Directors have a fiduciary duty to act in the best interests of the stockholders, and to exercise due care and have a reasonable business rationale for the decisions they make for a corporation. Shareholders, however, sometimes question whether the board of directors has breached their fiduciary duty through some sort of wrongful action. This post explains what the business judgment rule is and how it applies to North Carolina corporations.
Under North Carolina law, directors are required to exercise good faith, do care, and loyalty, in the course of their actions. These three factors comprise what we call fiduciary duty.
But the directors might act against the best interests of a corporation. For example, they might allow the sale of corporate assets to family or friends at a low price. Or, the company might be sold without having conducted due diligence as to the value of the company.
If the corporation’s board make such a decision, the shareholders made then bring a lawsuit for breach of fiduciary duty. The lawsuit would be brought by shareholders on behalf of the corporation against the officer or director who breached their duty. This is called a shareholder derivative claim.
The business judgment rule is a defense to a shareholder’s claim. Under North Carolina law, the business judgment rule creates a presumption that the directors acted with due care, in good faith, and that their actions were in the best interest of the corporation. The business judgment rule protects directors from being judicially second-guessed when they exercise a reasonable amount of care in making their decisions.
Where does this rule come from? Although these standards have been established by judicial decisions for some time, the North Carolina legislature codified them at G.S. § 55-8-30.
The authoritative treatise on North Carolina business law, Robinson on North Carolina Corporation Law, explains the business judgment rule as follows:
The business judgment rule precludes a court from unreasonably reviewing or interfering with managerial decisions by officers and directors, thus allowing them to be risktakers without being made subject to the hindsight of judicial second-guessing.
The treatise goes on stating:
The business judgment rule holds that a court will not invalidate or hold directors liable for an advertent business decision, made by disinterested directors, within the scope of their authority, in good faith, with reasonable care, and not for their own self interests.
In short, the business judgment rule protects officers and directors from being liable for decisions that, in retrospect, were poor, but were made with an honest intent and reasonable basis. In such cases, directors are not liable, even if their decisions ultimately ended up causing harm or loss.
An important exception to the business judgment rule is where self-dealing occurs. Self-dealing is when a director does business with him- or herself in their individual capacity. For example, if a director sells himself stock or assets at an unreasonably low price, or makes a sweetheart deal on behalf of the corporation with another company owned by the director.
You might reasonably ask if there are any specific criteria for what types of information officers and directors may rely on in making their decisions. After all, if directors could be sued for their bad decisions, they should know what they need to do to make good decisions. Fortunately, the legislature also provided an answer to this. Under G.S. § 55-8-30, directors are “entitled to rely on information, opinions, reports, or statements, including financial statements or other financial data” if the directors reasonably believe the information to be reliable, if the information is presented by attorneys, accountants, or other people with expert competence, or if the information comes from a committee or subcommittee of the board of which the director is not a member.
Thus, by showing that they relied on reliable and competent information, the directors may use the business judgment rule to avoid liability for decisions that, in hindsight, should not have been made.
As you can see, the business judgment rule provides corporate directors with a powerful defense to shareholders’ claims, but so long as those directors make their decisions on an informed basis, they are likely protected from any liability.
If you have a question about North Carolina corporate law, business issues, or the business judgment rule, contact us at 980-999-3557 to see how we can help. DYE CULIK PC is a Charlotte, North Carolina business and franchise law firm.