The Business Judgment Rule: A Director’s Guide to Risky Business

Denis Grigoras

Denis is a lawyer who draws on his background in complex legal disputes and transactions to problem-solve for his clients.

The business judgment rule has its roots firmly planted in the need to facilitate an environment of innovation and growth in business. Recognizing that running a business often involves taking risks, this rule has been developed to shield directors and officers who are willing to take calculated chances to propel a corporation forward.

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Business Judgment Rule

The Origin and Purpose of the Business Judgment Rule

The business judgment rule has its roots firmly planted in the need to facilitate an environment of innovation and growth in business. Recognizing that running a business often involves taking risks, this rule has been developed to shield directors and officers who are willing to take calculated chances to propel a corporation forward.

Under Canadian corporate law, directors are generally responsible for managing the corporation’s business and affairs, a responsibility that can be delegated to officers. The board’s role, while historically direct, is typically supervisory in today’s corporate environment.

When making decisions that could impact the corporation, directors must balance their roles as supervisors and managers with their fiduciary duties and duties of care. Recognizing the inherent risks involved in such decision-making, courts have adopted the business judgment rule, which provides legal protection for directors when making business judgments.

The business judgment rule essentially discourages courts from second-guessing the decisions made by directors, provided they acted reasonably, in good faith, and without conflicts of interest. This rule shields directors from legal accountability for their decisions, even when the outcomes may not be as expected or when they negatively impact the corporation.

Exceptions to the Business Judgment Rule: Not a Blanket Shield

While the business judgment rule provides a significant degree of protection for directors, it is not a blanket shield. The rule does not extend to decisions that breach specific shareholder agreements, favour personal interests over the company’s, or lack a justifiable business purpose.

This point was well demonstrated in several cases. In 2082825 Ontario Inc. v. Platinum Wood Finishing Inc., the court ruled that the business judgment rule didn’t protect the majority shareholders who unilaterally decided to stop the president’s pay and later fire him.

Similarly, in Look Communications Inc. v. Cytrynbaum, the court found that directors breached their duties by awarding themselves and other officers excessive compensation from the sale of the company’s assets. This decision was deemed not protected by the business judgment rule as it favoured the directors’ interests over the company’s.

In JBRO Holdings Inc. vs. Dynasty Power Inc., the court disagreed with the directors’ argument that voiding shareholders’ share certificates without payment was protected by the business judgment rule. This action was deemed as not a reasonable business decision with a justifiable business purpose.

Canada and U.S. Interpretations of the Business Judgment Rule

While the business judgment rule is a common principle in both Canada and the United States, the interpretation and application of the rule can differ between jurisdictions, especially when it comes to identifying the best interests of the corporation.

In the U.S., the board’s duty is generally interpreted to align with the corporation and its shareholders’ best interests. This interpretation implies that directors should prioritize shareholder value, as reinforced by the historical case Dodge v. Ford Motor Company.

In contrast, Canadian law has a broader interpretation, allowing directors to consider a wider range of stakeholders, including employees, creditors, consumers, the environment, and the community when determining the corporation’s best interests. This interpretation was highlighted in the landmark case BCE Inc. v. 1976 Debentureholders, which ruled that directors could consider a variety of stakeholders’ interests without any single stakeholder group’s interests automatically prevailing over others.

Despite these differences in judicial interpretation, the decision-making process is similar in both Canadian and U.S. boardrooms, with directors expected to engage with stakeholders, act in good faith, exercise due diligence, and document their actions.

An Overview of the Business Judgment Rule

In essence, the business judgment rule is a legal principle that safeguards the decisions made by a corporation’s directors. It assumes that directors make informed, good faith decisions that they believe are in the company’s best interest. Moreover, this rule limits the legal liability of directors, providing them a certain degree of protection against potential litigation arising from their decisions.

The business judgment rule is based on the understanding that directors are more informed about the business’s intricacies and the industry’s nuances. Courts, recognizing this expertise, tend to refrain from scrutinizing every decision made by directors. The rule does not allow for judicial interference merely because a decision may be unpopular with a minority of stakeholders, or because the outcome of a decision may not be favorable.

The Business Judgment Rule in Action: R. v. Bata Industries Ltd.

A practical example of the business judgment rule in action is the case of R. v. Bata Industries Ltd. The company and its directors were charged with environmental offences, with some directors accused of not taking adequate care to prevent these offences.

The directors argued that they had done their due diligence, which refers to taking all reasonable care to prevent such offences. However, the court found that one director hadn’t shown due diligence because he failed to act even after knowing about the environmental issues for six months.

This case underscores the importance of not only directing but also ensuring that instructions are implemented to minimize damage. It also illustrates that while the business judgment rule provides protection, directors must still act responsibly and in the best interest of the company.

Relying on Professional Advisors

The business judgment rule also allows directors to rely on the advice of professional advisors, such as lawyers. Despite any legal qualifications the directors themselves might have, they are not expected to double-check the work of these advisors. However, this reliance must be reasonable and in good faith.

Balancing Stakeholder Interests

The business judgment rule acknowledges the complexities involved in corporate decision-making. Often, directors are required to prioritize one group of stakeholders over another or sacrifice a short-term goal for a long-term benefit. The rule prevents judicial intrusion into these complex decisions, which could disrupt business activities if not handled carefully.

In conclusion, while the business judgment rule offers protection to directors and officers, it is not a carte blanche to act without regard to fiduciary duties, shareholder agreements, or the overall best interests of the corporation. Rather, it is a principle that supports informed, reasonable, and good faith decisions made with a view to advancing the corporation’s interests. It recognizes that in the pursuit of innovation and growth, risks must be taken, and not all decisions will have the desired outcomes. Understanding this rule and its application is crucial for directors, officers, shareholders, and indeed, all stakeholders within a corporation.

Example: Ernst & Young Inc. v. Essar Global Fund Ltd.

This case involved the business judgment rule in the context of corporate restructuring. Algoma Inc., undergoing restructuring under the Companies’ Creditors Arrangement Act (CCAA), was under the supervision of Ernst & Young as a court-appointed Monitor. In this capacity, the Monitor initiated an oppression action against Algoma’s parent company, the Essar appellants, who were accused of acting in a way that favoured their own interests over those of Algoma and its stakeholders.

The controversy stemmed from a transaction between Algoma and Portco, two entities indirectly owned by Essar Global, where Algoma’s port facilities were transferred to Portco. This transaction resulted in Portco gaining change-of-control rights, effectively granting them veto power over any change in control of Algoma’s business. This was seen as oppressive to Algoma’s stakeholders: trade creditors, employees, pensioners, and retirees, whose reasonable expectations were deemed violated by the transaction and the control it conferred to Portco.

The trial judge deemed the transaction unfairly prejudicial and concluded that it unfairly disregarded the interests of Algoma’s stakeholders. He asserted that the control clause in the Cargo Handling Agreement, which granted Essar Global control over potential buyers of Algoma’s business, was oppressive. He also found that Essar Global had unreasonably benefited from the transaction, which was seen as an act of self-dealing.

The appellants objected on the grounds that the Monitor lacked standing to bring an oppression claim and that any harm was done to Algoma, not the stakeholders, making a derivative action the proper recourse. However, the court dismissed the appeal. It held that the Monitor, in its role to facilitate restructuring, could bring an oppression claim in the interests of the restructuring and that there was prima facie evidence of personal harm to the stakeholders.

The court also noted that Algoma’s board could not invoke the business judgment rule. This rule, which ordinarily provides legal protection to directors’ decisions made in good faith, was deemed inapplicable as the court found that Algoma had no real choice but to accept the Port Transaction, and thus the board’s judgment was effectively bypassed.

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