Business Judgment Rule – Valuable Protection for Directors Against Liability

We have delved into director liability and director delinquency but it is not all doom and gloom.

There is a mechanism which has been introduced into South African Company Law with the implementation of the Companies Act, 71 of 2008, called the “Business Judgment Rule”. This rule basically states that a director is deemed or presumed to have exercised his or her powers of performed his or her functions in the best interests of the company if certain requirements have been met. This rule is encompassed in section 76(4) of the Companies Act of 2008. This rule prevents the courts from being able to intervene when the requirements of Section 76(4)(a) have been met. This is a defence on which directors can rely when faced with potential director liability as provided for in Section 77 of the Act.

Section 76(3) provides that a director of a company, when acting in that capacity, must exercise the powers and perform the functions of director—

a) in good faith and for a proper purpose;

b) in the best interests of the company; and

c) with the degree of care, skill and diligence that may reasonably be expected of a person—

  • carrying out the same functions in relation to the company as those carried out by that director; and
  • having the general knowledge, skill and experience of that director.

Section 76(4) of the Companies Act, 2008 states that a director would be considered to have acted or performed his/her powers and functions in the best of the interests, and have complied with section 76(3) if:

i) the director has taken reasonably diligent steps to become informed about the matter;

ii) either—

  • 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
  • the director complied with the requirements of section 75 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.

The Business Judgment Rule first originated in the United States of the America and became a part of their corporations law. The rule has since been adopted into Australian law in terms of section 180(2) of the Corporations Act of 2001 and was then adopted into South African Company Law with the implementation of the Companies Act on 2011.

The first requirement is that the director must take all the steps necessary in order to be fully informed about the matter. This is imperative.

With respect to the second requirement that the director must have no material personal financial interest in the subject matter of the decision, or had complied with section 75 of the Companies Act, this is a requirement of section 75 that a director must not have any conflicts of interest with his or her company and must not have any personal financial interest in business dealing in which the company participates. Section 75 also provides that should a director have any personal financial interests in a matter on which the board must decide, the director must immediately disclose his or her personal financial interest to the board and the director must not take part in any consideration or decision-making with respect to the subject matter.

Section 75(4) states that

At any time, a director may disclose any personal financial interest in advance, by delivering to the board, or shareholders in the case of a company contemplated in subsection (3), a notice in writing setting out the nature and extent of that interest, to be used generally for the purposes of this section until changed or withdrawn by further written notice from that director.

The third requirement of the Business Judgment Rule is that the director must have had a rational basis for believing, and did believe, that the decision was in the best interests of the company. The test for this requirement is an objective one based on the test as to whether or not the reasonable person in the same circumstances would have made the same decision.

The defence of the Business Judgment Rule is essentially to protect directors who made a decision on behalf of the company that was in good faith which was informed and and reasonable. It is there to protect the honest directors who truly act or acted in the best interests of the company.

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