parent nodes: abuse of control | business judgment | closely held corporation | corporation law | derivative suit | directors | duty of loyalty | fiduciary duty | purpose of corporation | right to treatment | voting control
business judgment
(a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.
DGCL § 141(a)
Definition and theory
The business judgment rule can be described as an abstention doctrine, see [Shlensky v Wrigley] (dismissing claim of fiduciary duty violations for failure to state a claim), or a substantive rule about the process directors must follow in reaching a business decision. [Cede II] (allowing inquiry into whether directors breached their duty of care, and rebutting BJR if violation found). In general, directors have broad discretion how to conduct the corporation's actions.
The business judgment encourages optimal risk taking, since it balances between risk-loving shareholders and risk-averse managers. The business judgment rule exists because liability rules are inadequate for most business situations, given that corporate actors are repeat players who internalize the costs they create from misbehavior, information is cheap, and employees have firm-specific investments in human capital that deter them from decreasing the firm's value. (In other words, capital, product, and labor markets are strong.) Note that in comparison, fraud and criminal behavior, which are more likely to be one-time occurrences, are more suitably handled by ex post liability rule. Likewise, last-period problems and fundamental transactions, since they do not allow for repeat players, may also be more suitably handled through a liability rule. Note that the business judgment rule reinforces the conception of shareholders' interests as a property rule, given that their main recourse to mismanagement is to sell their interest.
The rule also protects against hindsight bias from courts, as well as the risk of disrupting the decision process of directors as a team, since they're in a better position to make decisions.
Prerequisites for applying the BJR
The two pre-requisites for applying the rule are (1) no breach of the fiduciary duty of care and (2) no violation of the duty of loyalty. The prerequisites to apply the business judgment rule are that the directors are not self-dealing (that is, they have not breached their duty of loyalty, that the directors have not breached their fiduciary duty to the shareholders, and that there is no fraud or illegality present. A plaintiff may also shift the burden to directors to prove a transaction was "entirely fair" if the action is shown to be grossly negligent. [Cede II]. Likewise, the BJR may not apply in cases of "bad faith," which implies wrongful or tortious intent. (Dicta in [Brehm v Eisner]).
An violation of the fiduciary duty of care or the duty of loyalty is sufficient to rebut the presumption of the BJR; the directors must then show that the transaction was "entirely fair" in order to avoid liability. [Cede II]. The plaintiff need not show that he was injured by the duty's breach. [Cede II]. (allowing derivative suit against corporate sale where corporation violated fiduciary duty of care and the duty of loyalty, but transaction actually caused a gain to shareholders).
Note that the BJR is also rebutted if the directors have failed to make a business judgment at all, for example in a duty to monitor situation. [Francis v United Jersey Bank]. At the same time, if the BJR does not apply here, the plaintiffs must still show a violation of the fiduciary duty of care. [Francis v United Jersey Bank].
Shareholders may also use a statutory inspection right to inspect books and records for a "proper purpose", see DGCL § 220, if their litigation is summarily blocked by the business judgment rule. "Proper purposes" exclude fishing expeditions and political/social goals, but allow shareholders to look into the value of the firm, investigating mismanagement, [Brehm v Eisner], and proxy contests.
Note generally that a business' action should be compared:- to the relevant statutes
- to the corporation's charter
- to whether the board of directors or lower-level employees made the action (legitimately)
- to how much information the directors had
- how much consideration the directors gave the question
- the scope of the action against the corporation's size, profits, etc.
- whether a plausible business reason exists for the action (see purpose of corporation)
- note that a corporation could possibly defend its judgment by reference to the idiosyncratic values of its shareholders
See purpose of corporations
[Shlensky v Wrigley] (dismissing action against Cubs for refusing to build lights for night games for failure to state a claim, on the grounds that there was no fraud, illegality, or conflict of interest in its business decision not to do so)