Business Judgment Rule

Impact

The business judgment rule prevents courts from second-guessing management decisions and from interfering with management prerogatives. This is especially important in a capitalistic system as a way to provide an incentive to officers and directors to take the necessary risks preferred by shareholders and to create wealth for society. Mistakes sometimes occur when taking risks, but officers and directors would avoid risk taking entirely if they were to suffer personal liability from any mistake. They would then operate fearing litigation at every step.

Historically, Delaware courts have accorded more protection to management than to shareholders, especially during the wave of takeovers during the 1980s. It is more difficult today, however, for directors to invoke the veil of protection of the business judgment rule, due to recent judicial applications that have tightened the legal demands on officers and directors. Courts today more closely scrutinize potential violations of fiduciary duty by officers and directors.

Elements of the Business Judgment Rule

The elements of the business judgment rule are loyalty, candor, care, and good faith. The business judgment rule presumes that officers and directors abide by these elements, but the presumption is rebuttable and can be overcome by evidence in court. These are the elements of fiduciary duty, and the breach of any such duty can create personal liability for an officer or director. While good faith is an element of other duties, such as loyalty and care, courts increasingly see it as a separate duty, especially as corporate charters have eroded the significance of the duty of care.