Business Judgment Rule
The business judgment rule (BJR) is a presumption that directors made business decisions on an informed basis, in good faith, and in the honest belief that the action was in the company’s best interests. Courts will not second-guess a business decision if the directors were disinterested, informed, and acted in good faith.
Elements
For the BJR to apply:
- Disinterested: the director had no personal financial interest in the transaction not shared by the shareholders
- Independent: the director was not dominated or controlled by an interested party
- Informed: the director was adequately informed before making the decision (duty of care satisfied)
- Good faith: the director subjectively believed the decision was in the corporation’s best interest
- Rational business purpose: the decision had at least a rational basis
If BJR applies, the court will not review the substantive merits of the decision. The plaintiff bears the burden of rebutting the BJR presumption to obtain substantive review.
Standard of Review
| Standard | Trigger | Who Bears Burden |
|---|---|---|
| Business Judgment Rule | Disinterested, informed decision | Plaintiff must rebut |
| Enhanced Scrutiny (Unocal/Revlon) | Defensive measures; change of control | Defendants must show reasonableness |
| Entire Fairness | Interested director/controlling shareholder | Defendants must show fair dealing + fair price |
Rebutting the BJR
Plaintiff rebuts the BJR presumption by showing the directors:
- Were interested or lacked independence (duty of loyalty breach), OR
- Were grossly uninformed (duty of care breach — Smith v. Van Gorkom), OR
- Acted in bad faith (consciously disregarded their duties — Stone v. Ritter)
Once rebutted, the court proceeds to substantive review (usually entire fairness for interested transactions).
Oversight Liability (Caremark)
Directors may face liability for failing to implement a system to monitor compliance with law. The Caremark standard requires:
- The directors knew or should have known that employees were engaged in conduct that would harm the corporation, OR
- Directors knew of red flags and consciously disregarded them
This is a very high bar — mere failure to implement monitoring systems does not suffice without bad faith (Stone v. Ritter).
Policy
- Courts are ill-equipped to second-guess business decisions made in the heat of competition
- Directors bear significant business risk and should be protected from liability for honest mistakes
- Fear of liability would chill risk-taking and make directors overly conservative
- Shareholders elect directors precisely to make these decisions; judicial second-guessing undermines that allocation
Key Cases
| Case | Rule |
|---|---|
| Smith v. Van Gorkom (Del. 1985) | BJR did not protect merger approval; directors were grossly uninformed; gross negligence = duty of care breach |
| Aronson v. Lewis (Del. 1984) | Articulates BJR standard; presumption that directors acted on informed basis, in good faith, in honest belief action was in best interest |
| In re Caremark International Inc. (Del. Ch. 1996) | Oversight duty; sustained failure to implement monitoring systems can constitute bad faith |
| Stone v. Ritter (Del. 2006) | Oversight liability requires bad faith — either knew of violations and ignored them, or failed to implement any monitoring system |
| Disney (Del. Ch. 2005) | Approving executive compensation without adequate information fell short, but court found no bad faith; no BJR rebuttal |