The business judgment rule provides that the courts and even the stockholders will generally not interfere with or substitute their judgment for the honest business decisions of the board of directors made in good faith and within the scope of their authority. The rationale is that directors are chosen to manage the corporation, and decisions made honestly, prudently, and in the corporation's interest should not be second-guessed merely because they turned out to be unwise or unprofitable in hindsight. Two consequences follow: resolutions and acts of the board within its powers cannot ordinarily be reversed by the courts, and directors are generally not liable for losses resulting from mere errors of judgment. However, the rule has important exceptions. It does not protect directors who act in bad faith, with gross negligence, with fraud, or where there is a conflict of interest or self-dealing (such as directors profiting personally at the corporation's expense). In such cases, directors can be held personally liable, and their acts can be set aside. The rule protects honest business judgment, not misconduct.
The Rule
Courts and stockholders will generally not interfere with the honest business decisions of the board made in good faith and within its authority. Directors are chosen to manage.
The Consequences
- Board resolutions within its powers cannot ordinarily be reversed by courts; and
- Directors are generally not liable for losses from mere errors of judgment.
The Exceptions
The rule does not protect directors who act in bad faith, with gross negligence, fraud, or where there is a conflict of interest or self-dealing. Then they can be held personally liable.
Practical Takeaways
- Honest, good-faith business decisions are not second-guessed by courts;
- Directors aren't liable for mere errors of judgment;
- Bad faith, fraud, or self-dealing removes the protection.
Frequently Asked Questions
What is the business judgment rule? The principle that courts and stockholders generally will not interfere with or substitute their judgment for the honest business decisions of the board made in good faith and within its authority.
Are directors liable for a decision that caused losses? Generally not, if the decision was an honest error of judgment made in good faith. Directors are not liable for losses from mere errors of judgment under the business judgment rule.
When does the rule not protect directors? When they act in bad faith, with gross negligence or fraud, or where there is a conflict of interest or self-dealing. In such cases, directors can be held personally liable.
Can a court reverse a board decision? Ordinarily no, if the decision is within the board's powers and made in good faith. But acts tainted by bad faith, fraud, or conflict of interest can be set aside.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
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