The Need for A Business Judgement Rule in India: But Which One?

(Viraj Thakur is a third-year law student at the National Law School of India University.) Introduction

India currently lacks a defined business judgment rule (“BJR”). The BJR refers to the rule that shields directorial decision-making from derivative litigation (pp. 332). As Rahul Singh has argued, the lack of a BJR leads to avoidable transaction and judicial costs, disincentivising legitimate risk-taking (pp. 331). Numerous pieces have advocated for the codification of the BJR, or at least its development as a framework (see here, here, and here). Though the necessity for the BJR has been contested on this blog in the context of minority shareholders, in this essay, I focus on what particular form must be incorporated.

I first delineate the scope of the BJR, suggesting that the BJR must be understood as a doctrine of qualified immunity and not as a rule of judicial abstention. Second, I demonstrate that Indian law currently lacks the BJR, with reference to cases like Miheer H. Mafatlal v. Mafatlal Industries Ltd. and provisions such as §463 of the Companies Act, 2013 (“CA”). Thus, Indian law must be amended to incorporate the BJR – but as a doctrine of qualified immunity.

What is the BJR?

It has its origins in Delaware, most famously Aronson v. Lewis where the Delaware Supreme Court (“SC”) held that the BJR is “a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company” (pp. 812). An alternative formulation is provided by the American Law Institute (“ALI”) in §4.01(c). A director is protected from legal attack if first, they made a decision; second, they were free from a “disabling” conflict of interest; third, they exercised some care and due diligence in taking the decision; fourth, that they had a rational basis for their decision.

A few policy reasons justifying the BJR are well-accepted. The BJR allows courts to avoid going into the merits of a dispute, thus conserving judicial resources (pp. 632). Some argue that courts are ill-equipped to deal with business decisions, which are often about intangible market factors (pp. 637), though this is debatable (pp. 118). However, it can be safely asserted that the BJR prevents courts from becoming appellate boards regarding directors’ actions (pp. 1342). Most crucially, it incentivises persons to become directors and take risks, by assuring them of protection from incessant litigation (pp. 97).

The specific contours of this rule have seen much debate – doctrinally and in scholarship. As alluded to above, there are multiple distinct formulations of the BJR – the BJR as ‘presumption’ (as understood in Delaware), the “safe harbour” approach of the ALI, or most commonly as a ‘standard of liability’ that directorial decisions must reach (pp. 444-5). In scholarship, two leading formulations are that of Bainbridge’s BJR as “Abstention Doctrine” and McMillan’s BJR as an “Immunity.”

BJR as Abstention 

Bainbridge argues that the BJR as abstention means that courts are prevented from asking the question of whether the board breached its duty of care (pp. 90). Therefore, courts cannot review the actions of the directors, unless the plaintiff proves a disabling conflict of interest, a lack of good faith, an act that cannot be attributed to a rational business purpose, or gross negligence in considering all material facts reasonably available prior to reaching a decision (pp. 100).

This ensures that judicial review does not become the norm, with courts regularly peering into the merits of a decision, as is the case with the common “standard of liability” approach, defeating the purpose of the rule (pp. 127). It prevents a hindsight bias, where courts tend to find a violation of a duty of care if there is a loss caused by a decision, by restricting inquiry into merits.

Moreover, by offering greater protection to directors, the BJR as abstention incentivises even greater risk-taking. This is in the best interest of the shareholders, because a rational shareholder can always diversify their portfolio and minimise risk exposure (pp. 115). Hence, such a shareholder would prefer an incentive structure that encourages a director to take risks.       

BJR as Immunity Doctrine

I argue that the BJR must be conceptualised as a doctrine of qualified immunity, as McMillan contends, because first, while risk-taking is a concern, the abstention doctrine reduces accountability excessively. Second, it presents an illogical allocation of burden of proof in a dispute.

On the first, treating risk-taking as grounds for total abstention erases accountability and clarity. To do so assumes that directors enter their profession expecting complete preclusion from liability. However, it is far more likely that directors only want to know where the “line in the sand” is drawn (pp. 572) so they can take decisions while aware of the consequences a law entails (pp. 327-8). Their authority and discretion is not affected by a review that is designed to stay away from the substance of the decision, focusing on prima facie threshold requirements. Instead, the doctrine of qualified immunity grants directors a conditional procedural shield, thus maintaining accountability as well. If directors acted within the scope of their duties and were reasonably informed and had no disabling conflict of interest, the court would not inquire into the wisdom or merits of the decision at all. To clarify, the immunity must not be absolute as in the case of judges, to ensure that some accountability continues to exist by preventing unfettered discretion (pp. 570).

On the second, it is illogical to expect a plaintiff to prove that a director acted in bad faith or beyond their duties, as only the directors themselves know why they made a decision. While proof may exist in terms of audits, disclosures by a director, or communications between parties, this has two pitfalls. First, such proof cannot account for the cognitive processes of directors; it is impossible for a plaintiff to establish how a director interpreted the materials before them. This is the case with abstention doctrine, which requires proving lack of good faith as a threshold. Second, requiring such an inquiry forces courts into the merits of the decision to assess intent or conflicts of interest, defeating one of the BJR’s central purposes: conserving judicial resources at a prima facie stage of inquiry.

Furthermore, plaintiff counsel are naturally incentivised to bring before the court as much adverse evidence as possible against the director, as early as possible. In the absence of stringent guardrails in the form of evidentiary guidelines, it is likely that such evidence may form a probative hazard, with courts being influenced by hindsight bias. Consequently, if a chief purpose underpinning the abstention doctrine is to prevent inquiry into decision-making unless the plaintiff proves certain conditions, then having the court inquire at this stage itself defeats the purpose of the abstention doctrine.

In contrast, in the qualified immunity conception, the focus remains on a “list of disqualifiers” relating to the role of the director, and not on the actions of the directors (pp. 570). Thus, the directors must present proof that meets the required threshold, rather than the plaintiff being required to demonstrate that the director was not acting within the scope of their duties – with the latter being a logical absurdity and insufficient to account for internal cognitive processes.

Therefore, I argue that the conception of BJR as immunity is superior to the understanding of BJR as a doctrine of abstention.

Indian Position

India lacks a defined BJR (pp. 6). While tribunals have made reference to it, particularly to the conception in Aronson (see ¶¶109, 195), there is no clear statutory basis for it. The Indian SC has yet to articulate a definition of the BJR. Rulings by the SC have, however, alluded to the principles underlying the BJR. For instance, the SC in Miheer H. Mafatlal dealt with the validity of a scheme for compromise and arrangement, concluding that it must identify whether the scheme was “fair and reasonable from the point of view of prudent men taking a commercial decision beneficial to the class represented by them” (¶21).

The closest equivalent is §463(1) of the CA 2013. This rule allows an officer (including a director) to seek exclusion from liability if they are able to prove they acted reasonably and honestly, in regard to all circumstances. However, whether the director is successful in availing of this defence is up to the discretion of the court (¶11). This defence can be sought by any director (¶11) for any proceeding, including for offences under other statutes (¶6). However, while BJR is a pre-liability shield for business judgments,  it is clear that §463 is a distinct post-liability defence that fails to meet the purpose of conserving judicial resources: at a stage closer to the conclusion of the proceeding, there are not many resources left to conserve! 

Conclusion

Hence, I suggest that §463 of CA must be suitably amended to incorporate the BJR as qualified immunity. Particularly, I argue that the abstention doctrine is flawed as it removes accountability and blurs the limits of directors’ discretion; therefore, the qualified immunity conception of the BJR must be adopted. This is because apart from the policy rationales justifying the BJR, as McMillan argues, inconsistencies in application and understanding lead to uncertainty (pp. 525). Hence, a unifying interpretation is crucial to prevent excessive transaction costs in the form of directorial uncertainty about how much judicial oversight will be exercised and in ensuring fair and consistent treatment of different directors across cases.