The Business Judgment Rule under the Malaysian Companies Act 2016May 2019
The Business Judgment Rule under the Malaysian Companies Act 2016
By : Abdullah Abdul Rahman[i]
Date : 7 May 2019
Nature of the rule and statutory provisions
A director of a company has the duty under the law to act with reasonable care, skill and diligence. The Business Judgment Rule provides for the requirements a director will be deemed to have fulfilled this duty.
This rule is a recognition that ‘directors in whom are vested the right and duty of deciding where the company’s interest lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts.’[ii]
In Malaysia, the Business Judgment Rule has been given statutory recognition. It was provided under s. 132(1B) of the now repealed Companies Act, 1965. Presently, the rule is housed under s. 214 of the Companies Act 2016. Section 214 reads as follows:
1.) A director who makes a business judgment is deemed to meet the requirements of the duty under subsection 213(2) and the equivalent duties under the common law and in equity if the director—
(a) makes the business judgment for a proper purpose and in good faith;
(b) does not have a material personal interest in the subject matter of the business judgment;
(c) is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and
(d) reasonably believes that the business judgment is in the best interest of the company.
2.) For the purpose of this section, ‘business judgment’ means any decision on whether or not to take action in respect of a matter relevant to the business of the company.
Subsection 213(2) referred to in s. 214 reads as follows:
213(2) A director of a company shall exercise reasonable care, skill and diligence with-
(a) the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities; and
(b) any additional knowledge, skill and experience which the director in fact has.
Section 214 of the Companies Act 2016 is substantially similar to s. 180(2) of the Australian Corporations Act 2001. Section 180(2) reads:
A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.
The director’s or officer’s belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.
Thus, decisions from Australia on s.180(2) of the Corporations Act 2001 have been referred to and applied by the Malaysian courts in interpreting and applying the statutory Business Judgment Rule in s. 132(1B) of the Companies Act 1965 and will likely continue to be applied when making decisions on s. 214 of the Companies Act 2016.
Section 180(2) of the Corporations Act 2001, it has been said, was based to a large extent from the Business Judgment Rule contained in the American Law Institute’s (ALI) Principles of Corporate Governance: Analysis and Recommendations, adopted by ALI in 1992. The ALI formulation of the rule has, broadly speaking, the same four elements as s. 180(2) and had been drawn from the wealth of case law in the United States on the subject.[iii]
There scope of ‘business judgment’
For the rule to apply, there must first be a ‘business judgment. This is defined as any decision on whether or not to take action in respect of a matter relevant to the business of the company.[iv]
In Australia, it has been held that the words ‘in respect of’, ‘matter’ and ‘relevant’ in the definition of ‘business judgment’ give it a wide interpretation. A matter may be relevant to the business operations of the corporation though not itself a business operational matter.[v] This has been followed in Malaysia.[vi] In the US, the ALI formulation does not define the term ‘business judgment’. However, Professor Paul Redmond has opined that the rule undoubtedly extended to decisions preparatory to the making of a business decisions. Further, while most business judgment cases in the US deal with ‘risky’ or ‘economic’ decisions, there is clear authority that the rule applies to decisions on corporate personnel, termination of litigation and non-financial decisions.[vii] Some other examples of decisions where the rule has been held to apply are as follows:
- Planning, budgeting and forecasting;[viii]
- Announcing a takeover bid for another company without securing funding;[ix]
- Selling shares in a subsidiary at depressed price to meet urgent liquidity need and to fend off threatened litigation by creditors eventually resulting in loss of control of the subsidiary.[x]
However, there is an important limitation in the language of the statutory Business Judgment Rule, namely that there must be a decision to take or not to take an action. It cannot be utilised by a director who simply neglected to carry out his duties. On this point, it was held in Australian Securities and Investments Commission v Rich  NSWSC 1229 (‘ASIC v Rich’) as follows:
A director who ‘simply neglected to deal with proper safeguards, with no evidence that he even turned his mind to a judgment of what safeguards there should be’ has not made a business judgment and accordingly cannot invoke the defence… The position in the United States is evidently much the same… The important question is whether the director or officer has turned his or her mind to the matter.
Concomitantly, ASIC v Rich went on to hold that the rule was not applicable to the ‘oversight’ duties of the directors. It was observed as follows:
[T]he discharge by directors of their ‘oversight’ duties, including their duties to monitor the company’s affairs and policies and to maintain familiarity of the company’s financial position, is not protected by the business judgment rule, because the discharge or failure to discharge those duties does not involve any business judgment as defined… Monitoring the company’s affairs and maintaining familiarity with its financial position are not themselves matters that involve a ‘decision to take or not take action’ in respect of a matter relevant to the company’s business operation.
For a proper purpose and in good faith
The court will prima facie presume that directors have acted in good faith. It is for those who say directors have exercised their power improperly to give some evidence to that effect. It is contrary to the ordinary principles of justice to presume that directors have done wrong.[xi]
The presumption of good faith is rebuttable, for example where it could be shown that no reasonable man, acquainted with the facts and circumstances and credited with intelligence, would have acted in the way in which the directors did. The presumption is also usually displaced in circumstances where self interests of directors are involved, where there is absence or lack of independent judgment or where it is obvious that the interests of other persons were put before the company’s interests.[xii]
Directors cannot act merely upon the instruction of another person, including the majority shareholder. They cannot claim to have acted in good faith in the company’s interest if they fail to inquire into and understand the circumstances why a thing is being done. They cannot act unthinkingly or surrender their decision to others. Having to rely on the knowledge and experience of others and exercise independent judgment means that they, having listened to and assessed what their colleagues, management members or external advisors had to say, must bring their own mind to bear on the issue using such skill and judgment as they may possess. In Blackwell v Moray & Anor, Cohen J said:
A mere sense of honesty of purpose is not in my view sufficient to satisfy the requirements that a director acted bona fide for the benefit of a company. It requires at least a consideration of views or relevant material in order that he may act in a bona fide way. The abandonment of any proper consideration of relevant facts, the admitted failure to exercise independent discretion and the mere doing of what was thought that the majority shareholder wanted cannot in these circumstances have amounted to the bona fide exercise of the discretion required of a director.
The duty to act in good faith in the interest of the company must be distinguished from the duty to utilise power for proper purpose.
In Hogg v Crampton,[xiii] the directors believed in good faith that it was not in the interest of the company to allow a takeover of the company. In response, they established a trust for the acquisition of preference shares in the company by trustees for the benefits of employees. The trustees applied for preference shares which would carry ten votes per share on a poll. The directors allotted the shares to the trustees and also gave an interest free loan to the trustees to pay for the shares, the loan being repayable only upon termination of the trust. Accepting that the directors were not actuated by any unworthy motives of personal advantage and had acted in the honest belief that what they did was in the interest of the company, the court nonetheless held the transaction as bad, as its primary purpose was to entrench the position of the directors.[xiv]
Similarly, in Howard Smith v Ampol Ltd,[xv] two corporate shareholders, C and B, held 55% of the issued shares in a company, M which was in need of capital. C made an offer for all the issued shares of M. Another company, H then announced a higher offer for those shares. C’s offer was rejected for being too low. H then applied for allotment of new shares in M. The directors of M decided to allot and issue new shares to H. The effects of the issuance of the new shares were three-fold: (a) M had the much needed capital; (b) C and B’s combined shareholding was reduced to 36.6%; and (c) H was in a position to make a takeover offer. C challenged the validity of the issue of shares to H. The Privy Council decided that although the directors had acted honestly and had power to make the allotment, the power was improperly exercised because the director’s primary object for issuing the shares was to reduce the shareholding of C and B so that H could proceed with its takeover offer. The allotment and issuance of the new shares was held to be invalid.
No material personal interest
Personal interests may take the form of advantages, whether tangible or intangible, to the directors involved or has the effect of consolidating management powers in the hands of the incumbent directors or their faction.
However, personal interest is not necessarily fatal where in advancing the interests of the company, the personal interests of the directors are incidentally advanced.[xvi] For example, the action of a director who is also a shareholder is not necessarily invalid because his action with regard to the company increases the shareholders’ value including his.
Informing oneself about the subject matter
S.214(1)(c) of the Companies Act 2016 requires a director to inform himself on the subject matter of the judgment to the extent he reasonably believes to be appropriate under the circumstances.
In the Petra Perdana case, Nallini Pathmanathan J applied ASIC v Rich which held that the reasonableness of the belief should be assessed by reference to the following:
- the importance of the business judgment that is to be made;
- the time available for obtaining information;
- the costs related to obtaining information;
- the director's confidence in exploring the matter;
- the state of the company's business at that time and the nature of the competing demands on the board's attention; and
- whether or not the information is available to the director.
The requirement that the director must inform himself ‘to the extent they reasonably believe to be appropriate’ does not mean that the director must have regard to what he should have known over and above what he actually knew. The statutory language relates to the decision-making occasion, rather than the general state of knowledge of the director. It requires the director to become informed about the subject matter of the decision prior to making it, since the Business Judgment Rule should not protect decisions taken in disregard of material information readily available. The qualifying words, ‘to the extent they reasonably believe to be appropriate’, convey the idea that protection may be available even if the director was not aware of available information material to the decision, if he reasonably believed he had taken appropriate steps on the decision-making occasion to inform himself about the subject matter.[xvii]
Reasonable belief that the business judgment is in the best interest of the company
The phrase ‘interest of the company’ could mean several things depending on the factual circumstances. It may mean the interest of the company as a commercial entity which is distinct from its corporators or shareholders. Directors would not be acting in the interest of the company where, for example, they divert corporate opportunities available to the company towards themselves or their friends, make secret profits for themselves or others, expose the company to liabilities to secure their personal interests or prefer or advance the interests of third parties over the company’s interests.[xviii]
Where there is conflict between the majority and minority shareholders or where the decision will affect the shareholders, ‘interest of the company’ may mean, in the primary sense, the interest of the shareholders as a general body. When the company is or is prospectively insolvent, it may mean in the primary sense, the interest of the creditors.[xix]
In the context of group of companies, it is important to bear in mind that the interests of the member company under consideration are not to be regarded as being subservient or secondary to the interests of the group as a whole or its holding or parent company or other companies within the group. This is the result of the fundamental principle that each company was a separate and independent legal entity. This becomes apparent when one considers the case where the companies in the group have separate creditors.[xx]
Section 180(2)(d) of the Australian Corporations Act 2001 uses the phrase ‘rationally believe’ instead of ‘reasonably believe’ that is used in the Malaysian Companies Act 1965 and Companies Act 2016. There have been suggestions in the US and Australia that these phrases carry different connotations with the former being wider than the latter. However, in Malaysia, in the Petra Perdana case the two phrases have been held to have the same effect namely, alluding to a decision based on reason, logic or sense.
In Malaysia, both Companies Act 1965 and the Companies Act 2016 do not have the definition of ‘reasonably believes’ for the purpose of subsection (d). This is different from s. 180(2)(d) of the Australian Corporations Act 2001 which provides ‘[t]he director’s or officer’s belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.’
The Federal Court’s decision in Petra Perdana
In so far as it relates to the Business Judgment Rule, the Federal Court in Tengku Dato’ Ibrahim Petra v Petra Perdana Berhad[xxi] concluded that the statutory Business Judgment Rule as provided under s. 132(1B) of the Companies Act 1965 is that as stated in Howard Smith v Ampol Ltd,[xxii] namely, that the courts do not undertake the exercise of assessing the merits of a commercial or business judgment made by directors and the courts will not interfere with business decisions as long as the directors acted bona fide.[xxiii]
It must be reminded that bona fide, as discussed above, does not mean a mere sense of honesty of purpose. The Federal Court did, in coming to the conclusion take into account that the business decision in question was made for a proper purpose, in good faith in the best interest of the company and that there were valid grounds upon which a reasonable board of directors would have come to the decision.[xxiv] There was also no allegation of the directors being motivated by personal interest. Thus, the requirements of the statutory Business Judgment Rule under s. 132(1B) had been taken into account and satisfied before the directors were found to have been protected by that rule. Due to similar wordings of the corresponding provisions between the repealed 1965 Act and the present 2016 Act, this decision will continue to be applicable to the interpretation of s. 214 of the Companies Act 2016.
The Business Judgment Rule prescribes the requirements that directors must comply with in arriving at a decision. Once these requirements are met, the court will not inquire into the merits or correctness of the decision and deference is accorded to the decision.
[ii] Harlowe’s Nominees Pty Ltd v Woodside (Lake Entrance) Oil Co NL (1968) 121 CLR 483 at 493
[iii] Australian Securities and Investments Commission v Rich  NSWSC 1229, after this referred to as ASIC v Rich, at para. 7256 and 7257
[iv] S. 132(6) of the Companies Act 1965, S. 214(2) of the Companies Act 2016 and S. 180(3) of the Corporations Act 2001
[v] ASIC v Rich, at para. 7273
[vi] Petra Perdana Bhd v Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra  11 MLJ 1 at para. 364, after this referred to as the Petra Perdana case.
[vii] ASIC v Rich at para. 7273 referring to Professor Paul Redmond, “Safe Harbours or Sleepy Hollows: Does Australia need a Statutory Business Judgment Rule?” in IM Ramsay (ed), Corporate Governance and the Duties of Company Directors (Centre for Corporate Law and Securities Regulation), University of Melbourne, 1997, p 195.
[viii] ASIC v Rich, para. 7280
[ix] ASIC v Mariner Corporation  FCA 589
[x] The Petra Perdana case
[xi] Mohan a/l Paramsivam v Sepang Omnibus Co Sdn Bhd  1 MLJ 247 ; Re Coalport China Co  2 Ch 404.
[xii] Loh Siew Cheang, Corporate Powers, 2nd ed., Lexis Nexis Butterworth, p. 247
[xiii]  Ch 254
[xiv] Loh Siew Cheang, p. 261.
[xv]  AC 821
[xvi] Hirche v Sims (1894) AC 654 ; Mills v Mills (1938) 60 CLR 150
[xvii] ASIC v Rich, para 7279
[xviii] Loh Siew Cheang, pp. 237 and 238
[xix] Loh Siew Cheang, pp. 237
[xx] Walker v Wimborne (1976) 137 CLR 1 at 7; Charterbridge Corp Ltd v Lloyds Bank Ltd & Anor  1 Ch 62 at 74
[xxi]  2 MLJ 177
[xxii]  AC 821
[xxiii] At para. 193 of the Federal Court’s judgment
[xxiv] At para. 190 and 191 of the Federal Court’s judgment