What is the Business Judgment Rule?
Corporations are managed under the direction of a board of directors. The board has a fiduciary duty to protect the interests of the corporation, and to act in the best interests of its shareholders. If directors take actions that are not in the best interest of the corporation, shareholders may bring a lawsuit against them. In order for a shareholder to succeed in a case against a director, the shareholder must overcome the business judgment rule which creates a presumption that in making a business decision 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 interest of the company.
How Does a Shareholder Plaintiff Overcome the Business Judgment Rule?
To rebut the business judgment rule a shareholder plaintiff has the burden of demonstrating that a director breached the duty of good faith, duty of loyalty, or duty of care. Elaborating on the business judgment rule, the Delaware Supreme Court has stated the following: “[D]irectors’ decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.”
What is the Rationale Behind the Business Judgment Rule?
There are three primary justifications for the business judgment rule. First, courts are hesitant to presume to know more about business than corporate directors. Judges are experts in law, not business, and are ill-equipped to retrospectively determine the relative merits of a business decision. Second, without a rule like the business judgment rule, it would be difficult for corporations to recruit qualified directors that would be willing to occupy a seat on the board when they would be subject to immense personal liability. And third, the business judgment rule enables corporate directors to be less risk averse. As Chancellor Allen noted in a footnote in the Caremark opinion: “The corporate form gets its utility in large part from its ability to allow diversified investors to accept greater investment risk. If those in charge of the corporation are to be adjudged personally liable for losses on the basis of a substantive judgment based upon what persons of ordinary or average judgment and average risk assessment talent regard as ‘prudent’ ‘sensible’ or even ‘rational’, such persons will have a strong incentive at the margin to authorize less risky investment projects.”