Business decisions can sometimes be unpopular with stakeholders, especially if the decisions made are particularly risky or controversial. This can potentially lead to lawsuits against the company’s board of directors – even when the board has not violated any laws or acted against its fiduciary duties.
The courts recognize that, in order for businesses to continue operations and have the autonomy to make decisions, there needs to be some protection from this type of (often) frivolous legal challenge.
What is the business judgment rule?
The purpose of the business judgment rule is to afford protection to the board of directors against baseless legal allegations made by unhappy stakeholders. It’s designed to help businesses grow, operate and make mistakes without the constant looming threat of a lawsuit.
This legal doctrine presumes that management acted in “good faith” and places the burden on the plaintiff to provide evidence to the court that a board of directors breached their fiduciary duties of loyalty, prudence and care to their stakeholders.
What are the exceptions?
The rule does not extend, however, to simply offering the board of directors complete freedom to do whatever they like. There are a number of exemptions that apply. These include the following:
- Fraud
- Self-dealing
- Criminal activity
- Unjust enrichment
- Acting where there is a conflict of interest
For a plaintiff to be successful in proving one or more of the above, they will need to present evidence to the court that the board, or a particular board member, acted in “bad faith”.
So, in answer to the question, the business judgment rule is intended to offer protection to your company board of directors in circumstances where they made an unpopular (or even incorrect) decision but were acting in good faith. A plaintiff will have to provide the court with evidence in support of their claim that the board acted in bad faith for their claim to have any chance of success.
Finding out more about your rights as a business can help you to make sure you have the right protections in place. In the event you face a lawsuit against the company or its board, understanding your options is the first step. Contact us for a consultation. We help businesses that are facing shareholder derivative actions against boards of directors.