Directors, does the business judgment rule protect you?

Courts across the Country, including Minnesota, Iowa, Wisconsin and Arizona[1], “recognize the authority of corporate directors and want corporations to control their own destiny.”[2]  But “courts also provide a critical mechanism to hold directors accountable for their decisions by allowing shareholder derivative suits” in which the shareholder steps into the shoes of the corporation to seek redress.[3] How are these two competing concepts resolved?  The business judgment rule.

The business judgment rule was developed by state and federal courts to protect boards of directors against shareholder claims that the board made unprofitable business decisions.  “The business judgment rule is a presumption protecting conduct by directors that can be attributed to any rational business purpose.”  Dennis J. Block, et al., The Business Judgment Rule: Fiduciary Duties of Corporate Directors 18 (5th ed. 1998).[4]

Simply stated, the business judgment rule provides that if a disinterested director made an informed business decision, in good faith, he/she will not be liable if the corporation suffers losses from the decision.

The concept of the business judgment rule providing such protection: (1) is to allow directors to take reasonable risks to adapt to changing markets and capitalize on emerging trends; and (2) courts are ill-equipped to judge the wisdom of business ventures and have been reluctant to replace a well-meaning decision by a corporate board with their own.  Think of it as the courts refusing to armchair quarterback a decision with the benefit of hindsight.

The business judgment rule permits directors to rely, in good faith, upon the advice and guidance of others in making their decisions.  Whether it be accountants, financial professionals, officers or employees of the corporation, so long as the director reasonably believes those sources to be reliable and competent, such reliance falls within the protection afforded under business judgment rule.

The business judgment rule does not protect an interested director’s decision, a decision made in bad faith, or decisions in violation of unambiguous corporate governance documents.  Instead, it provides judicial deference to those decisions made in good faith by directors that may not have turned out as well as expected.

The business judgment rule can provide important protection when claims are asserted against you for your decision-making role as a director.

[1] MinnesotaJanssen v. Best & Flanagan, 663 N.W.2d 876 (Minn. 2003); Iowa Oberbillig v. West Grand Towers Condominium Association, 807 N.W.2d 143 (Iowa 2011); Wisconsin Einhorn v. Culea, 612 N.W.2d 78 (Wis. 2000); ArizonaUnited Dairymen of Arizona v. Schugg, 212 Ariz. 133 (Ariz. Ct. App. 2006).

[2] Janssen, 663 N.W.2d at 881.

[3] Id. at 882.

[4] Id.

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