Business Judgment and the Courts

Lead Research Organisation: University of Leeds
Department Name: Law

Abstract

Successful companies are essential for a strong economy. However poorly run companies can cause serious economic and social harm as the financial crisis and the Deepwater Horizon oil spill demonstrate. Directors of large companies exercise great power as their decisions can have significant ramifications for their companies and for society. Adequate accountability is often seen as necessary to legitimise power, deter careless and self interested behaviour and encourage better conduct. Yet directors of large public companies enjoy a high degree of immunity from legal liability for decisions that cause harm. A key reason is that courts have stated that the exercise of business judgment by directors should be immune from judicial review. Yet although classifying a decision as a business judgment provides directors with a powerful shield from accountability, exactly what is meant by a business judgment, and what decisions count as such, has not been closely considered. This is a significant gap in knowledge that makes it difficult to assess whether there are good policy reasons for directors' lack of legal accountability: this cannot be assessed without knowing what kinds of decision are exempted from review, what are reviewed, and why, the potential impact on directors of review, and in the light of these considerations, whether arguments for and against review justify the judicial position generally and in individual cases.
There are important social, legal and practical reasons for exploring these issues. The difficulty of challenging directors' decisions has led to an absence of legal accountability for directors, as the prospect of successful litigation against them in respect of their decisions is very low, and in public companies practically non-existent. The resulting lack of legal action against, for example, former bank directors for conduct castigated as reckless, caused widespread public dismay. Furthermore, insofar as the courts are now required by statute to assess commercial decisions (for example under section 263(2)(a) and(3)(b) Companies Act 2006), a failure to do so may undermine statutory goals. At the same time holding directors liable for their decisions may have adverse economic consequences: greater judicial scrutiny could cause directors to make conservative decisions, deter entrepreneurial risk taking and deter able people from being directors. Because there is no clarity about what constitutes a business judgment, when the courts do pass judgment (positively or negatively) on directors' decisions they may be assessing business judgments, but not recognising this. The ramifications of this, and of increased judicial scrutiny of directors' decisions, for boards, shareholders, stakeholders and corporate governance, is little understood.
This inter-disciplinary project which brings together a team of researchers from the School of Law, Leeds and the School of Management, Liverpool, aims to address this gap and allow for an informed assessment of whether the status quo should be maintained or, if changes are necessary, provide a framework within which to identify what changes are desirable. The project is of international significance: what constitutes a business judgment and when directors' decisions should be reviewed are difficult issues across jurisdictions, and are dealt with very differently. In the US the rule of law termed 'the business judgment rule' has rendered directors' decisions immune from judicial scrutiny in most cases. In contrast in Australia decisions taken by directors of public companies have been subject to judicial review following successful regulatory action. Both approaches have been subject to criticism. The study will contribute to and augment this international debate over the appropriateness of courts and regulators reviewing directors' decisions and the broader implications for corporate governance, entrepreneurial risk-taking and director accountability.

Planned Impact

1. Policy-Makers/Government
Successful companies are essential for a strong economy but when companies are poorly run, particularly large companies, this can have adverse economic and social consequences. How to regulate large companies to ensure that they are well run, and whether directors are sufficiently accountable to shareholders and other stakeholders are therefore key policy issues. Policy-makers have recognised this, setting out a need for greater director accountability to maintain and restore market trust in order to increase economic activity and investment (Department for Business, Innovation and Skills (BIS) papers 'Transparency and Trust' (2013 and 2014)). By examining the extent to which courts intervene in directors' decision-making, and the potential impact of greater or lesser intervention, the project will assist legislators and policy-makers such as BIS, in designing measures that may impact on directors' legal accountability for their decisions.

2. Regulators
The project will be relevant to regulators in the UK and other jurisdictions, such as the Financial Conduct Authority and the Australian Securities and Investments Commission that must determine when to take action in relation to directors' decisions that have adverse outcomes. This issue is likely to arise under the new liability regime for senior managers in financial institutions which will be implemented March 2016: the FCA's predecessor received much criticism when it decided that it could not challenge directors' business judgment even when, as in the case of RBS, this led to disaster. The empirical data will contribute towards evidence based policy-making particularly in relation to enforcement policies and policies designed to promote directorial accountability. By assisting better informed regulation of companies it will contribute toward wealth creation and economic prosperity.

3. The Courts
By facilitating a better understanding of when exactly the courts are holding directors to account it will be possible to assess whether directors and those bringing actions against them, such as shareholders, are being treated in a fair, consistent and principled manner. If this is not the case one would expect judicial practice to respond, to the benefit of directors and shareholders.

4. Professional and Practitioner Groups
The project has the potential to inform the practice of solicitors and barristers who act for companies, shareholders and directors, giving them reasoned bases for arguing in court for or against holding directors liable for particular categories of decisions. This in turn may impact on judicial practice and alter the law so that it develops on a more coherent basis and avoids inappropriate judicial scrutiny of directors' decisions whilst encouraging appropriate scrutiny and accountability.

5. Directors
The project is supported by the Institute of Directors. The focus groups will be offered as continuing professional development and, by providing a forum within which directors can interact with others regarding when courts will review decisions and what, if anything, they consider to be problematic about the decisions that form the basis of the case studies, will enable them to re-evaluate their own understandings and experiences.

6. Companies and Shareholders
It will assist shareholders in assessing when challenges to directors' judgments may be mounted thus facilitating board accountability to shareholders. This in turn may indirectly benefit the wider public by promoting wealth creation and prosperity by discouraging reckless decision-making such as that seen during the financial crisis. Companies will also benefit from ascertaining when reviewing decisions could be harmful.

7. The Public
The project will enable more informed public debate about whether it is appropriate to hold directors accountable for business decisions with poor outcomes, a matter of on-going public concern.

Publications

10 25 50
 
Description In the absence of an established definition of business judgment, the project developed an original analytical framework for categorising directors' judgments, based on recognising that there are distinctive roles for boards which imply different types of judgment. The entrepreneurial role gives rise to entrepreneurial decisions that are more likely to be classified as business judgments, whereas judgments more associated with the directors' monitoring/corporate governance role are less likely. The project opens up new avenues for research such as whether/how the courts conceive of judgment is an accurate reflection of how directors and boards actually function in practice.
A key finding is that the orthodox proposition that judges defer to the business judgments of directors is incorrect. There has been an increase in review and rates of liability in challenges involving business judgment, particularly since 2007. However the judgments of public company directors in England and Wales are challenged in the courts. Most claims involve private companies. Liquidators have brought the greatest number of claims, followed by the Insolvency Service (proceedings for disqualification), indicating that most claims involve insolvent companies.
Another key finding is that whilst review can involve the substantive merits of directors' judgments, it very frequently involves a systematic review of the processes of judgment. The imposition of liability is more likely when the process has gone wrong, indicators of which are for example, that directors overlooked a factor, or failed to consider an issue, failed to take advice, or seek information. Judges also consider the absence of process, where the director acts without having exercised any judgment at all, or takes no action where action was required.

To reach these findings, cases over a 148 year period were reviewed and a database was constructed. 130 cases were included in the database and comprehensively coded across a range of categories. This database comprises a significant new dataset that provides opportunities for further analysis that have not been exhausted by the objectives of this project.

The project also successfully generated rich new data from qualitative interviews and focus groups with directors in the UK, US and Australia, company secretaries, investor groups, and legal practitioners. These groups are very hard to access so this is valuable data. Significant findings generated include that directors accept that judicial review of their judgments is legitimate, subject to careful consideration of the context and process of directors' actions. Support for review and accountability was strongest when serious harm has been caused and when stakeholders, such as creditors, were harmed, and in insolvency. Other significant findings raise questions about the strength of key normative claims based on empirical presuppositions about the adverse impact of review on director behaviour including whether directors would be deterred from taking up positions by the prospect of judicial review of their judgments, and if review led to more risk adverse and cautious decisions, that this was not necessarily undesirable. The qualitative data generated opens up further avenues for research such as, for example, the impact of regulatory scrutiny on board behaviour.
Exploitation Route With reference to our Pathways to Impact statement we will: i) submit to future policy consultations and parliamentary committees on initiatives involving increased director accountability through enforcement and other avenues ii) brief judges on the qualitative research findings regarding directors' attitudes to judicial review of different types of decision and continue to disseminate at practitioner seminars iii) continue to engage with professional bodies and practitioners including Institute of Directors(IOD) and ICSA. These bodies and organisations such as BEIS, the Association of Business Ethics, the Investor Forum, Hermes, and Eversheds were involved in the final workshop and we remain in touch with them about how to disseminate and translate the research for the benefit of thought leadership, policy debate and professional education and practice of directors and effective accountability to shareholders; engage with IoD and ICSA to disseminate results to members in the UK and globally, developing education material which informs their taught professional programmes and workshops that cover directors duties; (iv) continue to seek publication in the national press by producing articles that link our research findings to current affairs. In terms of academic routes we will be presenting findings at academic conferences (for example SLSA 2019; EGOS 2019).
Sectors Financial Services, and Management Consultancy,Government, Democracy and Justice,Other

URL https://essl.leeds.ac.uk/directory_record/268/business-judgment-and-the-courts
 
Description The findings have been disseminated to judges and barristers at the Northern Chancery Bar Association in 2018. Following this a leading barrister requested permission to use the research in a presentation at a professional liability conference to other barristers, solicitors and judges in 2019. In November 2018 a summary of the findings were disseminated at an End of Project workshop and a Final Report was provided to directors, legal practitioners, judges, company secretaries, the Department from Business, Innovation and Skills. the Institute of Directors, ICSA. the Association of Business Ethics, the Investor Forum, and Hermes. Following this the findings from the project were blogged by Francis Keen, Executive Director in Willis Towers Watson's FINEX Global, an advisory and broking firm, to the firm's business clients and associates. This was promoted on twitter to its 24.4K followers. The findings were also picked up on a US blog D&O Diary, aimed at insurers of directors and company officers. This blog has been called by the New York Times called "influential" and the Wall Street Journal described it as "widely followed." Findings from the research were published in the trade magazine Governance in August 2018 that is read by company secretaries, general counsel and directors.
First Year Of Impact 2018
Sector Financial Services, and Management Consultancy,Government, Democracy and Justice,Other
Impact Types Economic,Policy & public services

 
Title Database 
Description A database of 130 English cases involving challenges to directors' business judgment 
Type Of Material Database/Collection of data 
Year Produced 2018 
Provided To Others? No  
Impact It has been used to analyse the extent to which directors business judgments are subject to review by the courts,, what exactly the courts review, and what is it about the judgments that trigger liability. This information has been disseminated to research users: directors, professional associations such as the Institute of Directors, the Investors Association, the Department for Business Innovation and Skills, ICSA, judges and legal practitioners 
 
Description Chancery Bar Association 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Professional Practitioners
Results and Impact Around 30 barristers and judges attended a meeting of the Northern Chancery Bar Association in Leeds in November 2018. There was a very high degree of interest in the findings. Following this I was contacted by a leading QC who then requested permission to use the research in a presentation at a professional liability conference to other barristers, solicitors and judges in 2019. The findings would be relevant to this audience as it would enable them to assess risks to directors of successful litigation, and also propsects for shareholders who wish to bring action.
Year(s) Of Engagement Activity 2018
 
Description Global Governance, Eversheds 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Industry/Business
Results and Impact Invited to give presentation as member of a panel by Eversheds solicitors in Manchester speaking to company secretaries, general counsel and other clients of the law firm
Year(s) Of Engagement Activity 2017
 
Description Global Governance, Present and Future' 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Industry/Business
Results and Impact Invited to give presentation as member of a panel by Eversheds solicitors in London speaking to company secretaries, general counsel and other clients of the law firm
Year(s) Of Engagement Activity 2017
 
Description Governance magazine 
Form Of Engagement Activity A magazine, newsletter or online publication
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Industry/Business
Results and Impact Findings from the research were published in the trade magazine Governance in August 2018 that is read by company secretaries, general counsel and directors.
Year(s) Of Engagement Activity 2018
 
Description ICSA forum 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Industry/Business
Results and Impact Presented project to company secretaries which led to questions and requests for further information
Year(s) Of Engagement Activity 2017
 
Description Kean blog 
Form Of Engagement Activity Engagement focused website, blog or social media channel
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Industry/Business
Results and Impact We liaised with Francis Kean who we invited to the End of Project workshop over the contents of a blog he wrote to report the project findings. He is Executive Director in Willis Towers Watson's FINEX Global, an advisory and broking firm. This was promoted on twitter to its 24.4K followers. The blog was republished on a US blog D&O Diary, aimed at insurers of directors and company officers. This blog has been called by the New York Times called "influential" and the Wall Street Journal described it as "widely followed."
Year(s) Of Engagement Activity 2018
URL https://blog.willis.com/2018/12/the-truth-about-directors-liabilities-in-the-u-k/
 
Description Loughrey blog 
Form Of Engagement Activity Engagement focused website, blog or social media channel
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Public/other audiences
Results and Impact Posting updates onto project web-site outlining progress on the project and project findings.Any updates were also tweeted on the twitter account of Joan Loughrey (628 followers), and the twitter account of the Centre for Business Law and Practice Leeds (79 followers) and on Professor Andrew Keay's LinkedIn page (955 followers) as well as on Researchgate
Year(s) Of Engagement Activity 2017,2018
URL https://essl.leeds.ac.uk/directory_record/268/business-judgment-and-the-courts
 
Description Project workshop 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Study participants or study members
Results and Impact Around 30 participants were invited to the End of Project Workshop in London in November 2018. A Final Report was provided to the attending directors, legal practitioners, judges, company secretaries, the Department from Business, Innovation and Skills, the Institute of Directors, ICSA. the Association of Business Ethics, the Investor Forum, and Hermes. The findings were discussed and there was a high degree of interest, particularly around the failures in process that courts focus on, and the type of conduct that seems to exonerate directors. There was much discussion and questions, both during the workshop and thereafter. There were a range of outcomes from the workshop including that there were a change in views, or better informed views, requests for further information and more detailed findings, discussion of future activities
Year(s) Of Engagement Activity 2018