[By Samrudh Kopparam]
The author is a student of O.P Jindal Global University.
Introduction
As environmental, social, and governance (‘ESG’) concerns polarize corporate realms, the resulting implications—political reprisal, declining stock values, and unfavourable market positioning—become significant. In response to these developments, it is imperative to implement safeguards for boards when faced with stakeholder pressure to adopt public stances on crucial ESG matters. ExxonMobil’s recent board battle with activist investors over climate-focused proposals further highlights this necessity. In this regard, we contend that the business judgment rule offers a means to reconcile and balance boardroom interests. This rule—essentially a legal presumption—posits that directors act in good faith, in an informed manner, and in the company’s best interests. Against this backdrop, the recent case of Simeone v. Disney sets an important precedent by extending the business judgment rule to protect directors when guiding corporate strategy on social and political issues. By examining the Disney case, this article seeks to examine the tenability of the business judgment rule’s protection in the murky waters of ESG challenges.
Lessons from the Disney Case
In February 2022, the Florida House passed HB 1557—dubbed the controversial “Don’t say gay” bill—that limited instruction on sexual orientation or gender identity in Florida classrooms. While Disney was initially silent on the bill, after receiving criticism from employees and collaboration partners, the Disney board convened a special meeting at which it decided to criticize the Bill publicly. This escalated into a public battle between the corporation and the government, with the latter threatening the dissolution of Florida’s Reedy Creek Improvement Act—which granted self-governance and tax benefits to Disney. The public conflict culminated in a sharp decline in Disney’s stock value. In response, shareholders filed a lawsuit, alleging a breach of fiduciary duty and a books-and-records demand.
In denying the books-and-records demand by applying the proper purpose rule, the Delaware Chancery Court also made an important observation on directors’ fiduciary duty. The proper purpose rule mandates that directors must exercise their powers for the purposes for which they were conferred, not for any collateral or personal reasons. This ensures that directors’ actions align with the company’s best interests and prevent abuse of authority. Further, the court opined that Delaware’s business judgment rule vests directors with significant discretion to guide corporate strategy, including social and political issues. This observation is crucial as directors enjoy the presumption of acting on an informed basis, in good faith, and with the honest belief that their decisions on significant social policies serve the company’s best interests. In this manner, a board may take into consideration the interests of non-stockholder corporate stakeholders where those interests are “rationally related” to building long-term value, unburdened by the looming threat of prosecution.
The Double-Edged Sword of the Extended Business Judgement Rule
The ruling exemplifies the challenges a corporation encounters when addressing divisive issues, particularly those beyond its core business operations. By extending the business judgment rule to encompass social policy decisions, the ruling empowers boards to consider the interests of non-stakeholders in pursuit of long-term value. This shift enables corporations to evolve from mere profit-driven entities to proactive participants in cultivating a socially responsible corporate culture.
In today’s political climate, issues like reproductive rights and gender identity are increasingly central to corporate identity. The ruling safeguards directors, allowing them to address socio-political interests without the threat of litigation, which, in turn, supports more robust ESG Initiatives. Specifically, it frees directors from the fear of shareholder backlash when pursuing ESG-related strategies. This enables them to consider a broader range of stakeholder interests and societal impacts that prioritize long-term sustainability—such as employee well-being and environmental sustainability—over immediate financial results. This provides a welcomed impetus to the shift from discretionary corporate social responsibility (‘CSR’) to a more integrated ESG approach. Furthermore, the ruling acknowledges that both law and corporate decisions are inherently political. By recognizing this political dimension, the ruling legitimizes the alignment of corporate actions with broader societal interests, reinforcing the role of corporations as active participants in shaping not only economic outcomes but also the social and political landscape. Consequently, corporate engagement in external policy matters creates new opportunities for corporations.
While the judgment serves as a shield to mitigate judicial interference within the boardroom, we argue that its extension to social policy decisions is not wholly appropriate and may be misguided. Doctrinally, the rationale behind the business judgment rule is to restrict the court from extending its domain of expertise to business decisions, which fall within the purview of the board of directors. However, social policy decisions are inherently subjective and often lie outside the directors’ area of expertise. After all, the board of directors consists of business experts, not social sciences experts. The judgment attempts to reconcile this lacuna by treating social policy decisions as ordinary business matters, a conceptualization we contend is flawed. On a similar agency aspect, shareholders typically defer to directors’ decisions in areas where directors have specialized expertise—such as business and management decisions that drive profit maximization. However, this deference is unlikely to extend to areas where directors lack such expertise, particularly in matters concerning ESG and socio-political concerns. This misalignment may foster significant internal conflicts within the boardroom, potentially undermining corporate governance and eroding shareholder confidence.
Moreover, the extension of the business judgment rule blurs the traditional boundaries of fiduciary duty. The duty of care traditionally requires directors to be fully informed before making decisions, with shareholder expectations defining the ‘ends’ of this duty. In the context of social policy issues, however, these ‘ends’ become less clear, as directors may struggle to reconcile diverse and sometimes conflicting shareholder expectations, leading to decisions that fail to fully satisfy any group. Compounding this challenge is the blanket presumption afforded by the business judgment rule, which could lead to abuses of power. Directors might justify almost any decision as being in the ‘best interest’ of the corporation or ‘rationally linked’ to its long-term interests. Further, without clear metrics or sufficient jurisprudence to determine what constitutes a rational link to long-term corporate interests, directors could evade responsibility for poor decisions. Lastly, there is a risk that corporate governance could become overly politicized, as evidenced by the controversies surrounding corporate donations to the erstwhile Electoral Bonds Scheme (‘EBS’). Such politicization could ultimately undermine the principles of ESG and backfire against the intended spirit of responsible corporate governance.
In an attempt to dull the adverse effects of extending the business judgment rule to social policy decisions, we propose the adoption of a ‘balancing test’ aimed at minimizing the risks of absolute discretion and subjectivity. This approach requires an analysis of the implications of remaining silent versus engaging in social policy discourse. Specifically, it requires directors to weigh the potential benefits of silence—such as avoiding political backlash—against the risks that silence may pose to the corporation’s corporate culture. To further enhance the efficacy of this test, the corporation may incorporate comments from independent third-party experts on the relevant social issues and evaluate the stance or viewpoints of the corporation’s members through surveys or polls. By integrating these additional perspectives, directors can better ensure that their decisions reflect a balanced consideration of the relevant factors. Ultimately, the decision to (not) speak should be based on the weighing of these key risks.
Exploring the Hypothetical Tenability of India’s Extended Business Judgement Rule
The ‘Indian-ized’ version of the business judgment rule exists in essence but not in principle. While there is no formal presumption, it was opined in Miheer v. Mafatlal that the court would not interfere when the director’s conduct was “just, fair and reasonable, according to a reasonable businessman, taking a commercial decision beneficial to the company.” In this manner, both the traditional and Indian-ized business judgment rules defend directors’ decisions, but the Indian approach relies on judicial discretion, applying immunity more conditionally than the traditional rule’s blanket protection.
Assuming arguendo that the precedent extending a presumption on directors’ decisions regarding social policy concerns is incorporated in India, corporations would likely feel more comfortable adopting progressive DEI policies. They may also engage more in public discourse, knowing that their decisions would be protected under the rule. While traditional CSR represents discretionary corporate philanthropy, ESG demands companies to build sustainable and socially responsible practices in their business. The extended business judgment rule catalyses this change by protecting boards that prioritize such social considerations alongside profits. This would bolster the transition from a CSR framework to an ESG regime. However, as previously argued, this development is a double-edged sword that may significantly taint the fabric of corporate governance.
For instance, amidst the EBS fiasco, it was observed that corporations, even those operating at a loss, diverted significant funds to the EBS. In an ideal scenario, such decisions could be challenged for breaching fiduciary duties. However, with the added protection of the business judgment rule, directors could easily justify these actions as necessary to foster favourable political conditions and align with the corporation’s strategic interests. While such decisions might be ‘rationally linked’ to the corporation’s interests, they carry the moral implication of potentially undermining democratic processes, leading to a paradoxical blend of progress and regression.
In addition, owing to the high subjectivity and cultural determinism in a country like India, there is significant potential for bias and social conditioning to influence directors’ social policy decisions. Lastly, the extended business judgment rule is fundamentally inappropriate within India’s current corporate landscape due to the absence of robust mechanisms for derivative and class action suits. Consequently, we argue that the extended business judgment rule is untenable without adequate safeguards, such as the postulated balancing test and jurisprudence defining ‘rationally-linked’ interests.
Conclusion
As a denouement, extending the business judgment rule to cover social policy decisions presents both opportunities and risks for corporate governance. While it empowers boards to engage in socio-political discourse without fear of shareholder backlash, it simultaneously risks blurring the traditional boundaries of fiduciary duty. In India, this approach could accelerate the shift from CSR to ESG, allowing corporations to align more readily with progressive initiatives. However, the lack of clear jurisprudence and the risk of politicizing corporate governance necessitates caution. A careful calibration of shareholder interests with broader societal considerations will be crucial in shaping a governance model that is both responsible and forward-looking. Moving forward, emphasis must remain on developing robust safeguards—such as the proposed balancing test—that support corporate decision-making while preserving shareholder confidence. This delicate balance will be instrumental in navigating the evolving landscape of corporate governance.