Business Judgment and the Courts

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.

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.