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A. McCrory G. Natullo
7 apr 2023Tempo di lettura: 6 min

THE BUSINESS JUDGMENT RULE

1. Introduction


As stated by Professor Douglas M. Branson, “the business judgment rule is not a rule at all”. It should be considered as a mere standard of “non-review”. Indeed, the business judgment rule provides a corporation’s director immunity from liability when a plaintiff sues on grounds that the director violated the duty of care to the corporation, provided that the director’s actions fall within the parameters of the rule.

This standard shall be taken in consideration by any court when judging on such matters. Accordingly, a court will uphold the decisions of a director as long as they are made

(1) in good faith;

(2) with the care that a reasonably prudent person would use;

(3) with the reasonable belief that the director is acting in the best interests of the corporation.

The standard is considered unfulfilled when it is determined that a director is guilty of gross negligence, has acted in bad faith or acted in spite of a conflict of interest.

If the corporation pleads the application of the rule, then the burden of proof will shift upon the plaintiff which will need to prove the inapplicability of the standard.

What do we mean by duty of care and by good faith?

According to the Principles of Corporate Governance, by The American Law Institute, the duty of care is the responsibility that rests upon a corporate officer or director to act in good faith while carrying out their duties. This duty prescribes making sound business decisions and devising strategies that are aimed at promoting the best interests of the corporation.

The performance of this duty entails a diligence standard, by which the director is expected to act with the care that an ordinarily prudent person would reasonably exercise in a similar position and under similar circumstances.

One of the most important and unique scenarios involving breach of fiduciary duties is the widely praised Delaware decision in Smith v. Van Gorkom, 1985. On this occasion, the Delaware Supreme Court held that the directors, after the approval of a merger, had infringed their duty of care to the corporation by failing to conduct an extensive investigation of a proposed merger and by relying on a single report that contained significant errors and omissions.


2. The application of the rule in Italy


The business judgment rule has been transposed in the Italian legal system through case law, offered mainly by the Corte di Cassazione starting from 1965 and has evolved overtime.

According to the Corte di Cassazione, when assessing the liability of directors, the judge cannot verify the appropriateness, advisability and profitability of their decisions, but only the adherence to the relevant decision-making process. The judge shall only consider the methods of exercising managerial power; the results of the director's activity cannot be scrutinized. This statement is clearly related to the sort of obligation which binds the director to the corporation: it is an obligation of means, not of results.

So, if the directors have followed the correct and appropriate decision-making process, they will not be found liable for their managerial decisions, even if those decisions prove to be wrong, harmful to the company or inappropriate.

Now, as stated by the Corte di Cassazione in a recent decision on the 16th February 2023, it is permitted for directors to make risky and potentially harmful decisions as long as they fall within the business risk. Regarding these acts, the directors will be liable only in presence of damage suffered by the corporation caused by negligent management, the so-called “mala gestio”. Following this reasoning, even after a corporation's bankruptcy, the liability of directors is not recognised by default, since it depends on their violation of the duties of care.


However, the application of the business judgment rule is limited in two ways. Firstly, the managerial decisions should be analyzed to determine that proper diligence and precautions were applied in the decision making process of the director.

Additionally, the second limit permits to challenge the rationality of the decision. It is not sufficient that the director gathered the appropriate information and the necessary checks, it is instead essential that these checks and information led the director to make a rational decision.


The new Corporate Governance Code, recently approved by the Borsa Italiana Committee in January of 2020, offers in recommendation number 1 a layout of the role carried out by the board of directors. More specifically, according to letter c), the directors must define the nature and level of risks that are compatible with the strategic objectives of the company.

However, from this risk profile choice, which is covered by the business judgment rule, arises the need to prepare adequate measures to cover the risks. For this reason, the choice itself may prove imprudent or unreasonable if the company is not equipped with the necessary resources, tools, and procedures for adequate monitoring and management of the risk objectives that the board has assumed.

So once again, we understand the applicability and the reasonable limits of the rule: the unquestionability of the managerial decisions is accepted only insofar as it doesn't transcend the company's realistic ability and capacity to enact them.


3. Business judgment rule and related-parties transactions


Another curious application of the business judgment rule can be observed in the context of transactions with related parties. In Italy, the discipline that regulates these types of transactions is found in the "Regulation containing provisions on transactions with related parties", adopted by Consob with resolution no. 17221 of March 12, 2010.

Under Article 8 of the Regulation, the so-called "major relevance transactions", i.e. those exceeding the threshold of 5% of at least three parameters (market capitalization, total assets, total liabilities), must be approved with a favorable opinion from a committee of independent directors. The given opinion must take into consideration the convenience and opportunity of the transaction for the company. In the absence of a positive opinion, the transaction may be submitted to a shareholders meeting, obtaining a favorable vote of the majority of non-related shareholders.

However, it is believed that, with respect to the "convenience" of the transaction, this should be considered as simply verifying the correctness of the procedure to be followed, as otherwise, it would risk venturing into the managerial competence exclusive to the Board of Directors, in any case assisted by the business judgment rule.


4. Case study


An intriguing analysis of the application of the business judgment rule in Italy can be done on the recent Corte di Cassazione decision from February 16th 2023. In this case, a corporation requested the court hold their directors liable for four corporate transactions, linked to the sale of assets, which resulted harmful to the corporation.

The corporation challenged just the convenience of the agreements, not their validity; in fact actions for nullity or annulment of the transactions, were not filed. Since the agreements were formally valid, the court established that the director's strategic decisions couldn't be contested, because they fell under the scope of discretionality granted to the directors in their role.

So, the court avoided any evaluation ex post of the decisions of the directors: their liability can't be ascertained based just on the damages suffered by the corporation.

The judicial assessment must be limited to the conduct of the directors, in light of their duty of care and their duty to act in good faith.

The complaint of the corporation seemed to forget that the contractual nature of directors’ liability towards the company implies that the latter has the burden of proving the existence of the infringements and the causal link between them and the occurred damage.

Finally, the Court established that the judgment on the diligence of the director in the fulfillment of their mandate shouldn't involve analysis of management decisions. For this reason, the liability action, ex art. 2392 c.c., cannot challenge directors’ choices considered to be inappropriate from an economical, strategic point of view.



5. Concluding statements


To conclude our analysis, we would like to underline the importance of this rule in relation to a fair corporate governance balance that shall be found inside of each corporation. Indeed, through the application of the business judgment rule, managerial roles are safeguarded by any potential intrusion deriving from other bodies, into strictly strategic and discretional areas. These areas and their corresponding decision-making powers pertain exclusively to the company's directors and cannot be questioned.



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