(b) and (c) and 76(4) of the Companies Act 71 of 2008. See Ch 5 para 5.5.2.2(b).

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rule has wider application than its Australian equivalent where the rule applies only to

directors’ duty of care.175

Other reasons for recommending the exclusion of the fiduciary duty of directors to act in

the best interests of the company, include: First, it will clarify that the business judgment

rule will only apply to directors’ duty of care and not to any fiduciary duties. The cause

of action will then always be in delict and not in breach of trust. It will be a far easier for

courts to make a determination as they will have only one cause of action as opposed to

two. Secondly, in accordance with section 78(7) of the Companies Act, 2008, a company

may purchase insurance to protect directors against any liability or expenses for which

the company is permitted to make payments indemnifying claims made against their

directors in accordance with section 78(5). Section 78(5) reads:

Except to the extent that the Memorandum of Incorporation of a company

provides otherwise, a company may indemnify a director in respect of any

liability arising other than as contemplated in subsection (6).176

Section 78(6) states that a company may not indemnify directors in respect of liability

arising from section 77(3)(a)-(c), or from wilful misconduct or wilful breach of trust.177

Subject to section 78(6), directors may be indemnified by the company for breach of their

duties, and furthermore, the company may, in terms of section 78(7), purchase insurance

on behalf of directors to protect them from any liability. Should directors breach their

fiduciary duties not due to wilful misconduct or wilful breach of trust, the company

may indemnify them from incurring liability and therefore they would not have to rely

on the business judgment rule for protection.

175 See Ch 2 para 2.4; Ch 4 para 4.5; and Ch 5 para 5.5.2.2 (b). 176 Ch 5 para 5.5.2.2 (b). 177 Ibid.

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Lastly, the company may, in terms of section 78(4) of the Companies Act, 2008, and

subject to its memorandum of incorporation, advance expenses to a director to defend

litigation in any proceedings arising from his or her service to the company. It may also,

directly or indirectly, indemnify a director from the expenses incurred, or to be incurred,

for such litigation, and if the litigation is abandoned, the director is exculpated, or which

arises in respect of any liability for which the company may indemnify the director as

described above. It is argued that directors already enjoy adequate protection for breach

of their fiduciary duty to act in the best interest of the company and the deletion of section

76(3)(b) from section 76(4)(a) will not be to their detriment.

6.3.2.3 Common law

The US opted not to codify directors’ duties and also not to codify the business judgment

rule. Both the Delaware and ALI versions of the rule therefore apply to the common-law

duties of directors which include both directors’ common-law fiduciary duties and their

duty of care.178 It was discussed that in the US directors’ fiduciary duties and their duty

of care are not two distinct concepts.179

Section 180(2) of the Corporations Act, 2001, makes the Australian position very clear:

the business judgment rule applies to the statutory duty of care as set out in section 180(1)

and also to the equivalent duties at common law and in equity.180 Australia has limited

the application of the statutory business judgment rule to directors’ duty of care only, but

extended it by including the equivalent duties in common law and equity.181 It is

understandable that Australia included the common-law duty of care within the ambit of

178 See Ch 2 para 2.3. 179 Ibid. 180 See Ch 4 paras 4.4 and 4.5. 181 Ch 4 paras 4.4 and 4.5.

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the business judgment rule. Although some argue that South Africa should have followed

the Australian example and also included directors’ common-law duties of care, skill,

and diligence, I do not, however, recommend such action for the reasons set out in para

6.3.2.2 above and those narrated below.

The business judgment rule in section 76(4) applies only to the statutory fiduciary duty

to act in the best interest of the company, and to the statutory duty of care.182 No further

provision is made for the inclusion of any common-law duties.183 In its current form,

section 76(4)(a) does not protect directors who breach their common-law duties.

I am, however, of the view that it is unnecessary to include directors’ common-law duties

in section 76(4)(a) for the reasons set out above regarding the exclusion of section

76(3)(b) from the statutory business judgment rule.184

In addition to the reasons given in paragraph 6.3.2.2 above, it can also be argued that

should directors breach their common-law duty of care, the elements required for delict

will still need to be proved in order for directors to incur liability.185 For breach of

directors’ common-law fiduciary duties and the statutory duties as set out in section

76(3)(a), the elements for breach of trust will have to be established. Directors currently

enjoy sufficient protection for breach of their common-law duties without it being

expressly included under the business judgment rule.

182 Ch 5 para 5.5.2.2(c). 183 Ibid. 184 See discussion in para 6.3.2.2. 185 Ch 5 para 5.5.2.2 (c). These principles includes: 1) the test for wrongfulness; 2) negligence; and 3) legal

causation.

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6.3.2.4 Directors and officers

In Chapter 2 the study presented that the business judgment rule applies to both directors

and officers of the company.186 In Delaware and New York, for example, this has been

clearly established in case law.187 The ALI formulation of the business judgment rule

also applies to both directors and officers of the company.188 The ALI Principles state

that:

Sound public policy points in the direction of holding officers to the same duty

of care and the business judgment standards as directors, as does the little case

authority that exists on the applicability of the business judgment standard to

officers, and the views of most commentators support this position.189

The Australian equivalent in section 180(2) is also very clear and specifically provides

that the business judgment rule applies to both directors and “other officers” of the

corporation. Section 180(2) does not limit the application to prescribed officers, but to

“other officers” and so includes any officer of the company.

In South Africa, section 76(1)(a) of the Companies Act, 2008, specifically states that

directors’ duties, as set out in this section, will also apply to prescribed officers and

members of the board, board committees and audit committees.190 It is therefore clear

that both directors and prescribed officers will have protection from the business

judgment rule for a breach of their statutory duties. There is thus no need for any

amendment to section 76(4) in this regard.

186 Ch 2 para 2.4. 187 Ch 2 para 2.4.4.1 188 Ibid. 189 Ibid. 190 Ch 5 para 5.4.

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6.3.2.5 Safe harbour or presumption?

In Delaware, the business judgment rule is formulated as a presumption that in making a

business decision the directors of a corporation acted on an informed basis, in good faith,

and in the honest belief that the specific action taken was in the best interests of the

corporation.191 Because the court recognises a presumption in favour of directors through

the business judgment rule, the challenging party carries the burden of proving that the

directors violated their duty in some way.192 The burden of proof will, however, shift if a

plaintiff shows that a majority of the directors had a personal interest in the transaction.193

The Delaware business judgment rule can be applied either as an abstention doctrine or

as a standard-of-liability test.194 First, under Delaware law the business judgment rule can

be applied as an abstention doctrine where the court would review the process followed

by the board in reaching a decision rather than the decision itself.195 Under the abstention

doctrine, the court refrains from reviewing the substantive merits of directors’ conduct

unless the plaintiff can rebut the business judgment rule’s presumption of good faith.196

The second application in Delaware law is the standard-of-liability test.197 This test

requires some objective review of the merits of the board’s decision which means that

the plaintiff will be able to shift the burden of proof if he or she can establish the existence

of certain conditions, such as fraud, illegality, self-dealing, or failure to make a decision

by the board.198

191 Ch 2 para 2.4.4.1. See also Aronson v Lewis 473 A.2d (Del. 1984) 812. 192 Ch 2 para 2.4.4.1. 193 Ibid. 194 Ch 2 para 2.5. 195 Ibid. 196 Ibid. 197 Ibid. 198 Ch 2 para 2.5.

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Section 4.01(c) of the ALI Principles labels the business judgment rule as a “safe harbour”

and not a presumption.199 Under the safe harbour application, the business judgment rule

protects a director from liability if he or she has made a business decision which meets

the following requirements:200 if the director was free from a conflict of interest in

relation to the subject of the decision;201 if the director was informed with regard to the

subject of the business judgement to the extent that he or she reasonably believed to be

appropriate under the circumstances;202 and if he or she rationally believed that the

business judgment was in the best interests of the corporation.203 If these conditions have

been met directors will be protected from incurring liability from breach of their duties.

This is also known as the immunity doctrine which insulates the director from liability

resulting from bad decisions, provided that the requirements of section 4.01(c) have been

met. Under the immunity doctrine there is no examination into the merits of the decision

as under the standard-of-liability doctrine, nor is it asked whether the directors breached

their duties. The directors bear the burden of proving that they met the requirements of

the business judgment rule. Should they prove that the requirements of the rule have been

met, the directors will be immune from liability.

In Australia the statutory business judgment rule also functions as a safe harbour as

opposed to a presumption.204 Should directors meet the requirements of section 180(2)

they will be immune from liability and there will be no further examination into the

business decision or its merits. In this instance, the burden of proof vests in directors to

199 Ch 2 para 2.4.4.2. 200 Ibid. 201 Section 4.01(c)(1) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. 202 Section 4.01(c)(2) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. 203 Section 4.01(c)(3) of the American Law Institute Principles of Corporate Governance: Analysis and

Recommendations of 1992. 204 See Ch 4 para 4.5.

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establish that the requirements of section 180(2) have been met.205 Section 180(2)

provides:

A director or other officer of a corporation who makes a business judgment is

taken to meet the requirements of subsection (1), and their equivalent duties at

common law and in equity, in respect of the judgment if they:206

The words “taken to meet” and “if they” make it clear that should directors meet the

requirements in section 180(2)(a)-(d), they will have satisfied the requirements under

section 180(1) (statutory duty of care) and its equivalent in common law and equity. No

further enquiry will be undertaken and the directors will be immune from liability.

As with the ALI and Australian versions of the business judgment rule, in my view the

South African version of the rule in section 76(4) also functions as a safe harbour as

opposed to a presumption.207 It will further be applied as an immunity doctrine and not

an abstention doctrine or standard-of-liability test.208 Section 76(4) provides:


performance of the functions of a director, a particular director of a company

will have satisfied the obligations of exercising his or her powers and functions

as a director in the best interests of the company and with a degree of care,

skill and diligence reasonably expected of a person (as specified in Section

76(3)(b) and (c)) if:209

The wording “will have satisfied” and “if” indicate that should directors meet the

requirements in section 76(4)(a)(i)-(iii), they will have met their obligations under

section 76(3)(b) (duty to act in the best interest of the company) and section 76(3)(c)

205 Ibid. Section 180(2) of the Corporations Act 2001. 206 See Ch 4 para 4.5. 207 Section 76(4) of the Companies Act 71 of 2008. See Ch 5 para 5.5.2.2(d). 208 See the discussion in Ch 5 para 5.5.2.3. 209 Section 76(4) of the Companies Act 71 of 2008. See Ch 5 par 5.5.2.2(d).

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(directors’ duty of care),210 and will be immune from liability and there will be no further

enquiry into the decision itself or the process followed to reach the decision.211

6.4 TABLE: COMPARISON OF THE BUSINESS JUDGMENT RULE IN

DIFFERENT JURISDICTIONS

In summary, the table below compares the business judgment rules in the different

jurisdictions, with the exception of the UK which opted not to include a statutory business

judgment rule in its company law.

Table 4:

Delaware ALI Australia South Africa

Legal

requirements

Business

judgment

Delaware: Yes –

An actual conscious

business decision

must be made.212

Section 4.01(c) of

the ALI Principles

provides that a

business decision

must be made in

order for the

business judgment

rule to apply.213

Yes – Section

180(2) of the

Corporations Act

2001 requires that a

business decision

must be made.214

Section 76(4)(a) of

the Companies Act

of 2008 does not

refer to a business

judgment but to

“any matter arising

in the exercise of

the powers or the

performance of the

functions of a

director”.215 It has

a wider application

than the other two

jurisdictions.

Informed

business

judgment

a) Directors must

inform

themselves prior

to making a

business

decision.216

a) Directors must

become informed

relating to the

subject matter of

the decision.219

a) Section 180(2)(c)

of the

Corporations

Act, 2001,

provides that

directors should

inform

a) Directors should

take reasonably

diligent steps to

become

informed on the

subject

matter.225

210 Sections 76(3)(b) and (c) and s 76(4) of the Companies Act 71 of 2008. 211 Ibid. 212 Ch 2 para 2.4.4.1. 213 Ch 2 para 2.4.4.2. 214 Ch 4 para 4.5. See also s 180(2) of the Corporations Act, 2001. 215 Ch 5.5.2.1 (a). 216 Ch 2 para 2.4.4.1. 219 Ch 2 para 2.4.4.2. 225 Ch 5 para 5.5.2.1 (b). See also s 76(4)(a)(i) of the Companies Act 71 of 2008.

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b) Only “material

information”

reasonably

available to

directors should

be reviewed.217

c) An objective

standard of

review is

followed.218

b) Does not only

apply to

“material”

information but to

all information

relating to the

subject matter.220

c) A subjective

standard of review

is followed.221

themselves about

the subject

matter.222

b) Information is

not limited to

material

information only

but extends to all

information.223

c) A subjective

standard of

review is

followed.224

b) No reference is

made that only

material

information will

apply.226

c) An objective

standard of

review is

followed.227

Best interests of

the company

Objective standard

of review is

followed.228

Objective standard of

review is

followed.229

Objective standard

of review is

followed.230

Objective standard

of review is

followed.231

Personal interest No provision is

made that directors

should not have a

personal interest in

the subject

matter.232

a) Directors should

not be interested

in the subject

matter.233

b) No distinction

between financial

and personal

interest.234

c) No reference is

made that it

should be a

“material”

personal

interest.235

d) Directors should

not have any

material

personal interest

in the subject

matter.236

e) Interest is not

limited to solely

“financial

personal

interest”.237

f) The personal

interest must be

“material”.238

a) Directors should

not have any

material

financial

personal interest

in the subject

matter.239

b) Limited to

personal

financial

interest only.240

c) Limited to

“material”

personal

financial

interest.241

217 Ch 2 para 2.4.4.1. 218 Ibid. 220 Ch 2 para 2.4.4.2. 221 Ibid. 222 Ch 4 para 4.5. 223 Ch 4 para 4.5. 224 Ibid. 226 Ch 5 para 5.5.2.1 (b). 227 Ibid. 228 Ch 2 para 2.4.4.1. 229 Ch 2 para 2.4.4.2. 230 Ch 4 para 4.5. See also s 180(2)(d) of the Corporations Act, 2001. 231 Ch 5 para 5.5.2.1 (c). See further s 76(4)(a)(iii) of the Companies Act 71 of 2008. 232 Ch 2 para 2.4.4.1. 233 Ch 2 para 2.4.4.2. 234 Ibid. 235 Ch 5 para 5.5.2.1 (d). 236 Ch 4 para 4.5. See also s 180(2)(b) of the Corporations Act, 2001. 237 Ibid. 238 Ibid. 239 Ch 5 para 5.5.2.1 (d). See also s 76(4)(a)(ii) of the Companies Act 71 of 2008. 240 Ibid. 241 Ibid.

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d) Extends to

related persons’

personal

financial

interests.242

Application of

the business

judgment rule

Good faith and

proper purpose

Provision is made

only that the

decision must be

taken in good faith.

No further

provision regarding

“proper

purpose”.243

Provision is made

only that the decision

must be taken in

good faith. No

further provision

regarding “proper

purpose”.244

The decision must

have been made in

good faith and for a

proper purpose.245

Section 76(4) has

no provision that

the decision must

have been made in

good faith and for

a proper

purpose.246

Directors’ duties Both fiduciary

duties and duty of

care apply.247

Both fiduciary duties

and duty of care

apply.248

The business

judgment rule only

applies to directors’

duty of care.249

The business

judgment rule will

apply only to

statutory directors’

fiduciary duty to

act in the best

interest of the

company and

statutory directors’

duty of care.250

Common law The business

judgment rule


common-law

duties.251

The business

judgment rule


common-law

duties.252

The business

judgment rule

applies to common-

law duty of care.253

The business

judgment rule does

not apply to

directors’

common-law

duties.254

Directors and

officers

Yes – will apply to

both.255


both.256


both.257


both.258

242 Ibid. 243 Ch 2 para 2.4.4.1. 244 Ch 2 para 2.4.4.2. 245 Ch 4 para 4.5. 246 Ch 4 para 5.5.2.2 (a). 247 Ch 2 para 2.4.4.1. 248 Ch 2 para 2.4.4.2. 249 Ch 4 para 4.5. 250 Ch 5 para 5.5.2.2 (b). See also ss 76(3)(b)-(c) and s 76(4) of the Companies Act 71 of 2008. 251 Ch 2 para 2.4.4.1. 252 Ch 2 para 2.4.4.2. 253 Ch 4 para 4.5. 254 Ch 5 para 5.5.2.2 (c). 255 Ch 2 para 2.4.4.1. 256 Ch 2 para 2.4.4.2. 257 Ch 4 para 4.5. 258 Ch 5 para 5.5.2.2 (d).

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Safe harbour or

presumption

The business

judgment rule is a

presumption.259

The business

judgment rule is a

safe harbour.260

The business

judgment rule is a

safe harbour.261

The business

judgment rule is a

safe harbour.262

Abstention-

immunity

doctrine, and

standard-of-

liability test.

The business

judgment rule can

be applied as both

an abstention

doctrine and

standard-of-

liability test.263

Business judgment

rule is applied as an

immunity doctrine.264

Business judgment

rule is applied as an

immunity

doctrine.265

Business judgment

rule is applied as

an immunity

doctrine.266

Burden of proof Plaintiffs bear the

burden of proof

unless they can

show that majority

of directors had a

personal interest in

the subject

matter.267

Directors bear the

burden of proof.268

Directors bear the

burden of proof.269

It is not clear-cut,

but it seems that

directors bear the

burden of proof.270

6.5 PROPOSED SECTION 76(4) OF THE COMPANIES ACT, 2008

Given the nature of a safe harbour as discussed in Chapter 1 and the comparisons drawn

in this study it clearly indicates that section 76(4)(a) in its current form provides a safe

harbour. This answers the research question of whether the South African business

judgment rule provides a safe harbour for directors from incurring liability for a breach

of their duties.271 The proposed amendments will therefore not change this position and

in my view it is the correct position. It is, however, submitted that the current formulation

259 Ch 2 para 2.4.4.1. 260 Ch 2 para 2.4.4.2. 261 Ch 4 para 4.5. 262 Ch 5 para 5.5.2.2 (e). 263 Ch 2 para 2.4.4.1. 264 Ch 2 para 2.4.4.2. 265 Ch 4 para 4.5. 266 Ch 5 para 5.5.2.3. 267 Ch 2 para 2.4.4.1. 268 Ch 2 para 2.4.4.2. 269 Ch 4 para 4.5. 270 Ch 5 para 5.5.2.3. 271 Ch 1 para 1.3; Ch 2 paras 2.4.4.1-2.4.4.2; Ch 4 para 4.5 and Ch 5 para 5.5.2.2.

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of section 76(4)(a) is sometimes too wide and it may afford directors with too much

protection under the safe harbour.

Based on the study and comparisons drawn, in conclusion, I propose that section 76(4)(a)

be amended to read as follows:272

In respect of [any particular matter] a business judgment arising in the

exercise of the powers or the performance of the functions of a director,

a particular director of the company will have satisfied the obligations

of exercising his or her powers and functions as a director [in the best

interest of the company and] with the degree of care, skill, and

diligence reasonably expected of a person (as specified in section

76(3)(c)) if the particular director can prove:

(i) the director [has taken reasonable diligent steps to become

informed about the subject matter] informed him or herself

about the subject matter of the judgment to the extent he or she

reasonably believes to be appropriate; and

(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 material personal

[financial] interest in the matter; or

(bb) the director complied with the requirements of section 75

(disclosure of personal [financial] interest) with regard to any

interest contemplated in subparagraph (aa); and

(iii) the director made a decision, or supported the decision of a

committee or the board with respect 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.

In this proposed version of section 76(4), “any particular matter arising in the exercise

of the powers or the performance of the functions of a director” is replaced by “business

judgment” in order to limit the application of the South African business judgment rule.

272 The portions in brackets are proposed deletions from this section. The underlined portions are proposed

additions to this section.

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A further proposed amendment is the inclusion of “the particular director can prove”.

This will provide clarity on whom the burden to prove falls that the elements of the

business judgment rule were met.273 This will remove any uncertainty. The study

showed that the burden lies with directors, but the position is not clear enough in the

current formulation of the business judgment rule.274

For the reasons discussed above it is proposed to omit the words “in the best interest of

the company and” and “Section 76(3)(b) and”.275 This will ensure that the business

judgment rule applies only to directors’ duty of care and will limit the application of the

rule. It will further resolve the concerns raised as regards blurring the distinction between

the fiduciary duty to act in the best interests of the company, and directors’ duty of care.

In the proposed version section 76(4)(i) includes a subjective standard of review in

preference to the objective standard of review. This will bring section 76(4) into line

with the heightened standard expected of directors in section 76(3)(c) and will also

address the concern that it is relatively easy for South African directors to meet the

requirements of the business judgment rule under section 76(4).276 The words “the

director has taken reasonably diligent steps to become informed about the matter” will

provide for the objective standard of review, with “informed themselves about the

subject matter of the judgment to the extent they reasonably believe to be appropriate”

providing for the subjective standard of review.

273 See para 6.3. See further s 76(1)(a) of the Companies Act 71 of 2008. 274 Ch 5 para 5.5.2.3. 275 See para 6.3. 276 Sections 76(3)(c) and 76(4) of the Companies Act 71 of 2008.

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It is further proposed that the word “financial” be omitted from section 76(4)(a)(i).

Omitting the word “financial” will ensure that all directors’ material personal interests

will be excluded from protection under the business judgment rule and not only their

material personal “financial” interests. It is further proposed to include the word

“material” when dealing with the personal interests of related persons. This amendment

will ensure that both directors themselves and related persons have the same obligations

which is currently not the case. It is further proposed that the word “financial” should be

deleted from section 75 of the Companies Act 2008 to align with section 76(4).

In conclusion, based on the research undertaken in this study, it is believed that the

proposed amendments to section 76(4) will provide more clarity and will improve the

corporate law on the rule. In my view the inclusion of a statutory business judgment rule

was warranted. It was discussed that South African directors have control of the company

and all risks and obligations are vested in directors. Therefore, honest directors do require

protection from incurring personal liability whilst performing their duties as directors of

a company. Although the statutory business judgment rule is warranted it is argued that

its application in its current form is too wide. The proposed amendments may serve to

bring more certainty regarding some issues raised in this study and may fulfill the ideal

of providing a safe harbour for directors, while also protecting the company and third

parties against abuse of power.

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TABLE OF STATUTES, CODES AND BILLS

AUSTRALIA

Act to Legalize Partnerships with Limited Liability 1853 (NSW)…………........................................147

Australian Uniform Companies Act 1961 …………………………………………………………...149,

156

382

Australian Securities and Investments Commission Act 2001 ………………………………………146,

153

Commonwealth of Australia Constitution Act 1900 …………………………………………………148

Commonwealth Industries Preservation Act 1906 …………………………………………………...148

Companies Act 1874 (NSW) …………………………………………………………………………147

Companies Act 1981 ………………………………………………………………………………….151

Companies (Acquisition of Shares) Act 1980 ……………………………………………………….151,

152

Companies (Acquisition of Shares) Code, 1981 …………………………………………………151,152

Company Law Review Act 1998 ……………………………………………………………………..152

Companies and Securities Act 1980 ………………………………………………………………….152

Companies Code 1981 ………………………………………………………………………………..151

Companies Statute 1864 (Vic) ………………………………………………………………………..148

Corporations Act 1989 (Cth) ………………………………………………………………………...152,

164, 167, 205

Corporations Act 2001(Cth) ………………………………………………………………………12, 30,

144, 145, 146, 147, 153, 154, 155, 158, 169, 170, 171, 172, 173, 174, 175, 177, 178, 181, 182, 183,

184, 186, 187, 188, 189, 190, 192, 193, 194, 195, 196, 197, 198, 199, 200, 202, 204, 205, 206, 216,

236, 263, 265, 286, 319, 320, 321, 323, 328, 332, 336, 340, 342, 344, 350, 351

Corporate Law Economic Reform Program Bill 1998 ……………………………………………….153

Corporate Law Reform Act 1992 …………………………………………………………………….164

Corporate Law Economic Reform Act 1999 ………………………………………………………...152,

167

First Corporate Law Simplification Act 1995 ………………………………………………………..152

Futures Industry Act 1986 ……………………………………………………………………………152

Futures Industry Code 1986 …………………………………………………………………………..151

Managed Investments Act 1998 ………………………………………………………………………152

National Companies and Securities Commission Act 1979 ……………………………………..151,152

Securities Industry Act 1980 ………………………………………………………………………….152

Securities Industry Code, 1981 …………………………………………………………………..151,152

Victorian Companies Act 1896 …………………………………………………………………145, 156,

157

383

Victorian Companies Act 1910 ……………………………………………………………………….156

Victorian Companies Act 1958 ………………………………………………………………….150, 157

UNITED KINGDOM

Companies Act 1862 ………………………………………………………………………………….99

Companies Act 1867 ………………………………………………………………………………….99

Companies Act 1877 ………………………………………………………………………………….99

Companies Act 1879 ………………………………………………………………………………….99

Companies Act 1880 ………………………………………………………………………………….99

Companies Act 1886 ………………………………………………………………………...………..99

Companies Act 1907 ………………………………………………………………………………….99

Companies Act 1928 ………………………………………………………………………………….99

Companies Act 1947 ………………………………………………………………………………….99

Companies Act 1985 ……………………………………………………………………………99, 120,

130, 132

Companies Act 2006 ……………………………………………………………………………....23, 29,

94, 95, 96, 109, 115, 118, 119, 120, 121, 122, 124, 125, 126, 127, 216, 221, 246, 263, 264, 265, 269,

313, 318

Companies Bill 1973 ………………………………………………………………………………….118

Companies Bill 1978 ………………………………………………………………………………….119

Company Directors Disqualifications Act 1986 ……………………………………………………...108

Insolvency Act 1986 ……………………………………………………………………….........122,125,

127

Limited Liability Act 1855 …………………………………………………………………………...100

Trustee Act 2000 ……………………………………………………………………………………...124


General Corporations Act 1899 …………………………………………………………………...38, 39,

86

Delaware General Corporation Law 2001 ……………………………………………………………..46

Model Business Corporations Act 1984 ……………………………………………………………….50

384

New York Business Corporations Law 2016 …………………………………………………………..47

Revised Model Business Corporation Act 1986 ……………………………………………………….65

SOUTH AFRICA

Basic Conditions of Employment Act 7 of 2018 ……………………………………………………. 249

Broad Based Black Economic Empowerment Act 53 of 2003 ……………………………………….234

Close Corporation Act 69 of 1984 ………………………………………………………………214, 260

Companies Act of 1892 (C) …………………………………………………………………………..213

Companies Act 61 of 1973 ………………………………………………………………………..23, 30,

208, 213, 214, 215, 216, 225, 245, 246, 247, 249, 251, 254, 260, 270, 271, 287, 303

Companies Act 71 of 2008 ………………………………………………………………................23, 28,

29, 31, 170, 176, 209, 210, 214, 215, 216, 217, 223, 225, 226, 227, 228, 229, 233, 236, 237, 238, 245,

246, 247, 262, 264, 265, 272, 274, 276, 277, 279, 280, 282, 283, 284, 288, 289, 290, 291, 292, 293, 298,

300, 301, 302, 304, 305, 306, 307, 308, 309, 312, 313, 315, 321, 324, 325, 328, 329, 330, 334, 337, 341,

342, 349, 350, 351, 352, 354, 355

Companies Bill 2007 ……………………………………………………………………………210, 214,

246, 260, 261, 262, 272

Constitution of the Republic of South Africa 108 of 1996 ……………………………………...233, 302

Income Tax Act of 1997 …………………………………………………………………………….. 225

Joint Stock Companies Limited Act of 1861 (C) ……………………………………………………..213

Labour Relations Act No 66 of 1995 …………………………………………………………………225

Mutual Banks Act 124 of 1993……………………………………………………………….20

Promotion of Access to Information Act 54 of 2002 …………………………………………………249

Union Companies Act of 1926 ……………………………………………………………………….213

TABLE OF CASES

AUSTRALIA

ASIC v Adler (2002) 168 FLR 253 ………………………………………………………..........171, 172,

173, 190, 191, 205, 278

ASIC v Cassimatis (No 8) (2016) FCA 1023 …………………………………………………………178

ASIC v Fortescue Metals Group Ltd (2011) 190 FCR 364 …………………………………….184, 198,

385

200

ASIC v Healey (2011) 196 FCR 291 …………………………………………………………….177,178,

179, 180, 205, 206

ASIC v Hellicar (2012) 286 ALR 501 …………………………………………………………..176, 177

ASIC v Macdonald (No 11) (2009) NSWSC 287 ………………………………………………174, 175,

176, 177, 182, 205

ASIC v Mariner Corporation Limited (2015) FCA 589 ………………………………………..198, 199,

200, 201, 202

ASIC v Maxwell (2006) 59 ACSR 373 ……………………………………………………………….182

ASIC v Rich (2009) 75 ACSR 236 FLR 1 ………………………………………………………184, 186,

192, 193, 194, 196, 198, 199, 200, 201, 202, 278, 297, 324, 334

ASIC v Vines (2003) 48 ACSR 282 ………………………………………………………..................171

Australian Securities Commission v Gallagher (1993) 10 ACSR 43 ………………………………...163

AWA Ltd v Daniels TIA Deloitte Haskins 6- Sells (1992) 10 ACLC 933 ………………………145, 146,

153, 156, 161, 162, 163, 164, 165, 166, 204

Byrne v Baker (1964) VR 443 …………………………………………………………………..157, 158

Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946 …………………………...146, 153,

158, 204

Daniels v Anderson (1995) 13 ACLC 614 ……………………………………………………...146, 153,

158, 164, 165, 166, 204, 205

Deputy Commissioner of Taxation v Clark (2003) 57 NSWLR 113 …………………………………159

Group Four Industries Pty Ltd v Brosnan (1991) 9 ACLC 1181; (1992) 10 ACLC 1437 ……..153, 159

Harlowe’s Nominees Pty Ltd v Woodside (Lake Entrance) Oil. Co (1968) 121 CLR 483 …………..161

Heide Pty Ltd v Lester (1990) 3 ACSR 159 ………………………………………………………….159

High Court in New South Wales v Commonwealth of Australia (1990) 169 CLR 482 ………………152

Huddart Parker v Moorehead (1909) 8 CLR 330 ……………………………………………...149, 150,

151, 152

Howard Smith Ltd v Ampol Petroleum Ltd (1974) 1 NSWLR 68 ……………………………………161

Metal Manufacturers Ltd v Lewis (1988) 13 ACLR 357 …………………………………..……159, 204

Morley v ASIC (2010) NSWCA 33 …………………………………………………………………...176

Re Denham & Co (1883) 25 Ch D 752 .........................................................................................155, 203

Rema Industries and Services Pty Ltd v Coad (1992) 107 ALR 374 ……………………. ………….159

386

Shafron v ASIC (2012) HCA 612 ………………………………………………………………..176, 198

Statewide Tobacco Services Ltd v Morley (1990) 8 ACLC 827; (1992) 10 ACLC 1233 ………153, 159

Strickland v Rocla Concrete Pipes Limited (1971) 124 CLR 468 ……………………………………151

Vrisakis v Australian Securities Commission (1993) 11 ACSR 162 ……………………………164, 171

Woolworths Ltd v Kelly (1991) 4 ACSR 431 (CA NSW) ……………………………………………165

UNITED KINGDOM

Brumder v Motornet Service and Repairs Ltd and another [2013] 3 All ER 412 ……………...126, 127,

134, 142

Bushell v Faith [1970] AC 1099 ………………………………………………………………..135, 136,

137

Dawn v Bell [2016] EWCA Civ 96 …………………………………………………………………...127

Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 ……………………………………..106, 117,

141

Gregson v HAE Trustees Ltd and others [2008] EWHC 1006 …………………………………. 96, 123,

124, 142

Grimwade v Mutual Society [1885] 52 LT 409 …………………………………………………101, 140

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 ……………………………………..128, 130

Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392 ………………………………………….104

Lexi Holdings Plc v Luqman [2007] EWHC …………………………………………………………134

Lexi Holdings (in administration) v Luqman and others [2008] EWHC 1639 ………………...124, 125,

143

Madoff Securities International Limited (in liquidation) v Raven and Others [2013]

EWHC 3147 …………………………………………………………………………………………..133

Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical

Services Ltd and others [1983] 2 All ER 563 …………………………………………………..105, 140,

141

Norman v Theodore Goddard [1991] BCLC 1028 ……………………………………………..104, 117,

122

Overend & Gurney Co v Gibb [1872] LR 5 HL 480 …………………………………………...101, 140,

155, 238

387

Re Brazilian Rubber Plantation and Estates Ltd [1911] 1 Ch 437 ……………………………..102, 103,

122, 155, 239, 240, 242, 287

Re D’Jan of London Ltd [1993] BCC 646 ……………………………………………………...104, 107,

117,122,126,141

Re Cardiff Saving Banks [1892] 2 Ch 100 ……………………………………………………………101

Re City Equitable Fire Insurance Co [1925] Ch 407 428 ………………………………...........103, 104,

105, 122, 125, 134, 140, 141, 155, 157, 158, 239, 242, 287

Re Elgindata Ltd [1991] BCLC 959 ………………………………………………………………….130

Re Kirby Coaches Ltd [1991] BCC 130 ……………………………………………………………...133

Re National Bank of Wales Ltd [1899] 2 Ch 629 ……………………………………………………..101

Re Produce Marketing Consortium Ltd [1989] 5 BCC 569 …………………………………………106

Re Smith & Fawcett Ltd [1942] Ch 304 ………………………………………………………………101

Regal (Hastings) Limited v Gulliver [1967] 1 AER 378 ……………………………………………..101

Secretary of State for Trade and Industry v Baker and Others [2000] 1 BCLC 523, CA ………108, 109

Turquand v Marshall [1869] LR 4 Ch App 376 ………………………………………………..101, 102,

140, 238


510 East 84th Street Co v Genitrini 2011 N.Y. Slip Op 50202(U)

(Sup. Ct. N.Y. 2011) …………………………………………………………………………………...82

AC Acquisitions Corp v Anderson, Clayton & Co 519 A.2d 103, 111

(Del. Ch. 1986) …………………………………………………………………………………...60, 295

Air Line Pilots Association International v UAL Corp 717 F. Supp.

(N.D. Ill. 1989) …………………………………………………………………………………………55

Allied Chemical & Dye Corp v Steel & Tube Co 120 A (Del. Ch. 1923) ……………….......................42

Aronson v Lewis 473 A.2d 805, 813 (Del. 1984) ………………………………………................43, 45,

50, 51, 52, 57, 59, 60, 76, 77, 83, 85, 87, 194, 268, 294, 295, 323, 326, 330, 346

Atlantic Refining Co v Hodgman 13 F.2d 781, 788 (3d Cir. 1926) ……………………………………49

Auerbach v Bennett 393 N.E.2d (N.Y. 1979) ………………………………………………………….56

Beam v Stewart 845 A.2d 1040, 1049 (Del. 2004) …………………………………………………….76

Beard v Elster 39 153, 160 A.2d 731, 738 (Del.1960) ………………………………………………..48

Bennet v Weimar 975 P.2d 691 (Ala. 1999) …………………………………………………………...49

388

Bodell v General Gas & Elec Corp 15 (Del. Ch. 1927) …………………………………………...48, 87

Brehm v Eisner 746 A.2d (Del. 2000) ………………………………………………….................53, 59,

60, 61, 62, 74, 89, 294, 295

Burford v Sun Oil Co 319 U.S. 315, 317–18 (U.S. 1943) ……………………………………………..62

Casey v Woodruff 49 N.Y.S.2d 625, 643 (N.Y.S. Term 1944) ………………………………………..49

Cede & Co v Technicolor Inc 634 A.2d 345, 360 (Del. 1993) ……………………………………57, 61,

76, 80, 297

Chisholm v Georgia 2 US. 419, 448 (1793) …………………………………………………………...32

C & J Energy Services Incorporated v City of Miami General Employees’

and Sanitation Employees’ Retirement Trust Nos. 655 /657 (Del.Ch. 2014) ………………………….78

Colorado River Water Conservation Dist v United States 424 U.S. 800, 818

(U.S. 1976) ……………………………………………………………………………………………..62

Detwiler v Offenbecher 728 F. Supp. 103, 149 (S.D.N.Y. 1989) ...........................................................50

Dodge v Ford Motor Cor 170 N.W. (Mich. 1919) …………………...............................................54, 56

Dynamics Corporation of America v WHX Corporation 967 F. Supp. 59

(S.D.N.Y. 1997) ……………………………………………………………………………………71, 91

Emerald Partners v Berlin 726 A.2d 1215 (Del. 1999) ………………………………………………..74

Emerald Partners v Berlin 787 A.2d 85, 97 (Del. 2001) ……………………………….................73, 74,

75

Emerald Partners v Berlin 840 A.2d 641 (Del. 2003) ……………………………………………..74, 75

Federal Deposit Insurance Corporation v Stahl 89 F.3d 1510, 1517 (11th Cir. 1996) ……………….52

FDIC v Faigin 2013 U.S. Dist. LEXIS 94899 (C.D. Cal. July 8, 2013) ……………………………...51

FDIC v Hawker 2012 U.S. Dist. LEXIS 79320 (E.D. Cal. June 7, 2012) ……………………………..50

FDIC v Laudermilk 2013 U.S. Dist. LEXIS 166924 (N.D. Ga., Nov. 25, 2013) ……………………...51

FDIC v Perry 2011 U.S. Dist. LEXIS 143222 (C.D. Cal. 2011) ……………………………………...50

Francis v United Jersey Bank 432 A.2d 814, 824 (N.J. 1981) …………………………………...35, 42,

87, 164

Gagliardi v TriFoods Int’l Inc 683 A.2d 1049, 1052 (Del. Ch. 1996) ...........................................47, 54,

55

Gander v Stephens 965 A.2d 695 (Del. 2009) …………………………………………………………51

Gesoff v IIC Industrial Inc 902 A.2d 1130, 1145 (Del. Ch. 2006) ………………………………...77, 92

389

Gottlieb v McKee 107 A.2d 240 (Ch. Ct. 1954) ……………………………………………………….87

Graham v Allis-Chalmers Mfg Co 188 A.2d 125, 130 (Del. 1963) ………………………………..42, 87

Gray v Manhattan Med Center Inc 18 P.3d 291 (Kan. Ct. App 2001) ………………………………...49

Gries Sports Enters Inc v Cleveland Browns Football Co Inc 496

N.E.2d 959, 963 (Ohio 1986) …………………………………………………………………………..56

Grimes v Donald 673 A.2d 1207, 1217 n.15 (Del. 1996) ……………………………………………...77

Guth v Loft 23 Del. Ch. 255, 5 A.2d 503 (Del. Ch. 1939) ..............................................................35, 42,

60, 87, 295, 335

Hanson Trust PLC v ML SCM Acquisition, Incorporated

781 F.2d 264, 274-75 (2d Cir. 1986) …………………………………………………………………..53

Heineman v Datapoint Corporation 611 A.2d 950, 952 (Del. 1992) …………………………………77

Hirsch v Jones Intercable Inc 984 P.2d 629 (Colo. 1999) …………………………………………….49

Hun v Cary 82 NY. 65, 71 (N.Y.1880) ……………………………………………….....................35, 41

In re Caremark International Derivative Litigation 698 A.2d 959 (Del. Ch. 1996) ........................47, 53

In re Citigroup Inc Derivative Litigation 964 A.2d (Del. Ch. 2009) …………………………………..62

In re El Paso Corporation Shareholder Litigation 41 A.3d 432, 439

(Del. Ch. 2012) ………………………………………………………………………………………...77

In re Family Dollar Stockholder Litigation C.A. No. 9985-CB 2014

(Del. Ch. 2014) …………………………………………………………………………………….77, 78

In re Integrated Resources Inc 147 B.R. 650 (S.D.N.Y 1992) ……………………….....................81, 82

In re Kenneth Cole Productions Inc Shareholder Litigation No. 54, (N.Y. 2016) ………………...82, 83

In re KKR Financial Holdings LLC Shareholder Litigation

101 A.3d 980 (Del. Ch. 2014) ………………………………………………………………………….79

In re MFW Shareholders Litigation 67 A.3d 496 (Del. Ch. 2013) ………………………………...78, 79

In re Orchard Enterprises Inc Stockholder Litigation C.A. No. 7840

(Del. Ch. 2014) ………………………………………………………………………...........................79

In re Solera Holdings Inc Stockholder Litigation C.A. No. 11524-CB

(Del. Ch. 2017) ………………………………………………………………………………………...81

In re TD Banknorth Shareholders Litigation 938 A.2d 654 (Del. Ch. 2007) ……………………...73, 82

In re Volcano Corporation Stockholder Litigation No. 10485 (Del Ch. 2016) …………………..80, 81,

92

In re Walt Disney Co Derivative Litigation 906 A.2d 27, 52 (Del. 2006) ……………………………..59

390

In re Zale Corp Stockholders Litigation 2015 WL 5853693 (Del. Ch. 2015) …………………………79

Joy v North 692 F.2d 880 (2nd Cir. 1982) ……………………………………………………………...55

Kamin v American Express Co 383 N.Y.S.2d 807 (N.Y. Sup. 1976) …………………………….60, 295

Kaplan v Centex Corp 284 A.2d 119, 124 (Del. Ch. 1971) ……………………………………….48, 50,

59

Kastel v Stieber 215 Cal. 37, 39 (Cal. 1932) …………………………………………………………43

Kelly v Bell 266 A.2d 878, 879 (Del. 1970) …………………………………………......................50, 85

Kahn et al v M&F Worldwide 88 A.3d 635 (Del. 2014) ………………………………………………82

Krasner v Moffet 826 A.2d (Del. 2003) ...........................................................................................73, 82,

91

Levandusky v One Fifth Avenue Apartment Co 75 N.Y.2d 530

(N.Y.1990) ………………………………………………………………………………………...82, 83

Litwin v Allen 25 NY.S.2d 667, 677 (N.Y. 1940) ...................................................................................43

Loftland v Cahall 118 A (Del. 1922) …………………………………………………………………..42

Lorne v 50 Madison Avenue LLC 65 A.D.3d 879 (1st Dept. 2009) …………………………………...82

Louis K Liggett Co v Lee 288 US 517, 548-49 (U.S. 1933) …………………………………………...39

Lynch v Vickers Energy Corp 383 A.2d 278, 281 (Del. 1977) ………………………………………...80

Marony v Applegate 266 A.D. 412 422 42 N.Y.S. 2d 768, 779

(N.Y. App. Div. 1943) ……………………………………………………………………………..34, 48

McMullin v Beran 765 A.2d 910 (Del. 2000) ………………………………………………………….74

McPadden v Sidhu 964 A.2d 1262 (Del. Ch. 2008) …………………………………………………...59

Mills Acquisition Co v Macmillan Inc 559 A.2d (Del. 1989) ……………………………………..70, 76,

81

Minzer v Keegan CV-97-4077 (CPS), 1997 U.S. Dist. 16445, 32

(E.D.N.Y. 1997) ……………………………………………………………………………………71, 91

MM Cos v Liquid Audio Inc 813 A.2d 1118 (Del. 2003) ……………………………………………...74

Nagy v Bistricer 770 A.2d (Del. Ch. 2000) ……………………………………………………………54

National Credit Union Administration v Siravo Case No. CV-10-01597

(C.D. Cal.) ……………………………………………………………………………………………...50

New Jersey Carpenters Pension Fund v Info GROUP Inc 2011 Del. Ch.

LEXIS (Del. Ch.2011) …………………………………………………………………………………54

391

New Orleans Public Service Inc v Council of New Orleans 491 U.S. 350, 361

(U.S. 1989) ……………………………………………………………………………………………..62

Official Committee of Unsecured Creditors v Baldwin 2011 U.S. App.

LEXIS (3d Cir. 2011) ………………………………………………………………………………….53

Omnicare Inc v NCS Healthcare Inc 818 A.2d 914, 927 (Del. 2003) ..............................................62, 89

Paramount Communications, Inc v QVC Network Inc 637 A.2d (Del. 1994) …………………….59, 70,

71, 72, 76, 84, 89, 91, 294, 295

Pepper v Litton 308 US 311 (U.S. 1939) ………………………………………………………….35, 40,

42, 87

Percy v Millaudon 8 Mart NS (La.1892) …………………………………………………………..48, 55

Platt v Richardson 1989 U.S. Dist. LEXIS 7933 (M.D. Pa. June 6, 1989) ……………………………52

Pogostin v Rice 480 A.2d 619, 624 (Del. 1984) ……………………………………………………….57

Potter v Pohlad 560 N.W.2d 389, 393 (Minn. Ct. App. 1987) ………………………………………...55

PSE&G Shareholder litigation 173 N.J. (N.J 2002) …………………………………………………...55

Puma v Marriott 283 A.2d 693, 695-96 (Del. Ch. 1971) ……………………………………………...48

Quadrant Structured Products Company v Vertin 102 A.3d (Del. Ch. 2014) …………………………56

Rabkin v Philip A Hunt Chem Co 547 A.2d 963, 972 (Del. Ch. 1986) ………………………………..52

Rales v Blasband 634 A.2d 927, 936 (Del.1993) ……………………………………………………...54

Reget v Paige 626 N.W.2d (Wis. Ct. App. 2001) at 310 ………………………………………………55

Reis v Hazelett Strip-Casting Co 28 A.3d 442, 457 (Del. Ch. 2011) ………………………………….76

Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A.2d 173 (Del. 1986) …...........................36, 67,

69, 70, 77, 91

Robinson v Pittsburgh Refining Co 126 A. 46 (Del. Ch. 1924) ……………………………………49, 50

Rosenblatt v Getty Oil Corporation 493 A.2d 929, 937 (1985) …………………………………...73, 91

RR Comm’n of Tex v Pullman Co 312 U.S. 496, 501–02 (U.S. 1941) ………………………………...62

Scattered Corporation v Chi Stock Exchange 701 A.2d 70, 72-73

(Del. 1997) ……………………………………………………………………………………………..77

Schlensky v Wrigley 237 NE2d 776 (Ill. App. 1968) ………………………………………………60, 63

295

Scully v Auto Fin Co 101 A. 908, 909 (Del. Ch. 1917) ………………………………………………..49

Sherlock v 20 East 9th Street Owners Corp 2011 WL 1337447

(Sup. Ct. N.Y.2011) ……………………………………………………………....................................82

392

Singh v Attenborough 137 A.3d 151, 151- 52 (Del. 2016) ………………………………………..59, 80,

81, 92

Sinclair Oil Corp v Levien 280 A.2d 717, 722 (Del.1971) ………………………………………..48, 59,

60, 295

Smith v Van Gorkom 488 A.2d 858 (Del. 1985) …………………………………………………..35, 36,

42, 43, 44, 45, 46, 53, 59, 76, 87, 92, 163, 179, 180, 182, 276, 326

Solash v Telex Corp 97, WL 3587 (Del. Ch. 1988) ……………………………………………………56

Spering’s Appeal 71 Pa. 11, 17, 24 (1872) ………………………………………………………..35, 40,

42

Sterling v Mayflower Hotel Corporation 93 A.2d 107, 110 (Del. 1952) …………………………..73, 91

Stone v Ritter 911 A2d 362, 370 (Del. 2006) ………………………………………………………….42

Swentzel v Penn Bank 147 Pa. St. 140 …………………………………………………………………41

Thomas v Kempner 398 A.2d 320 (Del. Ch. 1979) ……………………………………………………52

Trible v American Co 61 NJ. Eq. 340 (1901) ………………………………………………………….40

Twin-Lick Oil Co. v Marbury 91 US 587, 588-89 (1875) ……………………………………………..40

TW Service Incorporated v SWT Acquisition Corporation C.A. No.

10427 (Del.Ch. 1989) …………………………………………………………………………….52, 323

Unitrin, Inc v American General Corp 651 A.2d 1367 (Del. 1995) …………………………………...68

Unocal Corp v Mesa Petroleum Corp 493 A.2d 946 (Del. 1985) ………………………………...36, 59,

60, 67, 68, 69, 70, 77, 90, 91, 295

Washington Bancorp v Said 812 F.Supp. 1256 (D.D.C. 1993) ………………………………………. 55

Warshaw v Calhoun 43 148, 221 A.2d 487, 492-93 (Del.1966) ………………..............................48, 51

Wedel v Klein 282 N. W. (Wis. 1938) …………………………………………………………………43

Weinberger v UOP Inc 457 A.2d 701, 710 (Del. 1983) …………………………………………..73, 82,

91

Weinberger v Quinn 264 A.D. 405, 408, 35 N.Y.S.2d 567, 570-71

(N.Y. App. Div.) ……………………………………………………………………………………….48

Whitmer v Whitmer & Sons Inc 99 A. 428, 431 (Del. Ch. 1916) ……………………………………...49

Younger v Harris 401 U.S. 37, 43–46 (U.S. 1971) …………………………………………………….62

393

SOUTH AFRICA

Anderson and Others v Dickson and Another NNO

(Intermenua (Pty) Ltd Intervening) 1985 (1) SA 93 (N) ……………………………………………..216

Bellini v Paulsen 2012 JDR 2301 (WCC) ……………………………………………………………248

Bellairs v Hodnett and Another 1978 (1) SA 1109 (A) ………………………………………………228

Ben-Tovim v Ben-Tovim and Others 2001 (3) SA 1074 (CPD) …………………………………251, 269

Braitex (Pty) Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA) …………………..247, 248

Bytes Technology Group South Africa (Pty) Ltd v Michael 2014

JDR 2491 (GP) ………………………………………………………………………………………..244

Cape Empowerment Trust Limited v Druker and Others (2016)

JOL 36987 (WCC) ……………………………………………………………………………………275

Chemfit Fine Chemicals (Pty) Ltd v Maake 2017 JDR 1473 (LP) …………………………………...267

Cohen NO v Segal 1970 (3) SA 702 (W) ………………………………………………………..227, 287

Country Cloud Trading CC v MEC, Department of Infrastructure

Development 2015 (1) SA 1 (CC) ……………………………………………………………….243, 244

Cyberscene Ltd v i-Kiosk Internet and Information (Pty) Ltd

2000 3 SA 806 (C) ……………………………………………………………………………...219, 226,

227

Da Silva v CH Chemicals (Pty) Ltd 2008 (6) SA 620 (SCA) ………………………………………...226

Dantex Investment Holdings (Pty) Ltd v Brenner & Others

NNO 1989 (1) SA 390 (A) ……………………………………………………………………………244

Derbigum Manufacturing (Pty) Ltd v Callegaro and Others

2013 ZAGP JHC ……………………………………………………………………………………...227

Du Plessis NO v Phelps 1995 (4) SA 165 (C) ………………………………………………….227, 241,

287

Estate Wege v Strauss 1932 AD 76 …………………………………………………………………..213

Evins v Shield Insurance Co Ltd 1980 (2) SA 814 (A) at 835 ………………………………………..245

Ex parte Provisional Liquidator Hugo Franco (Pty) Ltd

1958 (4) SA 397 (W) …………………………………………………………………………………213

Ex parte Lebowa Development Corporation Ltd 1989 (3) SA 71 (T) ………………………….246, 271,

275

Fisheries Development Corporation of SA Ltd v Jorgensen;

Fisheries Development Corporation of SA Ltd v AWJ Investments

(Pty) Ltd 1980 (4) SA 156 (W) …………………………………………………………………208, 223,

224, 226, 238, 239, 240, 243, 246, 271, 275, 302

394

Fourie v Firstrand Bank Ltd and Another NO 2013 (1) SA 204 (SCA) ……………………………..247

Glenrand MIB Financial Services (Pty) Ltd v Van Heerden

NO 2013 1 All SA 511 (SCA) 16 …………………………………………………………………….226

Howard v Herrigel and Another1991 (2) SA 660 A …………………………………………...218, 240,

241, 247, 248, 301

Jacobs and Another v Transnet Ltd t/a Metrorail and Another 2015

(1) SA 139 (SCA) ……………………………………………………………………………………244

Kalinko v Nisbet and Others 2002 (5) SA 766 (W) …………………………………………………..248

KLM Royal Dutch Airlines v Hamman 2002 (2) SA 818 (W) ………………………………………..275

Kruger v Coetzee 1966 (2) SA 428 (A) ………………………………………………………………244

Kaimowitz v Delahunt and Others 2016 (3) SA 201 (WCC) …………………………………...215, 218

Levin v Feld and Tweeds Ltd 1951(2) SA 401 (A) ……………………………………………..251, 254,

269

Loureiro and Others v Imvula Quality Protection (Pty) Ltd 2014 (3)

SA 394 (CC) ………………………………………………………………………………………….243

Louw and Others v Long 1990 (3) SA 45 E …………………………………………………………..239

Mafikeng Mail (Pty) Ltd v Centner 1995 (4) SA 607 (W) ……………………………………...248, 251,

269

Majolica Pottery (Venda) (Pty) Ltd v Barrow & Coetzee and Others

1999 (1) SA 1166 (C) ……………………………………………………………. ………………….244

Maake v Chemfit Fine Chemicals (Pty) Ltd

(5772/2016/HCAA04/2018) [2018] …………………………………………………………………..267

Masethla v President of the Republic of South Africa 2008

(1) BCLR 1 (CC) ………………………………………………………………..................................291

Minister of Forestry v Quathlamba (Pty) Ltd 1973 (3) SA 69 (A) …………………………………...243

Minister of Water Affairs and Forestry v Stilfontein Gold

Mining Co Ltd 2006 (5) SA (W) ………………………………………………………………..253, 254,

255, 259, 260, 289, 304, 380, 397

Niagra Ltd (in liquidation) v Langerman and Others 1931 WLD 188 ………………………... 251, 269

Pharmaceutical Manufacturers Association of SA and Another:

In re Ex parte President of the Republic of South Africa and

Others 2000 (2) SA 674 (CC) …………………………………………………………………...281, 293

Perlman v Zoutendyk 1934 CPD 151 …………………………………………………………………242

Phindani v Manyepedza 2007 (3) BLR 141 (HC) ……………………………………………………287

395

Phillips v Fieldstone Africa (Pty) Ltd 2004 2 All SA…………………………………………………215

Philotex (Pty) Ltd and Others v Snyman and Others 1998 (2)

SA 138 (SCA) …………………………………………………………………………………..241, 242,

247, 248, 302

Premier, Western Cape v Faircape Property Developers (Pty) Ltd

2003 (6) SA 13 (SCA) ………………………………………………………………………………..244

Pressma Services (Pty) Ltd v Schuttler and Another 1990 (2) SA 411 (C) ……………………..246, 248

Rabinowitz v Van Graan 2013 (5) SA 315 (GSJ) …………………………………………………….266

Robinson v Randfontein Estates Gold Mining Co Ltd 1921 AD 168 …………………………...226, 227

Rustenburg Platinum Mines Ltd v South African Airways and

Pan American World Airways Inc 1977 (1) Lloyds LR 19 (QB (Com Ct)) ………………………….275

Saincic and Others v Industro-Clean (Pty) Ltd and Another 2009

(1) SA 538 (SCA) …………………………………………………………………………………….249

Sage Holdings Ltd v The Unisec Group Ltd 1982 (1) SA 337 (W) 354 ……………………………...224

Sibex Construction (SA) (Pty) Ltd v Injectaseal 1988 (2) SA 54 (T) …………………………...226, 227

Strut Ahead Natal (Pty) Limited v Burns 2007 3 All SA 190 (D) …………........................................216

S v de Jager and Another 1965 (2) SA 616 (A) …………………………………………………224, 226

S v Dhlamini 1988 (2) SA 302 (A) …………………………………………………………………...241

S v Gardiner and Another 2011 (4) SA 79 (SCA) ……………………………………………………229

S v Hepker and Another 1973 (1) SA 472 (W) 484 ………………………..........................................224

S v Humphreys 2015 (1) SA 491 (SCA) ……………………………………………………………...244

S v Shaban 1965 (4) SA 646 (W) 651 …………………………………………………………...222, 224

S v Van As 1976 (2) SA 921 ……………………………………………………………………..241, 302

S v Van Zyl 1969(1) SA 553 (A) ……………………………………………………………………...241

Swanee’s Boerdery (Edms) Bpk (in Liquidation) v Trust Bank

of Africa Ltd 1986 (2) SA 850 (A) ……………………………………………………………………226

Tsung and Another v Industrial Development Corporation

of South Africa Ltd and Another 2013 (3) SA 468 (SCA) ………………………………………247, 248

Otsile Holdings (Pty) Ltd and Another v De Freitas 2009 1

BLR 487 HC ………………………………………………………………………………………….215

Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd and

396

Others 2014 (5) SA 179 (WCC) ………………………………………………………………..226, 281,

283, 291, 293, 294, 333

REPORTS

AUSTRALIA

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director’s duties: Report on the social and fiduciary duties and obligations of company

directors” (AGPS Canberra 1989).

First Report of the Royal Commission of Inquiry into the Tricontinental Group of Companies,

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Rae Report: Senate Select Committee on Securities and Exchange Report, 1974.

WA Regional Commissioner Australian Securities & Investment Commission: Director’s

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UNITED KINGDOM

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of Best Practice (1992).

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Department of Trade and Industry Modern Company Law for a Competitive Economy: The

Strategic Framework, (1999).

Department of Trade and Industry Modern Company Law for a Competitive Economy:

Developing the Framework (2000).

Department of Trade and Industry Modern Company Law for a Competitive Economy:

Completing the Structure (2000).

Department of Trade and Industry Modern Company Law for a Competitive Economy: Final

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ESRC Centre of Business Research University of Cambridge Report 1999 Directors’ duties:

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Greenbury Report: Directors' Remuneration: Report of a Study Group (1995).

Hampel Report: Committee on Corporate Governance, Final Report (1998).

Higgs Report: Review of the roles and effectiveness of non-executive directors (2003).

397

House of Commons Trade and Industry Committee: White Paper on Modernising Company

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Owen Report: Report of the HIH Royal Commission (2003).

Smith Report: Audit committees combined code guidance: A report and proposed guidance

by an FRC-appointed group (2003).

The Law Commission: Company Directors and Officers: Indemnification, Relief and

Insurance, the Companies and Securities Law Review Committee (1992).

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The Financial Reporting Council: The UK Corporate Governance Code (2018).

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Turnbull Report: Internal control: Guidance for directors on the combined code (September

1999).

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Eisenberg Whether the business judgment rule should be codified: Background Study for the

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codified (1998).

SOUTH AFRICA

Department of Trade and Industry Policy Paper South African Company Law for the 21st

Century Guidelines for Corporate Law Reform (2004).

Institute of Directors in South Africa, The King Report on Corporate Governance for South

Africa (1994) – King I.


Africa (2002) – King II.


Africa (2009) – King III.


Africa (2016) – King IV.

The final report of the commission of inquiry into the affairs of the Masterbond Group and

investor protection in South Africa (2001).

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INDEX

A

abstention doctrine36, 60, 61, 62, 85, 86, 89, 189,

294, 295, 297, 301, 310, 347, 349, 353, 370, 402

agency cost problem57, 137, 139, 236, 237, 316,

317, 318, 321

ALI8, 29, 34, 36, 50, 52, 54, 64, 66, 67, 83, 84, 85,

86, 88, 89, 134, 193, 271, 278, 292, 297, 298, 306,

323, 327, 328, 329, 330, 331, 333, 334, 335, 336,

337, 340, 341, 344, 345, 347, 349, 350, 406

alternate director ........................................ 215, 217

American Law Institute8, 10, 29, 32, 50, 64, 65, 66,

84, 85, 88, 89, 129, 271, 272, 323, 327, 330, 331,

335, 340, 363, 372, 384

B

best interest of the company3, 13, 188, 209, 222,

225, 231, 232, 286, 287, 288, 300, 301, 307, 315,

341, 342, 344, 349, 352, 353, 354

best interest of the corporation .......... 36, 84, 88, 90

blockholder .180, 182, 236, 238, 319, 321, 322, 401

board of directors44, 46, 54, 55, 57, 59, 61, 68, 71,

73, 75, 90, 92, 138, 155, 162, 171, 174, 192, 214,

216, 224, 228, 229, 237, 256, 291, 318, 321

breach3, 23, 25, 35, 43, 44, 45, 46, 47, 49, 60, 61,

72, 82, 87, 95, 101, 106, 107, 123, 126, 127, 128,

131, 132, 133, 134, 137, 138, 139, 140, 143, 155,

157, 169, 171, 173, 174, 175, 176, 177, 179, 190,

192, 198, 203, 204, 206, 207, 224, 226, 228, 238,

242, 243, 246, 251, 254, 256, 260, 265, 267, 269,

271, 272, 274, 275, 276, 287, 288, 289, 290, 293,

296, 302, 304, 307, 308, 315, 317, 325, 326, 342,

343, 345, 346, 348, 374

burden of proof50, 51, 60, 61, 73, 89, 92, 133, 189,

194, 203, 207, 248, 295, 296, 298, 310, 335, 347,

348, 353

business decision36, 45, 51, 52, 53, 58, 59, 60, 65,

83, 88, 89, 134, 161, 182, 183, 184, 189, 194, 198,

202, 246, 276, 280, 291, 292, 294, 297, 309, 310,

314, 323, 324, 325, 326, 346, 347, 348, 350

business judgment rule3, 10, 12, 13, 15, 23, 24, 25,

26, 27, 28, 29, 30, 31, 32, 34, 35, 36, 37, 45, 46,

47, 48, 49, 50, 51, 52, 53, 54, 55, 56, 57, 58, 59,

60, 61, 63, 64, 65, 66, 67, 68, 71, 72, 73, 75, 76,

78, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, 90, 91,

92, 96, 109, 116, 128, 129, 130, 131, 132, 134,

139, 141, 143, 144, 146, 147, 154, 160, 161, 166,

168, 169, 170, 181, 182, 183, 185, 186, 187, 188,

189, 190, 191, 193, 194, 195, 197, 198, 199, 201,

202, 203, 205, 206, 207, 209, 210, 211, 214, 218,

225, 228, 238, 246, 251, 254, 259, 260, 261, 264,

265, 268, 269, 270, 271, 272, 273, 274, 275, 276,

277, 278, 279, 282, 283, 284, 285, 286, 287, 288,

289, 290, 291, 292, 293, 294, 295, 297, 298, 299,

300, 303, 304, 305, 306, 307, 308, 309, 310, 311,

312, 313, 314, 315, 316, 317, 318, 320, 322, 323,

324, 325, 326, 327, 328, 329, 330, 331, 332, 333,

334, 335, 336, 337, 338, 339, 340, 341, 342, 343,

344, 345, 346, 347, 348, 349, 350, 352, 353, 354,

355, 366, 369, 370, 371, 372, 375, 377, 378, 379,

380, 381, 384, 400, 401, 403, 404, 405, 406, 408

C

Chief Executive Officer ......................... 21, 44, 111

Chief Operations Officer ......................................21

common law27, 28, 29, 30, 48, 64, 85, 95, 101, 107,

116, 117, 120, 121, 124, 141, 146, 148, 155, 158,

170, 171, 183, 188, 189, 204, 206, 212, 214, 215,

225, 228, 229, 237, 241, 245, 247, 248, 249, 254,

260, 262, 263, 264, 265, 266, 269, 288, 290, 301,

304, 314, 321, 344, 348, 349, 375, 376, 377

company secretary .............................. 175, 176, 177

407

conflict of interest42, 65, 222, 226, 254, 274, 282,

283, 303, 306, 325, 348

corporate collapses ................ 19, 21, 145, 158, 204

corporate governance18, 20, 21, 22, 55, 58, 88, 101,

109, 110, 111, 113, 114, 115, 137, 153, 182, 213,

220, 226, 234, 236, 238, 239, 240, 249, 250, 251,

252, 258, 270, 277, 280, 289, 317, 372, 373, 374,

375, 377, 379, 381, 402, 406

D

Delaware6, 10, 28, 29, 32, 33, 34, 35, 36, 37, 38, 39,

40, 42, 43, 44, 46, 47, 48, 49, 50, 51, 52, 53, 57,

58, 59, 60, 61, 63, 65, 66, 67, 68, 70, 71, 72, 74,

75, 76, 77, 78, 80, 82, 83, 84, 85, 86, 87, 88, 89,

90, 91, 92, 134, 138, 189, 194, 272, 292, 294, 295,

296, 316, 323, 326, 327, 328, 330, 331, 333, 335,

337, 340, 341, 344, 345, 346, 347, 350, 357, 373,

378, 380, 382, 383, 384, 387, 402, 403, 404, 405,

408

delict242, 243, 244, 265, 270, 277, 287, 288, 290,

302, 308, 342, 345

director19, 23, 35, 36, 40, 42, 43, 46, 47, 48, 49, 52,

53, 54, 55, 57, 59, 60, 61, 62, 64, 65, 66, 73, 74,

75, 76, 77, 83, 84, 87, 89, 91, 92, 95, 96, 98, 101,

102, 104, 105, 106, 107, 108, 114, 115, 117, 118,

119, 121, 122, 123, 124, 125, 126, 127, 128, 129,

132, 133, 134, 135, 136, 137, 138, 139, 140, 141,

142, 143, 146, 153, 154, 155, 156, 157, 158, 159,

161, 162, 163, 164, 165, 167, 168, 170, 171, 172,

173, 174, 177, 178, 179, 181, 183, 185, 186, 189,

190, 191, 192, 194, 195, 196, 197, 198, 201, 205,

206, 209, 215, 216, 217, 218, 219, 220, 221, 222,

223, 224, 225, 226, 227, 228, 236, 237, 238, 239,

240, 241, 242, 244, 246, 248, 250, 251, 252, 258,

262, 263, 264, 265, 266, 267, 268, 269, 270, 272,

273, 274, 275, 278, 279, 280, 282, 283, 284, 285,

287, 288, 290, 291, 292, 294, 295, 301, 308, 313,

314, 316, 317, 318, 320, 323, 325, 326, 327, 329,

330, 331, 332, 333, 337, 338, 343, 347, 348, 349,

350, 353, 354, 355, 371, 373, 374, 375, 376, 380,

381, 384, 399, 402, 403, 407, 408

directors3, 10, 13, 19, 20, 21, 23, 24, 25, 26, 27, 28,

29, 30, 32, 34, 35, 36, 37, 40, 41, 42, 43, 44, 45,

46, 47, 48, 49, 50, 51, 52, 53, 54, 55, 56, 57, 58,

59, 60, 61, 62, 63, 64, 65, 66, 67, 68, 69, 72, 74,

75, 76, 77, 78, 79, 80, 82, 83, 84, 85, 87, 88, 89,

90, 91, 92, 95, 98, 99, 100, 101, 102, 103, 104,

106, 107, 108, 109, 110, 111, 112, 113, 114, 115,

116, 117, 118, 119, 120, 121, 122, 123, 124, 125,

127, 128, 129, 130, 131, 132, 133, 134, 135, 138,

139, 140, 141, 142, 143, 145, 146, 147, 150, 153,

154, 155, 156, 157, 158, 160, 161, 162, 163, 164,

165, 166, 167, 168, 169, 170, 171, 172, 173, 174,

175, 176, 177, 178, 179, 180, 181, 182, 183, 184,

185, 186, 187, 188, 189, 190, 191, 192, 193, 194,

195, 196, 197, 198, 199, 200, 201, 202, 203, 204,

205, 206, 207, 208, 209, 210, 213, 214, 215, 216,

217, 218, 219, 220, 221, 222, 223, 224, 225, 226,

227, 228, 229, 230, 231, 232, 233, 234, 236, 237,

238, 239, 240, 241, 242, 244, 245, 246, 247, 248,

249, 250, 251, 252, 253, 254, 255, 256, 258, 259,

260, 261, 262, 263, 264, 265, 266, 268, 269, 270,

271, 272, 273, 274, 276, 277, 278, 279, 280, 281,

282, 283, 285, 286, 287, 288, 289, 290, 291, 292,

293, 294, 295, 296, 297, 298, 300, 301, 302, 303,

304, 305, 306, 307, 308, 309, 310, 314, 315, 316,

318, 319, 320, 321, 322, 323, 324, 325, 326, 327,

328, 329, 330, 331, 332, 333, 334, 335, 336, 337,

338, 339, 340, 341, 342, 343, 344, 345, 346, 347,

348, 349, 350, 351, 352, 353, 354, 355, 366, 370,

371, 372, 373, 374, 375, 376, 377, 378, 379, 380,

381, 382, 384, 399, 400, 402, 403, 404, 405, 406,

407, 408, 409

duty of care3, 12, 13, 23, 24, 25, 27, 28, 30, 34, 35,

36, 42, 43, 44, 45, 46, 47, 53, 59, 60, 61, 64, 67,

68, 74, 75, 78, 85, 87, 89, 90, 95, 96, 101, 102,

103, 104, 105, 106, 107, 109, 117, 119, 122, 123,

124, 127, 128, 129, 130, 131, 133, 134, 138, 140,

141, 142, 144, 145, 147, 153, 154, 155, 156, 160,

161, 162, 163, 164, 168, 169, 170, 171, 173, 174,

175, 176, 177, 186, 188, 189, 190, 192, 203, 204,

206, 208, 210, 225, 226, 228, 238, 239, 241, 242,

245, 250, 251, 252, 254, 256, 258, 260, 261, 262,

263, 264, 266, 268, 269, 271, 272, 273, 276, 280,

283, 286, 287, 288, 289, 290, 294, 295, 300, 301,

302, 304, 307, 308, 314, 315, 333, 334, 341, 342,

344, 345, 346, 349, 352, 354, 366, 371, 373, 374,

375, 379, 380, 402, 403, 404, 406

E

enlightened shareholder.............. 138, 302, 318, 375

Enron .................................... 19, 359, 361, 372, 381

entire fairness37, 61, 68, 73, 75, 76, 78, 79, 82, 83,

91, 92

executive directors106, 109, 111, 112, 113, 114,

153, 163, 165, 172, 175, 176, 177, 204, 216, 217,

240, 251, 253, 254, 382

F

Fidentia................................................... 19, 20, 368

fiduciary duties23, 24, 30, 34, 35, 42, 44, 51, 68, 72,

73, 75, 76, 85, 87, 90, 91, 101, 119, 125, 130, 170,

188, 206, 209, 222, 225, 226, 228, 229, 232, 241,

253, 256, 259, 260, 261, 262, 272, 286, 287, 288,

289, 300, 304, 307, 308, 314, 315, 341, 342, 343,

344, 345, 352, 375, 376, 378, 382, 399, 404, 405

fiduciary duty3, 24, 42, 44, 46, 49, 61, 188, 210,

225, 226, 227, 228, 229, 265, 271, 286, 287, 288,

293, 300, 301, 307, 308, 315, 341, 342, 344, 352,

354, 371, 372, 375

functions of directors ..........................................229

408

G

good faith26, 36, 42, 46, 48, 49, 50, 51, 53, 54, 55,

56, 59, 60, 61, 62, 64, 65, 68, 76, 83, 84, 85, 88,

90, 106, 114, 118, 119, 128, 131, 161, 168, 170,

173, 182, 183, 187, 190, 193, 194, 195, 196, 200,

203, 206, 218, 220, 223, 226, 228, 229, 231, 232,

238, 256, 259, 268, 271, 274, 286, 291, 292, 294,

295, 298, 300, 303, 307, 309, 314, 323, 325, 340,

341, 342, 346, 347, 352

gross negligence41, 43, 59, 61, 66, 87, 96, 101, 103,

106, 140, 145, 155, 238, 241, 246, 275, 331

I

immunity doctrine65, 85, 86, 189, 203, 294, 297,

298, 301, 310, 348, 349, 353, 381

independent judgment ........ 111, 113, 115, 163, 223

informed basis36, 51, 59, 88, 182, 194, 254, 268,

291, 294, 303, 309, 314, 323, 346

J

judicial infringement ............ 10, 23, 32, 55, 56, 268

juristic person ............................................ 229, 284

K

KPMG ........................................................... 20, 21

L

liability3, 13, 23, 25, 26, 35, 36, 42, 44, 46, 47, 48,

50, 55, 59, 61, 65, 66, 68, 73, 74, 75, 76, 85, 86,

88, 89, 97, 100, 101, 117, 125, 132, 133, 138, 139,

148, 153, 155, 157, 166, 168, 172, 176, 177, 184,

186, 189, 191, 192, 198, 203, 206, 207, 209, 216,

217,222, 224, 225, 238, 239, 240, 241, 242, 243,

244, 245, 246, 247, 248, 249, 250, 253, 261, 262,

264, 266, 268, 270, 271, 274, 277, 278, 285, 288,

291, 292, 294, 296, 297, 298, 301, 308, 310, 315,

325, 343, 345, 347, 348, 349, 353, 355, 373, 375,

377, 381, 382, 384, 401, 402, 403, 404, 406, 407

M

Masterbond .................................... 19, 20, 401, 406

memorandum of incorporation .......................... 343

N

negligence43, 45, 61, 66, 90, 103, 105, 106, 133,

137, 138, 139, 155, 156, 162, 192, 239, 241, 243,

246, 254, 264, 268, 270, 275, 290, 317, 331, 345,

406

New York28, 33, 34, 36, 37, 39, 41, 42, 43, 47, 48,

49, 50, 67, 68, 71, 72, 81, 82, 83, 85, 87, 88, 90,

91, 92, 189, 345, 377, 381, 387

nominee directors .............................................. 217

non-executive directors106, 111, 113, 114, 163,

165, 176, 177, 204, 253

O

objective standard of review84, 141, 142, 157, 170,

173, 174, 176, 276, 305, 306, 326, 328, 329, 330,

334, 350, 351, 355

ownership structure57, 137, 180, 236, 313, 316,

317, 379

P

personal interest37, 60, 76, 85, 89, 101, 168, 183,

187, 190, 191, 193, 196, 201, 202, 206, 295, 310,

314, 335, 336, 337, 347, 351, 353

personal liability ............................. 46, 56, 139, 297

poison pill ............................................... 68, 71, 402

prescribed officers188, 216, 218, 224, 225, 290,

301, 309, 346, 378

presumption13, 15, 29, 37, 49, 50, 51, 58, 59, 60,

63, 65, 73, 76, 79, 81, 83, 85, 88, 89, 91, 169, 182,

189, 194, 199, 202, 203, 209, 291, 292, 294, 295,

296, 297, 301, 309, 310, 312, 314, 323, 335, 340,

346, 347, 348, 349, 352

proper purpose13, 15, 84, 85, 114, 168, 170, 173,

183, 187, 190, 193, 194, 195, 196, 200, 203, 206,

209, 226, 228, 286, 300, 307, 312, 314, 340, 341,

342, 352

puppet directors ..................................................217

R

rationality53, 59, 66, 185, 186, 198, 277, 280, 281,

292, 294, 306, 309, 330, 331, 332, 333, 334

reasonableness67, 76, 133, 185, 186, 197, 198, 199,

242, 277, 280, 282, 294, 309, 330, 331, 332, 333,

334

reasonably37, 44, 49, 50, 52, 53, 59, 62, 64, 65, 66,

72, 76, 77, 78, 84, 89, 102, 104, 105, 106, 107,

117, 121, 122, 125, 127, 133, 140, 142, 158, 159,

161, 168, 173, 178, 179, 183, 185, 190, 193, 196,

201, 239, 243, 246, 252, 253, 263, 264, 268, 270,

272, 273, 274, 276, 277, 278, 279, 281, 285, 292,

293, 300, 305, 326, 327, 328, 329, 348, 349, 350,

353, 355

S

safe harbour3, 25, 26, 29, 36, 50, 65, 66, 83, 85, 89,

169, 186, 189, 194, 197, 202, 203, 206, 207, 291,

292, 294, 295, 297, 298, 301, 309, 310, 314, 334,

347, 348, 349, 352, 356, 372, 374, 408

shareholders21, 26, 34, 36, 42, 43, 45, 47, 48, 56,

57, 60, 63, 64, 67, 68, 69, 72, 74, 75, 76, 77, 78,

79, 80, 81, 83, 87, 90, 91, 92, 93, 97, 98, 100, 110,

114, 132, 135, 137, 138, 139, 153, 172, 181, 182,

192, 225, 229, 230, 231, 232, 233, 234, 236, 237,

238, 245,254, 263, 267, 283, 295, 302, 303, 316,

317, 318, 319, 321, 338, 371, 381, 406, 407

South Sea Bubble . 11, 94, 97, 98, 99, 359, 360, 406

standard of liability ..............................................61

409

statutory duties120, 121, 156, 171, 177, 241, 263,

265, 267, 345, 346

statutory duty12, 121, 144, 145, 147, 156, 171, 174,

175, 176, 177, 189, 190, 192, 287, 288, 289, 344,

349, 379

Steinhoff ................................................ 20, 21, 407

subjective standard of review84, 117, 131, 141,

158, 174, 185, 202, 204, 276, 278, 306, 328, 329,

330, 350, 355

T

temporary directors ............................................217

W

WorldCom ............................................................19

wrongfulness242, 243, 244, 270, 277, 290, 345, 372

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