31/5/2021Corporate / Commercial Law
31/5/2021Corporate / Commercial Law
Reliance on Professional Advisors v. Duty of Diligence
The Business Judgment Rule (BJR)
The Business Judgment Rule (BJR) in the U.S.A.
Directors' Duties in Australia
It is important to compare and contrast the major difference between the standard of the legal duty imposed on Directors in Australia versus the U.S.A.
Reliance on the work of professional advisors is available as a defense in the U.S.A so long as Directors can show they had a sufficient basis to reasonably believe their Professional Advisors are both reliable + competent.
In Australia, Directors are held to a higher standard!
Under the Corporations Act, Directors have a mandatory Duty of Diligence to take additional steps and to make further inquiries to satisfy themselves with regard to the information and advice provided (even if it is provided by professional advisors they reasonably believe are reliable + competent).
"Equivalently, the duty of diligence requires directors to take reasonable steps to place themselves in a position to guide and monitor the company’s management.
611 In considering the approval of financial statements and addressing the facts at hand, more is required of a director than a mere “going through the paces”. As Middleton J stated in ASIC v Healey:
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 apply an inquiring mind to the responsibilities placed upon him or her. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further inquiries if matters revealed in these financial statements call for such inquiries.
612 Whether a director has exercised a reasonable degree of care and diligence in a given scenario can only be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question.
The Business Judgment Rule (BJR) defence/defense is available to Directors in both the U.S.A + Australia.
It appears that the above distinction between reliance on professional advisors v. Duty of Diligence has been incorporated into each countries application of the BJR.
In the Australian version of the BJR, the third element states:
3️⃣ Informs her or himself about the subject matter of the judgment to the extent she or he reasonably believes to be appropriate …
In the U.S.A version of the BJR (refer below), Directors need to make informed decisions, but in doing so they can rely upon professional advisors they reasonably believe to be reliable + competent.
Once advice has been obtained from professional advisors, in the U.S.A. there is no duty to make any further inquiry beyond this point.
Elliot J. at para [620-626]: [emphasis added]
The Business Judgment Rule
620 Under s 180(2), a director who makes a business judgment is taken to meet the requirements of the care and diligence duty if she or he
(1) makes the judgment in good faith for a proper purpose,
(2) does not have a material personal interest in the subject matter of the judgment,
(3) informs her or himself about the subject matter of the judgment to the extent she or he reasonably believes to be appropriate, and
(4) rationally believes that the judgment is in the best interest of the corporation.
 Section 180(2) further provides that the director’s belief is rational unless the belief is such that no reasonable person in her or his position would hold it.
621 There must be a contravention of s 180(1) for consideration of the business judgment rule to have any application. Conduct that falls short of breaching s 180(1) will not require consideration of the business judgment rule, because it will not meet the threshold enlivening the rule.
622 For the business judgment rule to apply, the facts must show that the director has made an identifiable business judgment. Business judgment is defined to mean any decision to take or not take action in respect of a matter relevant to the business operations of the corporation. Business judgments include matters that are preparatory to the making of a business decision, including planning, budgeting and forecasting activities.
Requirements of the Business Judgment Rule
623 In relation to the requirement that a business judgment be made in good faith for a proper purpose, this requirement can be met where a decision is made to refrain from doing something.
624 In relation to the director informing her or himself to the extent she or he reasonably believes to be appropriate, the reasonableness of the belief should be assessed by reference to:
(1) The importance of the business judgment to be made.
(2) The time available for obtaining information.
(3) The costs related to obtaining information.
(4) The director or officer’s confidence in those exploring the matter.
(5) The state of the company’s business at that time and the nature of competing demands on the board’s attention.
(6) Whether or not material information is reasonably available to the director.
625 The requirement that the director inform her or himself of the subject matter of the judgment to the extent she or he reasonably believes to be appropriate does not encompass an objective requirement that the director demonstrate that she or he was reasonably informed. It may be that the director was not aware of available information, but nonetheless took active steps to become informed about the subject matter of the decision and reasonably believed her or himself to be informed.
626 In relation to the requirement of a rational belief that the business judgment is in the best interests of the corporation, the director’s belief will be rational if it was based on reason or reasoning (whether or not the reasoning was convincing and therefore “reasonable” in an objective sense), but it would not be a rational belief if there was no arguable reasoning process to support it.
A Court will not second guess a business decision if it was:
2️⃣ Made in Good Faith;
3️⃣ Without Conflicts of Interest; and
4️⃣ Had a Rational Basis.
So, whether Directors' will be held liable for breach of their duty of care depends on the facts …
✅ Was the Board reasonably informed?
✅ Did it do appropriate homework before making the decision (analyze information, deliberate)?
✅ Did it act in good faith, free of self-interest, and with the belief that the decision was in the best interest of the Corporation?
If so, the Directors' are not liable, despite the poor substantive outcome of the decision, because the BJR recognizes that a Director is not a guarantor of success.
Reliance on others: It is not unreasonable for a director to rely on information from officers, legal counsel, committees, etc. the director reasonably believes to be reliable and competent.
The article Directors duties: care & diligence, business judgment rule, good faith, use of position & information by the Commercial Law Barrister: Jonathan Wilkinson provides a useful summary of the Directors' Duties required under the Corporations Act in Australia as set out by Elliot J. in the recent Victorian Supreme Court decision United Petroleum Australia Pty Ltd v Herbert Smith Freehills  VSC 347.
Cover image sourced from our Blue Ocean Law Group℠ core Brand Image Library.
This blog article was written by James D. Ford GAICD | Principal Solicitor, Blue Ocean Law Group℠.
This blog article is intended for general interest + information only.
It is not legal advice, nor should it be relied upon or used as such.
We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.
Your comment has been received and we will approve it shortly.