As an officer, or director of a company, or co-shareholder you can’t always please everyone, especially shareholders. Sometimes an unhappy shareholder sues the board of directors on behalf of the corporation. This is called a derivative 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 before us to review, the company first thinks of the business judgment rule. This defense is most frequently cited in shareholder litigation and various other director and officer liability lawsuits. The rule provides protection against many claims and demands made by minority interest shareholders. There are some important issues that clients and shareholders need to evaluate regarding this defense. This page will offer a general introduction to the business judgment rule as applied in New Jersey.
The Director’s Duty
Although shareholders own the corporation, it is the directors who are charged with the management of its business and affairs. That’s the legal obligation of a board under New Jersey corporation laws.
The business judgment rule “protects a board of directors and its officers from being second-guessed on decisions affecting business affairs except in instances of fraud, self-dealing, or unconscionable conduct.” 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 management.” 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 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 an initial burden on the person who challenges a corporate decision to demonstrate the decision-maker’s “self-dealing or other illegal or inappropriate factor”. If the challenger meets that initial burden, the burden of proof shifts to the defendant directors or officers 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, its shareholders. The breach of that duty imposes personal liability on the director and enables individual shareholders to initiate a derivative claim on behalf of the corporation, especially when the corporation is complicit in the action.
The Business Judgment Rule and Oppressed Minority Shareholders
The business judgment rule is often cited in minority shareholder oppression actions. 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. I am easy to talk to, very approachable 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