[Dhvani Shah is a penultimate year student at Gujarat National Law University]
In January 2022, the Rajasthan High Court stayed trial court proceedings against Mr. Pratip Chaudhuri, ex-SBI Chairman, for an alleged bank loan scam. Mr. Chaudhuri was arbitrarily arrested for discrepancy in the sale of a non-performing asset (NPA) of the bank, i.e., the “Garh Rajwada hotel” to the Alchemist Asset Reconstruction Company Limited of which he was a director following his retirement from the SBI. However, the sale of the NPA took place after more than six months of Mr. Chaudhuri’s retirement.
The arrest was met with severe criticism from the banking community, and it was in contradiction to section 17A of the Prevention of Corruption Act, 2018 that provides for prior approval before arresting a public official for an alleged contravention of the Act. Any business decision involves certain degree of risk assessment and punishing a business decision taken in good faith reduces the autonomy of the management of the company.
This post aims to analyze the extent to which the business judgement rule should be made applicable in the Indian context and sheds light on the requirement of adoption of this doctrine to provide a safeguard to decisions undertaken through the wisdom of the management of a company.
Understanding the Business Judgement Rule
The doctrine of business judgement was propounded by the Delaware Supreme Court through numerous decisions, the most notable of which is Aronson v Lewis, in which the court set the threshold for holding directors liable. This doctrine aids in reducing frivolous litigation and offers the management of a company the benefit of doubt by presuming that their acts are in the interests of the company and its stakeholders, unless proven otherwise.
In the Aronson case the doctrine was upheld as a defence against derivative actions initiated by shareholders. According to the doctrine, in a case where a director holds no interest in a particular transaction, he or she must prove that the decision in question was an informed one, taken in good faith with the honest belief that the decision is aligned with interests of the company.
According to the doctrine, in case a director did in fact hold an interest in the transaction, such director – firstly, should not appear on both sides of the transaction nor can he or she derive any personal financial benefit, in terms of self-dealing a benefit devolved from the corporation or any of the shareholders. Secondly, the doctrine made protection under the principle conditional, by imposing a duty on the directors to inform shareholders of all material information reasonably available to them, prior to making a business decision.
In Cede v Technicolor, the Delaware Supreme Court expanded upon this doctrine by ruling that an act must be performed with a due care and loyalty in order to qualify as business judgement. Loyalty in this case required proof that the board of the company was not dominated by a disloyal director. Moreover, the Court reasoned that a director having a preconceived interest should maintain arm’s length distance from said decision and prevent any negative consequences from an improper sale of a company by its board of directors.
Applicability of the Business Judgement Rule in India
In India, the arrest of Mr. Pratip Chaudhuri highlights the dire need for the inclusion of this doctrine in the corporate legal system. While there has not been an express adoption of this doctrine by the Supreme Court, certain aspects of it have been imbibed in the Indian jurisprudence.
For instance, section 463(1) of the Companies Act, 2013 provides that an individual facing a proceeding for negligence, default, breach of duty, misfeasance or breach of trust may be relieved of liability wholly or partly if the court finds that the person acted honestly and reasonably with due regard to the circumstances. Such immunity is, however, subject entirely to the discretion of the courts and not a right or privilege under the law.
The doctrine has been implicitly accepted by Indian courts through the extension of this immunity to certain directors for their decisions. The Supreme Court of India in Miheer H Mafatlal v Mafatlal Industries held that the court would not interfere when the director’s conduct was “just, fair and reasonable, according to a reasonable business man, taking a commercial decision beneficial to the company,”
Such a ruling arose in respect of the valuation of shares prior to a merger. However, the doctrine has evolved over time and now tribunals and courts have adopted a stricter scrutiny for valuations of shares to consider whether the same is carried out for the sole benefit of promoters. For instance, in Re Cadbury India Limited the Bombay High Court ruled that courts are not subject to ipse dixit of the majority, thereby calling for an independent valuation of Cadbury’s financials on account that it must not be unfair to any class of shareholders.
Thus, the courts in India have placed more importance on the rights and interests of minority shareholders, allowing them to scrutinize the decisions and actions of directors. The burden, therefore, lies on the board of directors to prove that their conduct was in the best interests of the company and not unfair towards any of its shareholders.
Contrary to this, the US scenario results in immunity being granted under the business judgement doctrine when the arm’s length principle is exercised in third party transactions. The rule creates a strong presumption in favour of the board decision. Unless it cannot be “attributed to any rational business purpose,” the rule places a strong presumption in favour of board decisions made by directors who are loyal and well-informed. As a result, prima facie the onus is on a plaintiff challenging a board decision to rebut the rule’s presumption. If a plaintiff fails to provide evidence that directors violated any one of the fiduciary duty, good faith, loyalty or due care, then the business judgement rule shields directors and their actions from any additional judicial scrutiny.
However, such disclosure of interest and exercise of arm’s length principle has been recognized to be inapplicable in Indian context as held in Globe Motors Ltd. v. Mehta Teja Singh. The Court noted in this case that when a significant portion of the board becomes interested in some or other transaction, even if the interested directors disclose their interest and do not participate in decision-making, their presence is enough to incentivize the entire board to engage in back scratching, thereby prioritizing their self-interest over the company’s.
In India, the business judgement doctrine has not been fully incorporated into the domestic law. However, the landmark ruling in Miheer Mafatlal does attempt to introduce certain aspects of this doctrine to the Indian context. Since then, the immunity granted to directors have been diluted by the courts with due consideration to the interests of shareholders. However, the doctrine still plays a pivotal role and has been indirectly applied by the tribunals on occasion. Nonetheless the authors of this post believe that the absence of such immunity in an express fashion ensures that there is very little scope for error by the courts when deciding on the acts of the board of directors and at the same time weeding out to a reasonable extent any frivolous lawsuits which might pin unwarranted liability on the directors.
– Dhvani Shah