The business judgment rule is why most claims against directors and managers fail, and understanding it explains what a viable claim has to look like.
What it is
A presumption that in making a decision, directors acted on an informed basis, in good faith, and in the honest belief that the action was in the company’s best interests. Where it applies, a court will not second-guess the substance of the decision — including decisions that turned out badly.
The rule protects the process, not the outcome. Business involves risk, and a standard that punished losses would make no one willing to serve.
How it is overcome
Not by showing the decision was wrong. Generally by showing one of:
- Lack of independence or a conflict. A director on both sides of the transaction is not disinterested, and the presumption does not attach.
- Failure to inform. A decision made without reasonable inquiry into the material facts.
- Bad faith. Conduct that cannot be attributed to any rational business purpose, or conscious disregard of a known duty.
- Waste. A transaction so one-sided no rational person would agree to it.
What follows for a claim
The work is in the facts around the decision rather than the decision itself: who was in the room, what they were told, what they were not told, what the minutes record, who stood to gain, and whether an independent process was used where a conflict existed.
What follows for a board
Document the process. Get the information, record that you got it, and where a director has an interest, have the disinterested members decide without them. The protection is real, and it is earned by procedure.