The business judgment rule is a principle that applies to officers and directors when it comes to deciding about the legality of their management and whether there is any basis for liability. Directors or managers of a business organization have a fiduciary duty to act in the best interest of the entity and its owners. As fiduciaries, they are expected to perform their duties with due care, diligence, and loyalty. The rule is a legal doctrine that makes officers, directors, managers, and other agents of a business entity immune from liability for loss incurred in corporate transactions that are within their authority and power to make when there is sufficient evidence to show that the transactions were made in good faith.
The Duty of Care
The duty of care requires officers and directors to be informed and avoid acting negligently in the execution of their responsibilities. In other words, they must take reasonably sufficient steps to get material information about a business transaction, from reliable sources, before making a decision. Additionally, fiduciaries are expected to act in good faith. The standard of care for holding a director liable for actions or decisions that cause a loss to the business entity is that of a reasonably prudent person. Therefore, a director that takes an action or makes a decision that is negligent or reckless may be shielded from liability if he acted in good faith.
The Duty of Loyalty
In the performance of their duties, directors, officers, and managers are expected to advance the best interest of the entity and to avoid conflict of interest or competition against the organization. A director who enters into a transaction affected by a conflict of interest may not be protected by the business judgment rule. A conflict of interest exists when the interests of a director or someone related to him are in conflict with those of the organization. In this case, the director should disclose all material information to the disinterested directors and have the proposed transaction approved by a majority vote of the directors not affected by the conflict. Additionally, the transaction should be fair to the organization.