Does the President’s decision have to be right? What happens if you take a risk and the Company fails? Are you liable to your Shareholders?
In your role as an officer or director, it is important you understand how the business judgment rule works and how it can benefit you if you face any legal trouble in the future.
The business judgment rule is a legal principle that makes officers, directors, managers, and other agents of a corporation immune from liability to the corporation for any loss incurred as a result of corporate transactions that are within their authority. The rule applies when there is enough evidence to show that the transactions at issue were done in good faith. In other words, the business judgment rule provides the officer or director a presumption that they are acting with their best business judgment.
A director’s obligation to make a reasonable inquiry generally arises when the circumstances indicate that a further inquiry is needed. The “business judgment rule” insulates directors from judicial intervention and liability, in the absence of fraud or self-dealing, if the directors exercise reasonable diligence and honestly and rationally believe their decisions are in the best interests of the corporation. Underlying the business judgment rule is the assumption that reasonable diligence has been used in reaching the decision which the rule is invoked to justify. So, it depends on whether the directors’ reliance upon the information provided by one or more officers (or others) is in good faith, and whether there is a reasonable basis for relying upon such officers.
BUSINESS JUDGEMENT RULE: THE STANDARD OF CONDUCT
The standard of conduct for directors generally requires that a director perform the duties of a director:
- in good faith;
- with care that an ordinary person in a similar position would exercise under similar circumstances; and
- in a manner the directors/officers reasonably believe to be in the best interests of the corporation.
Essentially, in order to bring a case against an officer or director, a plaintiff must be able to show that the individual did not uphold their fiduciary duty of care, good faith, or loyalty to the corporation while making a business decision. If there is no show of breach of fiduciary duty, the claim will not survive and the case will likely be dismissed under the business judgment rule.
However, even if there is no violation of fiduciary duty, if it can be shown that no reasonable person would have done what the defendant did, most courts will allow the case to go forward. These cases usually involve some extreme risk-taking or misbehavior and they do not come up very often.
THE BUSINESS JUDGEMENT RULE IS VERY DIFFICULT TO OVERCOME AND COURTS WILL NOT INTERFERE WITH DIRECTORS/OFFICERS UNLESS IT IS CLEAR THAT THEY ARE GUILTY OF A BREACH OF FIDUCIARY DUTY.
At the end of the day, corporate officers and directors do not have to make the “right” decisions to take advantage of the business judgment rule. As long as they meet the criteria set out above and have not breached their duties of care, good faith, and loyalty to the corporation, their business decisions are protected from legal claims.
Courts will analyze the Director conduct on a case by case basis. In 2014, the Delaware Supreme Court case Kahn v. M&F Worldwide Corp., the Court identified conditions under which the protection of the business judgment rule may be available in conflict circumstances. According to LexisNexis® analysis of the case, the court stated that the application of the business judgment rule’s protections to more problematic contexts, the modern business judgment rule “is not a one-size-fits-all doctrine, but rather a moveable boundary, marking the shifting line between judicial scrutiny and judicial deference.” The Delaware jurisprudence on the business judgment rule “reflects a general reluctance by Delaware courts to assume responsibility for the substance of business decisions.” Even in the more fraught contexts, the Delaware courts use the business judgment rule to “mark the point at which their responsibility for evaluating the decision ends.”
Further, an American Bar Association Report focusing on the responsibility of a board of directors and the issues to be considered by the board in preparing for and in reacting to an unsolicited tender offer looked at various cases involving the Business Judgment Rule. The wide range of actions available to the board are reviewed. The report determined, absent an abuse of discretion, and so long as improper motive or disabling self-interest is not present, the actions taken by directors basically will be governed by the business judgment doctrine.
The rule has been around for a long time. Some trace the rule all the way back to 1927, the Bodell v. General Gas & Elec. (Bodell I and Bodell II) case. Later, in 1971, the Delaware Supreme Court in Sinclair Oil Corp. v. Levien said, a court “will not substitute its own notions of what is or is not sound business judgment” if “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.” The law continues to be shaped today, but has not dramatically changed in thought since its origination.
Should you have any questions about the Business Judgment Rule rules or other laws that may affect your business, or would like to schedule a free initial consultation, please contact Waltz, Palmer & Dawson, LLC at (847)253-8800 or contact us online.
Waltz, Palmer & Dawson, LLC is a full-service law firm with various areas of service to assist your business, including: Employment Law, Intellectual Property, Commercial Real Estate, Litigation and general Business Law services. Individual services include Estate Planning, Wills and Trusts, Probate, Guardianship, Divorce and Family Law, Collaborative Divorce & Mediation.
This article constitutes attorney advertising. The material is for informational purposes only and does not constitute legal advice.
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