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The business judgment rule in the US means that a board of directors won’t be held liable for mistakes made in good faith. Decisions must be reasonable and made in the best interests of the company. The rule is used to determine if shareholders have a lawsuit. Some argue it can be abused.
In the United States, the business judgment rule is an aspect of corporate law that states that a company’s board of directors will not be held liable for mistakes made if the decisions underlying the mistakes were made in good faith. The idea behind this rule is that doing business inherently involves decisions that may be contentious or risky in nature and that boards of directors may not be able to act freely if they are constantly concerned about the potential for litigation by shareholders.
Several standards must be met to confirm that the members of a board of directors cannot be challenged. The entire premise of the corporate judgment rule is based on the idea that board members always work in the best interests of the company. In addition to being legally required to do so, they have a vested interest in keeping the company in financial health because their pay is often based on performance.
Decisions must be made in good faith, must be reasonable, and must be made in the belief that they were made in the best interests of the company for the rule of business judgment to apply. For example, the board of directors might spin off an underperforming unit of an automaker because it believes it would be better for the company to sell that brand than to try to revive it. A shareholder could believe that this decision was wrong, but board members could not be challenged if they could demonstrate that they acted in good faith, that they believed the choice was right for the company and that their decision was reasonable and conservative by industry standards.
Board members have a duty of care to the parent company. If misconduct is believed to have occurred, these can be taken to court by a shareholder or, more commonly, a group of shareholders. The business judgment rule is used to review such cases to determine whether or not people have a lawsuit. In that case, the board of directors will be held accountable for the decisions taken and asked to demonstrate their reasoning.
Some people have taken issue with the corporate judgment rule arguing that it effectively insulates board members from liability and that it can be abused. In 2009, there were some attempts to lobby for a rethink of the standard on the grounds that standards like this allowed for questionable business practices that contributed to the global economic meltdown that began in 2008.
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