Understanding the Business Judgment Rule
As an officer or director of a company, you can’t always please everyone, especially all shareholders. Sometimes an unhappy shareholder or shareholders sue the board of directors and corporate officers on behalf of the corporation alleging actionable wrongdoing or failure to act. This type of legal action is called a derivative corporate lawsuit. In response, the corporation and/or its directors hire legal representation to defend them from individual liability. When a case like this is brought to us for review, we first think of the business judgment rule. This defense is most frequently cited in shareholder litigation and involves director/officer liability. The business judgment rule provides protection against many claims made by minority shareholders against the corporation and its officers/directors. There are some important issues that need to be evaluated regarding this defense. This page will offer a general introduction to the business judgment rule as applied in New Jersey.
A Director’s Duty to Its Other Corporation
Although shareholders own the corporation, it is the directors and officers who are charged with the management and significant decisions of the company. That’s the law under New Jersey’s corporation statutes.
The business judgment rule “protects a board of directors and its officers from being second-guessed on decisions affecting business affairs except when claims of fraud, self-dealing, and/or unconscionable conduct are alleged.” One of the purposes of the rule is to “promote and protect the full and free exercise of the power of management given to the directors and officers.” The rule also serves to recruit qualified businessmen and women to serve as directors/officers who are willing to approve responsible entrepreneurial risks inherent in running a business. Generally, the business judgment rule reflects a judicial reluctance to interfere with business decisions absent a showing of bad faith. Remember, judges are lawyers and generally many lawyers are not very qualified to run the affairs of a corporation or business of which they know very little.
The business judgment rule is not absolute. Rather, it is a “rebuttable presumption” that places the initial burden on the person who challenges corporate decision makers to demonstrate that their management of the company is more about the welfare of the corporation than their self-dealing or other illegal or inappropriate influence”. If the challenger meets that initial burden, the burden of proof shifts to the director(s) or officer(s) to show that their actions were, in fact, fair to the corporation. By law, a breach of legal duties, i.e., due care, loyalty, and good faith — negates benefits that flow from the business judgment rule and permits a challenger to void an action of the board under the entire fairness standard.
Directors and officers owe a fiduciary duty to the corporation and, by extension, to its shareholders. A breach of that duty imposes personal liability on the director and enables individual shareholders to file a derivative lawsuit in the name of the corporation itself, especially when a majority of directors are complicit in the action.
The Business Judgment Rule and Oppressed Minority Shareholders
The business judgment rule is also often cited in minority shareholder oppression cases. Generally, a claim of majority oppression or freeze-out in a closely held corporation will similarly shift the burden to the corporation and its directors “to show the intrinsic fairness of the transaction in question upon the showing of self-dealing or ‘other disabling factor’. ” To learn more about minority oppressed shareholders law visit the page found on this site which discusses the law in considerable detail.
The business judgment rule can offer significant protection to directors and officers. It is not, however, absolute nor does it shield directors or officers from instances of fraud, self-dealing, or other unconscionable conduct.
Contact me personally to discuss your rights as an officer/director of a NJ company or your dissatisfaction as a shareholder with the existing Board of Directors. I am easy to talk to and can offer you practical, legal ways to handle your concerns and protect your interests and the interests of your company. You can reach me toll-free at (855) 376-5291 or email me at email@example.com
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County New Jersey Shareholder Rights Attorney