... the following question from Maarten Mussche landed in my inbox.I have a question, Professor Assink. If I see it correctly, the rationale behing the business judgment rule is to allow directors to make risk neutral business decisions. In inquiry proceedings the investigated mismanagement doesn't always concern a business decision. It could be about e.g. internal struggles that cause a decision deadlock or about disobeying the interests of minority shareholders. There's no business judgment in play in those cases, no risk of giving directors an incentive to be inefficiently cautious. General application of the bjr to the judicial verdict about corporate mismangement in enquiry proceedings (as you and Prof. Maarten Kroeze seem to propose in your column) is therefore imho undesirable. Key is that a business decision is concerned. Do you agree?Good question. The short and simple but true answer is that, without a business decision under attack, there is no reason to apply the business judgment rule. For this reason, a Dutch BJR would not automatically apply throughout the right of inquiry, something sceptics have difficulty to grapple. It's role would actually be relatively modest, as quite some cases don't involve an attack of management business decisions. This doesn't take away the case for introduction of a Dutch BJR though, let me be clear on that.
Well, yes, but....
In my Corporation Law (Concept and Insight Series) treatise, I explain that:
The business judgment rule is relevant only where directors have actually exercised business judgment. A decision to refrain from action is protected just as much as a decision to act, but there is no protection where directors have made no decision at all. Instead, the consequences of inaction are subject to review under the duty of care.
When I next update the text, I'll have to amend the last sentence to indicate that the important class of cases in which the board allegedly failed to exercise proper oversight (so-called Caremark claims) are now governed by the obligation of good faith, which in turn has been subsumed into the duty of loyalty. I have sharply criticized that doctrinal development, but to no avail. See generally The Convergence of Good Faith and Oversight. Curiously, the Delaware courts have resisted the inescapable logic of my position; indeed, they have gone so far as to ignore it, something I've tried to let slide.
Having said that, however, at least some Delaware jurists (notably Bill Chandler) have acknowledged that the same principles that inform judicial reticence in cases falling within the business judgment rule are also relevant to application of the good faith principle in at least a subcategory of oversight cases. See generally Caremark and Enterprise Risk Management, in which I observed that:
The defendants were current and former directors and officers of Citigroup. Plaintiffs’ claims against them included an argument “that the director defendants are personally liable under Caremark for failing to ‘make a good faith attempt to follow the procedures put in place or fail[ing] to assure that adequate and proper corporate information and reporting systems existed that would enable them to be fully informed regarding Citigroup’s risk to the subprime mortgage market.’” Chancellor William Chandler seemingly was tempted simply to exclude these claims from Caremark’s ambit, observing that:Later in that article, I explained that:Although these claims are framed by plaintiffs as Caremark claims, plaintiffs’ theory essentially amounts to a claim that the director defendants should be personally liable to the Company because they failed to fully recognize the risk posed by subprime securities. When one looks past the lofty allegations of duties of oversight and red flags used to dress up these claims, what is left appears to be plaintiff shareholders attempting to hold the director defendants personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company. Delaware Courts have faced these types of claims many times and have developed doctrines to deal with them—the fiduciary duty of care and the business judgment rule.
Just as the business judgment rule insulates risk taking from judicial review, so Caremark should insulate risk management from judicial review.Hence, while it's true that the business judgment rule technically should not apply to oversight cases--there is no exercise of business judgment in such cases--I think Chandler was quite correct to view at least the subcategory of risk management-based Caremark claims as posing the same policy concerns as traditional business judgment rule cases. Accordingly, he correctly declined to impose liability on the Citigroup board.
Risk management necessarily overlaps with risk taking because the former entails making choices about how to select the optimal level of risk to maximize firm value. Recall that there are only four basic ways of managing risk: avoiding it by avoiding risky activities, transferring it through insurance or hedging, mitigating it, and accepting it as unavoidable. All of these overlap with risk taking. Operational risk management, for example, frequently entails making decisions about whether to engage in risky lines of business and, more generally, determining whether specific risks can be justified on a cost-benefit analysis basis. As a result, it is becoming increasingly “difficult to draw a line between corporate governance and risk management.” ...
As Chancellor Chandler correctly recognized in Citigroup, Caremark claims premised on risk management failures thus uniquely implicate the core concerns animating the business judgment rule in a way typical Caremark claims do not. Chancellor Chandler seemingly understood that risk management cannot be easily disentangled from risk taking, because it described plaintiffs’ claim as “asking the Court to conclude … that the directors failed to see the extent of Citigroup’s business risk and therefore made a ‘wrong’ business decision by allowing Citigroup to be exposed to the subprime mortgage market.” He declined to do so, explaining that “this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a Caremark theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.”