Business Judgment Rule

The business judgment rule protects a director from personal liability if he or she has performed diligently and carefully in legitimate furtherance of corporate objectives and purposes and has not acted fraudulently, illegally, or otherwise in bad faith. The business judgment rule may be codified, but it is largely a matter of judicial interpretation and application. The business judgment rule is frequently invoked in shareholder damage suits against a director or board of directors. Courts generally acknowledge that the business judgment rule either does or may apply to corporate officers.

Traditionally, judges have recognized that they are ill-equipped to evaluate what are essentially business judgment calls. Even with 20-20 hindsight, courts rarely imposed an objective standard for measuring the correctness of each business decision. Instead, courts typically afforded directors broad discretion in managing business affairs given their unique capabilities and experience in the business community. In the past, application of the business judgment rule frequently meant that the court deferred to the director's business judgment and conducted no further inquiry or review of the processes leading up to the challenged business decision. Increasingly, courts apply the business judgment rule as a standard of liability that warrants objective review of the business decision.

Thus, the business judgment rule can be a defense to claims of corporate mismanagement and breach of a director's duty of care. The business judgment rule recognizes that all of a director's business decisions may not ultimately benefit the corporation or appear prudent in retrospect. The business judgment rule presumes that a director (or a board of directors) "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 business judgment rule is available to shield a director from liability when the following traditional elements are present: business decision

• Absence of self-dealing
  
• Due care
  
• Good faith
  
• No abuse of discretion

The burden is on the plaintiff to rebut the presumption that the board's decision is entitled to deference as to at least one of the elements of the business judgment rule. A plaintiff must plead specific facts that demonstrate improper conduct. Conclusory allegations are insufficient to overcome the presumption. In some courts, the primary inquiry is addressed to the elements of disinterestedness (absence of self-dealing) and good faith. If the evidence as to these two elements is sufficient, the focus shifts to the remaining three elements.

The degree of director culpability varies from state to state. In many states, a plaintiff must provide sufficient evidence that the director's business decision amounted to gross negligence. If the evidence is sufficient to rebut the presumption, the burden shifts to the director to justify the business decision. The director must then prove that the transaction was fair and reasonable to the corporation.

The Model Business Corporation Act incorporates some of the traditional elements of the business judgment rule in its analytical framework for judicial review. A challenger must prove that the director's conduct is actionable on any of the following grounds:

• Lack of good faith
  
• Insufficient or deficient belief
  
• Lack of information
  
• Lack of objectivity
  
• Lack of independence
  
• Sustained inattention
  
• Improper financial benefit
  
• Other breaches of fiduciary duty

Copyright 2011 LexisNexis, a division of Reed Elsevier Inc.