Bad Faith And Business Judgment

Can The Director Of A Company Be Held Liable For Any Mistakes Made On His Or Her Watch?

Although directors theoretically can be held liable for any mistakes made on their watch, there is a high legal standard for proving individual liability. To successfully defend themselves, directors need only show that their decisions were the result of their valid “business judgment,” made in good faith and not recklessly.

Corporation statutes protect directors who, in discharging their duties, rely in good faith on information presented to the company by a professional about matters the directors reasonably believe are within that person’s professional competence. Directors should have the intricate or technical matters explained to them by a knowledgeable expert, and the minutes or other record should indicate this.

How Is The Business Judgment Rule Interpreted By State And Federal Courts?

Historically, the business judgment rule presumed that directors of corporations making decisions on behalf of shareholders were correct if they acted (1) in good faith, (2) on an informed basis, (3) in a disinterested manner, (4) with due care, and (5) without discretion or waste. If these criteria were met, directors’ fiduciary obligations were satisfied and they could not be held personally liable.

To overcome this presumption, challengers were forced to show that a director had acted in a grossly negligent manner or had a conflict of interest, but directors could then overcome the latter charge by showing that they had informed the board of their interest and that their actions had served the best interests of the shareholders.

How Is “Good Faith” Defined In The Business Judgment Rule?

Since the law presumes that directors act in good faith when making business judgments, it is probably easier to define bad faith rather than try to pin down the contours of good faith. Bad faith has been defined as authorizing a transaction for some purpose other than a genuine attempt to advance corporate welfare or when the transaction is known to constitute a violation of applicable positive law. Bad faith can also be found when a corporate officer engages in a systematic or sustained shirking of duty

Mere ignorance, in and of itself, probably will not constitute bad faith. Directorial inaction will not be given the protection of the business judgment rule unless it is a reasoned and conscious decision not to act. However, even though plaintiffs may be able to demonstrate that directorial inaction is a breach of the duty of care and should not be afforded the protection of the business judgment rule, to get monetary damages they will need to get past the protection afforded by Section 102(b)(7). A single and isolated failure to act, though not covered under the business judgment rule, may not be enough to constitute bad faith.

Is The Business Judgment Rule Interpreted Differently Depending On The Current Business Climate?

The corporate law doctrine of the business judgment rule is curiously protean in judicial interpretation. During “good” times, courts typically adopt a robust vision of the business judgment rule and pay maximum respect to the principle of board authority. On the other hand, during periods of market decline and with the emergence of highly publicized corporate scandals and their resultant extralegal pressures, judicial review of board decision making increases. However, once the crisis defuses and the pressure recedes, courts return to their position of board deference.