The Business Judgment Rule and Thai Law: Is a Director Liable When a Business Decision Goes Wrong?

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The question every director should be able to answer

Picture this situation: the board of directors resolves to approve a 100 million baht investment to expand the factory, after carefully studying the market, consulting financial advisers, and assessing the risks. Two years later the market turns, the company suffers heavy losses, and one furious shareholder asks, "Are the directors personally liable?"

The answer depends on a legal principle known as the business judgment rule, under which a business decision made in good faith, on an informed basis, and free of any conflict of interest should be protected by law even if it turns out to be wrong.

The problem is that Thai law has no explicit provision to this effect. This article analyzes where Thai company directors stand under the Civil and Commercial Code, and what can be learned from the world's leading legal systems.

The root of the problem: the agency problem and directors' duties

In a limited company, the shareholders are the "principal" and the directors are the "agent" authorized to manage the business. The fundamental tension in this structure is called the agency problem

The leading economists Michael C. Jensen and William H. Meckling, in their 1976 article, defined "agency costs" as the sum of three components: (1) the principal's monitoring expenditures; (2) the bonding expenditures the agent incurs to earn the principal's trust; and (3) the residual loss that arises because the agent's decisions still do not fully align with the principal's best interests.

The key mechanism corporate law uses to reduce these costs is to impose duties and standards of conduct on directors. In every legal system there are 2 core duties: the duty of care and the duty of loyalty.

The duty of care in Thai law: Section 1168 of the Civil and Commercial Code

In Thailand, Section 1168, paragraph one, of the Civil and Commercial Code (Book III, Title 22 Partnerships and Companies, Chapter 4 Limited Companies) provides:

"The directors must in their conduct of the business apply the diligence of a careful business man."
Thai original: "ในอันที่จะประกอบกิจการของบริษัทนั้น กรรมการต้องใช้ความเอื้อเฟื้อสอดส่องอย่างบุคคลค้าขายผู้ประกอบด้วยความระมัดระวัง"
— Civil and Commercial Code, Section 1168, paragraph one (English text as published in the Thailand Law Library; unofficial translation)

This "careful business man" standard is a reasonable-person standard for someone engaged in trade. Most scholars consider it similar to the Sorgfaltspflicht standard of German law: it takes into account both the actual knowledge and experience of the particular director and the standard of a reasonable person in the same position.

Section 1168, paragraph two, sets out matters for which the directors are jointly responsible, such as the application of the money paid for shares, the keeping of the books and documents, and the proper distribution of dividends. Paragraph three then provides:

"Furthermore, a director may not, without the consent of the general meeting of shareholders, carry on any commercial business of the same nature as, and in competition with, that of the company, whether for his own benefit or for the benefit of another person, or become a partner with unlimited liability in another commercial concern carrying on business of the same nature as, and in competition with, that of the company."
Thai original: "อนึ่ง ท่านห้ามมิให้ผู้เป็นกรรมการประกอบการค้าขายใด ๆ อันมีสภาพเป็นอย่างเดียวกัน และเป็นการแข่งขันกับการค้าขายของบริษัทนั้น ไม่ว่าทำเพื่อประโยชน์ตนหรือเพื่อประโยชน์ผู้อื่น หรือไปเข้าหุ้นส่วนไม่จำกัดความรับผิดในห้างค้าขายอื่นซึ่งประกอบกิจการมีสภาพเป็นอย่างเดียวกันและแข่งขันกับกิจการของบริษัท โดยมิได้รับความยินยอมของที่ประชุมใหญ่ของผู้ถือหุ้น"
— Civil and Commercial Code, Section 1168, paragraph three (unofficial translation)

This provision is part of the duty of loyalty in Thai law, in the form of a prohibition on competing with the company without the consent of the general meeting. It is comparable to the non-competition rule for directors under Section 88 of Germany's AktG.

The business judgment rule in the United States: the standard the world refers to

Section 141(a) of the Delaware General Corporation Law (DGCL) provides that the business of a corporation shall be managed "by or under the direction of" the board of directors. This system gives directors broad discretion and uses the business judgment rule as the protective mechanism.

Under the business judgment rule, the Delaware courts presume that the directors acted (1) in good faith, (2) on an informed basis, and (3) in the honest belief that the action was in the best interests of the company. The burden of proof falls on the plaintiff, who must rebut this presumption.

If the directors can invoke the business judgment rule, the court will not review the merits of the decision, however bad the outcome. DGCL Section 102(b)(7) further allows a corporation to include a provision in its certificate of incorporation limiting or eliminating the personal liability of directors for breaches of the duty of care in certain cases.

The German standard: Sorgfaltspflicht and a codified business judgment rule

Section 93(1) of Germany's Stock Corporation Act (Aktiengesetz, AktG) requires management board members to "apply the care of a prudent and conscientious manager" (Sorgfaltspflicht). This is a mixed objective-subjective test: it measures the director against a reasonable person in the same position, combined with the actual knowledge and experience of the director concerned.

Notably, the 2nd sentence of AktG Section 93(1), added in 2005, codifies the business judgment rule directly:

"There is no breach of duty if, in making a business decision, the member of the management board could reasonably assume that he was acting on the basis of adequate information for the benefit of the company." (German original: "Eine Pflichtverletzung liegt nicht vor, wenn das Vorstandsmitglied bei einer unternehmerischen Entscheidung vernünftigerweise annehmen durfte, auf der Grundlage angemessener Information zum Wohle der Gesellschaft zu handeln.")
— Aktiengesetz, Section 93(1), 2nd sentence (inserted by the UMAG of 2005, building on the Federal Court of Justice's ARAG/Garmenbeck decision of 1997 · unofficial translation)

Germany is therefore an example of a civil law country that has clearly codified the business judgment rule, a model Thai law might consider adopting in the future.

The United Kingdom: a mixed objective-subjective standard

Section 174 of the Companies Act 2006 (CA 2006) requires a director to "exercise reasonable care, skill and diligence." The minimum standard is the general knowledge and skill that may reasonably be expected of a person in the same position, but a director with knowledge or skill above that general standard is judged by the higher standard of the knowledge he or she actually has.

The English system has no explicit business judgment rule like the American one, but the English courts generally defer to the commercial judgment of directors and will not substitute their own view for a business decision made in good faith and on an informed basis.

Comparison table: four legal systems

Where does Thailand stand? The current position and the gaps in the law

Comparing the Civil and Commercial Code with international standards shows that Thailand has a strong foundation but still lacks 2 important mechanisms.

First — no codified business judgment rule: The Code sets the standard of care in Section 1168 but does not expressly lay down a business judgment principle protecting directors who decide in good faith. As a result, Thai courts may have wider scope to review the substance of a business decision than courts in systems that have a business judgment rule.

Second — no systematic mechanism for limiting liability: There is no provision comparable to DGCL Section 102(b)(7) allowing a company to limit its directors' liability for breaches of the duty of care in its certificate of incorporation. This may be one factor that makes directors reluctant to take innovative decisions (conduct risk).

Nevertheless, because the Code uses the "careful business man" standard, an objective standard measured against a person in the same position, in practice Thai courts generally do not find a director in breach of duty merely because a well-reasoned decision turned out to be wrong, provided the decision was reasonable in the context in which it was made.

In practice: how Thai directors can protect themselves

Although Thai law has no explicit business judgment rule, directors can protect themselves by following the principles applied in every legal system:

One — document the decision-making process: The minutes should show what information the directors received, whether experts were consulted, and the reasons supporting the resolution. In law, this process matters more than the outcome, because the duty of care under Section 1168 of the Code is measured by the care taken in making the decision, not by whether the result was correct.

Two — consult experts before major decisions: A director can more easily show that he or she exercised the care required by Section 1168 if there is evidence that accountants, legal consultants, or outside experts were consulted before a major decision.

Three — disclose conflicts of interest immediately: Section 1168, paragraph three, of the Code prohibits a director from carrying on a business that competes with the company without the consent of the general meeting. Disclosing the conflict and abstaining from voting on a matter in which the director has an interest is the clearest evidence of good faith.

Four — use a shareholders' agreement to set the boundaries: Although the Code has no liability-limiting mechanism like DGCL Section 102(b)(7), shareholders can set out the decision-making framework and the approval process for major transactions in a shareholders' agreement, which helps reduce the risk of later disputes.