The director’s friend: The business judgment rule
By Mark Adams
Reprinted with permission, Orange County Business Journal, August 27, 2012
A corporate director is entrusted to act for and on behalf of the corporation and its shareholders in managing the corporation’s affairs. A director assumes fiduciary duties and is expected to act with honesty, loyalty, and good faith.
But directors, like anyone else, make mistakes or bad decisions, and become personally liable for them. Since few individuals would voluntarily take on such liability, the common law developed the Business Judgment Rule.
Under this Rule, courts will not review directors’ business decisions, or hold directors liable for errors or mistakes in judgment, so long as they were disinterested and independent; acting in good faith; and reasonably diligent in informing themselves of the facts. The rationale of the Rule is based on judicial reluctance to “Monday morning quarterback” directors’ business decisions and a recognition that a business venture already involves risk and should not be encumbered with threats of liability for mistakes.
The Business Judgment Rule is codified in California law in Corporations Code § 309(a), which provides:
A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.
When directors are sued
Disinterested directors are rebuttably presumed to have acted in good faith and to have believed their decision was in the corporation’s best interests. A plaintiff has the burden of showing a board decision involved a conflict of interest, or was made in bad faith or without the requisite degree of care and diligence.
Except when directors take action in response to a takeover threat, there is a presumption that directors’ actions are made on an informed basis, in good faith, and in the honest belief that they are in the best interests of the company.
Although Section 309(a) refers to the “ordinary prudent person,” the Business Judgment Rule’s standard as to a decision is actually one of gross negligence — the failure to exercise even slight care. California cases have shown that directors will generally not be held liable for a decision based on ordinary negligence provided that the process leading to the negligent decision meets the Rule’s requirements.
Disinterested directors’ are protected from poor decisions made with reasonable diligence in ascertaining the facts and believed to be in the corporation’s best interests.
Directors who perform their duties in accordance with the Business Judgment Rule will have no liability based upon any alleged failure to discharge their obligations as directors.
Mark S. Adams is a litigation partner at Jeffer Mangels Butler & Mitchell LLP. He has tried numerous cases in state courts, federal courts, and in domestic and international arbitrations. Contact Mark at MarkAdams@jmbm.com or 949.623.7230.