Business Judgment Rule – Shielding the Corporate Director From Personal Liability and Considerations of Efficient and Financially Reasonable Resolutions

The business judgment rule shields corporate directors from personal liability.  However, directors must not breach the fiduciary duties owed to the corporation.  Under Florida law, corporate directors owe fiduciary duties to the corporation and its shareholders, which requires good faith, due care, and loyalty.  The directors’ fiduciary duties are codified in Florida Statutes, section 607.0830(1):

A director shall discharge his or her duties as a director, including his or her duties as a member of a committee: (a) in good faith; (b) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (c) in a manner he or she reasonably believes to be in the best interests of the corporation.

Good faith is a deceptively simple term that means “honesty in fact and the observance of reasonable commercial standards of fair dealing.”  Fla. Stat. § 671.201(20).   The duty of due care requires directors to be attentive and prudent in making business decisions.  Further, the duty of loyalty requires directors to put the corporations’ interests ahead of their own.

While the focus of this article is on corporations, the business judgment rule also protects directors of other organizations, including community association board members and directors.  For that discussion, see James O. Birr, III’s article, The Business Judgment Rule: A Shield for Community Association Board Members and Directors.

Elements of Judicially-Created Presumption

When making business decisions on behalf of a corporation, courts presume that corporate directors act in compliance with the above-referenced statute, by acting on an informed basis, in good faith, and with ordinary care.  This presumption is judicially created and is known as the business judgment rule.   The business judgment rule is based on the premise that directors, for the most part, are more capable of making business decisions than are judges. Thus, when the rule is applicable, corporate directors will not be held liable for decisions made when conducting the business and affairs of a corporation.

Florida case law provides four elements which must be present for the business judgment rule to act as a shield to director liability:

1. the decision under review must be a business decision;
2. the director must not receive a personal benefit from the transaction;
3. the director must exercise due care; and
4. the director must exercise good faith.

F.D.I.C. v. Stahl, 854 F. Supp. 1565, 1570-1571 (S.D. Fla. 1994).  Therefore, the business judgment rule only protects directors when they are carrying out their duties as directors, (e.g., making decisions and analyzing issues as directors).

Self-Interested Directors and Breach of Fiduciary Duties

The business judgment rule is inapplicable when the director furthers his or her self-interest.  “A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders, or will suffer a detrimental impact from the proposed transaction.”  McCabe v. Foley, 424 F. Supp. 1299, 1315 (M.D. Fla. 2006).

Of course, the rule will not shield a director from liability if he or she does not carry out the basic fiduciary duties of loyalty, good faith, and informed decision making.  However, a director will not be held to breach the fiduciary duties he owes to a corporation and its shareholders when he makes decisions on an informed basis in a good faith belief that the decision will serve the best interest of the corporation.

Stated another way, the business judgment rule under Florida law will adequately shield a director from potential liability no matter how poor his business judgment.  However, poor business judgment coupled with bad faith, fraud, illegality, or oppressiveness will lead a court to disturb a board decision and hold directors personally liable.  Essentially, the policy behind the business judgment rule categorizes directors and protects a “good director,” who makes an honest mistake or has an error in judgment, but not a “bad director” who makes a bad decision and simultaneously breaches his fiduciary duties.

Practice Pointers: Taking Advantage of the Business Judgment Rule

In order to increase the likelihood that a court will find that the business judgment rule protects the directors of your company, it is important to address the board’s decision making process when making potentially controversial decisions. Corporate minutes should sufficiently reflect the board’s factual foundation for its decisions, include reports received from outside experts or management, and should illustrate the board’s contemplation of other alternatives.

Keeping Costs Down

It is important to realize that though the business judgment rule is a means of shielding a corporate director from potential liability, the protection, which it may or may not afford, often comes with a hefty price tag.  In the real word, use of the business judgment rule as a defense to director liability can prove to be both time consuming and costly.

Money spent on attorneys’ fees, discovery, investigation, and experts can lead to towering costs before the trial has even begun.  Also, when a director facing liability cites the business judgment rule as a defense, it is difficult to dispose of a lawsuit prior to trial. Several courts have resisted and questioned dismissing business judgment rule cases in a motion to dismiss.  In addition, Florida state courts generally disapprove of granting summary judgment in tort cases.

Generally, avenues for more efficient resolution are available.  One such option is mediation.  Agreeing to mediate in the early stages of a dispute, can sometimes lead to resolution at the outset, before everyone involved invests their time, money, and emotional energy in fighting the issues that the case presents.

Noticing a case for trial within 20 days after the defendant answers the complaint can also lead to a more efficient resolution.  When this is done in state court, the trial court will schedule the case for trial in an expedient manner, which will lead to early discovery and pretrial deadlines.

It is also useful to depose parties or key witnesses early rather than later in the dispute.  The discovery of pertinent information in an early deposition, before exorbitant amounts are spent on attorneys’ fees, discovery, investigation and experts, may position a case for early resolution.

Conclusion

The business judgment rule, when properly utilized, is a powerful defense to personal liability for corporate directors.  Understanding the fiduciary duties of good faith, due care, and loyalty is critical for any corporate director.  A breach of any of the fiduciary duties could leave a director personally liable for a business decision gone awry. Therefore, corporations should be mindful of how to protect their directors and themselves.

Source Reference:  James F. Carroll, The Business Judgment Rule in Florida – on Paper and in the Trenches, Fla. B.J. 80, 7 July, 2006.