DEFINITION of 'Business Judgment Rule'
The business judgment rule helps to guard a corporation's board of directors from frivolous allegations about the way it conducts business. Commonplace in common law countries, the rule states that boards are given the assumption that they have acted with fiduciary standards of loyalty, prudence and care. Unless it is apparent that the board of directors has blatantly violated some major rule of conduct, the courts will not review or question its decisions or dealings.
BREAKING DOWN 'Business Judgment Rule'
The business judgment rule assumes that boards act with a fiduciary duty in an interest to protect the company that the board serves. Unless it can be proven otherwise, the benefit of the doubt is given to the board members. This is to protect board members from frivolous accusations regarding their decision making for a company. The reason for this rule is to acknowledge that the daily operation of a business can be innately risky and controversial. Therefore, the board of directors should be allowed to make decisions without fear of being prosecuted. The business judgment rule further assumes that it is unfair to expect those managing a company to make perfect decisions all the time. As long as the courts believe that the board of directors acted rationally in a particular situation, no further action will be taken against them.
Example of the Business Judgment Rule
For example, XYZ Company's board of directors is considering shutting down a particular product line. Profit margins on the product have been shrinking and the line of business is becoming extremely costly and eating revenues from other lines of business. The board feels there is better opportunity to focus on other areas of the business and that they would have the resources necessary to do so if this other product were discontinued. After much deliberation, they decide to proceed. Due to the business judgment rule, they are protected from persecution by people who do not agree with their decision or who were negatively affected by it.
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