19. What is the “business judgment rule”?
The business judgment rule is a principle that applies to officers and directors acting within the scope of their positions. Directors of a corporation have a fiduciary duty to act in the best interest of their stockholders. This includes exercising due care and having a business justification for their decisions and actions. The duty of care requires officers and directors to be informed and avoid acting negligently in the execution of their responsibilities. The business judgment rule takes steps to further protect directors from liability for their decisions or actions if they acted in good faith. Basically, it raises the standard of care for holding a director liable for actions or decisions that cause a loss to the corporation. A director that takes an action or makes a decision that is negligent or reckless may be shielded from liability if they acted in good faith. Acting in good faith simply means that the officer or director genuinely believed that her decision was appropriate and in the interest of the corporation. The major limitation on the protections of the business judgment rule is when the officer or director either acts to intentionally harm the corporation or breaches her duty of loyalty.
• Example: I am a director of ABC Corp. I sell authorize the sale of corporate assets to members of my family at a very low price. This could be considered a self-dealing transaction. The business judgment rule will not protect me from liability for my actions if those actions are challenged by shareholders for causing a loss to the corporation.
• Discussion: How do you feel about the additional protections of the business judgment rule for directors? Should directors be protected from liability when making negligent or reckless decisions? Why or why not? Why do you think the law exempts director actions or decisions that breach the duty of loyalty from protection?
• Practice Question: Francis is director of ABC Corp. He, along with other directors, makes the decision to invest significant corporate assets in short-term construction loans. The loans are very high risk but yield high annual returns. Several of Francis’s family members own a substantial interest in many of the construction companies benefiting from the loans. If several of the loans default and cause a loss to ABC Corp, will the business judgment rule protect Francis from personal liability? Why or why not?