Doctrine of “Business Judgment Rule”

In the Company laws, there are clear provisions to govern all types of companies including all necessary details according to the merits of each case. However, with reference to Public Joint Stock Companies, there are special details regarding the role of the Board of Directors and, also, Directors (and officers), because they have the necessary powers to manage the company on behalf of the shareholders. Herein, they are liable if they commit mistakes in gross negligence.

A question arises here, are they liable in all cases all through?

In answering the question, we say that, they are not liable for mere errors of judgment when they act with due care and in good faith. This is, what is called in legal literature, “the business judgment rule”.

This rule precludes the courts from substituting their business judgment for that of the companies’ managers. In short, the rule protects Directors and even officers from personal liability for honest mistakes in judgment. As this could normally and easily happen at any time to any human being. No one, is fully free from errors.

However, in order to obtain the protection of the business judgment rule, the directors and officers must meet three requirements in arriving at their decision in question. This includes an informed decision, non- conflict of interest and rational basis.

Firstly, they must make an informed decision and herein they may rely on information collected and presented by other persons and assistants. Secondly, the decision makers must be free from conflicts of interest. Any self-dealing on the part of the directors or officers in the course of making the decision would deprive them of the shelter provided by the business judgment rule. Thirdly, the board of directors must have a rational basis for believing that the decision is in the best interest of the company. Generally, this means that the decision must not be “manifestly unreasonable.”

In many cases the courts hold that the directors’ decision is not rational if their actions amount to “gross negligence.” If the business decision violates any of these requirements, the directors or officers are stripped of the protection provided by the business judgment rule. Courts would then feel freer to substitute their judgment for that of the corporate company decision makers.

Further, if the court found the decision to be unwise or unacceptable by applying the “reasonable man” test, the directors or officers would be liable unless they could prove that the transaction at issue was intrinsically fair to the interest of the company.

Legally speaking, it would be advisable for all involved in management issues in companies, to take utmost care with due diligence in every action they are taking. This would bring better results for themselves and their companies. Be wise, if not sure, talk to your assistants, knowledgeable advisors or even experienced colleagues. “Wisdom” helps in all instances.

(The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Daily Tribune)