If you are the director of a corporation with shareholders, your job is all about one concern (basically): Maximizing the profit for the shareholders over the long term. While shareholders may be the true “owners” of a corporation, they employ directors such as yourself to assist in the strategic planning and operation of the business. While many shareholders understand that directors are only human who can make mistakes – even mistakes that endanger the company or reduce its value – some shareholders are not quite so forgiving. Luckily, even when a lawsuit is brought against a director or proceedings are commenced to replace one or more directors because of a bad decision made, the “business judgment rule” operates to protect these directors.
What is the Business Judgment Rule?
Recognizing that they themselves are not business people and do not generally have experience in operating business entities, judges will typically defer to the business decisions made by directors and assume that the decisions they make are reasonable and appropriate. This is true even where the decision is determined to be based on false or erroneous data, does not produce the profit the directors and shareholders may have wanted or expected, or even causes harm to the short- and/or long-term viability of the company.
For example, suppose that the directors of ABC Corp. are approached by a sales professional from XYZ Company. The sales professional offers to sell ABC Corp. a large tract of land that can be developed and used for expanded business operations. The sales professional represents to the directors of ABC that XYZ has clear title to the land and that there are no concerns or issues that would prevent ABC from immediately developing the land.
Based on the sales professional’s pitch, ABC purchases the land only to discover that the land is not as desirable as XYZ’s sales professional warranted it to be. There are a number of encumbrances on the land and the soil would not support large, heavy machinery and buildings. The directors discover that they will need to pay a significant amount of money to improve the land and make it useable (this on top of the sizeable amount they have already spent to purchase the land from XYZ). Shareholders get wind of the issue and are not pleased. Several get together and bring suit against the directors who participated in the decision.
Business Judgment Rule Protects Reasonable Decisions
So long as all of the directors named in the suit took reasonable steps to investigate the offer being made by XYZ and made a reasonable decision based upon the data and facts available to them at the time, the business judgment rule will protect the directors from legal repercussions. This is true even if ABC loses money on the land deal. The key is reasonableness: A director or officer who fails to investigate a matter before acting or who takes unnecessary risks may not be protected by the business judgment rule.
If you find yourself embroiled in a business law dispute or need experienced legal advice about a business matter, contact the Law Office of John C. Grundy today by calling (33) 637-9030 or contacting us through our firm’s website.