Posted in Business Attorney, Business Law, M&A
Business Judgement Rule
This article was written by Ishika Patel, an intern with the Law Offices of Ryan Reiffert, PLLC. The business judgment rule is a crucial principle for corporate directors and shareholders to understand as it protects the jobs and assets of each respectively. This post breaks down the rule into its main points so it is easier to digest. It will go through the structure of the rule, as well as famous examples and new modifications of it. This is a general overview of the rule and relevant topics though, and I advise everyone to consult with a business attorney for personalized advice.
Duty of CareFor the Business Judgement Rule to stand, the directors must prove that they upheld the duty of care, one of their many fiduciary duties. The duty of care, as defined by Cornell Law School, is “the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act in the same manner as a reasonably prudent person in their position would”. Essentially, their actions should be objectively reasonable and understandable. For example, a teacher has a duty of care to their students to educate them, but not to file their taxes; they must teach in their best ability, and in a way that other teachers and professionals in their position would. The duty of care holds a large chunk of the standards expected to be held under the business judgment rule and effectively protects the shareholders against any ill-intended or outright irrational decisions made by directors.
Duty of LoyaltyAnother important principle to understand is the duty of loyalty, which, according to Cornell Law School, “stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act without personal economic conflict”. Essentially, directors should not make decisions with their personal financial interests in mind, but instead with the shareholders interests. An example of a failure to meet the duty of loyalty is insider trading; this act uses personal financial gain to influence decisions, violating fiduciary duties of loyalty (and care). The duty of the fiduciaries, which in this case are usually the directors, is to preserve the assets of the company’s shareholders and to assure them that those assets are safe in someone else’s hands. This principle is not as relevant to the business judgment rule as the duty of care, but it is crucial to Unocal v. Mesa, which will be discussed later on in the post.
Business Judgement RuleCorporate directors make hundreds of decisions a day, and because of human nature, they are bound to eventually make a mistake. It is safe to assume that most people in these positions take great care and deliberation with these large decisions, whether that be out of care for the company or for self-protection. No matter how careful someone is, however, when in such a risky business there is always a margin for error that can leave directors facing lawsuits and scrutiny; this is where the business judgment rule comes in. The business judgment rule is useful for directors because if it stands in a court of law, they are given the “benefit of the doubt” of some sorts, and will not be subjected to an entire fairness review—a process where the defendant is burdened with proving that the decision made was in good standing; this process is tedious and it can be very hard to win. The business judgment rule, according to the American Law Institute, is upheld when a director or officer:
- is not interested in the subject of his business judgment;
- is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and
- rationally believes that the business judgment is in the best interests of the corporation.