Business Judgement Rule: Everything You Need to Know
The business judgement rule is a regulation put in place to allow a company's owners or directors to run their business as they see fit without legal interference unless the company is obviously violating basic rules of conduct. 3 min read
2. Role of Directors and Officers
3. Why Is the Business Judgement Rule Important?
The business judgement rule is a regulation put in place to allow a company's owners or directors to run their business as they see fit without legal interference unless the company is obviously violating basic rules of conduct.
What Is the Business Judgement Rule?
Under the business judgement rule, the board of directors of a corporation is given the freedom to conduct business and is protected from the courts digging into their business deals or decisions due to unfair or unwarranted allegations.
It is well understood that the day to day running of a company is an inherently risky business with some controversial aspects. Company heads are human and therefore will not always make the best decisions. Because of the nature of the business, the courts generally allow business owners and corporate directors to make their tough decisions without worrying about prosecution.
If legal action is brought against a company's board of directors, as long as the leadership can show that their actions and decisions were rational, the court will not prosecute further. The business judgement rule is often used in cases where the director of a corporation is sued for violating his obligation to act in the best interested of the company.
Under the business judgement rule, a court will not prosecute a director for his or her decisions if it can be shown that they were made:
- In good faith
- With the understanding that they were acting in a way that was good for the business
Role of Directors and Officers
The leadership of a business is held responsible for the conduct of that company as a whole. Officers and directors of a business should have an active role in its regular affairs. Due to such responsibility, leaders in the company are frequently expected to handle complicated situations like:
- Mergers and acquisitions
- Sale or liquidation of assets
- Expansion into other fields
- Stock and dividend distribution
- Hostile takeover attempts by other companies
With the potential for such major issues to come up during the management of a company, the court shows favor to officers and directors. Such decisions are hard enough to make without constantly having to worry about being sued.
Why Is the Business Judgement Rule Important?
As the most important and well-known rule in corporate law, the business judgement principle protects corporate decisions that are made in good faith. If a director or board does act outside of the best interest of the company in a way that breaches the fiduciary duty put upon them, a well-argued case must be brought. This can happen if it is proven that the board's decision was coerced somehow or irrational.
If the business judgement rule wasn't in place, the desire for equity between the interests of shareholders and the power of the board could cause the company's leadership to make decisions based on fear of legal action from the shareholders rather than on the what's best for business. If directors are always worried about being sued, they won't be able to properly exercise their role in the company.
The business judgement principle retains equity and gives a board or directors the confidence of the state to run their company rationally, but not without simple mistakes.
A court could decide to run a full fairness review if they find good reason to set aside the business judgement rule and look into the decisions that were made. In such a case, equity will come into play in full force. There is no place for fairness under the business judgement principle, so fairness reviews are only carried out if it has been shown that the principle does not apply.
The business judgement rule does not apply under the following circumstances:
- Breach of fiduciary duties
- Business decisions were tainted or coerced
In order for shareholders to bring about an investigation into the decisions of their board, they'll need to provide substantial proof that the business judgement rule should not apply.
This provides a balance between the two sides of a company. Equity is on the side of the shareholders, while the business judgement rule is on the side of the leadership. Each principle working to provide a healthy relationship between the two sides and therefore a healthy company.
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