Section 115 of the Companies Act 1997 states the standard, and then supplies a safe harbour for genuine commercial decisions.
Section 115(1) — care and diligence
A Director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they —
(a) were a director or officer of a corporation in the corporation’s circumstances; and
(b) occupied the office held by, and had the same responsibilities within the corporation as, the Director or officer.
Unlike section 112, which turns on what the director believes, section 115 is objective: what would a reasonable person do?
But the reasonable person is placed in this corporation’s circumstances — its size, its business, its financial position — and in this office with these responsibilities. So more is expected of a finance director in a large trading company than of a non-executive director of a small one, and more of an audit committee member in relation to the accounts than of a colleague who is not on it.
Note that the section applies to “a Director or other officer” — wider than the directors’ duties in sections 112 to 114.
“I left it to the others”, “I signed what I was given”, and “I do not understand accounts” are not answers. A director who accepts an office accepts the responsibilities the objective standard attaches to it — which is why section 130 requires a written consent and a certification that the person is not disqualified before appointment.
Sections 115(2) and (5) — the business judgment rule
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter to the extent they reasonably believe to be appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.
“Business judgment” means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.
The rule protects the process, not the outcome. A decision that turns out badly is protected if it was made honestly, for a proper purpose, without a material personal interest, on a properly informed basis, and with a rational belief that it served the company.
Limb (b) is why the interested transaction provisions matter so much: an interested director cannot use the safe harbour for that decision at all. Limb (c) is why board papers, advice and analysis matter — the standard is what the director reasonably believes to be appropriate inquiry, which in a significant transaction means real inquiry.
Note that a decision not to act is expressly a business judgment under subsection (5). Inaction can be a protected judgment — but only if the four limbs are satisfied, which requires a conscious, informed decision rather than mere inattention.
Sections 115(3) and (4) — what “rationally” means
The belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.
Subsection (3) only operates in relation to duties under this section and their equivalent duties at common law or in equity, and does not operate in relation to duties under any other provision of this Act or under any other laws.
Subsection (3) sets a generous threshold: the belief fails only if no reasonable person in that position would hold it. Courts do not second-guess commercial judgment.
Subsection (4) then confines the protection. It applies to section 115 and the equivalent general law duties — and to nothing else. It does not protect a director against:
- section 112 (good faith and best interests) or section 114 (compliance with the Act and constitution);
- section 54 liability for an improper distribution;
- sections 348 and 348A — insolvent trading and failure to keep accounting records;
- the interested transaction provisions in sections 117 to 122; or
- obligations under any other law — tax, employment, environment, occupational safety.
Section 115(6) — the offence
A person whose actions are criminally negligent in contravention of this section commits an offence and is liable on conviction to the penalty under section 413(4).
Ordinary negligence is a civil matter; the offence requires conduct that is criminally negligent. That is a materially higher threshold, consistent with the general approach of the Criminal Code Act (Chapter 262), which continues to apply to dishonesty offences in its own terms.
Discharging the duty in practice
- Attend and prepare. Read the papers before the meeting; ask for what is missing.
- Understand the accounts. Section 188 requires records that enable the financial position to be determined with reasonable accuracy at any time, and section 348A makes a failure to keep them a source of personal liability.
- Monitor solvency continuously — not only when a distribution is proposed.
- Use section 116 properly. Reliance on employees, professional advisers and committees is protected under section 116 only where the director acts in good faith, makes proper inquiry where the circumstances indicate the need, and has no knowledge that the reliance is unwarranted.
- Record the four limbs for any significant decision: the purpose, the absence of personal interest, the inquiry made, and the reasoning.
- Dissent in writing where you disagree. Several liability provisions turn on whether a director voted for a resolution or took reasonable steps to prevent something.
- Monitor delegates. Under section 111(2) the board remains responsible unless it believed on reasonable grounds in the delegate and monitored by reasonable methods properly used.
Sources
- Companies Act 1997 — ss 54, 111, 112–117, 130, 188, 348, 348A, 413
- Criminal Code Act (Chapter 262)
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.