When Does the Business Judgment Rule Protect Directors and Officers from Liability? - Romano Law

When Does the Business Judgment Rule Protect Directors and Officers from Liability?

When Does the Business Judgment Rule Protect Directors and Officers from Liability?

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The Business Judgment Rule is a long-standing principle that is intended to protect directors and officers from liability arising from decisions they make in their corporate capacities.  Generally, a court will defer to the decision of a director or officer as long as their decision was made in good faith and with a degree of care which an ordinarily prudent person in a like position would use under similar circumstances.  However, there are exceptions to the Business Judgement Rule which can leave directors and officers vulnerable to lawsuits.

Rationale for the Business Judgment Rule

The Business Judgment Rule provides a presumption that a director or officer acted appropriately and in the interests of the company.  The principle underlying the rule is to allow these persons to make business decisions without fear of frivolous lawsuits.  Courts do not want to meddle with the internal management of companies and are often ill-equipped to evaluate whether complex corporate decisions are correct.

Common Claims Invoking the Business Judgment Rule

Typically, the Business Judgment Rule is used as a defense to shareholder lawsuits alleging that a decision of a director or officer violated their duty of care to the corporation and resulted in a financial loss or other damage to the company.  Some common examples include changing product lines of the business or paying too much under a contract, but it can apply to many different situations.

In addition, lawsuits against co-op and condominium board members by unit owners frequently involve the Business Judgment Rule.  Board decisions are often contested by unit owners who claim board members did not act properly.

Burden of Proof

In a lawsuit against a director or officer, the Business Judgment Rule is asserted as a defense.  If the court agrees that the presumption applies, the burden of proof shifts to the plaintiff to show the rule does not apply.

The Business Judgment Rule does not apply where there is proof of:

  • Fraud or bad faith
  • Gross negligence
  • Conflict of interest
  • Self-dealing
  • Decision making tainted by discriminatory considerations 
  • Actions that exceed the director’s authority under the relevant corporate bylaws

Minimizing the Risk of a Lawsuit

Although the Business Judgment Rule is a deterrent against lawsuits, it may not prevent them entirely. Best practices for companies, directors and officers include the following:

  • Seek professional advice.  Section 717 of the New York Business Corporation Law permits a board director “to rely on information, opinions, reports or statements including financial statements and other financial data.”  Accordingly, board members should engage relevant professionals such as accountants, attorneys, engineers, and others in the decision-making process, particularly if the issue is contentious or controversial.
  • Be honest and transparent.  Directors and officers should make all necessary disclosures especially if there may be a conflict of interest or the appearance of a conflict of interest.  In addition, they should document the reasons for their decision.
  • Obtain multiple opinions.  It may be helpful to solicit expert opinions on an issue or provide opportunities for shareholders to comment on an issue.  If a board is awarding a contract, they should seek bids from multiple parties.

Claims involving the Business Judgment Rule are fact-specific and require an in-depth analysis of the actions of a director or officer.  Whether you are a possible plaintiff or defendant, an experienced attorney can assess your claim or defense and advocate for your rights.

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This Blog is made available by Romano Law PLLC for general informational and educational purposes only, not to provide specific legal advice. By using this Blog you understand that there is no attorney client relationship between you and Romano Law PLLC or any individual contributor. You should consult a licensed professional attorney for individual advice regarding your own situation.

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