Management liability: business judgment rule
Effective 1 January 2014, the recodification of Czech civil law introduced the business judgment rule which incorporates the principle that members of statutory bodies will not be held liable retroactively for damages caused to business corporations that result from past business decisions, if the below outlined conditions are met. The introduction of the business judgment rule by the Business Corporations Act No. 90⁄2012 Coll. (the “BCA”), together with the reinforced system of due managerial care, is a reflection on the former, rather rigid, concept of management liability based on a scale of injunctions and restrictions. That concept was incompatible with a modern free market, as it saw members of statutory bodies primarily as potential offenders, and only then as managers.
Although the provisions of the BCA regulating due managerial care impose strict standards on members of statutory bodies of business corporations – as they are required to exercise loyalty, necessary expertise and caution at all times when holding office – the business judgment rule creates a “safe harbour” for them, eliminating potential liability arising from bad business decisions, if the decisions were made by the respective member (i) in good faith, (ii) on an informed basis, and (iii) with requisite loyalty towards, and in the defensible interest of the business corporation. This is aimed at creating a correct balance and gives the members of statutory bodies enough freedom to manage the business corporation’s business.
That being said, not every act performed by a member of a statutory body of a business corporation can be seen as a business decision to which the business judgment rule can be applied. Although it is sometimes difficult to establish whether the business judgment rule is applicable – as in addition to making business decisions, managing a business corporation also involves overseeing its internal organisation, technical operations, etc – the members of the statutory body should be aware of the limits of its application.
Concept in snapshot
Most jurisdictions impose a legal obligation on members of statutory bodies of business corporations, and set a certain standard of reasonable care which they are required to adhere to. Czech law is no exception, as it establishes a duty of care through due managerial care. It is, however, very difficult to review if a particular business decision complies with the set standard of reasonable care.
Historically, the main reason for the emergence of the business judgment rule in the US, and its later spread into jurisdictions worldwide, was that in the event of a trial, business decisions had to be reviewed by the courts from the point of view of the managers and the level of knowledge available to them at the moment they made the decision in the past (eg five years back). To make such a decision is very difficult as the judges usually did not have the requisite knowledge about business to decide with absolute certainty on the accuracy of pertinent business decisions, and eventually on the manager’s liability. There are also no universal or objective criteria upon which to judge such business decisions, making it even more difficult to decide.
Accordingly, the business judgment rule usually sets conditions that are either presumed and may be rebutted, or have to be substantiated. If these conditions are met, the court will not (usually) review the business decision itself. Although the legal form of the business judgment rule differs from jurisdiction to jurisdiction, the principle and the reasons for its implementation are the same.
The enactment in the BCA is inspired by the judicial practice of the Delaware courts, mainly from the decision in Aronson v. Lewis (473 A 2d 805 – Del 1984), which formulates the business judgment rule as “…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”. In contrast to the decision in Aronson v. Lewis, however, the BCA lays the burden of proof on the members of the statutory body, unless the judge rules that this requirement would be unjust.
The enactment of the BCA resulted in a major overhaul of Czech civil law, which brought about many changes to various legal institutions, including the system of managerial liability. Due managerial care and the business judgment rule, as enacted in the BCA, have laid the groundwork for members of statutory bodies to perform their duties. The adjustment to the law was necessary, as it reflects the social, market, and legal changes in the Czech Republic in the past twenty years. So far, the new system of managerial liability has been positively received, and an increasing trend of its reflection in internal management manuals of business corporations is being witnessed.
The new civil law imposes more stringent rules and requirements on the performance of office of a statutory body in a business corporation, requiring a more cautious and diligent approach. At the same time, the Business Corporations Act introduces the concept of the business judgement rule to protect members of statutory bodies for bad business decisions reached in the past.