The business judgment rule

I’m a director of a corporation and I’m concerned about making a bad business decision on behalf of the company. Can I be held personally liable for a poor business deal?

Directors of corporations owe a duty to exercise good business judgment, using the care an ordinary person would use under the same circumstances. If a director acts negligently, they can be held liable for violating that duty of care.

Directors are obviously not required to guarantee the success of the corporation. In most cases, a director will not be liable for their business decisions as long as they performed their duties in good faith, with the same care an ordinarily prudent person in the same situation would use and they are acting in the company’s best interests.

This liability protection comes from what’s called the “business judgment rule.” If a director exercises reasonable diligence and makes an honest mistake or error in business judgment, that director is usually protected from liability.

The business judgment rule is difficult to overcome, and most courts will not interfere with directors unless they have committed fraud, misappropriation or some other kind of grossly negligent activity.

A good example of breaching the duty of care would be if a director wasted corporate assets by overpaying for something, such as a piece of property or a consultant. Paying a few thousand dollars more for a building than it’s worth probably wouldn’t be a big deal, but if you’re spending tens of thousands or hundreds of thousands of dollars more, that’s an issue.

It’s also a problem if the building’s owner and director are related. Any time a director makes a decision that involves a direct self-interest, it could overcome the business judgment rule protections. The rule protects directors from bad business decisions, not decisions based on self-dealing.

Directors do have a right to rely on information from others in making their decisions. If a director receives an opinion from an attorney, financial data from an accountant or a report from a professional consultant, the director may rely on that professional’s information.

So if you hire an expert to give you advice about purchasing a building, and you believe that the expert is reliable and competent you may rely on their advice when making a business decision. Now, in the situation above, with the overpriced building, if you fail to ask reasonably appropriate questions, like whether the building is priced appropriately, you may not be acting in good faith.

Mary Luros is a business law attorney with Hudson & Luros, LLP, in Napa, and can be reached atmary@hudsonluros.com. The information provided here is not legal advice, nor does it form an attorney-client relationship with the author. The author makes no representations as to the reliability or accuracy of the above information.