The business judgment rule
The management board conducts the affairs of the company, represents the company externally, and under certain circumstances can be liable to the company and its creditors. Management board members should act with due care, which corresponds to the standard of care that would be observed by a conscientious merchant in dealings of a given sort. Failure to observe due care can lead to liability of members of the corporate authorities—and conversely, compliance with due care can shield them from such liability. An amendment to the Commercial Companies Code will make certain changes to these rules.
On 4 April 2022 the President of Poland signed an act amending the Commercial Companies Code. The amendment, commonly referred to as the “Holding Law,” is designed to regulate dealings between parent companies and subsidiaries. Certain rules for action by company authorities have also been revised, including the rules for liability imposed on members of corporate bodies. The changes will enter force on 13 October 2022.
One of the changes concerns the standard of due care for members of the management board of a limited-liability company or a joint-stock company. It reflects that management board members act within the bounds of justified economic risk. The change should be advantageous to members of the bodies of these companies. Clarification of the notion of due care and introduction of a rule the same as that in force since recently in the case of the simple stock company (Commercial Companies Code Art. 300125) will effectively lower the standard of care required in the action of the members of bodies of limited-liability companies and joint-stock companies. In certain situations, that will allow members of company authorities to avoid liability. The new rules should ensure consistent rules for liability in companies by introducing to limited-liability companies and joint-stock companies changes identical to those now in place for simple stock companies.
Due care—meaning what?
A management board member is liable to the company for injury caused by an act or omission contrary to law or the articles of association, unless the member was not at fault (Commercial Companies Code Art. 293 §1 and 483 §1). This is one of the fundamental principles of liability of members of the management board, which also applies to members of the supervisory board or audit committee and to liquidators. The discussion below will thus generally apply as relevant to all these persons, even when we refer only to members of the management board or other bodies.
In performing their duties, members of corporate bodies are required to exercise the care arising from the professional nature of their activity (currently Art. 293 §2 and 483 §2, and after entry into force of the changes, Art. 2091, 2141, 3771 and 3871 respectively). In light of the foregoing, a member of a corporate body shall be liable if his or her act or omission, contrary to law or the articles of association, causes injury to the company, although there must be an adequate causal connection between the act or omission and the injury. It is up to the company to prove these circumstances. The management board member will be liable if his or her behaviour is culpable. But the company does not have to prove that. It is up to the management board member to prove that he or she was not at fault for the injury caused by the act or omission.
While conducting commercial activity, it is obvious that management board members often operate within the bounds of certain risks, and take various business decisions whose consequences cannot be foreseen at the time they are taken. These can generate significant gains for the company, but also significant losses. But in maintaining a high standard of due care, it is harder to demonstrate a lack of fault.
The standard degree of care is due care, i.e. exercising the care required in relations of a given type. But management board members are held to a greatly elevated degree of care, as they must exercise the care arising from the professional nature of their activity. This is generally an objective standard, which cannot be reduced by the articles of association. It may be raised, however, for example by requiring management board members to possess certain educational attainments.
It is also clear that one level of care will be necessary in the case of small companies, or companies conducting little or no commercial activity, and another, higher level in the case of big companies operating on a large scale.
There are certain common requirements, however, that always apply. This can be depicted by citing three examples from the case law.
The first involves the duty to file a bankruptcy petition if the grounds for it arise. In that situation, it is no defence for the management board member to claim that the company was functioning within certain commercial relationships, including affiliation and dependence, which in the member’s view prevented filing of the bankruptcy petition. The mere subjective belief of a management board member that they cannot file a bankruptcy petition due to relations with the parent company does not remove the obligation to file a petition under the Bankruptcy Law. Such a belief thus does not demonstrate a lack of fault and is insufficient for the management board member to escape liability. Acting with due care means not just protecting the company, but also exercising care to protect the interests of creditors threatened by the company’s insolvency (Supreme Court of Poland judgment of 27 May 2009, case no. II UK 373/08).
The second example involves attempts to shift liability to other persons acting within the company. The requirements imposed on management board members are rigorous. A management board member must be equipped with knowledge of organisational and financial regulations, the principles of managing human resources, and familiarity with applicable laws. Clearly, a board member may consult colleagues, employees and advisers with relevant knowledge and experience, but the board member is still responsible to the company for exercising due care. Merely entrusting an issue to a person professionally involved in the specific domain and with the relevant training is not tantamount to exercising due care (Gdańsk Court of Appeal judgment of 29 July 2014, case no. V ACa 781/13).
The third example involves the management board member’s lack of actual knowledge of the company’s situation. A management board member cannot plead ignorance of company affairs, in particular concerning the company’s financial standing. The board member must take the active initiative to acquire that knowledge (Supreme Court judgment of 15 May 2014, case no. II CSK 446/13).
As these examples from the courts demonstrate, a high degree of due care is demanded of management board members.
New regulations—introduction of the business judgment rule
The amendment, drawing among other things on the views developed in judicial decisions and legal scholarship, patterned on the solutions recently adopted for simple stock companies (Art. 30054 and. 300125), introduces a version of the “business judgment rule” for assessing situations and determining when due care has been exercised. Under the new wording of Commercial Companies Code Art. 293, a management board member will not violate the duty to exercise the care reflecting the professional nature of the activity if, proceeding in a manner loyal to the company, he or she acted within the bounds of justified economic risk, including on the basis of information, analyses and opinions which under the given circumstances should be considered in making a careful assessment.
The existing wording of the regulations does not directly reflect that management board members actually take decisions within the bounds of economic risk. It is clear that doing business means assuming risk, and due care means that the risk should be examined, calculated, and weighed before taking any action carrying a risk. But in acting, a manager cannot exclude the risk of failure. Failure as such has not, and still will not, automatically render a management board member liable. The new wording clarifies when due care is exercised, and thus when management board members will not be liable to the company if their decision proves erroneous and causes a loss to the company. Management board members will be deemed to exercise due care if they:
- Act loyally toward the company
- Act within the bounds of justified economic risk
- Act on the basis of information, analyses and opinions relevant to the given situation, and
- Make a careful assessment on that basis.
The new wording will thus introduce more broadly what is known as the business judgment rule. The drafters stressed that loyalty to the company is essential, as is acting within the bounds of justified risk, after careful examination and assessment of the situation.
Justified economic risk is to be assessed after thoroughly taking into account the circumstances of the given matter. Certainly risks typically assumed in the commercial dealings in which the given company participates would fall within the bounds of justified economic risk. In the particular situation, this could also extend to atypical or above-average risks, but as always, it will be necessary to weigh the benefits associated with the decision and the potential negative consequences, as well as the likelihood of each, taking into consideration possible factors increasing or decreasing the risk. There could certainly be said to be excessive risk if the decision would very likely generate negative consequences for the company and there was little chance of achieving the intended goal.
Certainly it is not possible to develop a single definition of justified economic risk, as it depends on the circumstances. It may nonetheless be expected that after these changes enter into force, the civil courts will have to interpret this notion.
The assessment of whether economic risk is justified is to be backed by the analyses, information and opinions which under the circumstances should be considered when making a careful assessment of the situation. This will include, for example, information, analyses and opinions of colleagues or staff of the company, employed by the management board specifically to support the board in taking certain decisions for itself or taking decisions based on authorisations issued by the board. It appears that this may also include analyses and opinions prepared by the management board itself (particularly if the members have the experience or qualifications needed in the given matter). These could also include opinions from external advisers, such as legal and tax advisers, consulted by the board in taking its decisions.
However, it does appear that instead of the conjunction used in the amendment (analyses and opinions), it would be more apt to employ the disjunctive (analyses or opinions), as sometimes an analysis alone, or an opinion alone, might suffice. In any event, neither of these terms is defined, and they could overlap.
Corporate groups, binding instructions, and due care
The standard of due care will be relevant in the case of corporate groups and issuance of binding instructions. The new regulations allow shareholders to adopt a resolution on a subsidiary’s membership of a corporate group. This type of control will be subject to disclosure in the commercial register, and the parent company will be able to issue binding instructions to the subsidiary involving the subsidiary’s affairs.
In certain instances, the subsidiary will be able to refuse to carry out the instructions. This involves situations where following the instructions could lead to insolvency or a threat of insolvency.
The new regulations expressly state that a member of the management board of the subsidiary shall not be liable for injury caused by executing a binding instruction if in the member’s act or omission the member exercises due care arising from the professional nature of the activity, bearing in mind the business judgment rule set forth in the new wording of Commercial Companies Code Art. 293.
Assessment of the amendment
The exercise of due care will remain decisive for the management board in order to demonstrate a lack of fault in connection with a business decision, if it later proves to be erroneous and causes the company to suffer a loss. In acting (or failing to act), the management board should proceed with loyalty to the company and within the bounds of justified economic risk, preceded by a careful assessment, including an assessment of relevant information, analyses and opinions. What this boils down to is that in taking a decision, the management board members can consciously, and with discernment, assume that they are acting in the interest of the company.
Consequently, the earlier rigorous requirements for exercising due care will remain in place—but with an exception reflecting the business judgment rule. By acting within the bounds of the business judgment rule, management board members should be in a position to demonstrate that they were not at fault, because they exercised due care, and therefore will not be liable under Art. 293 §1 if the company suffers a loss.
Consistent rules for liability of members of corporate bodies across all companies in Poland is undoubtedly a much-desired change.
The original version of this article, at an earlier stage in the legislative process, was published in the 2022 Yearbook.
Bartosz Kuraś, attorney-at-law, Anna Dąbrowska, attorney-at-law, M&A and Corporate practice, Wardyński & Partners