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Standard of Conduct or Standard of Review? Examination of an African Business Judgment Rule under South Africa's Companies Act 71 of 2008

Published online by Cambridge University Press:  18 January 2019

Brighton M Mupangavanhu
Brighton M Mupangavanhu*
Affiliation:
University of the Western Cape
*
bmupangavanhu@uwc.ac.za
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Abstract

This article highlights that section 76(4)(a) of South Africa's Companies Act, which reflects the business judgment rule (BJR) concept, is a standard of review, providing a means of determining whether a director has met his or her undertakings under section 76(3). The article suggests that section 76 should be titled “Standards of conduct and review” instead of referring only to standards of conduct. It draws a clear distinction between standards of conduct (including the personal financial interests disclosure requirements) on one hand, and a standard of review on the other. After tracing the traditional international requirements of BJR, the article analyses the decision-making requirements under section 76(4)(a). It concludes that, while section 76(4)(a) compares favourably with US and Australian laws, the omission of a good faith requirement is unfortunate since that is a critical component of decision-making. The article proposes that good faith and proper purpose under section 76(3)(a) should form part of the section 76(4)(a) requirements.

Keywords

Business judgment rulestandard of conductstandard of reviewduty of caregood faithdecision-making
Type
Research Article
Information
Journal of African Law , Volume 63 , Issue 1 , February 2019 , pp. 127 - 150
Copyright
Copyright © SOAS, University of London 2019 

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Footnotes

*

PhD (commercial law) (University of Cape Town); LLM (Natal); LLB (University of Fort Hare). Senior lecturer, Mercantile and Labour Law Department, Faculty of Law, University of the Western Cape.

References

1 BM Mupangavanhu Directors’ Standards of Care, Skill, Diligence and the Business Judgment Rule in View of South Africa's Companies Act 71 of 2008: Future Implications for Corporate Governance (PhD thesis, University of Cape Town, 2016) at 142.

2 US courts developed the BJR as a common law rule alongside the duty of care. See C Weng “Assessing the applicability of the business judgment rule and the ‘defensive’ business judgment rule in the Chinese judiciary: A perspective on take-over dispute adjudication” (2010) Fordham International Law Journal 124 at 128.

3 Australia adopted the BJR in statute through sec 180(2) of the Corporations Act 2001.

4 Sec 76 indiscriminately classifies all provisions under it as “standards of directors’ conduct”; the author argues that this is a misnomer.

5 Weng “Assessing the applicability”, above at note 2 at 128.

6 S Bainbridge “The business judgment rule as an abstention doctrine” (2004) Vanderbilt Law Review 83 at 84. See also Manne, HG “Our two corporation systems: Law and economics” (1967) 53/2 Virginia Law Review 259 at 270CrossRefGoogle Scholar.

7 See L McMillan “The business judgment rule as an immunity doctrine” (2013) William & Mary Business Law Review 521 at 524.

8 Id at 521.

9 Bainbridge “The business judgment rule as an abstention doctrine”, above at note 6 at 87.

10 D Branson “A business judgment rule for incorporating jurisdictions in Asia?” (2011) Singapore Academy of Law Journal 687 at 687.

11 Ibid.

12 Ibid.

13 See Weng “Assessing the applicability”, above at note 2 at 128.

14 McMillan “The business judgment rule as an immunity doctrine”, above at note 7 at 528.

15 See the Act, sec 19(1)(b)(i). Also see Investigating Directorate: Serious Economic Offences v Hyundai Motor Distributors (Pty) Ltd; In re Hyundai Motor Distributors (Pty) Ltd v Smit NO 2001 (1) SA 73 (W) 106.

16 In Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd (1915) AC 705, Lord Richard Burdon Haldane made a telling remark in this regard, when he said (at 713): “A corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and center of the personality of the corporation …”

17 The Act, sec 66(1) confirms this principle.

18 McMillan “The business judgment rule as an immunity doctrine”, above at note 7 at 527.

19 See Bainbridge “The business judgment rule as an abstention doctrine”, above at note 6 at 113–14.

20 McMillan “The business judgment rule as an immunity doctrine”, above at note 7 at 526.

21 Triads comprise three fiduciary obligations. See L Johnson “The modest business judgment rule” (2000) Business Law 625 at 627.

22 See Aronson v Lewis 473 A.2d 805 (Del 1984) at 812.

23 746 A.2d 244 (Del 2000) at 264.

24 Especially in Shlensky v Wrigley 237 NE 2d 776 (III App Ct 1968). The understanding established by the court in this case (at 778) was that, “the directors’ [board] room rather than the courtroom is the appropriate forum for thrashing out purely business questions”. The court in this case appears to have advocated a strong presumption against the judicial review of boardroom decisions.

25 Brehm v Eisner, above at note 23 at 264.

26 Ibid.

27 Ibid.

28 Ibid. A good example of this is to be seen in the decision of the Delaware Supreme Court in Cede & Co v Technicolor, Inc 634 A.2d 345 (Del 1993) at 360. The defendant board of directors could not be protected against liability claims because it failed to make a properly informed decision before taking a decision to merge Technicolor into MacAndrew and Forbes Group, Inc.

29 Australia adopted BJR into statute through sec 180(2) of the Corporations Act 50 of 2001.

30 See South African Company Law for the 21st Century: Guidelines for Corporate Law Reform GN 1183 in GG 2004-06-23, para 1.2.

31 See the Act, sec 7(e).

32 See id, sec 7(a).

33 See the Constitution, sec 39(1)(c).

34 Principles of Corporate Governance: Analysis and Recommendations (1994, The American Law Institute). See D Branson “The rule that isn't a rule: The business judgment rule” (2002) Valparaiso University Law Review 631.

35 Branson “A business judgment rule for incorporating jurisdictions”, above at note 10 at 691.

36 Ibid. See Rosenfield v Metals Selling Corp 643 A 2D 1253 (Conn 1994) at 1261; Omnibank v United Southern Bank 607 So 2d 76 (Miss 1992) at 85; Cuker v Mikalauskas 92 A 2d 1042 (Pa 1997) at 1045.

37 See ALI Formulation, as adapted from Lipton, P and Herzberg, A Understanding Company Law 6th ed (1995, Law Book Co Information Services) at 393Google Scholar.

38 Dodge v Ford Motor Co 170 NW 668 (Mich 1919) at 684 is authority to the effect that a corporation is organized and carried on primarily for the profit of the stockholders.

39 Havenga, M “The business judgment rule: Should we follow the Australian example” (2000) 12 South African Mercantile Law Journal 25 at 28Google Scholar.

40 ALI Formulation, above at note 34, sec 4.01(c).

41 473 A 2d 805 (Del 1984) at 812.

42 Ibid. Also see Cede v Technicolor, above at note 28 at 361 for a similar manner in which the Delaware formulation was presented.

43 488 A 2d 858 (Del 1985) at 872.

44 Sec 66(1) of the Act similarly provides that “the business and affairs of a company must be managed by or under the direction of its board, which has the authority to exercise all of the powers and perform any of the functions of the company, except to the extent that this Act or the company's Memorandum of Incorporation provides otherwise”.

45 The triad includes the absence of disabling conflicts of interest, informed business decision-making and a rational basis for believing that the business judgment was in the corporation's best interests.

46 As per Smith v Van Gorkom and Cede v Technicolor this entails due care of process.

47 See Cecilia Goliath v Member of the Executive Council for Health, Eastern Cape (085/2014) [2014] ZASCA 182 (25 November 2014).

48 For example, with respect to dismissal matters under labour law, the Labour Appeal Court has held that, as per sec 192(2) of the Labour Relations Act 66 of 1995, once an employee has established the existence of a dismissal in terms of sec 192(1), the onus shifts to the employer to prove the fairness of the dismissal. See SACWU v AFROX 1999 20 ILJ 1718 (LAC).

49 As is also the case in the dismissal cases under the Labour Relations Act.

50 Branson “A business judgment rule for incorporating jurisdictions”, above at note 10 at 692.

51 Ibid.

52 ibid.

53 Above at note 28. The court in Cede v Technicolor explained how the presumption in favour of the director works, by stating (at 361): “Thus, a shareholder plaintiff challenging a board decision has the burden at the outset to rebut the rule's presumption. To rebut the rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty - good faith, loyalty or due care. If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments. If the rule is rebutted, the burden shifts to the defendant directors, the proponents of the challenged transaction, to prove to the trier of fact the ‘entire fairness’ of the transaction to the shareholder plaintiff …”

54 See Corporations Act 50 of 2001, sec 180(1), entitled “Care and diligence: Directors and other officers”, which provides: “A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they: (a) were a director or officer of a corporation in the corporation's circumstances; and (b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.”

55 See id, sec 180(3).

56 Under the South African equivalent in sec 76(4)(a) of the Act, the director should have “taken reasonably diligent steps to become informed about the subject matter of the decision”. That is different from a more relaxed requirement in sec 180(2) of the Corporations Act that a director “informs himself / herself about the subject matter of the judgment to the extent they reasonably believe to be appropriate”.

57 See J Cassidy “Models for reform: The directors’ duty of care in a modern commercial world” (2009) Stellenbosch Law Review 373 at 403.

58 See J Farrar “Directors’ duties of care: Issues of classification, solvency and the business judgment and the dangers of legal transplants” 2011 Singapore Academy of Law Journal 758.

59 See sec 180(2)(d).

60 See the Act, sec 76(4)(a).

61 The duty to act in good faith and for a proper purpose is one of the three common law duties codified under sec 76(3). See the Act, sec 76(3)(a).

62 See id, sec 76(4)(a)(iii) in particular.

63 The requirement in sec 180(2)(c) of the Corporations Act is that the director “informs himself / herself about the subject matter of the judgment to the extent they reasonably believe to be appropriate”.

64 Including the need to scrutinize alternatives available, as was remarked by the Delaware Supreme Court in Cede & Co v Technicolor, above at note 28 at 361.

65 See a similar view expressed by Prof Cassidy in Cassidy “Models for reform”, above at note 57 at 404.

66 J Velasco “A defense of the corporate law duty of care” 2015 Journal of Corporation Law 648 at 651.

67 Ibid.

68 M Eisenberg “The divergence of standards of conduct and standards of review in corporate law” 1993 Fordham Law Review 437 at 444–45.

69 Ibid.

70 See Bainbridge “The business judgment rule as an abstention doctrine”, above at note 6 at 89.

71 See sec 76(4)(a).

72 That is between the standard of conduct and the standard of review, in particular between the duty of care and the BJR.

73 See Eisenberg “The divergence of standards of conduct”, above at note 68.

74 See RJ Rhee “The tort foundation of the duty of care and the business judgment rule” (2013) Notre Dame Law Review 1153. Rhee gives an example of tort law where the standards of conduct and review conflate to a single standard for the purposes of judicial review. Also see Eisenberg, ibid, for further examples of areas of law where standards of conduct and review are conflated without difficulty.

75 Rhee, ibid.

76 US case law decided that gross negligence is the appropriate standard of review in duty of care claims; see the Delaware Supreme Court's decision in Smith v Van Gorkom, above at note 43 at 873.

77 See Blackman, M, Jooste, R, Everingham, GK et al. Commentary on the Companies Act (2010, Juta & Co) at 190Google Scholar. This standard was confirmed in the South African cases of Ex parte Lebowa Development Corporation Ltd 1989 (3) SA 71 (T) 106 and Du Plessis v Phelps 1995 (4) SA 154 (C) 170.

78 Rhee “The tort foundation”, above at note 74.

79 Ibid.

80 See TS Ulen “Cognitive imperfections and economic analysis of law” (1989) Hamline Law Review 385 at 385–87, cited in Eisenberg “The divergence of standards of conduct”, above at note 68 at 466.

81 Importantly, the implications of such a potential divergence of standards for South African law will have to be explored.

82 That is the heading chosen by drafters of the Act for all provisions falling under sec 76.

83 Put differently, is this a legislative design by the drafters of the Act? If so, what purpose could they have sought to achieve by describing a standard of review as a standard of conduct? Such questions are not easily answered from the reading of the legislative text. For this reason, it is suggested below that the title of this section needs to be changed to avoid unnecessary confusion.

84 There should have been clarity regarding classification of the different standards in sec 76(3) and the standard in sec 76(4)(a). Housing all standards under one umbrella title of “Standards of conduct” in sec 76 is a cause for confusion and can wrongly create the impression that the Act intended to conflate standards.

85 This is a result of the fact that the duty of care is said to be a late arrival on the corporate law scene in Delaware after the BJR had been in use for many years, leading to an over-emphasis on the BJR and the diminishing importance of the duty of care. See such a view expressed in Johnson, LPQ “Unsettledness in Delaware corporate law: Business judgment rule, corporate purpose” (2013) 38 Delaware Journal of Corporate Law 406 at 424Google Scholar.

86 See Bruner's critique of how the Delaware Supreme Court relegated the status of the duty of care together with the duty of loyalty in Cede & Co v Technicolor, above at note 28 at 366, to mere elements of the BJR: CM Bruner “Is the corporate director's duty of care a ‘fiduciary’ duty? Does it matter?” (2013) Wake Forest Law Rev 1040.

87 Gervurtz, FA “The business judgment rule: Meaningless verbiage or misguided notion?” (1994) 67 Southern California Law Review 287 at 295Google Scholar.

88 A similar view is expressed by renowned South African author Blackman, who confirms that “the essential principles of this branch of our company law are the same as those in English law”: Blackman et al Commentary on the Companies Act, above at note 77 at 191.

89 For example, in Howard v Herrigel 1991 (2) SA 660 (A) at 676, Goldstone JA accepted that “the knowledge of hindsight can be misleading and give rise to unfair criticism” of business directors, especially if their risky decisions result in bad outcomes. Also see Blackman et al, id at 192.

90 See Shuttleworth v Cox Brothers and Company (Maidenhead) Limited [1927] 2 KB 9 at 23–24.

91 1951 (2) SA 401 (A) at 414.

92 2001 (3) SA 1074 (CPD).

93 See Lordon v Dusky Dawn Investments (in liquidation) (Pearmain Intervening) 1988 (4) SA 519 (SECLD) at 521 B–D. Also see L Mswaka “Directors’ duties and the business judgment rule in South African company law: An analysis” 2013 International Journal of Humanities & Social Science 89.

94 Visser Sitrus (Pty) Ltd v Goede Hoop Sitrus (Pty) Ltd and Others 2014 (5) SA 179 (WCC), para 90.

95 See du Plessis, JJ “Open sea or safe harbour? American, Australian and South African business judgment rules compared (part 1)” (2011) 32 The Company Lawyer 345 at 346Google Scholar. Du Plessis continues however to refer to a South African common law rule, despite having expressed such a view.

96 See Farrar, JH “Business judgment and defensive tactics in hostile takeover bids” in King, DB (ed) Essays on Comparative Commercial and Consumer Law (1992, Fred B Rothman & Co) 173Google Scholar.

97 It can be argued that it is sec 76(4)(a) of the Act that introduced the real form of the BJR into South African law, as seen in US law and in Australia in sec 180(2) of the Corporations Act.

98 Above at note 44.

99 In this regard, sec 5(2) provides that “to the extent appropriate, a court interpreting or applying this Act may consider foreign company law.”

100 See sec 5(1), which provides: “This Act must be interpreted and applied in a manner that gives effect to the purposes set out in section 7.”

101 The relevant part of sec 158(b) states: “the Commission, the [Takeover Regulation Panel established by sec 196 of the Act], the Companies Tribunal or a court –  (i) must promote the spirit, purpose and objects of this Act”.

102 Also see the Constitution, sec 233.

103 See the Act, sec 7(a). Thus, when applying company law, consideration of sec 39(2) of the Constitution constitutes compliance with the Bill of Rights.

104 See the Act, sec 7(b).

105 It can be argued that this can in a way result in the attainment of yet another goal of the Act in sec 7(i), which seeks to “balance the rights and obligations of shareholders and directors within companies”.

106 See id, sec 7(j).

107 The Corporations Act, for example in sec 180(2), clearly shows that that section applies to a director or officer “who makes a business judgment”. Arguably, this can be distinguished from reference in sec 76(4)(a) to “any particular matter arising in the exercise of the powers or the performance of the functions of director”.

108 The term is not defined under either sec 1 or sec 76 of the Act.

109 du Plessis, JJ “Open sea or safe harbour? American, Australian and South African business judgment rules compared (part 2)” (2011) 32 The Company Lawyer 377 at 381Google Scholar.

110 See Corporations Act, sec 180(3).

111 The Act, sec 76(3)(b) and (c).

112 See McMillan “The business judgment rule as an immunity doctrine”, above at note 7 at 529.

113 See Branson “A business judgment rule for incorporating jurisdictions”, above at note 10 at 689. Branson expressed this view with reference to the US Model Business Corporation Act.

114 This obviously refers to the subject matter of the decision to be taken by the board of directors, including a decision that can be taken by a single director.

115 See the ALI Formulation, sec 4.01(c).

116 See Australian Securities and Investments Commission v Rich [2009] NSWSC 1229 (ASIC v Rich). At 7291, the court appears to confirm that the level of information required for decision-making is more subjective than it is objective. The position however is not very clear.

117 Corporations Act, sec 180(2)(c).

118 In ASIC v Rich, above at note 116 at 7283, Austin J seemed to have come to the conclusion that the assessment of the reasonableness of the director's belief that he was reasonably informed may result in the application of a somewhat objective standard of an honest and reasonable person in the position of the manager. For the US position, see Brehm v Eisner, above at note 23 at 259.

119 Or any other jurisdiction that incorporates BJR into statute.

120 See McMillan “The business judgment rule as an immunity doctrine”, above at note 7 at 534.

121 See this confirmation in Smith v Van Gorkom, above at note 43 at 873.

122 In Brehm v Eisner, above at note 23 at 259, the court described the approach as follows: “we think the concept of gross negligence is also the proper standard for determining whether a business judgment reached by a board of directors was an informed one”.

123 South African case law has established that the standard of liability for breach of the duty of care obligations is negligence, not gross negligence. See Ex parte Lebowa Development Corporation Ltd 1989 (3) SA 71 (T) 106 and Du Plessis NO v Phelps, above at note 77.

124 See in particular the Act, sec 76(4)(a)(i).

125 See id, sec 76(4)(a)(ii).

126 See Re Smith and Fawcett Ltd [1942] Ch 304 (CA) at 306.

127 This is the statutory duty to act in the best interests of a company. Section 76(3)(b) codifies the relevant common law duty.

128 It is not an objective one in the sense of entitling a court, if a board decision is challenged, to determine what is objectively in the company's best interests. See Visser Sitrus v Goede Hoop Sitrus, above at note 94, para 74.

129 Ibid.

130 Id, para 90.

131 Ibid.

132 The belief that the decision taken was in the company's best interest.

133 Visser Sitrus v Goede Hoop Sitrus, above at note 94, para 74.

134 In the English case of Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244, a director of Item Software encouraged a distributor company dealing with Item Software to make its terms more stringent and to consider dealing with him direct. In the event, the negotiations between Item Software and the distributor collapsed as a result of the director's interference. In this example it is clear that the director was not acting in the company's best interests.

135 See the views expressed by Scrutton LJ in Shuttleworth v Cox, above at note 90 at 23–24. Also see Dorchester Finance v Stebbing [1898] BCLC 498.

136 That is the requirement that a director acts in good faith and for a proper purpose.

137 See Visser Sitrus v Goede Hoop Sitrus, above at note 94, para 80.

138 A focus on the absence of good faith requirements will be the subject of a future article by the author.

139 See the Act, sec 76(4)(a)(ii)(aa).

140 See id, sec 76(4)(a)(ii)(bb).

141 In terms of id, sec 1 and in the context of id, sec 76(4)(a), which is the decision-making context.

142 See id, sec 1.

143 See Aronson v Lewis, above at note 22 at 814.

144 Sec 2(1) of the Act defines the term “related person” to include natural persons romantically related, such as married couples or even co-habitants; people “separated by no more than two degrees of natural or adopted consanguinity or affinity”, and natural persons in such a position in relation to a juristic person as to enable those persons to exercise direct or indirect control of the juristic person concerned.

145 The mischief that the disclosure rules seek to avoid is rather the prevention of director disloyalty through self-interest. The fiduciary duty is therefore preventative of this mischief by encouraging a director to employ all means to attain the best interests of his principal, the company.

146 FHI Cassim et al The Law of Business Structures (2012, Juta Claremont) at 297 and 312.

147 See the Act, sec 75(5).

148 See id, sec 75(4).

149 See id, sec 75(5)(e).

150 Cassim et al The Law of Business Structures, above at note 146 at 313.

151 See the Act, sec 75(5)(d)–(e). For the purposes of satisfying quorum requirements, the director who would have “recused” himself is considered to be present at the meeting: see id, sec 75(5)(f)(i). However, for the purposes of determining whether a resolution has sufficient support to be adopted, the “interested” director is regarded as being absent: see id, sec 75(5)(f)(ii).

152 See id, sec 75(5)(g).

153 See du Plessis “Open sea or safe harbour? (part 2)”, above at note 109 at 381.

154 The section broadly relates to the duties to act: in good faith and for a proper purpose (sec 76(3)(a)); in the best interests of the company (sec 76(3)(b)); and with a degree of care, skill and diligence (sec 76(3)(c)).

155 See Visser Sitrus v Goede Hoop Sitrus, above at note 94, para 80.

156 In Smith v Van Gorkom, above at note 43 at 873, it was stated that gross negligence is that appropriate standard of review for the duty of care.