Business leadership can be rewarding, but it undoubtedly has its challenging moments. In those times, senior executives and directors are expected to do their best to make the decisions they feel are right for the business. These decisions frequently have positive results. In some cases, however, they don’t, and the fallout causes harm to the company.
Whether a business can hold those in leadership positions responsible for the outcome of bad decisions has been the subject of much debate. To resolve disputes about who should be liable when business decisions turn out badly, some lean on a judicial doctrine known as the “business judgment rule.”
If you run a business and are worried about the aftermath of a questionable decision, it’s important to understand this common defense and what it could mean for the future of your company.
What Is the Business Judgment Rule?
The business judgment rule is a judicial doctrine based on the idea that corporate executives shouldn’t have to worry about lawsuits arising from their business decisions and transactions. It operates on the assumption that executives take action in good faith, sincerely believing that what they’re doing will ultimately help the business and benefit stakeholders.
This doctrine holds that even when decisions don’t turn out as favorably as intended, it isn’t the court’s role to interfere with, review, or question them.
Business Executives and Their Fiduciary Duties
The business judgment rule is bolstered by the fact that a company’s senior executives and board of directors have a fiduciary duty to the business. That is, they’re beholden to act in a way that will benefit the company. Board members of Houston businesses generally have three types of fiduciary duties:
- Duty of Care: Board members and officers must exercise reasonable care in seeking out necessary details to make informed decisions.
- Duty of Loyalty: Board members and officers must place the interests of the company and its shareholders above their own.
- Duty of Obedience: Board members and officers must follow the law and the corporation’s governing documents and act within the scope of their authority.
Business executives must uphold these fiduciary duties in every decision they make. Otherwise, they can be held personally liable for the outcomes of those decisions.
Business executives must act in good faith when making decisions that will impact the business. This is one of the central premises of the business judgment rule.
How the Business Judgment Rule Impacts Houston Executives
Offers Protection
The business judgment rule is intended to protect business executives and board members from the outcomes of business decisions and transactions made in good faith and within the scope of their authority. The doctrine acknowledges that not every decision will ultimately work out for the best, even when all the data suggests that the results should have been positive. It shields business leaders from frivolous lawsuits alleging that they’ve breached their fiduciary duties and should pay when their business moves don’t go as planned.
Allows for Growth
Running a business often requires executives to make unpopular decisions and always involves some level of risk. While that risk can be mitigated, it can’t ever be completely eliminated. Regardless, businesses must continue moving toward their goals and objectives, even when some are uncomfortable with what’s happening.
When business executives fear that they could face a lawsuit for every decision they make, they could become less likely to take risks that might ultimately lead to growth and innovation. Under the protection of the business judgment rule, executives are emboldened to act and try new things that promise to benefit the venture.
Keeps Decisions Within the Scope of the Business
The basic premise of the business judgment rule is that the courts should rule only on legal matters and that business decisions should be made by knowledgeable and experienced directors and executives who truly understand their impact. In this way, the rule keeps decision-making in the boardroom and out of the hands of those who don’t have the necessary information and experience to act in the company’s best interests.
Are you curious about whether the business judgment rule applies to your situation? The attorneys at The Weisblatt Law Firm, PLLC, can help you find the answer. Call us today at (713) 666-1981 for a free phone consultation.
Exceptions to the Business Judgment Rule
The business judgment rule protects Houston business executives acting in good faith to set the company on a path toward consistent growth. However, it doesn’t excuse every decision that board members and executives make.
There are certain situations in which the rule doesn’t apply and likely won’t hold up in court, including the following:
Ultra Vires
In some cases, an executive may make a poor decision while acting outside the scope of their authority. This type of transgression is known as “ultra vires,” which is Latin for “beyond the powers.” For example, a director can’t decide to enter into a contract without the board’s approval. The powers of every executive and director must be outlined in the company’s bylaws, which ultimately determine whether they acted beyond their authority.
Illegal Actions
The business judgment rule can’t be used to justify illegal or fraudulent business decisions. If a business executive or director breaks the law, they can’t claim that their actions were in the best interests of company stakeholders.
Corrupt Motivations
Business executives also can’t make decisions that are self-dealing or represent a conflict of interest. For example, an executive might take a loan from the company’s funds without authorization or repayment terms or receive a bonus that can’t be justified by performance or industry benchmark data.
When executives commit actions like these, they’re no longer acting in the company’s best interests. They’ve breached their fiduciary duty of loyalty, and the business judgment rule no longer applies to the situation.
Gross Negligence
Lastly, business executives must not forget that there’s a fiduciary duty of care associated with their roles. As such, it’s essential to review all necessary data, reports, and information associated with a decision before making it. Without this crucial step, the decision may be deemed reckless, and the executive likely won’t receive any protection from the business judgment rule.
Consult a Qualified Business Attorney for Tailored Guidance
The business judgment rule has a broad scope, and it isn’t always clear whether it applies in a given situation.
It’s not enough to take an executive to court because their decision harmed your business. To overcome this defense, you must prove that they took illegal action, acted with gross negligence, or otherwise abandoned their fiduciary duties. Doing so often requires extensive evidence, which is why working with a business attorney is key.
A legal professional skilled in handling complex business litigation cases can help you anticipate legal challenges, identify potential exceptions, and present evidence effectively, improving your chances of a successful outcome.
Do you need help protecting your business from negligent decision-makers? Contact The Weisblatt Law Firm, PLLC at (713) 666-1981 to set up a free phone consultation with a knowledgeable business attorney.
Attorney Andrew Weisblatt
Mr. Weisblatt has practiced continuously since becoming licensed in 1992 and has represented businesses ranging in size from one person start-up ventures to multi-national corporations employing hundreds of people in multiple countries. From 2005 through 2009 Mr. Weisblatt was in-house counsel and chief operating officer of a multi-national corporation in the steel products industry. That in-house position provided valuable insight into how businesses work and what they actually need from their lawyers – both in-house and outside counsel. Attorney Bio
