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Dr. Joel Fischer
Attorney-at-law, Bär & Karrer

Best practice for evaluating proposals and resolutions: legal and practical information

How does the Board of Directors make a "good" decision? This is one of the most important questions for a Board in terms of both its success and its liability.

For the most part, the proposal that the Board of Directors needs to evaluate is submitted by management. In some cases, the proposal is also prepared by one of the Board Members. Either way, the proposal must be reviewed by the entire Board of Directors, and an appropriate decision must be made. In doing so, certain requirements must be observed. From a legal perspective, the primary question is not about whether the decision was "good" or "successful", but whether it was taken carefully. In particular, the question is: which were the bases used and reviewed for making the decision so as to ensure that the decision-making process was performed carefully. This is of crucial importance for the liability prevention of the Boards of Directors. If the Board of Directors observes specific guidelines when preparing the decision, it shall benefit from the Business Judgement Rule, which shall considerably reduce its liability risk. Conversely, failing to comply with the relevant guidelines can bring the Board of Directors into the position of running short of explanations in a liability process. In particular, if the decision turns out to be detrimental and the company even falls into financial difficulties, the risk of becoming liable in the event of non-compliance with the guidelines is very large.

Obligation of the Board of Directors and the Business Judgement Rule

Under the Business Judgement Rule, the courts grant the Board of Directors significant discretion when reviewing business decisions, if the following requirements are met:

  • There are no conflicts of interest.
  • The decision is formally correct, it has been made by the responsible body and it is compliant with all regulations (e.g. approval quorums).
  • The decision is made on appropriate information, which was evaluated  in a proper decision-making process.

If these requirements are met, the court reviews the content of the decision with restraint. In case the requirements are not met, the court shall discard the restraint and undertake a strict review of the content of the decision. Most important from a material perspective is the requirement for an appropriate information basis and a proper decision-making process. These requirements are explained in more detail below.

Requirements for the information and the decision-making process

The requirements for the information and the decision-making process cannot be separated and complement each other. The decision-making process provides structural guidelines for the aspects to be covered by the information. If these guidelines are observed, this will significantly help to protect the Board of Directors against liability lawsuits. A checklist is attached to the article, which can be used by Board Members during the decision-making process. This should help to comply with the necessary legal requirements.

 Starting positiondefinition and analysis of the problem 

Consideration of different options for action

  • Creation of alternatives
  • Description of the options for action
  • Strengths, weaknesses, opportunities and threats
  • Review of assumptions

 Actual decision

1. Starting position: definition and analysis of the problem

The Board of Directors should have a main understanding of the starting position and it should be able to classify the specific question. It is advisable to re-establish the facts relevant to the decision from the start. Subsequently, a clear definition of the problem and setting of a goal indicate a careful decision-making process. In doing so, the following questions should be answered:

  1. What is the problem?
  2. What is to be achieved? And what characterises a good solution?
  3. Which key factors influence the problem?

2. Consideration of different options for action

2.1 Creation of various alternatives

It is fundamentally advisable to create several alternatives before making a decision. This clarifies the scope and, in the distinction between different alternatives, the strengths and weaknesses of the various alternatives are more apparent. An empirical study has shown that the quality of decisions is greater if instad of two1 three alternatives are created. This is explained by the fact that the third alternative makes the pros and cons of the other alternatives clearer. It can also be a warning signal if management only presents one approach (without an alternative). This suggests that the approach offers more of a benefit to management than the company.

It is disputed whether the Board of Directors must look for different alternatives before making a decision. In my opinion, a failure to create any alternatives does not generally represent a breach of duty. However, in view of the legal uncertainty and the fact that creating alternatives enhances the quality of the decision it is advisable to consider different approaches.

2.2 Description of the options for action

The Board of Directors should be aware of the main points of the option(s) for action. For major decisions, a viable financial framework showing their effects should be created if possible. In an ideal case, the effects on the asset, financial and profit situation should be apparent. A particularly important question is whether the decision is compatible with the company’s financial circumstances.

2.3 Evaluation of the options for action

  • Strengths, weaknesses, opportunities and threats 
    Strengths, weaknesses, opportunities and threats are to be evaluated and carefully considered (SWOT analysis). There are incentives for management to withhold or gloss over the disadvantages and risks of preferred alternatives for action so that the Board of Directors accepts the proposal. It is, therefore, incredibly important for the Board of Directors to ensure that, for all alternatives, negative aspects and risks are also sufficiently discussed. The Board of Directors must take notice if there are indications that management’s preferred option would result in alternatives not being measured by the same yardstick in the decision-making documents, and there being a distortion of the information in favour of management’s “favourite.”
    The threats are to be contrasted with the strengths and opportunities. The expected profit or other financial effects are also relevant here as soft factors.

  • Risk control
    The Board of Directors should deal with possibilities for controlling and limiting risks. If measures were implemented to limit risks, it can partly be justified to analyse risks less precisely as precautions were taken to prevent them arising. Contractual regulations (e.g. guarantees, right to adjust prices, right of revocation) can compensate, to a certain extent, for specific aspects being investigated in less detail during the due diligence process. The risks are always to be considered in terms of the tolerance and appetite for risk within the company. Risks that could threaten the company’s financial stability (e.g. cluster risks) must be considered in detail and, where appropriate, such risks may not be taken.

  • Significant assumptions
    The Board of Directors should understand the significant assumptions underlying the evaluation. A central component of forming an independent opinion is that the Board of Directors must review the assumptions and form its own opinion. There is particularly large potential for distorting information about the assumptions. In particular, for important decisions that rely strongly on assumptions it is also advisable to create various scenarios and perform a sensitivity analysis. If the assumptions about the information were reasonable, this would by no means result in a breach of duty of care if the assumptions subsequently turn out to be incorrect.

3. Actual decision

The Board of Directors should have a good overall assessment of the opportunities and risks, strengths and weaknesses. It must evaluate and contrast them. For evaluating the financial aspects of a project, it is advisable to determine the net present value. There should be clarity about the decisive criteria for the decision, particularly if several options for action are compared with one another. This is less self-evident for a decision-making process in the group than it appears. Primarily from an evidence viewpoint, it is advisable to record adequately the rationale and document the decision-making process. If a Board Member requests additional information, but the overall Board refuses this request, it is recommended to insist on this fact being recorded. The member in question can then prove that it had insisted on an appropriate decision-making process but was overruled by the overall Board. The legal situation can be precarious in such cases. If a Board Member feels that the overall Board is not performing its duties properly, it is recommendable to seek legal advice. Furthermore, it is also beneficial to document measures related to conflicts of interest and the actions necessary for complying with the formal regulations.

Critique of the Business Judgment Rule (BJR)

The BJR (Business Judgement Rule) is based on the assumption that the decision about content can be separated from the question of whether there was an appropriate information basis, which was developed during a careful decision-making process. If it is agreed that the information basis was appropriate, the judge should only review the content of the decision with restraint. In my opinion, this construction is based on a misconception about the decision-making process. The content of the decision is directly derived from a review of the information during a meaningful process. When the judge evaluates the content of the decision, he is merely assessing the review of the information performed during the decision-making process. It is, therefore, a matter of chance as to whether a question from the judge is assigned to the information and decision-making process or the content of the decision. It was decided in one verdict that the Board of Directors had made the decision to grant a loan, even though the borrowers had a reputation as "crooks and multiple bankrupts," on the basis of insufficient information. The Federal Court found that the Board of Directors should have gathered additional informationon the borrowers’ creditworthiness and that the prerequisites for the BJR (Business Judgement Rule) were not met2. However, we could also argue that the content of the decision was inappropriate as, by granting the loan to the apparent crooks, the Board of Directors took on too great a risk. In another case, the Federal Court then also decided to this effect3.The assignment is thus arbitrary and creates legal uncertainty. This assignment is relevant as the content of the decision should only be reviewed with restraint, whereas the information basis and decision-making process are reviewed relatively strictly. There is therefore the risk that the protective effect of the BJR  (Business Judgement Rule) is circumvented, as the judge performs a strict review of the information, which ultimately extends to the content of the decision. In my opinion, it would therefore be sensible to forego the dichotomy between the content of the decision and the review of the information. Instead, the entire decision-making process should be reviewed with restraint. The judge should review whether, within the framework of the decision-making steps stated below, the significant information was gathered and reviewed and the content of the decision was reasonable. Throughout this entire process the Board of Directors should be allowed to use sufficient judgement.

 


[1] HAUSCHILDT JÜRGEN, Number of alternatives and the efficiency of decisions, Schmalenbachs Zeitschrift für betriebswirtschaftliche Forschung, 1983, 111.
[2] Verdict 4A_97/2013 (28.08.2013) deliberation 5.3.
[3] Verdict 4A_626/2013, 4A_4/2014 97/2013 (08.04.2014) deliberation 7.3; for more details on the whole issue, see Fischer Joel, information and responsibility of the Board of Directors (forthcoming). 

   

Proposal evaluations and resolutions

Dr. Joel Fischer
Attorney-at-law, Bär & Karrer
Dr. Joel Fischer is attorney-at-law with Bär & Karrer, one of the leading Swiss business law firms with offices in Zurich, Geneva, Lugano and Zug. Joel specializes in banking and financial market law, M&A-Transactions, and Corporate Governance. He regularly advises Board Members of listed as well as of small and mid-sized companies in matters concerning corporate governance and the prevention of liability. Additionally, Joel has a several years of experience in management consulting from one of the leading international management-consulting firms. In his legal advisory work, he attaches great importance to business aspects. In his dissertation, Joel explores the question of which information Board Members should seek so as to minimize their liability. He regularly writes on topics related to corporate governance and he is currently working on a guidebook for Board Members that shall be published shortly. In addition to his education as a lawyer, he holds a dual master degree in Law and Finance from the University of Oxford.
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