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The Business Judgment Rule: A Self-Defense Tactic for Corporate Officers and Directors

By Richard D. Worth |

As the driving force behind a company's success or failure, corporate officers and directors are bestowed with broad powers under Missouri law. Nonetheless, these individuals owe certain duties and responsibilities to the corporation and its shareholders. For instance, officers and directors owe a fiduciary duty of loyalty, which is governed by the same rules that apply to trustees and agents. Officers and directors breach this duty when they profit by virtue of their position at the expense of the corporation or the rights of the stockholders. An officer or director will not be permitted to retain any secret profits made by him or her in breach, or in disregard, of the fiduciary relation. In addition, Missouri courts have held that the fiduciary duty of loyalty generally imposes an obligation on officers and directors to avoid conflict-of-interest transactions.

In addition to their duty of loyalty, officers and directors of a corporation are required by law to perform their obligations in accordance with a minimum standard of care. Missouri courts generally apply the duty of care in cases involving alleged negligence, mismanagement or intentional decisions to commit unlawful acts. Cases involving fraud, self-dealing and conflicts of interest generally are covered under the duty of loyalty.

The standard of care for officers and directors is derived from Missouri common law and state statutes. However, this standard is tempered to a large extent by what is known as the "business judgment rule," which protects corporate officers and directors from liability for intra vires decisions within their authority made in good faith, uninfluenced by any other consideration than the honest belief that the action subserves the best interests of the corporation. The business judgment rule recognizes that officers and directors are not prophets who can ensure a company's success, and therefore the legal system should not punish a prudent officer or director if he or she mistakenly makes a poor decision. The rule therefore precludes courts from interfering with the decisions of corporate officers and directors absent a showing of fraud, illegal conduct, an ultra vires act or an irrational business judgment. Stated another way, the rule creates a shield from liability for decisions made in good faith that are ultimately unfavorable for the corporation and its shareholders. Under the business judgment rule, a decision will not be disturbed unless the judgment is exercised in an arbitrary and capricious manner or contrary to the bylaws or majority stockholders' action.

The rationale behind the business judgment rule requiring illegal, ultra vires or fraudulent acts, or that the business judgment of the board be exercised unfairly or in a dishonest manner, is that such acts cannot be ratified by shareholders. Importantly, a director's motivation is different than whether there was a rational basis for a decision. Poor judgment, however motivated, does not equate to fraud or irrationality. Similarly, an illegal act is limited to one expressly prohibited by statute or against public policy. An act of a corporation is ultra vires, or beyond its power, when the act is outside the objects for which the corporation is created as defined in the law of its organization.

Because of the business judgment rule, Missouri courts generally will not hold a corporate director or officer liable for mere negligent mismanagement untainted by self-dealing. However, there are a number of situations where the business judgment rule does not apply — for example, where no decision was made, or where directors have a conflict of interest, or where directors failed to take sufficient care to inform themselves before making a decision.

Even when the business judgment rule controls, an officer or director is liable for a good-faith error if that error amounts to gross negligence. Missouri courts generally agree that the degree of care required of an officer or director is the degree of care an ordinarily prudent person would exercise in a like position under similar circumstances. An ordinarily prudent person "in a like position" has been interpreted to mean an ordinarily prudent person who was an officer or director of the particular corporation. The phrase "under similar circumstances" has been interpreted to mean that a court should take account of the officer's or director's responsibilities in the particular corporation, the information available at the time, and the individual's special background knowledge or expertise.

At Weiss Attorneys at Law, P.C., we utilize our knowledge and experience in business to provide guidance to our clients in all facets of corporate governance. If we can be of assistance, please contact Weiss Attorneys at Law, P.C. at 314-588-9500, by email at law@weisslawstl.com or online. BIG FIRM EXPERIENCE. Small Firm Accountability.

Richard D. Worth is an attorney with Weiss Attorneys at Law (www.weisslawstl.com). His practice primarily includes representing individuals and small and medium-sized businesses in commercial litigation, employment law, employment discrimination, real estate, securities and consumer protection. He represents clients in state and federal courts as well as arbitration. Richard also represents plan participants and plan sponsors in ERISA litigation. He can be reached at 314-588-9500 or rworth@weisslawstl.com.

 

Submitted 3 years 263 days ago
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