Company Directors’ Key Duties and Business Judgment Rule

245 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule CHAPTER 13 Company Di ec o s’ Key Du ies and Business Judgmen Rule JANNE RUOHONEN Takeaways o Leading Change Cons an change and he complexi y o he su ounding socie y a ec s bo h company decision-making and legal ules on company decision-making. Socie al change c ea es challenging p oblems o companies. Ve sa ile expe ise and leade ship is equi ed in he boa ds o di ec o s. F om he poin o iew o company di ec o s, new business models and new ways o dealing wi h p oblems lead o unce ain y bo h when i comes o business and when i comes o hei legal du ies. Di ec o s mus exe cise du y o ca e in all hei ac ions as membe s o he boa d, bu in he no mal cou se o business decisions mus be aken quickly and wi hou knowledge o all possible in o ma ion and ce ain y wha will happen in he u u e. This is why di ec o s mus ha e ce ain le el o p o ec ion agains liabili y o damages. O he wise hey would no ha e he cou age o make he necessa y decisions conce ning in es men s, expansions o he business and isky new business s a egies. Taking isks is a no mal pa o doing business. The sha eholde s bene i when di ec o s ha e incen i es o make complex decisions wi hou ea o con inuous h ea o claims o damages. The business judgmen ule has ound i s way also o EU coun ies. Di ec o s a e no held liable o he damages i he business decision has been based on adequa e and app op ia e p ocesses and in o ma ion. The abili y o use a ious sou ces and in o ma ion is one o he mos impo an elemen s o he ule. Using in o ma ion om di e se sou ces makes di ec o s be e equipped o adap o changes in he business en i onmen and socie y. 246 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule O e he cou se o ime he limi ed liabili y company (US) – o company limi ed by sha es (UK) – has become globally he mos signi ican o m o doing business. Cu en ly, he e a e millions o limi ed liabili y companies (LLCs) in Eu ope and mo e han 270 000 LLCs e en in Finland. 1 An LLC may be public o p i a e, and a na ional le el he egula ion o companies may be di ided in wo sepa a e ac s: The Public Companies Ac and he P i a e Companies Ac . The main di e ence be ween public and p i a e companies is ha sha es o public companies can be o e ed o he gene al public. P i a e company sha e may no . The ea lies models o he LLC can be ound om I aly, om he 15 h cen u y Genoese Bank o Sain Geo ge, bu he his o ical oo s o mode n LLCs lie in 17 h cen u y Eu opean cha e ed companies (Schybe gson, 1964, p. 10–12; Toi iainen, 2008, p. 258–262). Based on common his o ical oo s, he e a e many simila i ies be ween limi ed liabili y companies wo ldwide. Companies a e p ima ily egula ed h ough na ional legisla ion. In he Eu opean Union, company law is only pa ially ha monised and ha monisa ion mainly conce ns public companies. The Eu opean Model Companies Ac 2017 (EMCA 2017) was d a ed by company law schola s om 22 EU coun ies. The EMCA is a collec ion o combined ea u es o na ional company ac s and is no legally binding. Howe e , he EMCA o e s a use ul pic u e o he gene al p inciples o Eu opean company law, as i has aken in o accoun many di e en app oaches o company law issues. The EMCA could po en ially be a ool o u u e Eu opean in eg a ion in he company law a ea. One a ge o he EMCA is o ensu e ha he legisla i e ame o Eu opean companies is eady o he challenges mode n businesses ace in he u u e (EMCA, 2017, p. 1). Success ul company leade ship equi es new kind o expe ise as he wo ld and he business en i onmen is changing apidly. The boa d o di ec o s (o co esponding) is compulso y in limi ed liabili y companies wo ldwide. I is esponsible o he success o he company. The di ec o s o he company mus ha e new kinds o leade ship skills a company le el – hey mus possess adequa e expe ise conce ning legal and 1 Fo in o ma ion on company o ms in Finland, see he Finnish T ade Regis e www.p h. i/en/kauppa ekis e i.h ml 247 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule business ma e s and unde s and he wide backg ound o hei decisions in o de o become e ec i e leade s. Di ec o s o he company mus esol e inc easingly complex p oblems conce ning, o example, business s a egy. This means socie al challenges a e ine i ably e lec ed in he company decision-making le el as well. New business models lead o unce ain y om a company di ec o s’ poin o iew when i comes o legal esponsibili ies. The business decisions o di ec o s mus be aken ca e ully bu quickly and wi hou ce ain y o wha will happen in he u u e. O he wise hey would no ha e he cou age o make necessa y and some imes complex decisions. New dynamic en i onmen s a e su ounded by unce ain ies bu he di ec o s do no ha e a choice. They ha e o esol e p oblems acco ding o alid laws and co po a e go e nance codes.2 Fo his eason, di ec o s mus ha e a ce ain le el o p o ec ion agains liabili y o damages. The chap e desc ibes he in e na ionally widely ecognised gene al p inciples o a LLC and ou lines he key elemen s o di ec o s’ du ies such as du y o ca e, skill and diligence and du y o p omo e he success o he company. Di ec o s ha e liabili y o negligence. The aim o he chap e is also o cla i y he con en s o he so-called business judgmen ule, a well-known ule in he USA and Eu ope and i is also called a “sa e ha bou ” o di ec o s. The ule s ipula es ha di ec o s canno be held liable o damages i a decision has been based on adequa e and app op ia e p ocesses and in o ma ion. The pe spec i e o he a icle is judicial. The pu pose o he a icle is no bound o any single na ional ju isdic ion. 2 P io o he adop ion o he Companies Ac in 2006, UK companies we e go e ned by common law p inciples (e.g., iducia y du ies). Gene al du ies ha e since been codi ied in he Ac (F ench e al., 2016, p. 477–478). The chap e desc ibes he in e na ionally widely ecognised gene al p inciples o a LLC and ou lines he key elemen s o di ec o s’ du ies such as du y o ca e, skill and diligence and du y o p omo e he success o he company. 248 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule Gene al Fea u es o Limi ed Liabili y Companies Be o e ocusing on he ac ual du ies o di ec o s, one mus unde s and he mos impo an gene al ea u es o a limi ed liabili y company. LLCs o e ways o di ide business isks be ween se e al sha eholde s. The e a e se e al sha ed ea u es in LLCs wo ldwide. An LLC has legal pe sonali y o i s own and i is dis inc om i s sha eholde s. No mally a company mus acqui e legal pe sonali y upon egis a ion on a na ional ade egis e . The e a e, howe e , a ia ions conce ning egis a ion and legal pe sonali y e en wi hin he EU (EMCA, 2017, p. 27). In an LLC he e is indeed sha eholde s’ limi ed liabili y o he obliga ions o he company. Sha eholde s a e no liable o he obliga ions o he company and pe sonal asse s o he sha eholde s a e sa e in case o company’s insol ency. Sha eholde s can only lose he amoun hey ha e in es ed. The e is li le doub his has been, and con inues o be, he mos impo an ea u e o an LLC – and he eason o i s wo ldwide success as he mos impo an o m o doing business. One o he mos impo an ea u es o an LLC is he pu pose o he company, which is o gene a e p o i s o sha eholde s. In o he wo ds, he company’s alue mus inc ease unless o he wise p o ided in he a icles o associa ion.3 The pu pose o he company can be changed bu only by s a ing o he wise in he a icles o associa ion. I could be, o ins ance, cha i y wo k o p oducing se ices a a easonable p ice o he sha eholde s. Ensu ing company managemen is ca ied ou wi h a long- e m and sus ainable iew is also impo an (EMCA, 2017, s. 1.06, commen s). The company should no simply aim a sho - e m qua e ly p o i -making – on he con a y, i is he ask o di ec o s o ad ance long un objec i es. The pu pose o he company in e wines wi h he ac ha managemen mus always exe cise easonable ca e, skill and 3 See o example, he Companies Ac 2006 (UK), Companies Ac 2005 (Sweden), and Companies Ac 2006 (Finland). Inc easing alue is conside ed he p ime a ge in EMCA 2017, sec ion 1.06. Some esea che s ha e sugges ed ha na ional Ac s should s a e pu pose o he company is “sus ainable alue wi hin plane a y bounda ies” (See Sjå jell & Mähönen, 2014, p. 59). 249 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule diligence in all ac i i ies. This means ha managemen is legally obliged o p omo e he pu pose o he company. 4 Typically he company mus ha e sha e capi al. Due o limi ed liabili y o he sha eholde s, dis ibu ing asse s o sha eholde s is subjec o limi a ions. The asse s o a company may only be dis ibu ed by ollowing p ocedu es se ou in law. The mos common ways o dis ibu e asse s a e yea ly p o i dis ibu ion (di idends) o sha eholde s and acquisi ion o he company’s own sha es. In no mal si ua ion i is o cou se possible o dis ibu e he p o i s o he sha eholde s bu some s ic equi emen s (limi a ions) p e ail (Bou ne, 2016, p. 124–132; Dignam & Low y, 2014, p. 120–123; Fe an & Look, 2014, p. 202–231; Ruohonen, 2015). These limi a ions a e o example balance shee and sol ency es s ha need o be ca ied ou be o e p o i paymen s. In o he wo ds, he company mus ha e he asse s o pay i s deb s o c edi o s i s . Only a e ha i is possible o dis ibu e asse s o sha eholde s. This p inciple is called c edi o p o ec ion. A limi ed liabili y company is a legal pe son. This means ha someone mus ac on behal o he company. 5 No mally he e a e wo i al and compulso y o gans in an LLC: he gene al mee ing and managemen , which can consis o boa d o di ec o s, a managing di ec o and supe iso y boa d. Managemen o he company is sepa a e om he sha eholde s. Howe e , B i ish law allows sha eholde s he eedom o o ganise go e nance o he company qui e eely. 6 Typically sha eholde s o a limi ed liabili y company exe cise hei powe o decision a he gene al mee ing ( ha is, sha eholde s’ mee ing). The e, decisions a e mos ly made by he majo i y o he o es cas . All sha es no mally ca y he same igh s. The p inciple o equal ea men is a ypical p inciple in na ional companies’ ac s in Eu ope. 4 The pu pose o he company is balancing be ween sho - e m in e es s o cu en sha eholde s and long- e m in e es s o u u e sha eholde s (Hannigan, 2016, p. 211). 5 Fo managemen o he company in UK legisla ion, see Companies Ac (UK) 2006 and Bou ne, (2016, p. 146–165). 6 Da ies (2010, p. 12–13) emphasises he e is conside able eedom o choose how he powe s be ween sha eholde s and managemen a e di ided. 250 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule Usually (majo i y) sha eholde s ha e he igh o elec he di ec o s o he company (Pe e , 2001, p. 3). 7 The composi ion o managemen a ies in di e en coun ies; he e is no “common Eu opean s anda d”. Fo ins ance EU law does no con ain binding ules conce ning he managemen s uc u e o companies. Acco ding o he EMCA, in a public company he boa d o di ec o s should comp ise o no ewe han h ee membe s. A p i a e company should ha e a leas one di ec o (EMCA, 2017, p. 174–175). In so called one- ie sys em he e mus always be he boa d o di ec o s. In a wo- ie sys em he e mus be a managemen boa d, and also a supe iso y boa d which supe ises he managemen boa d and appoin s he membe s o he boa d.8 The di ec o is a membe o he boa d. 9 This a icle ocuses on dealing wi h di ec o s o he boa d. Boa d may consis o sha eholde s o i may be sepa a e om he owne s. In bo h cases, he di ec o s o he company mus unde ake se e al du ies. Key Du ies o Di ec o s The boa d o di ec o s is he mos signi ican decision-making body in he LLC. The boa d is collec i ely esponsible o he success o he company (Keya, 2016, p. 27). I is esponsible o o ganising he adminis a ion o he company and he app op ia e o ganisa ion o i s ope a ions. The boa d is also esponsible o making he app op ia e a angemen s o con ol o company accoun s and inances. This means he boa d mus ad ance he pu pose o he company, which is no mally making p o i o he bene i o company’s sha eholde s. The boa d o di ec o s mus also supe ise he managing di ec o (CEO) o he company. The du ies and esponsibili ies o he di ec o s a e su p isingly simila in many EU coun ies – o cou se some di e ences also occu (Ge ne - 7 Fo he managemen s uc u e om sha eholde s’ poin o iew, see Vah e a (2011, p. 209–226). 8 Fo example, in Ge many he supe iso y boa d is a compulso y o gan which appoin s he membe s o he boa d. In Finland and he UK, supe iso y boa ds a e olun a y. This a icle ocuses on dealing wi h he one- ie sys em. 9 Fo managemen s uc u es o companies in Eu ope, see EMCA (2017, p. 167–173). 251 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule Beue le, Paech, & Schus e , 2013; EMCA, 2017, p. 221). The e a e many obliga ions imposed on di ec o s by he law o common law p inciples o make su e hey ac ai ly as ep esen a i es o he company. The di ec o ’s posi ion as a iducia y means hey mus ac on behal o he company o p ope pu poses and wi hou sel -in e es (Keya, 2016, p. 1, 25–26). Many o a di ec o ’s legal du ies a e ecognised almos wo ldwide. Fi s , he boa d mus exe cise easonable ca e, skill and diligence (du y o ca e). This is he basis o he di ec o ’s du ies in all na ional companies’ ac s (EMCA, 2017, p. 204). As desc ibed in EMCA 9.03, du y o ca e e e s o he ca e, skill and diligence ha would be exe cised by a easonably diligen pe son wi h a) he gene al knowledge, skill and expe ience ha may easonably be expec ed o a pe son ca ying ou he unc ions ca ied ou by he di ec o in ela ion o he company, and b) he gene al knowledge, skill and expe ience ha he di ec o possesses. Second, di ec o s ha e he du y o loyal y. Simply pu , his means di ec o s mus place he company’s in e es s ahead o hei own. Thi d, di ec o s mus o p omo e he success o he company as discussed ea lie . Fou h, di ec o s ha e he du y o a oid con lic s o in e es . Di ec o s need o a oid si ua ions in which he o she would ha e in e es s which con lic o may con lic wi h he in e es s o he company (Da ies & Wo hing on, 2016, p. 540–541). In addi ion, hey ha e a du y o no accep bene i s, a du y o exe cise independen judgmen and a du y no o ac ou side powe s. Co po a e go e nance codes o public companies (lis ed companies) migh impose e en mo e equi emen s o di ec o s. In he UK Co po a e Go e nance Code 2016 he e a e se e al o he equi emen s conce ning di ec o s’ du ies. As he wo ld changes, company di ec o s mus esol e inc easingly complex p oblems wi hin hei powe s and du ies. I is impo an o unde s and how di ec o s should make decisions om a legal poin o iew – wha a e hei legal du ies in each case. In addi ion, i is i al ha di ec o s ga he all he necessa y ac s conce ning he decision hey As he wo ld changes, company di ec o s mus esol e inc easingly complex p oblems wi hin hei powe s and du ies. 252 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule a e abou o make. Then he di ec o s mus look in o he de ails wi h easonable ca e, skill and diligence. Decision-making mus be a ional. The di ec o s mus ake in o accoun he changing business en i onmen , complexi y o he issue and unce ain ies conce ning he u u e changes. I hey ail o do so, di ec o s may some imes be held liable o damages hey ha e caused as membe s o he boa d i hey a e no able o p o e hemsel es igh . The di ec o s o he boa d and CEO can be held pe sonally liable o damages hey ha e caused. Some imes he cou migh also iden i y as a di ec o a pe son ha ac ually ac s in he capaci y o di ec o wi hou being o mally appoin ed o ha pos (de ac o di ec o ) o a pe son whose ins uc ions he boa d is accus omed o ollow (shadow di ec o ).10 Due o pe sonal liabili y he di ec o s o he boa d should always ha e he necessa y expe ise. Fo example acco ding o he Co po a e Go e nance Code (UK) “ he boa d and i s commi ees should ha e he app op ia e balance o skills, expe ience, independence and knowledge o he company o enable hem o discha ge hei espec i e du ies and esponsibili ies e ec i ely” (Co po a e Go e nance Code UK, 2016, Sec ion B.1.). Discussion O en di ec o s need o make isky and complex decisions, o example in es men decisions. I di ec o s we e always pe sonally liable o he damages caused by hei decisions, hey migh be emp ed o “play sa e”. Due o his ac , by ollowing a ce ain ule di ec o s a oid ha m ul consequences o aking w ong decisions. This ule is called a business judgmen ule (BJR), some imes also desc ibed as a “sa e ha bou ” o di ec o s. The BJR is conside ed one o US co po a e law’s cen al doc ines (Keya, 2016, p. 261). EMCA desc ibes he BJR as ollows: 10 See e.g. EMCA (2016, Sec ion 9.01). Fo a heo e ical iew o he business judgmen ule, see G een ield (2014, p. 217–240). 253 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Company Di ec o s’ Key Du ies and Business Judgmen Rule EMCA 2017, Sec ion 10�01 Di ec o s’ Liabili y (3) A di ec o who makes a business judgemen in good ai h ul ils he du y [o ca e] unde his Sec ion i he o she: (a) is no in e es ed in he subjec o he business judgemen ; (b) is in o med wi h espec o he subjec o he business judgemen o he ex en ha he di ec o o managing di ec o easonably belie es o be app op ia e unde he ci cums ances; (c) a ionally belie es ha he business judgemen is in he bes in e es s o he company�11 Di ec o s making business judgmen s a e “in e es ed” i hey, o example, aim o pe sonal inancial bene i (sel -dealing). A con lic ed di ec o does no make a business judgmen in good ai h and ul il his du y o ca e. The di ec o mus also be in o med o he con en s o he business judgmen and ac in he bes in e es s o he company. The business judgmen ule is an impo an pa o he decision-making p ocess as i conce ns e ec i ely all decisions made by di ec o s (Sa ela, 2015, p. 94). Di ec o s can be held esponsible o damages hey ha e caused as membe s o he boa d i hey ail o ollow he business judgemen ule. Consequen ly, business judgmen ule means ha he di ec o is no liable o he damages i he di ec o has made he business decision based on adequa e and app op ia e p ocesses and in o ma ion conce ning he ma e . They mus ha e ac ed in good ai h (bona ide), belie ing ha he in e es s o he company ha e been aken in o accoun . This basically gi es di ec o s o he company eedom o make decisions wi hin he limi s desc ibed (T ask & DeGui e, 2013, p. 162–163). I is equi ed ha di ec o ul ils his o he du y o ca e and exe cises easonable ca e, skill and diligence in all his o he ac ions as a membe o he boa d. All decisions mus be made conside ing hese ci cums ances and need o ha e a a ional economic basis om he company’s poin o iew (Mähönen & Villa, 2010, p. 460–461). All he ele an in o ma ion a ailable a he ime 11 In he US, he BJR is almos iden ical (Ame ican Law Ins i u e: P inciples o Co po a e Go e nance §4.01(c); EMCA, 2017, p. 223).