Business judgment rule

Published July 22, 2020, 10:00 PM

by Atty. Jun De Zuñiga

The corporate powers of a corporation are exercised, and all its business conducted, by its board of directors by reason of which the directors occupy a fiduciary relationship to the corporation.  In the performance of their duties, the directors are under obligation of trust and confidence and must act in good faith, and with due care and diligence.  As long as the directors act honestly and in accordance with their authority, the courts generally will not interfere in the exercise of their judgment.  This is the essence of the “business judgment rule” (Sharfman, 14 New York University, Journal of Law and Business, 27 Fall 2017).

The business judgment rule, the most prominent and important standard of judicial review under corporate law, protects a decision of the corporate board of directors from a “fairness” review.  This rule is found invoked in suits when a board takes an action and a plaintiff or complainant then sues alleging that the directors violated their duty of care.  In such suits, the courts can evaluate the case based on the business judgment rule.  Under this standard, the court will uphold the decision of the board as long as it is made (1) in good faith, (2) with the care that a reasonably prudent man would use, and (3) with the reasonable belief that the directors are acting in the best interests of the corporation.  Practically, the business judgment rule is a presumption in favor of the board and is sometimes referred to as the “business judgment presumption” ( judgment rule).

There were valuable insights derived from the formulation of this rule.  Without this rule, complainants could conceivably require all challenged board decisions to undergo an entire fairness review. The issue for the courts is to determine how the interests of stockholders are to be balanced against protecting the board’s authority to run the company, without the fear of constantly facing potential liability for honest mistakes of judgment (Sharfman, ibid.).

It also means that an entire fairness review is not allowed unless there is evidence that a fiduciary duty has been breached or taint surrounds the decision making process.  If no breach or taint is found, then review is halted and the decision stands, upholding the board’s authority to manage the corporation.  The rule in effect is a constraint on a court’s powers.  It works as an abstention doctrine by requiring the courts to abstain from an entire fairness review if there is no evidence of a breach in fiduciary duties or a taint surrounding a board decision (ibid.).

There are a number of ways to defeat the business judgment presumption.  If the plaintiff can prove that the directors acted in gross negligence or bad faith, or that there was conflict of interest, then the court will not uphold the business judgment presumption. When the corporation pleads the business judgment rule, if the court finds that the presumption applies, the plaintiff then must prove that the business judgment rule does not apply.  However, if the court finds that the presumption does not apply, then the board needs to prove that the process and the substance of the transaction was fair (cornell, supra).

The business judgment rule is believed applicable in the Philippines since its corporate law similarly incorporates the directors’ duties of obedience, care and loyalty to the corporation (De Leon, The Corporation Code, p. 215; Herbosa and Recalde, The Revised Corporation Code, p.150).

The above comments are the personal views of the writer. His email address is [email protected]