[Archie is a student at National Law School of India University.]
In a recent UK case, two directors have been ordered to pay 100 Million Euro as compensation because they failed to promote the success of the company. The fiduciary duty of the directors encompasses the promotion of the company’s success, to exercise reasonable care and diligence, to avoid any conflict of interests and not prioritize their own interest over company’s. Similar standard of fiduciary duty is followed in India as per Section 166 of the Companies Act 2013 (Act).
In several jurisdictions, directors alleged for breaching their fiduciary duties are protected by the business judgment rule (BJR), which safeguards their decisions made in good faith with due care and diligence. Similarly, Section 463 of the Act provides directors accused of negligence, breach of duty, or misfeasance with relief if they acted honestly and diligently.
The article argues that Indian courts have implicitly applied the BJR in cases of directorial protection. However, the absence of its codification creates uncertainty, weakening corporate governance and stakeholder interests. Thus, the article suggests for codifying BJR to balance judicial interference with corporate independence by taking an objective approach towards Section 166 to maintain directors' autonomy and protect stakeholders.
Understanding BJR
The BJR provides protection for corporate directors when they make decisions for company. The rule fundamentally restricts standard for judicial review, favoring minimal scrutiny in corporate decisions, laying down a framework for limited or non-review of decisions by corporate officials. The rule is justified by 4 key principles: acknowledging directors' expertise, encouraging business risk-taking, minimizing judicial interference, and preserving corporate governance autonomy.
The United States and Australia have already incorporated the BJR into their legal statutes with specific legislative references. However, UK courts have not formally codified the rule but their judicial precedents elucidate the uniform application of the rule. UK courts generally apply the rule in two ways: first, a good faith standard that examines the content of a decision and requires reasonableness, without conducting a strict objective analysis, and second, an ordinary due diligence standard that demands careful consideration of the situation, taking into account both the director's personal knowledge and experiences through an objective and subjective lens.
Traditionally, directors have been held accountable in cases where they demonstrated several problematic behaviour like being insufficiently informed about crucial matters, blindly following directives without critical examination, or neglecting essential internal control mechanisms such as reporting systems and checks and balances. Thus, BJR balances the stakeholders’ interests with the directors’ independence.
Interestingly, these accountability considerations resemble the judicial approach taken by Indian courts in deciding directorial responsibilities and duties.
Judicial Precedents of BJR in India
Unlike other countries’ jurisprudence, India lacks a codified BJR. However, Indian courts’ judicial precedents and statutory provisions have implicitly incorporated its principles. To illustrate, the Supreme Court of India in cases such as Miheer H Mafatlal has held that the court would not interfere in a director's decision if it was "just, fair and reasonable, according to a reasonable businessman, taking a commercial decision beneficial to the company." Similarly, in Needle Industries, the board's decision was upheld to issue rights shares, as the decision was taken for the company’s interest and larger corporate purpose. In a case, the director was presumed to be innocent as there was no specific allegation of dishonest intent in a show cause notice issued to him.
In a case, Securities and Exchange Board of India has acknowledged the rule as a presumption that directors act on an informed basis, in good faith, and in the honest belief that their actions are in the stakeholders' best interests. Additionally, the National Company Law Tribunal opined that directors’ decisions may not always align with stakeholder interests, but the absence of mala fide intent and unfairness should be the main parameters for review. As evident, courts have recognized the complexity of directors' decision-making, where numerous factors are involved, and the absence of mala fide intention absolves directors of legal liability. Although directors can seek protection under Section 463 of the Act for alleged fiduciary breaches, this article argues that the section undermines directors' corporate independence.
Analyzing Section 463 as BJR
A few people have quoted that “Indian Parliament has come out with an Indianized version of the business judgment rule under Section 463 of the Act”. While not a direct equivalent of the BJR, Section 463 provides a degree of protection to directors who act honestly and reasonably. Some aspects of Section 463 are similar to the BJR standard. For instance, the burden of proof lies on the plaintiff to establish that a director's decision was made in bad faith, was not in the best interests of the company, or involved a conflict of interest. Once the plaintiff has met this burden, the director must demonstrate that they acted in good faith and reasonably.
The Supreme Court of India held that the power of the High Court to grant relief in cases of Section 633 (corresponding to Section 463) cannot be interpreted in a restricted sense. Here, the case undermines the other stakeholders’ interest in Section 166(2) by providing too much levy to the directors. However, in Dulal Chandra Bhar, the court denied relief to the directors for failing to comply with statutory obligations due to internal disputes as their actions neither honest nor reasonable. Similarly, in Sanatan Ganguly, the court emphasized that relief under Section 463 could not be granted without a detailed trial. Thus, Section 463 subjects the directors to substantive judicial scrutiny, forcing them to justify their actions through evidence in a trial, thereby deterring them from making bold, strategic decisions. However, the BJR offers a presumption in favor of directors, shielding their decisions from excessive, thereby providing an environment that encourages risk-taking and innovation. Additionally, Section 463 is limited to breaches under the Act, whereas the BJR applies more broadly to shield directors' commercial decisions.
As evident from the previous section, courts have absolved the directors from any liability referring to BJR without laying down any proper framework. Similarly, in some cases, courts, ignoring any BJR principle, have held the directors liable under Section 463 mainly because they took some risky decisions in company’s interests. The courts have time and again held that Section 633 is on the discretion of the courts, highlighting the clear judicial overreach in corporate decision-making.
Absence of a codified BJR in India poses significant risks to corporate governance and director decision-making. The non-codification not only harms the other stakeholder but also the directors. The current de facto application of BJR-like principles through Section 633 (463) creates uncertainty where courts have ample discretion in companies’ matters. Thus, it increases the scope of judicial overreach into corporate affairs and may deter qualified directors from serving on boards, fearing personal liability for good-faith decisions.
Thus, this article proposes the codification of BJR in Indian legislation and affirms that an objective approach is necessary towards Section 166 to minimize judicial interference.
Road Ahead: Towards an Objective Approach
As seen in the previous section, courts do not have any set standard while deciding on the breach by a director. Due to this ample discretion of courts, this article suggests that courts should take an objective approach towards Section 166.
Section 166 allows for both subjective and objective interpretations, with the subjective interpretation (where directors must only believe in good faith they are acting in all stakeholders' interests) being more likely. This subjectivity grants substantial discretion, potentially enabling directors to prioritize their own interests while explicitly harming other stakeholders. Further, the high degree of subjectivity makes it difficult to prove that directors have failed to consider stakeholder interests, unless their actions are egregiously in bad faith.
By applying an objective test, courts can better assess whether directors have truly considered and tried to balance the interests of all stakeholders, rather than solely deciding for the company’s interests. It focuses on the facts and evidence presented, and courts would determine whether any man would have reasonably done the same as the directors. The objective approach would give equal platform to other stakeholders as well. It is well established that directors act as agents of the company, may be inclined to prioritize maximizing returns for shareholders and company over other stakeholders' interests. Thus, an objective approach would help the court see the potential bias towards shareholder interests inherent in the agency relationship. This would minimize the judicial interference in corporate matters. The objective approach towards Section 166 and codification of BJR along the lines of Section 463 would better improve the situation in the country.
While Section 463 already allows courts to relieve directors of liability for any alleged breach on court’s discretion, codification of the BJR would balance judicial interference with independence in corporate decision-making. The codification of the BJR should aim to strike a balance between protecting directors' autonomy and ensuring accountability. Thus, drawing from global models, like the Delaware Supreme Court, India can adopt the BJR as a legal presumption in favour of directors, wherein courts abstain from reviewing business decisions unless the plaintiff demonstrates bad faith, fraud, or gross negligence. The accountability consideration can be managed by the objective approach towards Section 166 which would test directors’ decision through an independent lens balancing directors’ autonomy and stakeholders’ interests. This would pave the way for derivative actions suit while giving ample freedom to the directors to take decisions for the company.
Comments