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The Business Judgment Rule and Director Liability

Published August 15, 2010

The business judgment rule is a legal concept that gives the directors and officers of a corporation a measure of protection against liability while they are conducting business for their corporation.  Directors and officers are entrusted with the responsibility of managing the corporation’s affairs.  In this role, they often face difficult questions concerning whether to sell assets, acquire or merge with other businesses, expand to new areas of business, or issue stocks and dividends. In addition, they may  be forced to deal with  hostile takeovers by other businesses.

The courts have been sensitive to the challenging nature of  the  decisions the directors and officers must make. Under the business judgment rule, the officers and directors of a corporation are protected from liability for losses incurred in corporate transactions within their authority, as long as there is sufficient evidence that the transactions were made in good faith and with reasonable skill and forethought.

Doing business inherently involves having to make decisions which may be controversial or risky in nature. Boards of directors might not be able to act freely and in the best interest of their corporations if they had to constantly be concerned about the potential for a lawsuit from shareholders. The business judgment rule gives them the freedom to make decisions without the constant fear of litigation.

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