Corporate directors are responsible for making decisions that can cost shareholders a lot of money. These costs can be imposed by bad decisions, of course, but they can also be imposed by good decisions that don’t satisfy everyone. If a director could be sued in his personal capacity by any shareholder who disagreed with his decisions, few people would dare to act as a corporate director. The business judgment rule limits the personal liability of directors.
The Duties and Liabilities of Corporate Directors
Two broad principles govern the decision making of California corporate directors:
The fiduciary duty of loyalty: A director must act with loyalty to the corporation, not his personal financial interests. A director is not allowed to use corporate resources for his own benefit (beyond his salary) even if the corporation is not thereby harmed.
The fiduciary duty of care: A director must exercise diligence, competency, and “good faith” (laudable motivations) when making corporate decisions.
Breach of either of these duties can subject a director to personal liability.
The California Business Judgment Rule
The business judgment rule is designed to prevent shareholders and courts from second-guessing the decisions of corporate directors. It serves as a counterweight to, and to an extent a restatement of, the potential liability that directors face for breach of their fiduciary duties. Under the California business judgment rule, a director cannot be held personally liable if the following conditions are met:
The director acted on an informed basis;
The director acted in good will; and
The director honestly believed that the decision at issue was in the corporation’s best interests (regardless of whether it actually was or not).
If a director is sued by a shareholder, the director can assert that he complied with the business judgment rule and ask the court to dismiss the lawsuit. This is without ever reaching the question of whether the director’s decision was right or wrong under the circumstances.
Although the business judgment rule can be overcome, in a civil lawsuit it, is the party asserting director liability who has the burden of proving, under a “more likely than not” standard, that the business judgment rule does not apply to the dispute. Some examples of loopholes through which liability has been successfully asserted include:
Establishing that the director violated his fiduciary duty of loyalty or care. A major red flag occurs if the director personally benefited from a decision he made (he gave himself a raise, for example).
Establishing that the director’s decision wasted corporate resources, even if no violation of the duties of care and loyalty occurred.
Once a plaintiff has submitted evidence that the business judgment rule does not apply to his claim, the director can still put forth evidence that his decision was right (because it was reasonable and fair, for example). This time, however, the burden of proof will be on the director, not the shareholder.
Here at CKB Vienna, we understand the difference between the “lawyer’s solution” to a business problem and a more effective business solution that takes into account surrounding circumstances and business realities. We stand ready to help you craft a tailor-made solution to your problem. Call us at 909-980-1040 or contact us online to schedule a consultation in our Rancho Cucamonga Office. We serve clients all over town including Alta Loma and Etiwanda.