Faculty of law blogs / UNIVERSITY OF OXFORD

Making up for Lost Time, Poland Introduces the Business Judgment Rule Into Its Liability Regime for Directors

Author(s)

Marcin Wnukowski
Lecturer at Lazarski University in Warsaw and partner in Squire Patton Boggs Warsaw office
Bernard S. Sharfman
Senior Corporate Governance Fellow, RealClearFoundation

Posted

Time to read

6 Minutes

Poland’s Code of Commercial Companies (‘CCC’) has been amended (Section 3 of Article 293 and Section 3 of Article 483) to provide board members of both private and public limited liability companies with the financial liability protections of the business judgment rule (‘BJR’).  These protections will arise as a result of business decisions that turn out badly as long as directors can demonstrate an adequate amount of ‘procedural due care’ in their making:

‘An authority member does not breach the obligation to exercise professional due diligence if, acting loyally to the company, they act within the confines of justified economic risk, including on the basis of information, analyses and opinions that should be taken into account under particular circumstances when making a careful assessment.’

Even though the existence of the BJR under Polish law has been the subject of speculation since 2005, with the incorporation of this statutory language, the uncertain status of the BJR has been resolved. 

What makes this statutory language so interesting and also so challenging for the Polish courts is that this BJR is not a codification of a formulation that has developed over time through case law, but a pure creation of the legislative process. Developing the BJR through case law has the advantage of allowing the formulation itself to evolve over time as well as allowing ambiguities that exist in the formulation to be explained as new fact patterns are presented to the courts.  However, for obvious historical reasons, the Polish courts were not able to take this approach. Instead, they must start from a fixed formulation and begin the process of resolving its ambiguities with a very limited amount of Polish case law to guide it.    

This process will be difficult and definitely take time.  However, the courts should be able to benefit greatly from the thousands of cases that have applied the BJR in other countries.  In this post we look at what the Polish courts can learn from the BJR as applied in the United States, with a special focus on the Delaware courts, the most important jurisdiction for US corporations.   

The BJR in the US

In the US, the BJR is an equitable doctrine that protects a decision of a corporate board of directors from a fairness review ‘unless a well-pleaded complaint provides sufficient evidence that the Board has breached its fiduciary duties or that the decision-making process is tainted, such as with interestedness or a lack of independence.’ Fairness is from the perspective of shareholders in terms of both process and price.  While the BJR can take many forms, the following formulation from the Delaware Supreme Court  case of Aronson v. Lewis has typically been applied by US courts:

It 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. Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption.

The primary objective of the BJR (first identified in the English case of Charitable Corp. v. Sutton (1742)) is to protect board members and executive management from facing financial liability for honest mistakes of judgment that turn out badly. This equitable doctrine becomes of heightened importance when a board determines that the judicious maximizing of shareholder value requires the taking on of high-risk, high-return projects.  As so well stated by former Delaware Chancellor William Chandler in In re Citigroup Inc. Shareholder:

Ultimately, the discretion granted directors and managers allows them to maximize shareholder value in the long term by taking risks without the debilitating fear that they will be held personally liable if the company experiences losses. This doctrine also means, however, that when the company suffers losses, shareholders may not be able to hold the directors personally liable.

Delaware’s BJR requires the court to abstain from making judgments on the reasonableness of the business decision, looking only for evidence that there was a ‘rational business purpose’ behind the business decision.  As stated in the Delaware Supreme Court case Sinclair v. Levien: ‘A board of directors enjoys a presumption of sound business judgment, and its decisions will not be disturbed if they can be attributed to any rational business purpose.’ As further explained in the Delaware Supreme Court case Brehm v. Eisner, in terms of determining liability for a breach in the duty of care: ‘Courts do not measure, weigh or quantify directors’ judgments. We do not even decide if they are reasonable in this context. Due care in the decision-making context is process due care only.’ That is, the BJR directs the courts to focus only on director liability in the context of ‘procedural,’ not ‘substantive’ due care.  This is the optimal approach as judges are not business experts, something that has been understood by US courts at least since the 1919 case of Dodge v. Ford.  As stated by one of us in a previous article:

Judges need to respect Board decision-making for the simple reason that they are inferior to the Board in terms of determining what is the best corporate decision and therefore should not take on the role of reviewing the substantive decisions of the Board, including determining the ‘appropriate degrees of business risk.’ Judges recognize that they lack information, decision-making skills, expertise, and vested interest (ie stake in the company) relative to corporate management.

Using the Lessons Learned from US Case Law

Poland is not the US so it cannot be expected that the secondary authority provided by US case law, when used, will be applied without modification.  However, we believe the Polish courts may want to seriously consider the following lessons learned when applying the BJR: 

Justified economic risk: The term, as it appears in Articles 293 and 483 of the CCC, should be defined as close to ‘rational business purpose’ as possible.  This will keep the courts, the least qualified in terms of expertise, from having to make a determination of whether a board of directors were justified in making a business decision, especially a risky one.

Gross negligence standard: If the requirements for procedural duty of care are too strict, this will have a cooling effect on business risk-taking.  Therefore, the courts should adopt a gross negligence standard in applying Article 293 of the CCC.  This standard will be used to determine if appropriate procedures have been put in place so as to allow a director to be adequately informed.  This was the standard established in the famous Delaware Supreme Court case Smith v. Van Gorkom (1985)

Burden shifting: Again, to make sure potential litigation does not have a cooling effect on business risk taking, the burden of proof should be on the plaintiffs (company or shareholders), not the defendant (director(s)).  It should be left to the plaintiffs to prove that the information gathered and assessed by the board members were inadequate or insufficient.  This may require a change in the CCC since Polish law puts the burden of proof on the members of the board.   

Exculpation clauses: In the US, such clauses allow directors to be protected against financial liability for all duty of care claims.  These clauses also help mitigate cooling effects.  Given that Polish statutory law is currently silent on the legality of a company to incorporate such shareholder approved clauses into its articles of association, there are dissenting opinions whether modification of the scope of liability under Article 293 is allowed.  Since the CCC is a broad enabling act, companies may already have the legal authority to include exculpation clauses into their articles of association.  Therefore, the courts should consider whether such clauses are legal without explicit statutory language.  However, if the courts do not find that such authority exists, then a change in the CCC would be required.

Advice for Directors

To maximize the protections of this new BJR, directors of Polish companies should take any and all measures to properly document their decision-making process. This may mean that the major steps in the process should be documented by Board resolutions adopted in writing and kept on file. It is also worth considering that such resolutions contain a more detailed discussion of their subject matters.  Gathering a proper ‘defense file’ containing all advice that the Board received from the external advisors—lawyers, tax counsels, accountants, etc. —may also be a good idea. Moreover, the new BJR may lead Board members to seek external advice more often than they have been accustomed to doing.    

Conclusion

We strongly commend the Polish Parliament for inserting the BJR into the CCC.  Given that directors under the CCC are held to the standard of professionals in determining financial liability (Article 483 of the CCC) and that Poland’s Supreme Court has indicated in recent opinions that a general breach in a director’s duty of care was enough to demonstrate liability without requiring a breach of a particular article of the CCC or the company’s articles of association, Poland’s BJR should have a significant impact in removing the inhibitions of boards to take on high-risk, high-return endeavours.  This should benefit both company shareholders and the growth and competitiveness of the Polish economy. 

Marcin Wnukowski is Lecturer at Lazarski University in Warsaw and partner in Squire Patton Boggs Warsaw office. 

Bernard S. Sharfman is a senior corporate governance fellow at RealClearFoundation and a research fellow with the Law & Economics Center at George Mason University’s Antonin Scalia Law School. 

The opinions expressed here are the authors’ alone and do not represent the official positions of Squire Patton Boggs, the RealClearFoundation, or the Antonin Scalia Law School Law & Economics Center.

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