Explain the business judgment rule.

Question

What will be an ideal response?

Answer 1

Directors are not liable for mere errors of judgment when they act with care and good faith. This is the business judgment rule. The rule precludes the courts from substituting their business judgment for that of the corporation's managers. In short, it protects officers and directors from personal liability for honest mistakes in judgment.
In order to obtain the protection of the business judgment rule, the directors must meet three requirements in arriving at their decision:
1. An informed decision
2. No conflict of interest
3. Rational basis
First, they must make an informed decision. They may rely on information collected and presented by other persons. Second, the decision makers must be free from conflicts of interest. Any self-dealing on the part of the directors in the course of making the decision would deprive them of the shelter provided by the business judgment rule. Third, the board of directors must have a rational basis for believing that the decision is in the best interest of the corporation. Generally, this means that the decision must not be "manifestly unreasonable." (Many courts hold that the directors' decision is not rational if their actions amount to "gross negligence.")
If the business decision violates any of these requirements, the officers or directors are stripped of the protection provided by the business judgment rule. Courts would then feel freer to substitute their judgment for that of the corporate decision makers. Further, if the court found the decision to be unwise, the officers or directors would be liable unless they could prove that the transaction at issue was intrinsically fair to the corporation.