Managing Business Judgment to Ensure a Smoother Operation

Figuring out how to initiate and bring to life an idea is the beginning of a corporation. Once the corporation is formed, the board of directors and officers must make many different key decisions.

Many new online business owners aren’t sure if they should incorporate, what their business structure options are, what incorporation might mean for the business, or even what they need to do to form a company. Photo: Shopify Inc.

Figuring out how to initiate and bring to life an idea is the beginning of a corporation. Once the corporation is formed, the board of directors and officers must make many different key decisions. In the process of these decisions, they may make choices which are not popular. In most cases though, they are protected through the Business Judgment Rule.

The Business Judgment Rule Generally

The Business Judgment Rule is a rule which protects the directors, and sometimes the officers, of a corporation. It creates a presumption that, when making a business decision, the directors acted on an informed basis, in good faith, and in the honest belief that the action and how to incorporate the same was in the best interest of the corporation.

The important thing to remember though is that this applies only to decisions and not to positions; therefore, it helps protect the interests of almost anyone who might be involved in the decision making process regardless of the position that they might be holding within the corporation.

The reason that this matters so much is that it offers effective protection for the directors. In most cases, this applies to the officers as well. This way they can make decisions which they feel are in the best interests of the company without the concern that they will be liable if things do not turn out well; thereby allowing them to take decisions that could otherwise be deemed as risky even though they might be vital to the success of the corporation.

However, the Business Rule does not offer total protection for all decisions. The reason behind the policy is often considered. The reason behind the Business Judgment Rule was designed to encourage risk taking and potential reward as well as to leave the business making decisions in the hands of the directors rather than having judges always second guessing them.

Additionally, it places the focal remedy as being on the shareholders who can then vote the directors out of office if things do not go well. So the risk that directors will always run into is that they may face consequences from shareholders voting them out rather than being taken to court, which is somewhat both good and bad at the same time.

When the Court Abstains

In most cases, the court follows what is known as the abstention rule when looking to a business decision. This means that the judges do not want to meddle with the inner workings of a business by second guessing the directors except for a few situations. This is generally known as abstention.

The situations in which the judges are likely to abstain from abstention; however is when the case involves fraud, uninformed decisions which reach a gross negligence standard, wholly irrational actions, and conflict of interests or director self dealing.

The most common of these is the conflict of interest or the director self dealing. These cases arise in those situations where the directors do not give out vital information that might change the board or shareholders’ decision or perception of a situation such as by hiring a family member for a key position rather than someone who is qualified; which in turn, might affect the corporation in a negative manner and put the trust of the shareholders in the corporation at risk.

The burden of proof to move past this abstention, however, is fairly high. Those bringing suit must demonstrate beyond a reasonable doubt that these facts meet the various situations, and, even then, the matter remains in the judge’s discretion. This means that the judge may choose not to hear the case regardless.

However, the Business Rule does not offer total protection for all decisions. The reason behind the policy is often considered. The reason behind the Business Judgment Rule was designed to encourage risk taking and potential reward as well as to leave the business making decisions in the hands of the directors rather than having judges always second guessing them.

Share this article

We welcome comments that advance the story directly or with relevant tangential information. We try to block comments that use offensive language, all capital letters or appear to be spam, and we review comments frequently to ensure they meet our standards. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Coinspeaker Ltd.