The business judgement rule as a mechanism to protect directors from liability when making business decisions

Written on 23 Jan 2020

Directors are elected by the shareholders of a company to manage the company by exercising their decision-making role. All business decisions carry a risk and, therefore, directors are liable to shareholders for the actions they take. This is one of the reasons why the business judgement rule, which protects directors from being held personally liable as long as they comply with certain requirements, has been incorporated into Spanish law.

The origin of the business judgement rule

The business judgement rule has its origins in eighteenth-century English court decisions and was later developed in the US, especially by the courts of the State of Delaware. In the landmark case Aronson v. Lewis (Del. 1984), Delaware courts produced one of the most frequently cited interpretation of the business judgement rule in US jurisprudence:

The business judgement rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Absent an abuse of discretion, that judgement will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption.

Consequently, directors are immune from liability for decisions that may end up being harmful to the company as long as they meet certain requirements in the decision-making process.

In mainland Europe, German lawmakers were among the first to introduce this doctrine, although shaping it as a safe harbour. In the event of a dispute, directors shall prove that their decision was based on the requirements established in the safe harbour in order to be able to benefit from the protection of the rule. Thus, when performing their managerial duties, the directors of German companies must gather all the necessary documentation in order to avoid potential claims for any damages that may eventually arise from their business decisions.

Requirements to be met in order to be protected by the business judgement rule according to Spanish law

Although the business judgement rule had already been accepted by Spanish courts, Spanish lawmakers officially incorporated this rule into Spanish statutory law through Law 31/2014, of 3 December, amending the Spanish Companies Law. Article 226 of the Spanish Companies Law, under the title protection of business discretion, establishes the requirements with which directors shall comply when making strategic business decisions in order to avoid being held personally liable. In general, in performing their managerial duties, directors must act with the diligence of an orderly businessperson (article 225 of the Spanish Companies Law), which is the highest standard of diligence under Spanish law. Pursuant to article 226 of the Spanish Companies Law, directors are deemed to have met the standard of diligence as long as the following requirements are met:

  • They have acted in good faith, in the honest belief that the decision made was reasonable and in the best interest of the company.
  • They have no conflict of interests. They are favouring the company’s interest over their own interest or the interest of related persons.
  • They have acted on an informed basis. They have been provided with all the necessary information to make a reasonable decision (i.e. external reports).
  • They have followed an adequate decision-making process, according to internal applicable rules and regulations, to ensure the right adoption of the corresponding business decision.

Strict observance of these requirements will protect directors from any liability in the event that the decisions they make have a negative impact on the company.

However, the configuration of the business judgement rule by the Spanish lawmakers leaves whether article 226 of the Spanish Companies Law follows the model established by the courts of the State of Delaware or the German safe harbour open for discussion . As explained above, the main difference between both models lies in which party has the burden of proof when a business decision has resulted in harm to the company.

In the US system, the burden of proof is on the plaintiff, who shall prove that the directors have not met the requirements established in the business judgement rule to rebut the presumption that the decision was properly made. If the presumption is rebutted, the burden of proof will be placed on the director, who will need to prove that his/her action was taken in the company’s best interest. That is what happened in the In Re Trados Incorporated Shareholders Litigation (2013), where the plaintiff was able to prove that the majority of directors of Trados Inc. had a conflict of interests when they decided to sell the company to SDL plc. In this case, the fact that preferred shareholders received a liquidation preference and that the board of directors approved a certain incentive plan, which benefited the management team when the company was sold, resulted in common shareholders receiving no consideration. Curiously, although the directors of Trados Inc. lost the protection of the business judgement rule, they managed to prove that common shareholders were not entitled to receive any consideration at all and, therefore, in the absence of harm, the court exonerated them from liability.

However, as we have explained above, in the German safe harbour model directors are required to prove that they meet all the requirements of the business judgment rule to benefit from immunity against any liability claim.

In Spain, most scholars consider that article 226 follows the German safe harbour model, under the so-called principle of ease of prove (principio de facilidad probatoria), given the difficulties that a plaintiff, who is not familiar with the ins and outs of the decision-making process of directors, would be required to face to prove that the decision is not protected by the business judgement rule. However, this does not necessarily mean that Spanish courts should admit any claim based on any damage arising from any business decision. It is one thing to prove that certain requirements of the business judgement rule have not been met, but quite another to file a claim based on no reasonable indication that the directors acted negligently when making the corresponding business decision.