In this article, we explain the Business Judgment Rule for corporate officer and director liability in Illinois. We answer the questions, “what is the Business Judgment Rule?”, “how does the business judgment rule protect corporate officers and directors from liability to shareholders?”, “what is a shareholder derivative lawsuit?”, “what is the standard of conduct for Illinois corporate officers?”, and “is it possible to overcome the Business Judgment Rule?”
When it comes to shareholder derivative lawsuits for breach of fiduciary duty, the Business Judgment Rule provides an important defense to Illinois corporate officers, providing a legal basis on which to dismiss such suits at the pleading stage. It is wise for all corporate officers and directors to familiarize themselves with this rule, its exceptions, and its application.
The Business Judgment Rule assumes all corporate officers are acting in good faith. However, it also provides a personal liability avenue for plaintiffs to follow if they can prove that the corporate officers or directors were not acting in good faith.
The Business Judgment Rule, also referred to as the Business Judgment Presumption, is a case law-derived doctrine in corporate law that creates a defense against personal liability for corporate officers, directors, managers, and other agents of a corporation. According to the business judgment rule, corporate agents cannot be held personally liable for actions that they take in the ordinary course of business if they are using their best business judgment and acting in good faith. It is a standard of judicial review of corporate director conduct; it is not a standard of conduct in itself.
Shareholders are increasingly turning to derivative lawsuits in order to hold partners accountable for their financial losses. Corporate directors owe the corporation and its shareholders fiduciary duties of diligence and fidelity in performing their duties. Because of this expectation, Illinois corporate officers are protected by the Business Judgment Rule in shareholder derivative lawsuits when a corporation takes an action or the directors make business decision that negatively affects the corporation and a plaintiff sues, alleging that the director violated the duty of care to the corporation. For example, if a director is being accused of wasting corporate assets or overpaying for a property, the courts will evaluate the case based on the Business Judgment Rule.
A shareholder derivative action is an acknowledgment under the applicable law that a shareholder of a corporation can bring a lawsuit on behalf of the corporation, which the corporation has failed to bring. The plaintiff cannot personally benefit from winning the case. He or she initiates the case on behalf of the company with the best interests of the corporation in mind. The BJR is used as a defense doctrine in these cases.
When it comes to determining whether or not an individual was acting with his or her best business judgment, the standard of conduct for corporate officer and directors requires that he or she performs his or her duties:
1. In good faith;
2. With the care that an ordinary person in a similar position would exercise under similar circumstances; and
3. In a manner the officer or director reasonably believes to be in the best interests of the corporation.
At the end of the day, directors do not have to always make the “right” decisions. Illinois corporate officers cannot guarantee that every single decision is 100% successful. As long as they meet the above criteria and have not breached their duties of care, good faith, and loyalty to the corporation, their business decisions are protected from legal claims.
In performing the duties of a director, an individual is entitled to rely on information, opinions, reports or statements including financial statements and other financial data, in each case prepared or presented by any of the following:
1. One or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented;
2. Counsel, independent accountants or other persons who the director believes to be within their professional or expert competence;
3. A committee of the board upon which the director does not serve, duly designated in accordance with a provision of the certificate of incorporation or the by-laws, as to matters within its designated authority
The Business Judgment Rule is very difficult to overcome, as most Illinois courts typically do not interfere with directors and officers unless it’s very clear that they are guilty of a breach of fiduciary duty. In order to be successful in a case against an officer or director, the plaintiff has to be able to prove that the individual did not properly uphold his or her fiduciary duty of care, good faith, or loyalty to the corporation while executing a business decision. The plaintiff must plead fraud, breach of trust, conflict of interest, oppression, corruption, improper motive, bad faith, overreaching, complete abdication of corporate responsibility, or a failure to investigate that was “clearly unreasonable under the circumstances known to them at the time.”
If the plaintiff cannot show the breach of fiduciary duty, the case will likely be dismissed under the Business Judgment Rule. However, in cases where there is no clear violation of fiduciary duty, if the plaintiff can show that any reasonable person would not have made the same business decisions the corporate director made, most courts will allow the case to progress. If the court finds that the presumption does not apply, the board has to prove that the process and the substance of the transaction were fair.