The business judgment rule assumes that boards of directors act in good faith. For example, if you serve on a board in California, it is assumed that you act in the best interest of stakeholders. Therefore, board members cannot be prosecuted for their decisions unless there is significant evidence that they did not act in the company’s best interest.
Exceptions to business judgment law
The most common way the business judgment rule is broken is by considering only some material facts before making a decision. There are other ways that this law can be broken, including:
- Bad faith
- Committing fraud
- Corrupt motive
- Corporate waste
- Self-dealing
- Conflict of interest
Two guiding principles of business judgment law
When making decisions, people serving on boards of directors must remember two guiding principles. The first is the duty of care, broadly defined as avoiding actions that could hurt your customers. The second principle is the duty of loyalty which can be defined as acting in the best interest of the company and its clients whether than self-interests.
Example of business judgment law
A car manufacturer is debating shutting down a U.S. manufacturing plant because of labor costs. The vehicles they make can be made in a different country. The board of directors cannot be sued over the decision to close and relocate the plant because they considered pertinent facts before making their final decision regarding the plant closure.
Business judgment law is designed to protect the board of directors who must make challenging decisions. If the board acts responsibly, they minimize the possibility that they might be held liable for their decisions by the courts.