What is the business judgement rule?

It’s a principle of corporate law that protects board directors and other corporate leaders from legal liability or “frivolous lawsuits” should their actions negatively impact a corporate stakeholder. 

But remember, they need to have acted according to their fiduciary duty, in the shareholders’ best interests.

• Directors must have committed an action “in good faith” for the rule to apply. In other words, the director(s) needs solid reasoning for making a decision the way they did. 
• If there is any provable instance of fraud, breach of fiduciary duty or other legal pitfall, the director can’t rely on the rule as a defence. 
• The rule doesn’t apply everywhere, and in the countries it does apply, it may not be a “law” – merely a legal doctrine or precedent.

No board is perfect and no board can please everyone. Occasionally, directors may need to make tough decisions that cause some investors to lose our. Or they may simply get a crucial decision wrong. It’s part of the job, even if it’s bad for the business. 

The problem is that board members act in shareholders’ interests, not their own. So, bad board decisions impact shareholders’ finances, how far can their anger go? Could it escalate to legal action?

It depends. But the business judgement rule is often key to board members’ defences.

It usually applies in all cases unless there is a proven reason for it not to apply. 

In cases where the business judgement rule is needed, there are usually one or more disgruntled investors or other stakeholders, who have lost out due to a board decision. 

As long as the director(s) can show sound reasoning for a business decision – one that complies with fiduciary duty – they are protected by the business judgement rule.

When there has been proven wrongdoing. Examples include:

• Fraud
• Letting a conflict of interest impact a decision. 
• Gross negligence 

The first two above require extensive legal action in court cases that could take years. The last, therefore, is the channel most stakeholders to hold a director responsible. In this instance, if they can prove that the director(s) failed to use all information available, properly consider it, or use sound judgment to decide based on it, then they might have a case that can bypass the business judgement rule.

An old assumption is that the business judgement rule is primarily for common law jurisdictions (usually states with a historical connection to the British empire). However, you’ll find it in many other countries too. 

Examples of where you can come across it include:

• The United States
• Canada
• Australia
• Germany
• Portugal
• Romania
• Croatia
• Greece

In these places, the rule is codified to some extent. In other places, aspects of the rule simply arise within the legal system, as in India. 

Remember though, the rule applies differently in every country. The threshold for what qualifies as a “good faith” decision will vary, effecting a director’s ability to depend on the business judgement rule.