Business Judgment Rule: Having Poor Business Judgment Isn’t a Tort
November 22, 2016 | By Rad Wood
As a business attorney who represents investors, startups, and companies of varying sizes I often hear stories about company mismanagement by directors, officers, and executives. And while some of the stories are riddled with hearsay and rumors, it is not uncommon for the protesting party to have a valid gripe. Unfortunately, the truth is that poor business management is rather ordinary—we lawyers are not immune from this either.
While I listen intently to my clients, jotting down notes as they vent about the most recent injustice they have had to endure, I measure each allegation I hear against three words: Business Judgment Rule. Most clients have never heard of this legal doctrine before, and based upon its plain meaning one would not be faulted for believing that it may actually help a potential plaintiff address the poor judgment of a company executive. The opposite, however, is true.
The Business Judgment Rule protects company management from Monday-morning quarterbacks. The rationale behind the rule is to shield those individuals that owe fiduciary duties to a Company (directors, officers, executives) from fear of a lawsuit each time they make a decision that in hindsight might end up being bad for the company. In doing so, the Business Judgment Rule sets the bar by which a business decision is measured rather low—was there any logical or reasonable basis for the CEO’s decision? If the answer is yes, it is unlikely you will be able to hold the CEO accountable in a court of law. Unless you can prove the CEO did something more than just make a bad decision.
After a client has finished listing the CEO’s improper acts and explained all the ways he or she has hurt the company, I ask several questions about those statements—(a) do we have any proof the CEO made a decision for his own personal benefit or the benefit of friends and family? (b) did the CEO have a conflict of interest that he or she did not disclose at the time of making the decision? And (c) was the CEO’s act made in such a way as to intentionally harm the Company? If the client cannot provide a yes answer to one of these questions, I tell them we are going to have a tough time moving forward. And if the answer is yes, but the client doesn’t have proof to support that yes, then I tell them we will have a tough time proving up the case.
This doesn’t mean parties should shy away from pursuing breach of fiduciary duty, fraud, and/or misappropriation cases. It simply means parties must have a realistic understanding of the uphill battle it can take to hold executives accountable for their poor business judgment. It’s not tortious to be dumb or wrong. It takes a lot of evidence and time and, not infrequently, experts to prove that your CEO acted in a way that was not only stupid, but intentionally hurt the company, or was purposefully done to benefit the CEO or his friends/family.