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Business judgment rule
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Related areas of law
Contract · Civil procedure

The business judgment rule is a case law-derived concept in Corporations law whereby a court will refuse to review the actions of a corporation's board of directors in managing the corporation unless there is some allegation of conduct that (1) violates (a) the directors' duty of care, (b) duty of loyalty, or (c) duty of good faith; or (2) that the decisions of the directors lacks a rational basis. Courts often analyze the rational basis requirement as part of the director's duty of good faith. (It remains unclear whether the duty of good faith is a separate duty. The Delaware Supreme Court's decision in Disney did not clarify the issue.)

In effect, the business judgment rule creates a strong presumption in favor of the Board of Directors of a corporation, freeing its members from possible liability for decisions that result in harm to the corporation. In short, it exists so that a Board will not suffer legal action simply from a bad decision. As the Delaware Supreme Court has said, a court "will not substitute its own notions of what is or is not sound business judgment" (Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)) if "the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." (Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971))

The rationale for the rule is the recognition by courts that, in the inherently risky environment of business, Boards of Directors need to be free to take risks without a constant fear of lawsuits affecting their judgment. See, for instance, Gagliardi v. TriFoods Int’l Inc., 683 A.2d 1049, 1052 (Del. Ch. 1996) (setting out rationale for the rule).

The presumption raised by the Business Judgment Rule may be rebutted by the plaintiff. Rebuttal typically requires a showing that the defendants violated duty of loyalty, care, or good faith. If the plaintiff can show that an action should not be protected by the business judgment rule (such as for violation of duty of loyalty or care), then the burden will shift to the defendant to show that the action meets the higher burden of entire fairness.

In addition, even if there is no duty violation, acts constituting waste are not protected by the business judgment rule.

Some Board decisions lie outside the business judgment rule. For instance, in the takeover context, courts will apply the more stringent Unocal test, also called intermediate scrutiny.

Example.

The following test was constructed in the opinion for Grobow v Ross Perot 539 A.2d 180, Del. 1988, as a guideline for satisfaction of the business judgment rule. Directors in a business should:

• not involve self-interest
• act on an informed basis
• act in good faith
• act in the best interests of the corporation