A central and perennial issue in English company law is how to come up with a set of techniques that would effectively control the discretionary exercise of powers by directors while ensuring that directors are not impeded from efficiently managing the company. One such technique is the standard of review of directors’ decisions in cases concerning breach of directors’ duties. Courts can vary the standard or intensity of their review of directors’ acts or decisions concerning directorial wrongdoing. Judicial approach in undertaking such a review is informed by the understanding that courts should be very careful in not second-guessing board decisions, and that bona fide board decisions should be generally immune from judicial scrutiny.
Under s 172 of the Companies Act 2006 (‘the Act’), courts will not interfere with the board’s decision concerning an alleged breach of the duty to promote the success of the company unless it is one that no reasonable director could have made, which is known as the Wednesbury standard. Section 172 has been interpreted to mean that courts are to abstain from reviewing on objective grounds whether the board’s decision was actually in the best interest of the company; it is for the directors, in their subjective view, to decide. Courts will only intervene if the decision is one that no reasonable director could have considered to be in the company’s best interest. In short, the standard of conduct required of directors under s 172 is subjective, and the standard of review adopted by courts is rationality or plausibility.
Tellingly, none of the directors of the financial institutions that were subjected to government bailout during the 2008 global financial crisis were held liable for breaching their duties under the Companies Act, although it was not disputed that their recklessness and failure to provide proper oversight led to ruinous decisions that nearly resulted in the collapse of the financial institutions. This resulted in some scholars lamenting that the statutory duty under s 172 is not fit for purpose in a post-financial crisis world.
The importance of the question of whether courts should be necessarily barred from undertaking a searching review of board actions where appropriate is further underscored by the finding that although enforcement of directors’ duties by courts plays a significant role in promoting good corporate governance, a number of jurisdictions have a technique or mechanism that is similar to that in the UK under which courts will abstain from reviewing bona fide decisions of directors, thereby insulating directors from liability, the result of which is that the deterrent value of directors’ duties seems to be attenuated.
Although courts should not second-guess board decisions (which explains the basis for having the Wednesbury standard), it does not follow that courts should be precluded from intervening in boards’ decision-making process through the adoption of a searching standard of review when they assess whether directors have breached s 172. In my forthcoming article, I advance and defend a framework to evaluate board decision-making processes under s 172 – the ‘Heightened Review’ under which courts can and should take into account the following factors including but not limited to: (a) whether the board possesses the requisite expertise that is relevant to the transaction or decision in question; (b) whether the board members (particularly the non-executive directors) have devoted sufficient time and resources to the matter at hand, both prior to the meetings and at the meetings themselves; (c) whether the board has given consideration to matters that are relevant and excluded from consideration irrelevant matters; (d) whether the board has put in place effective oversight and monitoring systems of the firm’s strategies and operations (which include operational, financial, and compliance controls, as well as of course risk management); and (e) whether the board’s decision was made after discussions with shareholders, or if not, whether shareholders have had an opportunity to question and evaluate the actions of the board upon receiving adequate information and explanation from the board after its decision was made.
Part I first explains the circumstances under which courts have intervened in directors’ decisions, and then advances the Heightened Review which will assist courts in deciding the extent of their intervention in directors’ decision-making process; and articulates five justifications for adopting such a standard. Part II shows how the enhanced but restrained mode of judicial intervention advocated in this article—the Heightened Review—is supportable by case law, and explains how it can augment the interpretation and enforcement of s 172 of the Act. Part III addresses four policy and two institutional objections against judicial intervention. The policy objections are the following: first, courts will suffer from hindsight bias and thus directors will be averse to taking risks that benefit the company; secondly, qualified people will be deterred from becoming directors; thirdly, the volume and cost of litigation will escalate; and finally, the exercise of governance rights by shareholders is more effective than judicial intervention in deterring directorial misconduct. The institutional objections are that courts lack both the expertise and legitimacy to undertake a searching review. Part IV examines the judicial dicta that have been used to support the rejection of judicial intervention and finds them unpersuasive. Part V concludes.
Ernest Lim is Associate Professor at the Faculty of Law of the National University of Singapore.