Business judgment rule: directors may be held liable for disproportionate organizational decisions

This article has been also published on the EACCNY website on September 17, 2020.

The Court of Rome[1] recently issued a decision on the business judgment rule topic, which has been dealt with several times by Italian courts over the years.

The recent decision is interesting because (i) it summarizes Italian case-law principles on the abovementioned topic and (ii) based on such principles, it concludes that even organizational decisions made by directors can trigger their liability.

1. The case at stake

A newly established company controlled by the Italian foundation for doctors’ and dentists’ social security (Enpam) sued two of its directors and sought to have the Court of Rome order them to reimburse the damages suffered by the company due to certain decisions made and acts carried out by the defendants.

While the trial was pending, the newly established company was wound-up and Enpam, as its sole equity-holder, continued to act as claimant.

Via an ancillary urgency procedure, Enpam requested that the Court of Rome seize the property of the directors, and the Court of Rome upheld that request by means of the decision in question.

Specifically, the subsidiary (at first) and Enpam (subsequently) claimed that the decision of the directors to hire a significant number of employees during the start-up phase of the newco (i.e., before the relevant authorities granted the company license to carry out its main activity) was unreasonable and triggered significant losses, which eventually led to the decision to liquidate the newco.

2. The principles of the business judgment rule as summarized by the Court of Rome

As mentioned above, the decision at hand is interesting because in it the Court of Rome summarizes case-law principles relating to the business judgment rule. Indeed, according to the Court of Rome:

  • based on the business judgement rule, directors cannot be held liable due solely to unsuccessful business decisions (although, in such cases, equity-holders may decide to remove directors from office) provided that
    • I. directors have used adequate diligence to evaluate in advance the risks arising from a specific transaction;
    • II. directors make decisions that are consistent with diligence assessments.

It should be noted that condition II, as summarized by the Court of Rome, is debatable.  Indeed, if the principle is that business decisions cannot trigger directors’ liability, directors should be free to make certain decisions, even if, based on the information collected during due diligence investigations, such decisions trigger potential risks for the company.

Needless to say that, in such cases (i.e., risky transactions), it is advisable for directors to obtain equity-holders’ consent in advance.

3. Organizational decisions

After having summarized the abovementioned principles, the Court of Rome had to decide whether organizational decisions made by directors can trigger their liability.

Generally speaking, according to the Court organizational decisions may trigger directors’ liability, since:

  • Italian law provides that directors must ensure that companies have adequate organizational, management, and accounting structures;
  • at the end of the day, organizational decisions are also business decisions and, therefore, they are subject to the principles of the business judgment rule summarized above.

As to the case at hand, the Court found the defendants’ decision to hire a significant number of employees during the start-up phase of the company to be unreasonable and to be made without carrying out adequate prior assessments.

Indeed, when the employees were hired, the application for a license that the company would have needed in order to carry out its main business was still pending, and the competent authorities had informally let the company know in advance that they were going to reject that request.

Based on the abovementioned circumstances, the Court authorized seizure of the defendants’ property in an amount corresponding to the costs borne by the company to hire and dismiss the employees.

As mentioned above, the way the Court of Rome tackles certain aspects relating to directors’ liability and the business judgment rule is debatable.

It will be interesting to see whether the Court of Rome will confirm this decision when judging on the merits of the dispute and if, subsequently, the case will be brought before higher courts.

The decision of the Court of Rome is available at this link.

[1] Decision issued on April 8, 2020.

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