The time may be ripe to reconsider Australia's Business Judgement Rule

Australia's business judgment rule was adopted two decades ago to protect directors who undertake reasonable and informed commercial decision-making from breach of directors' duties claims, however it has found limited use. This may be because the form it takes renders it less effective than comparable rules in peer countries, write Rachel Nicolson, Andrew Wilcock and Madeline White of Allens.

Business judgment rules (BJRs) are intended to protect directors against claims that they were acting without skill, care or diligence when making legitimate business decisions. Australia adopted a statutory BJR in 1999 to address perceived intrusions by the judiciary into commercial decision-making. However, over the ensuing 23 years, not one defendant director has invoked the BJR to avoid liability.

Several other countries have enshrined BJRs in their corporations laws. At the AICD's request, Allens reviewed the scope, operation and effectiveness of Australia's BJR, as compared with equivalent rules in Canada, Delaware, South Africa and the United Kingdom (Comparator Jurisdictions). We found that Australia's and the Comparator Jurisdictions' BJRs share common policy objectives, but that Australia's BJR operates differently, has a narrower application and provides less protection to directors than do the Comparator Jurisdictions' rules.

How do BJRs operate?

Australia's and the Comparator Jurisdictions' BJRs share a consistent policy basis. They are intended to protect the authority of directors to make good faith commercial decisions, acknowledge that directors make decisions with imperfect information, and avoid an unreasonable level of risk aversion and encourage sensible commercial risk-taking. At the same time, BJRs are not intended to insulate directors from liability in relation to decisions that are made negligently or otherwise in bad faith.

However, Australia and the Comparator Jurisdictions have enshrined their BJRs in law in different ways.

• In Australia, the BJR functions as a defence, and the burden falls to a director defending a breach of duty claim to prove that an action under question was a protected business judgment. Elsewhere, the BJR functions as a standard of proof,[1] and the burden falls to a person bringing a breach of duty claim to displace a presumption that the action under question was a protected business judgment.
• In Australia, the BJR may only be raised in relation to alleged breaches of the duty of reasonable care, skill and diligence. In some Comparator Jurisdictions, the BJR may be raised in relation to alleged breaches of other duties.
• In Australia, the BJR does not modify the level of director culpability required to establish a breach of the duty of reasonable care, skill and diligence. In Delaware, perhaps the world's leading corporate law jurisdiction, the BJR requires a plaintiff to show gross negligence to establish a breach of that duty.

The upshot of these key differences is that Australia's BJR is an international outlier, and has a narrower application than the BJRs of the Comparator Jurisdictions.

By way of a comparative example, in one Australian case, a group of directors were found to have breached their duty of care by approving a misleading press release.[2] The CEO sought to rely on the BJR but could not reach the evidentiary threshold to satisfy the court that a business judgment had been made or that the statutory terms of the rule applied.[3] By contrast, in Delaware, a CEO failed to adequately oversee the hiring of an executive who had minimal managerial experience. The court applied the BJR presumption, finding that although the CEO stretched the outer boundaries of his authority by acting without specific board direction or involvement, the evidence did not show that he displayed 'gross negligence'.[4]

These examples illustrate the significant burden that rests on defendant directors in Australia, as opposed to the significant onus that rests on the plaintiff in the Comparator Jurisdictions.

How is Australia's BJR performing?

Allens considered the possibility that the Australian BJR is properly calibrated, and that the Comparator Jurisdictions' BJRs provide an inappropriately high level of cover to directors by reviewing academic commentary on the performance of the respective BJRs.

We found that Australian commentators are more dissatisfied with the performance of their country's BJR than their peers from Comparator Jurisdictions. Among the key criticisms to emerge are that Australia's BJR does not have a clear operation and places too high an onus on directors when the apparent intention of Parliament was for a BJR that would operate as a presumption in favour of the director. This is seen to have effectively neutered any potential for the statutory BJR to offer a real and practical 'defence'.

Further, commentators are critical that the Australian BJR applies to too narrow a range of duties and protects too narrow a range of activities and business judgments. For example, the BJR does not apply to considerations about compliance with legal obligations on the basis that these are not decisions related to the business operations of the corporation. In one notable Australian case, non-executive directors and an officer of a company were liable for a breach of the duty of care for not picking up an error in the company's financial statement, notwithstanding that the reports were prepared in close collaboration with auditors and the company's CEO.[5] Unsurprisingly in this context, a key theme to emerge is that commentators caution that the Australian BJR does not provide a degree of protection that is actually felt by directors.

These findings suggest that Australia's BJR is not fulfilling its policy objectives.

How does the underperformance of the Australian BJR interplay with other unique features of the Australian director liability environment?

The AICD and Allens have previously published a paper taking stock of the unique liability environment for directors in Australia, as compared with other common law jurisdictions[6] (read more here).

Among the unique features of the Australian environment is the primarily public enforcement of directors' duties by ASIC, as compared to private enforcement by shareholders in the Comparator Jurisdictions. This creates additional exposure for Australian directors to enforcement action. By itself, additional exposure does not justify broadening the BJR, however it does amplify the chilling effect that an underperforming BJR has on sensible commercial risk-taking.

Further, this chilling-effect may be accentuated in Australia where a second unique feature of the director liability environment is a rapidly expanding remit of corporate governance decisions that are subject to public enforcement risk. For example, ASIC is increasingly utilising the emergent doctrine of 'stepping stone liability' to impose civil liability on directors for company contraventions of law and the doctrine conceivably could be applied in relation to other acts or omissions which harm a company's interests – for example, where the company fails to disclose environmental and social risks to the market resulting in reputational harm. In Canada, the law explicitly recognises the interests of a wide range of stakeholders in corporations, and the BJR does heavy work to offer significant protection for directors' making decisions that balance competing interests. However, in Australia, the absence of a robust BJR means directors are at risk of a wide-range of corporate decision-making becoming reviewable as a breach of the duty of care.

Taken together, these findings reinforce that defendant directors in Australia are afforded comparatively lesser protection than their overseas counterparts, and highlight again why the time may be ripe to reconsider the Australian formulation of the BJR.

[1] This specific issue has not been tested in South African courts yet but academic commentary suggests that it likely is the case.

[2] Australian Securities and Investments Commission v Macdonald (No 11) (2009) 256 ALR 199.

[3] Ibid 288.

[4] In re Walt Disney Co Derivative Litigation 907 A.2d 693.

[5] ASIC v Healey (2011) 196 FCR 291.

[6] Canada, Hong Kong, New Zealand, the United Kingdom and the United States.