DEFINITION of 'Business Judgment Rule'

The business judgment rule is a  legal principle which grants directors, officers, and agents of a company immunity from lawsuits relating to corporate transactions if it is found that they have acted in good faith. The rule assumes that a company’s officers act in the best interest of the company when making decisions.

BREAKING DOWN 'Business Judgment Rule'

Corporate executives and other managers are tasked with making decisions that can be complex, and that can have long-term implications for the health of the company. Often, officers are making decisions without perfect information, and must estimate the impact that the decisions will have. Sometimes, decisions such as a merger with another company or acquisition of a competitor, may ultimately result in financial loss.

Good Faith Actions

The business judgment rule provides some cover for these decisions. It is used by courts to determine whether an officer or director of a company should be held liable for his or her actions. Generally, the principle grants immunity for liability if it is found that the officer acted in good faith, with the care that an ordinary person would take if faced with the same situation, and in what the director reasonably believed was in the best interest of the company.

This legal principle creates a presumption of innocence in court cases, but can be overturned if it is found that an officer did not follow the three basic guidelines. For example, a company’s executive board may accept an acquisition offer that is less than the fair market value of the company. If it is determined that the officers hurried the decision or did not adequately complete the duties assigned to them, the courts may strip their immunity.

The courts may also remove the immunity if it is determined that the officer acted in self-interest. For example, an officer who is granted a position with an acquiring company if he or she accepts a lower bid would not be acting in the best interest of the company.

In deciding business judgment cases, courts apply the Aronson rule (from the case Aronson v. Lewis, 473 A.2d 805, 814, Del. 1984) for two tests which must be met, according to business attorney Steven Goldberg. "The complaint must allege particularized fact that establish a reasonable doubt that “(1) the directors are disinterested and independent [or] (2) that challenged transaction was otherwise the product of a valid exercise of business judgment.” The test is stated in the disjunctive."

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