In today’s dynamic business environment, decision-making frequently entails venturing into unknown territory. It is often challenging to accurately foresee which among various possible actions will prove effective or most advantageous economically for the company. Therefore, one thing is universally acknowledged: corporate decision-makers must be granted a level of entrepreneurial freedom and autonomy that cannot be micromanaged by courts afterwards. If not, the decision-maker might hesitate to make decisions involving uncertainty, hindering the company’s ability to grow successfully and enhance its profitability. In other words, decision-makers need assurance that they won’t be held accountable because, in hindsight, the usual entrepreneurial risks associated with their decisions came to pass and another decision might have been seen as reasonable.
Business Judgement Rule (BJR) as a “safe harbour” for business decisions
In practice, commercial discretion can be both a blessing and a curse. On the one hand, it provides the flexibility necessary to reflect the ever-changing dynamics of the market. On the other hand, the discretion is not without its limits and often requires a delicate balancing act, where exceeding the boundaries of discretion can result in serious consequences, including liability for damage incurred by the company.
This blog post intends to elucidate the Business Judgment Rule (BJR), illustrating how, when applied correctly, it can serve as a “safe harbour” for making business decisions and evolve into a powerful tool for navigating intricate strategic choices.
The BJR is a legal principle that applies to business decisions. These decisions are not pre-determined “by law”, such as mandatory law, the company’s articles of association or binding obligations under the relevant board members’ service contracts. Thus, the corporate decision-maker has the option of choosing between several feasible and permissible alternative courses of actions. Business decisions are inherently forward-looking, characterised by forecasts and judgements. This is particularly true in today’s complex environment, where corporate decision-makers are faced with many challenges, such as geopolitical tensions, ESG requirements and cyber risks, to name but a few. Due to the inherent uncertainty in business decision-making, executives require a sufficient degree of discretion. The BJR offers precisely this: it allows executives to make informed and courageous choices without the risk of personal liability, provided they stay within specified limits. Originating in Anglo-Saxon law, the BJR is codified in Section 93(1)(2) of Germany’s Stock Corporation Act (AktG) and applies to both the management boards of stock corporations (AG) and limited liability companies (GmbH).
How to make BJR-compliant decisions
To effectively use the BJR as a strategic tool and steer clear of possible liability, adhering to a well-defined decision-making process is crucial. By following these steps, decision-makers can take full advantage of the BJR’s “safe harbour” protection:
Step 1: Establish an adequate factual basis
Decision-makers are required to reasonably assume that they are making a decision on the basis of adequate information. While this may sound straightforward, as the foundation of any business decision should be a thorough assessment of the relevant facts, it can quickly become complex depending on the nature of the decision at hand. The decision-maker will inevitably have to deal with the important question of what information must be obtained and assessed so that a decision can be assumed to be based on “adequate information”.
Generally, all available sources of factual and legal information must be properly examined in the specific decision-making situation. However, the context of the decision serves as the framework for determining what constitutes “all available sources”:
- The information that needs to be examined varies depending on the case and may include relevant facts related to corporate social responsibility (CSR) or sustainability challenges like climate change.
- It is important to understand that not every potential information source needs to be explored when considering the range of information to be reviewed. The adequacy of the factual foundation hinges on what a diligent businessperson can reasonably be anticipated to ascertain. This assessment can be demanding, with the very first step of collecting information possibly necessitating an initial business judgment to evaluate the advantages and expenses associated with thorough fact-gathering. The urgency of the decision is a crucial factor, alongside the practical and legal feasibility of accessing the information and the anticipated advantages that such information could provide.
- If the decision-maker does not have the necessary expertise to make a specific decision, they may (and may be required to) seek information or advice from third parties. However, they must not “blindly” rely on such information or advice but must perform an adequate validation of such external third-party advice by themselves.
Step 2: Weigh up and balance risks and opportunities and act in the best interests of the company
Once an adequate factual basis has been established, the next step is to weigh up and balance the risks and opportunities and make a decision that can reasonably be considered to be “in the best interests of the company”. This assessment must take into account not only the interests of the parent company but also those of its subsidiaries and the group as a whole.
What exactly does it entail to act in the company’s best interests? Typically, this encompasses measures aimed at improving the company’s long-term profitability and competitiveness, along with enhancing its products and services. However, the emphasis should not solely be on maximizing profits for shareholders but on considering the company as a whole, including all its stakeholders. Fundamentally, decision-makers have the flexibility to determine what this involves. Nevertheless, they must not exceed the limits of responsible corporate conduct or recklessly extend their acceptance of commercial risks.
Given these limitations, decisions can be made based on experience and insights into market trends, customer responses, and competitive movements. Intuition might also be significant, particularly when various options are available, and none are clearly unreasonable.
Step 3: Act without conflicts of interest and in good faith
Inherent in the mandate to act in the company’s best interests, the decision-maker must ensure that decisions are made without conflicts of interest and free from external influence. If there are objective indications that the decision might benefit the decision-maker personally or third parties (e.g., in the case of transactions with spouses or with companies in which the decision-maker also holds a management position), the decision-maker generally can no longer rely on the BJR. If there is a conflict of interest, the decision-maker must disclose it. If the decision is made by a team of several decision-makers and one of them is biased, the remaining decision-makers can rely on the BJR (if they meet its requirements), provided that the biased member is excluded from both the discussion and the final decision-making process.
Finally, the decision-maker is required to act “in good faith”: if they do not believe the relevant decision is the correct one, they are not granted protection under the BJR.
The ex-ante perspective
If a decision is subsequently scrutinised, a court will evaluate whether the limits of the BJR were observed. The crucial point is the “ex-ante” perspective: this means the decision will be judged based on the information and circumstances that were available at the time it was made, i.e., not with hindsight. This approach ensures that, where the BJR criteria were adhered to, decision-makers are not held liable for negative outcomes. Therefore, and given the decision-maker’s burden of proof in this regard, it is especially important to document each step leading to the decision from the very beginning.
Residual uncertainties
The reality is that the steps outlined above can be challenging to implement effectively since there are numerous factors that must be taken into account. We continue to see that business decision-makers from multiple industries struggle to reach commercial decisions based on the criteria of the BJR or require help managing risks after a decision has been made. This relates to a broad range of complex issues, such as
- distinguishing cases that fall under the BJR from those where there is a legal obligation to act in a particular way;
- whether it is necessary to initiate an internal review or investigation to ensure an adequate information base (e.g., following a whistle-blower’s complaint); or
- when there is legal justification for not pursuing claims owned by the company, even if they have a high chance of success in court.
To avoid liability, corporate leaders should strictly follow the BJR criteria as a “safe harbour”, enabling them to make strategic and well-informed decisions with confidence. Meticulously recording each step in the decision-making process is vital for maintaining transparency and ensuring traceability from the beginning. When faced with uncertainties, seeking professional advice is strongly recommended to effectively manage risks and enhance the decision-making process.
