The business judgment rule is a
case-law-derived doctrine in
corporations law that courts
defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation ... are clothed with
hepresumption, which the law accords to them, of being
otivatedin their conduct by a
bona fides regard for the interests of the corporation whose affairs the stockholders have committed to their charge."
[''Gimbel v. Signal Cos.'', 316 A.2d 599, 608 (Del. Ch. 1974).] The rule exists in some form in most
common law
Common law (also known as judicial precedent, judge-made law, or case law) is the body of law primarily developed through judicial decisions rather than statutes. Although common law may incorporate certain statutes, it is largely based on prece ...
countries, including the United States,
Canada, England and Wales, and Australia.
To challenge the actions of a corporation's
board of directors
A board of directors is a governing body that supervises the activities of a business, a nonprofit organization, or a government agency.
The powers, duties, and responsibilities of a board of directors are determined by government regulatio ...
, a plaintiff assumes "the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their
fiduciary duty
A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (legal person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, fo ...
—
good faith
In human interactions, good faith () is a sincere intention to be fair, open, and honest, regardless of the outcome of the interaction. Some Latin phrases have lost their literal meaning over centuries, but that is not the case with , which i ...
,
loyalty
Loyalty is a Fixation (psychology), devotion to a country, philosophy, group, or person. Philosophers disagree on what can be an object of loyalty, as some argue that loyalty is strictly interpersonal and only another human being can be the obj ...
, or
due care." Failing to do so, a plaintiff "is not entitled to any remedy unless the transaction constitutes waste ...
hat is,the exchange was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration."
Basis
Given that the directors cannot ensure corporate success, the business judgment rule specifies that the court will not review the business decisions of directors who performed their duties (1) in
good faith
In human interactions, good faith () is a sincere intention to be fair, open, and honest, regardless of the outcome of the interaction. Some Latin phrases have lost their literal meaning over centuries, but that is not the case with , which i ...
; (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the directors reasonably believe to be in the best interests of the corporation. As part of their duty of care, directors have a duty not to waste corporate assets by overpaying for property or employment services. The business judgment rule is very difficult to overcome and courts will not interfere with directors unless it is clear that they are guilty of fraud or misappropriation of the corporate funds, etc.
In effect, the business judgment rule creates a strong
presumption
In law, a presumption is an "inference of a particular fact". There are two types of presumptions: rebuttable presumptions and irrebuttable (or conclusive) presumptions. A rebuttable presumption will either shift the burden of production (requir ...
in favor of the board of directors of a corporation, freeing its members from possible liability for decisions that result in harm to the corporation. The presumption is that "in making business decisions not involving direct self-interest or self-dealing, corporate directors act on an informed basis, in good faith, and in the honest belief that their actions are in the corporation's best interest." In short, it exists so that a board will not suffer legal action simply from a bad decision. As the
Delaware Supreme Court
The Delaware Supreme Court is the sole appellate court in the United States state of Delaware. Because Delaware is a popular haven for corporations, the Court has developed a worldwide reputation as a respected source of corporate law decisions, ...
has said, a court "will not substitute its own notions of what is or is not sound business judgment"
Sinclair Oil Corp. v. Levien
', 280 A.2d 717, 720 (Del. 1971) if "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 interests of the company."
Duty of care and duty of loyalty
Although a distinct common law concept from
duty of care
In Tort, tort law, a duty of care is a legal Law of obligations, obligation that is imposed on an individual, requiring adherence to a standard of care, standard of Reasonable person, reasonable care to avoid careless acts that could foreseeab ...
,
duty of loyalty
The duty of loyalty is often called the cardinal principle of fiduciary relationships, but is particularly strict in the law of trusts. In that context, the term refers to a trustee's duty to administer the trust solely in the interest of the b ...
is often evaluated by courts in certain cases dealing with violations by the board. While the business judgment rule is historically linked particularly to the duty of care standard of conduct, shareholders who sue the directors often charge both the duty of care and duty of loyalty violations.
This forced the courts to evaluate duty of care (employing the business judgment rule standard of review) together with duty of loyalty violations that involve self-interest violations (as opposed to gross incompetence with duty of care). Violations of the duty of care are reviewed under a
gross negligence
Gross negligence is the "lack of slight diligence or care" or "a conscious, voluntary act or omission in reckless disregard of a legal duty and of the consequences to another party." In some jurisdictions a person injured as a result of gross neg ...
standard, as opposed to simple
negligence
Negligence ( Lat. ''negligentia'') is a failure to exercise appropriate care expected to be exercised in similar circumstances.
Within the scope of tort law, negligence pertains to harm caused by the violation of a duty of care through a neg ...
.
Consequently, over time, one of the points of review that has entered the business judgment rule was the prohibition against self-interest transactions. Conflicting interest transactions occur when a director, who has a conflicting interest with respect to a transaction, knows that she or a related person is (1) a party to the transaction; (2) has a beneficial financial interest in, or closely linked to, the transaction that the interest would reasonably be expected to influence the director's judgment if she were to vote on the transaction; or (3) is a director, general partner, agent, or employee of another entity with whom the corporation is transacting business and the transaction is of such importance to the corporation that it would in the normal course of business be brought before the board.
Standard of review
The following test was constructed in the opinion for ''Grobow v. Perot'', 539 A.2d 180 (Del. 1988), as a guideline for satisfaction of the business judgment rule. Directors in a business should:
*act in good faith;
*act in the best interests of the corporation;
*act on an informed basis;
*not be wasteful;
*not involve self-interest (duty of loyalty concept plays a role here).
Rationale
Under the
Delaware General Corporation Law
The Delaware General Corporation Law (sometimes abbreviated DGCL), officially the General Corporation Law of the State of Delaware (Title 8, Chapter 1 of the Delaware Code), is the statute of the Delaware Code that governs corporate law in the U ...
, the business judgment rule is the offspring of the fundamental principle, codified in Del. Code Ann. tit. 8, § 141(a), that the business and affairs of a Delaware corporation are managed by or under its board of directors. In carrying out their managerial roles, directors are charged with an unyielding fiduciary duty to the corporation.
['']Smith v. Van Gorkom
''Smith v. Van Gorkom'' 488 A.2d 858 ( Del. 1985) is a United States corporate law case of the Delaware Supreme Court, discussing a director's duty of care. It is often called the "Trans Union case". ''Van Gorkom'' is sometimes referred to as t ...
'', 488 A.2d 858 (Del. 1985). The rationale for the rule is the recognition by courts that, in the inherently risky environment of business, Boards of Directors need to be free to take risks without a constant fear of lawsuits affecting their judgment.
The presumption raised by the business judgement rule may be rebutted by the
plaintiff
A plaintiff ( Π in legal shorthand) is the party who initiates a lawsuit (also known as an ''action'') before a court. By doing so, the plaintiff seeks a legal remedy. If this search is successful, the court will issue judgment in favor of the ...
. "The business judgment rule is 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 interests of the company. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one."
Further, rebuttal typically requires a showing that the defendants violated duty of care or loyalty (with courts assuming director's good faith otherwise).
If the plaintiff can show that an action should not be protected by the business judgment rule (such as when a director decides to give over a certain percentage of the company's profits to charity (duty of care violation) or lines his/her own pockets with company's money (self-interest/duty of loyalty violation)), then the burden will shift to the defendant to show that the action meets the burden of
good faith
In human interactions, good faith () is a sincere intention to be fair, open, and honest, regardless of the outcome of the interaction. Some Latin phrases have lost their literal meaning over centuries, but that is not the case with , which i ...
/rational decision. In many cases, it is relatively easy for a director to find some rational reason for his actions and, with the courts using the business judgment rule, the case will likely be dismissed (U.S. courts disdain getting involved in business matters). All directors must have the option of vetoing the decision.
Frequently, the winning cases for plaintiffs involving the business judgment rule involve acts constituting corporate waste. Also, note that some Board decisions lie outside the business judgment rule. For instance, in the takeover context, courts will apply the more stringent
''Unocal'' test, also called intermediate scrutiny. Illegal decisions are also not protected by the business judgment rule.
One of the earliest cases, ''
Dodge v. Ford Motor Co.'', ruled, for example, that "courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise towards the stockholders."
['' Dodge v. Ford Motor Co.'', 204 Mich. 459, 170 N.W. 668 (1919).]
See also
*
Company
A company, abbreviated as co., is a Legal personality, legal entity representing an association of legal people, whether Natural person, natural, Juridical person, juridical or a mixture of both, with a specific objective. Company members ...
*
Corporate law
Corporate law (also known as company law or enterprise law) is the body of law governing the rights, relations, and conduct of persons, companies, organizations and businesses. The term refers to the legal practice of law relating to corpora ...
*
US corporate law
United States corporate law regulates the governance, finance and power of corporations in US law. Every state and territory has its own basic corporate code, while federal law creates minimum standards for trade in company shares and governa ...
*
UK company law
British company law regulates corporations formed under the Companies Act 2006. Also governed by the Insolvency Act 1986, the UK Corporate Governance Code, European Union Directive (European Union), Directives and court cases, the company is th ...
*
German company law
*''
In re Caremark International Inc. Derivative Litigation'', 698 A.2d 959 (Del. Ch. 1996)
*''
Benihana of Tokyo, Inc. v. Benihana, Inc.''
Notes
External links
Companies House in the UK
{{DEFAULTSORT:Business Judgment Rule
Corporate law