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 [the] presumption, which the law accords to them, of being [motivated] in their conduct by a bona fide regard for the interests of the corporation whose affairs the stockholders have committed to their charge". [1] The rule exists in some form in most common law countries, including the United States, [1] Canada, [2] England and Wales, [3] and Australia. [4]
To challenge the actions of a corporation's board of directors, 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 — good faith, loyalty, or due care". [5] Failing to do so, a plaintiff "is not entitled to any remedy unless the transaction constitutes waste... [that is,] the exchange was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration". [6]
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; (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. [7] 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. [8]
In effect, the business judgment rule creates a strong presumption 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." [9] In short, it exists so that a board will not suffer legal action simply from a bad decision. As the Delaware Supreme Court has said, a court "will not substitute its own notions of what is or is not sound business judgment" [10] 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." [11]
Duty of care and duty of loyalty
Although a distinct common law concept from duty of care, duty of loyalty 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, [12] 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 standard, as opposed to simple negligence.
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. [13]
Rationale
Under the Delaware General Corporation Law, 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. [14] 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. [15]
The presumption raised by the business judgement rule may be rebutted by the plaintiff. "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." [14] 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/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. [16]
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." [17]
A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties. Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for example, a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to another party, who, for example, has entrusted funds to the fiduciary for safekeeping or investment. Likewise, financial advisers, financial planners, and asset managers, including managers of pension plans, endowments, and other tax-exempt assets, are considered fiduciaries under applicable statutes and laws. In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance, and trust in another whose aid, advice, or protection is sought in some matter. In such a relation, good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts.
A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.
The Supreme Court of Delaware 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, particularly in the area of mergers and acquisitions.
The duty of loyalty is often called the cardinal principal 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 beneficiaries, and following the terms of the trust. It generally prohibits a trustee from engaging in transactions that might involve self-dealing or even an appearance of conflict of interest. Furthermore, it requires a fiduciary to deal with transparency regarding material facts known to them in interactions with beneficiaries.
Smith v. Van Gorkom 488 A.2d 858 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 the most important case regarding business organizations because it shows a unique scenario when the board is found liable even after applying the business judgment rule. The decision "stripped corporate directors and officers of the protective cloak formerly provided by the business judgment rule, rendering them liable for the tort of gross negligence for the violation of their duties under the rule."
In United States corporation and business association law, a duty of care is part of the fiduciary duty owed to a corporation by its directors. The other aspects of fiduciary duty are a director's duty of loyalty and (possibly) duty of good faith.
In re Caremark International Inc. Derivative Litigation, 698 A.2d 959, is a civil action that came before the Delaware Court of Chancery. It is an important case in United States corporate law and discusses a director's duty of care in the oversight context. It raised the question regarding compliance, "what is the board's responsibility with respect to the organization and monitoring of the enterprise to assure that the corporation functions within the law to achieve its purposes?" Chancellor Allen wrote the opinion.
Guth v. Loft Inc, 5 A.2d 503, 23 Del. Ch. 255 is a Delaware corporation law case, important for United States corporate law, on corporate opportunities and the duty of loyalty. It deviated from the year 1726 rule laid down in Keech v Sandford that a fiduciary should leave open no possibility of conflict of interest between his private dealings and the job he is entrusted to do.
Directors' duties are a series of statutory, common law and equitable obligations owed primarily by members of the board of directors to the corporation that employs them. It is a central part of corporate law and corporate governance. Directors' duties are analogous to duties owed by trustees to beneficiaries, and by agents to principals.
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 governance rights, found mostly in the Securities Act of 1933 and the Securities and Exchange Act of 1934, as amended by laws like the Sarbanes–Oxley Act of 2002 and the Dodd–Frank Wall Street Reform and Consumer Protection Act. The US Constitution was interpreted by the US Supreme Court to allow corporations to incorporate in the state of their choice, regardless of where their headquarters are. Over the 20th century, most major corporations incorporated under the Delaware General Corporation Law, which offered lower corporate taxes, fewer shareholder rights against directors, and developed a specialized court and legal profession. Nevada has done the same. Twenty-four states follow the Model Business Corporation Act, while New York and California are important due to their size.
The corporate opportunity doctrine is the legal principle providing that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation. The corporate opportunity doctrine is one application of the fiduciary duty of loyalty.
Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, was a landmark decision of the Delaware Supreme Court on hostile takeovers.
In re Walt Disney Derivative Litigation, 907 A 2d 693 (2005) is a U.S. corporate law case concerning the scope of the duty of care under Delaware law. Disney is the leading case on executive compensation.
Directors' duties in the United Kingdom bind anybody who is formally appointed to the board of directors of a UK company.
Canadian corporate law concerns the operation of corporations in Canada, which can be established under either federal or provincial authority.
Kiobel v. Royal Dutch Petroleum Co., 569 U.S. 108 (2013), was a United States Supreme Court decision in which the court found that the Alien Tort Claims Act presumptively does not apply extraterritorially.
Benihana of Tokyo, Inc. v. Benihana, Inc., 906 A.2d 114 was a case in the Delaware Supreme Court between Benihana of Tokyo, Inc., and its subsidiary Benihana, Inc. that concerned the duty of loyalty between a company and its directors. The court held that a Board's approval of an issuance and purchase of preferred stock was a valid exercise of its business judgment under Delaware law.
In re Citigroup Inc Shareholder Derivative Litigation, 964 A 2d 106 is a US corporate law case, concerning the standard under Delaware law for the duty of loyalty among directors' duties.
Shlensky v Wrigley, 237 NE 2d 776 is a leading US corporate law case, concerning the discretion of the board to determine how to balance the interests of stakeholders. It represents the shift in most states away from the idea that corporations should only pursue shareholder value, seen in the older Michigan decision of Dodge v Ford Motor.
Aronson v Lewis, 473 A.2d 805, is a US corporate law case, from Delaware concerning the possibility of a shareholder to bring a derivative suit.
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