The Business Judgment Rule and Liability
The business judgment rule is an important aspect of business, and an essential instrument in a high-level executive’s toolbox. Corporate directors are required to make important business decisions on a daily basis.
What is the Business Judgment Rule?The business judgment rule can be divided into two main sections. The first part is statutory, stemming from Corporations Code sections 7231 and 309, intended for nonprofit and for profit companies respectively, which insulate corporate directors from personal liability if they act in accordance with these sections. The second part of the business judgment rule is based on common law. This custom prevents the court from intervening in any management decisions made by corporate directors in good faith.
When Can it Be Claimed?As long as a director acts in good faith and what he or she believes to be in the best interests of the company, a director is protected by the business judgment rule. This includes making a decision based on faulty information, as long as it can be proved that the executive was not aware of this, and another prudent person in the same position would have likely followed said information. The application of the business judgment rule is decided on a case by case basis, and is an intensely fact driven issue. Corporate directors who faithfully comply with the statutory and common law requirements of the business judgment have a powerful shield from any personal liability due to a loss in company value.
Are There Exemptions?Executives are expected to always be well-informed of the potential outcomes and impacts of any and all business decisions they may make, and expected to act in good faith. When a corporate director chooses not to comply with these statutory and common law standards, he or she may fall outside the protection of the business judgment rule. 1. Fraud or "Bad Faith": If it can be proved that a corporate director either aspired to commit fraud or purposefully hid information from the company and the board, he or she will be unable to claim protection under the business judgment rule. 2. Reckless Action: As noted previously, executives should be well-informed of the potential negative and positive outcomes of any business decisions. A director may be held personally liable for any loss in company value due to excessively risky decisions. 3. Breach of Loyalty: Executives are always expected to place the interests of the company above their own personal interests. Directors who choose to usurp opportunities that rightly belong to the firm forfeit any protection under the business judgment rule.