Business Judgement Rule

The business judgement rule of s 180(2) of the Corporations Act (2001) is designed
to counter-balance the test of due care and diligence.

The business judgement rule can be used as a defence for company directors who are accused of not exercising due care an diligence simply because a business or business unit were to fail under their supervision. Businesses must have a healthy appetite for risk, and directors need to be able to take calculated risks to further the enterprise.

To rely on the business judgement rule, the company director needs to:

  1. have made a business decision;
  2. have made the decision in good faith and for a proper purpose;
  3. not have a material personal interest in the subject matter of the judgement;
  4. have been informed of the subject matter to the extent they reasonably believe appropriate;
  5. rationally believe that the judgement is in the best interests of the company.

The business judgement rule requirements enable the directors to conduct business like business people do. In the absence of a crystal ball, it is reasonable to assume that not all business decisions will benefit the company. So long as the five tests of the business judgement rule are satisfied, the company director has a defence against liability for a failed venture or under performing business unit.

In practice, the business judgement rule has been difficult to rely on in cases that have actually proceeded to court. This should not be seen as a weakness of the business judgement rule as a defence for directors acting in the genuine best interests of the company. In most cases where ASIC prosecutes these kinds of cases, the ‘material interest’ aspect of the test does not hold.

Company directors need to appreciate that they are responsible for their decisions and will be held to account, but the business judgement rule means that they can still take calculated risks to further the enterprise they govern.

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