April 11, 2005
The German Business Judgment Rule
Posted by Gordon Smith

There is no more confusing doctrine in corporate law than the business judgment rule. Why would Germany want such a thing?

The quick answer is that some people in Germany fear that the current standards of liability are too threatening to corporate managers. Like most of the rest of the developed world, Germany has been doing a lot of navel gazing about corporate governance lately, and one of the results was the creation of the Baums Commission, which produced the German Corporate Governance Code. In the press release issued upon adoption of the Code, Dr. Gerhard Cromme, Chairman of the Government Commission on the German Corporate Governance Code observed:

The aim of introducing the corporate governance code is to make Germany more attractive to international - and national - investors by addressing all the major criticisms - especially from the international community - leveled against German corporate governance and providing suitable solutions. These criticisms are:

    • inadequate focus on shareholder interests;
    • the two-tier system of executive board and supervisory board;
    • inadequate transparency of German corporate governance;
    • inadequate independence of German supervisory boards;
    • limited independence of financial statement auditors.

I find it interesting that there is no mention of manager liability, even though subsequent reform efforts raised concerns about the ambiguity of German corporate law on this front. (My guess is that corporate managers saw the reform effort as a chance to get some insulation, and they nabbed the opportunity.)  Moreover, as far as I can tell, no one raised concerns sometimes heard in the U.S. about conflicts between the business judgment rule and shareholder interests. (Some want corporate managers on a tighter leash.)

After the adoption of the Corporate Governance Code, the German government embraced a 10-point program for reform, and here the business judgment rule had a prominent role. The program published a call for the clarification of the business judgment rule, which had been introduced in Germany via judicial innovation in 1977. This led to a proposed amendment to the German Stock Corporation Act that reads something like this:

The member of the management board has not violated his duty when in making a business decision he reasonably believes to act in the best interest of the company on the basis of sufficient information.

This is very similar to American formulations of the business judgment rule. Whether it will have any effect on German law is unclear. With the recent introduction of stockholder derivative suits in Germany, many feel that the codification of the business judgment rule is a useful addition.

This is not a law review article, so I won't bother with an extended analysis, but I have two comments:

(1) The proposed German statute probably does not capture the essence of the business judgment rule. Of course, to decide that, we need to have some idea about the meaning of the American rule, and there is still a lot of debate about that. The most commonly cited formulation in the U.S. comes from the Delaware Supreme Court, which articulated the business judgment rule as a "presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Despite still frequent references to this formulation, I think almost everyone who has thought deeply about the business judgment rule understands it to be more than an evidentiary presumption. As Lyman Johnson wrote in a 2000 article: "the statement of principle therein expressed is not--or should not be regarded as--the business judgment rule."

(2) The debate in Germany over potential managerial liability reminds me very much of a similar debate that occurred in the U.S. in the mid-1990s. It led to my writing a short symposium article on the ABA's proposed changes to the Model Business Corporation Act. Among other things, I argued that liability fears under the duty of care were grossly exaggerated. Knowing what little I know about Germany's current standards, the fears of liability may be slightly more grounded, but as far as I know, they have not witnessed any dramatic instances of manager liability.

Thanks to LLM student Ingo Kahler for teaching me about German corporate governance debates.

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