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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.
Previously published in Orange County Business
Journal
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guide to the subject matter. Specialist advice should be sought
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