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Corporations • Directors and Officers
CORP#029
Legal Definition
Directors are not liable for innocent mistakes that turn out badly. The business judgment rule is a rebuttable presumption that corporate business decisions are made by disinterested and independent directors, acting on an informed basis, and in the good faith belief that the decisions are in the best interests of the corporation and its shareholders.
Plain English Explanation
A director who acts ethically and reasonably cannot be held liable simply because their decisions resulted in negative consequences to the corporation. Even decisions made "from the gut" have been upheld as valid under the business judgment rule. The business judgment rule is the strongest defense a director has against any claims that they are liable for some negative outcome.
Hypothetical
Hypo 1: Sam is on the board of HypoCorp. Bob is the CEO and Chairman of the board for ExampleCorp. HypoCorp wants to acquire ExampleCorp. Bob, without consulting with anyone, proposes a $55 per-share price for a buyout. HypoCorp accepts, and Bob and the other board members for ExampleCorp put the plan into motion. When other shareholders of ExampleCorp find out, they are upset because they feel that ExampleCorp could have asked for a much higher amount. ExampleCorp argues that, based on their understanding of the finances, $55 felt fair. Result: Under the business judgment rule, there is a rebuttable presumption that Bob and the other directors made the right decision. However, here, it appears as if ExampleCorp didn't bother to inform themselves of any prudent information. Though courts have upheld "from the gut" type decisions in other cases, here, the magnitude of the decision (setting a share price for a buyout) is worthy of consulting with a financial advisor. This hypo is based on a famous case, Smith v. Van Gorkom, in which the court found that the directors acted grossly negligent because they quickly approved a merger without substantial inquiry or expert advice. Because of this, the business judgment rule was not available as a defense and the plaintiffs were able to rebut its presumption, finding the directors liable.
Related Concepts
Can a corporation indemnify an officer or director who is held liable to their own corporation?
Can a corporation indemnify an officer or director who successfully defends themselves against a lawsuit from another party?
How can a director defend against a claim that they breached their duty of loyalty?
What are some common examples of permissive indemnification?
What are the statutory requirements of board of directors meetings?
What are the statutory requirements of directors?
What duties do directors have to the corporation and shareholders?
What duties do officers have to the corporation and shareholders?
What is the duty of care?
What is the duty of loyalty?
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