How Does the Business Judgment Rule Impact Family Business Decisions?

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Fiduciary duties are applicable to all businesses, family businesses included. In simple terms, a fiduciary duty is an obligation to act in the best interest of another party. For example, an attorney has a fiduciary duty to act in the best interest of the client.

There are several types of fiduciary duties and a range of ways to operate your family business to discharge those duties. The basic fiduciary duties imposed on directors and management fall into two main categories: the duty of care and the duty of loyalty. DWT partner Andrew Steen wrote an excellent article published on our website that we encourage you to read for some background context on fiduciary duties in a family owned business.

This article focuses on one particular rule that helps directors meet their fiduciary duties of care and loyalty: the business judgment rule. Directors, those who oversee the policy, direction, and decision-making of a corporation, bear the burden that with any business-related decision made, there are likely risks involved.

While directors have the fiduciary duty to act in the best interest of the business, the business judgment rule provides guidance to protect directors. Directors need protection as they should not fear liability every time a business-related decision does not work out.

Fundamentally, the business judgment rule is a standard of review that is protective of the directors of a business against possible claims that they have not met their fiduciary duties. For example, in the case where a director of a family business is sued over a decision related to the family business, under the business judgment rule, a court will base the standard of review on the presumption that the director is complying with the fiduciary duty of loyalty.

It is this presumption that serves as the foundation of the business judgment rule. When a court applies the business judgment rule it is actually saying, "We see nothing to suggest that the director did not comply with his or her fiduciary duties, and thus the business judgment made by the director is supportable; there is no need for the court to reexamine it."

A key element of the business judgment rule is that in making informed decisions on behalf of the corporation, the directors are authorized to engage experts and follow the advice of those experts in making corporate decisions. Such experts may have expertise in business valuations, legal matters, accounting and audit matters, executive compensation, federal and state tax matters, or even marketing and sales.

Good faith reliance on advice from experts, well documented for purposes of the corporate records, can provide a needed shield from liability for decisions by the board that might later prove to have been improvident.

For a family business, the business judgment rule is important to know and understand. If a family business ever faces a lawsuit, as from an unhappy shareholder, the business judgment rule is one type of protection that directors can rely on when facing liability for a business decision. Further, the rule provides encouragement for competent individuals to become directors who otherwise might decline for fear of personal liability. The fundamental proposition of the rule is that there is a need to keep courts from becoming enmeshed in complex corporate decision making, a task that courts may very well be admittedly ill-equipped to perform.

Of course, it is also possible that under certain fact situations, the business judgment rule would be rebuttable, as, for example, when there is evidence that directors made decisions to benefit themselves personally against the interests of the corporation, or where they acted in bad faith or with too little information. However, someone who is challenging a board's reliance on the business judgment rule needs to prove more than just that a board decision turned out poorly for the corporation, even if in hindsight the decision may perhaps seem wrong.

Familiarity with the business judgment rule is an important part of a director's preparation for board service, and family business boards would be well advised to understand and apply the rule whenever important decisions are made.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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