[No. 20] The Business Judgment Rule

1. Today, Professor Stephen Bainbridge nicely explained the gist of the (Delaware) business judgment rule on his 'new' blog, against the backdrop of:

1. In re Citigroup, Inc. Shareholder Derivative Litigation (see my post about that important decision here); and
2. Professor Jay Brown's critique of that decision here, here, here, here, here and here (part of his quest against the 'Delaware approach').

2. The business judgment rule has been addressed by the Delaware courts many times. Although there are still some issues that need tweeking and fine-tuning, for example that weird linkage between the business judgment rule, enhanced scrutiny and entire fairness review, the rule has famously been defined by Chief Justice Veasey in Brehm v. Eisner, 746 A.2d 244 (Del. 2000) (quoted, for example, in In re The Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006)), as not allowing judicial second-guessing of business judgments made by corporate directors, unless there is:

• a serious conflict of interest issue;
• a lack of good faith;
• a grossly negligent decision making process (including the failure to consider all material information reasonably available); or
• a lack of any rational business purpose (like waste), typically indicative of bad faith.

This basically means that in the basic business judgment setting a court is precluded from interfering, except in cases of bizarre gaffes, bad faith behavior and/or self-dealing by the directors (fraud). Bainbridge rightly explains that this approach makes sense, in part because judges are almost by definition ill-equipped to review director conduct in the business judgment setting ex post in a responsible manner.

3. I explained the rationale for this approach, the gist of the Delaware business judgment rule and the way Dutch corporate law should develop a Dutch version (e.g., in inquiry proceedings and in section 2:9 DCC director liability proceedings) in detail in Judicial Review of Director Conduct - Under Dutch and Delaware Corporate Law, Deventer: Kluwer 2007.

4. Although there has been some scepticism in Dutch legal literature about the necessity of a business judgment rule type approach and the possibility of introducing a Dutch version in Dutch corporate law (see my response to the flawed reasoning of a former Enterprise Chamber judge, who basically argued we should stick to our traditional 'reasonableness and fairness' type of scrutiny), I believe change is in the air in the Netherlands. Illustrative is the article by Maarten Verbrugh and Professor Vino Timmerman in the latest Journal of Company Law (2009-3, no. 35), in which they argue on page 152 that an important method to increase predictability in the way the Enterprise Chamber applies and develops general norms in inquiry proceedings (especially 'well founded reasons to doubt the correctness of the corporation's policy' and 'an obvious incorrect course of action') is introducing a judicial review mechanism that is inspired by the business judgment rule (mentioning my book; also see the Dutch Social Economic Council's advice of February 2008, containing a proposal to introduce the business judgment rule in inquiry proceedings, also referring to my book). I agree (duh), but would like to go a bit further and argue for the introduction of an actual Dutch business judgment rule, and not just in inquiry proceedings but also in personal liability proceedings (especially section 2:9 DCC proceedings, see, e.g., post No. 11). Although inquiry proceedings generally do not deal with personal liability issues, the problems related to judicial review of director conduct in the business judgment in inquiry proceedings do not really differ from those related to judicial scrutiny in personal liability proceedings. I see no reason to apply different approaches in these proceedings and have not come across convincing arguments to the contrary (see, e.g., here).

5. So far the Dutch legislator has not shown any initiatives in this direction, despite the fact that section 2:9 DCC is part of coming legislation aimed at modernizing Dutch corporate law (including the formal introduction of an optional one-tier board structure). I don't find this very disturbing, as I don't really see the necessity of a codified mechanism anyway (see, e.g., here). A judge made mechanism would be flexible and could work just fine, provided the contours are clear and the mechanism is not too complicated; Delaware is the obvious example leaving aside the tweeking/fine-tuning part. The real initiative should come from the Dutch Supreme Court. I happen to know that there are some section 2:9 DCC proceedings on the Supreme Court's docket. Interestingly, in most corporate law cases the Advocate General - who helps the Supreme Court to decide the case by writing a learned opinion about the relevant issues beforehand - is Vino Timmerman. He is rather familiar with the concept of the business judgment rule. Not only was he my promotor, he also elaborated on the Delaware approach in his learned opinion in the 2007 ABN AMRO case (3.3 et seq.). If he also handles these section 2:9 DCC cases (and my guess is he will), we may be on the eve of some nice developments in the field of the judicial review of director conduct in the business judgment setting.

I've got my hopes up...