Directors’ and officers’ liability marks a centre point of the corporate governance debate everywhere. Legal approaches to the duties of care and loyalty seem to have converged over recent years. Persisting differences between jurisdictions affect the direction of multi-national companies. In a forthcoming paper, we argue that courts should take a functional perspective when dealing with this topic.
Liability can be described as a constraints strategy. Constraints serve to draw a line between acceptable and unacceptable behaviour, the latter being subject to a monetary sanction. The use of liability as a constraints strategy in limited liability corporations must distinguish between inside and outside responsibilities.
First, inside liability towards the corporation serves to protect owners against stealing and shirking by agents. Whilst possible forms of stealing can be described relatively clearly, shirking is less easily described and requires a more flexible legal test. This test is widely known as the business judgment rule. It serves to enable risk-taking ex ante by shielding agents from second guessing by courts ex post.
Secondly, liability should be on hand to prevent coalitions with owners that aim to misuse the corporate veil to the detriment of parties outside the corporation. However, overly far-reaching outside liability will preclude the achievement of the goals of court abstention under any type of business judgment rule.
How to get the interaction between these types of liability right in practice? The real picture depends on the availability and shape of indemnification, waivers, and insurance covers as well as on the procedural setting for private enforcement.
The least resolved problems concern liability for monitoring failures especially of non-executive directors and supervisory directors. Monitoring failures seem to be a double mirror of management failures. For a balanced approach, it seems advisable to reconsider the thoughts that have inspired court abstention from second-guessing management decisions under the business judgment rule.
Patrick C. Leyens is Professor (hon.) of Law & Economics at the Erasmus University Rotterdam, Erasmus School of Law, and Guest Professor at the Humboldt University of Berlin, School of Law.
Michael G. Faure is Professor of Comparative and International Environmental Law at the University of Maastricht, and Professor of Comparative Private Law and Economics at the Erasmus University Rotterdam, Erasmus School of Law.