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A Wrong Decision Isn’t a Wrongful Act: Understanding The Business Judgment Rule

Business owners and operators make decisions every day. When those in control of a business, such as officers or directors in a corporation or a manager in a limited liability company (“LLC”), make the right ones, owners and their fellow executives (e.g., directors, officers, managers, general partners, etc.) shower them with praise (and perhaps generous bonuses). But when they make the wrong decisions, and a company’s fortunes go south, finger-pointing and allegations of incompetence or malfeasance often follow.

Sometimes, when a business finds itself in dire straits, in whole or in part due to choices made by business leadership, disgruntled shareholders and other interested parties may accuse the business’ operators – whether officers, directors or managers of misconduct or breach of their fiduciary duties. However, a bad decision does not necessarily equal a bad act that would subject such leadership to personal liability for the fallout caused by poor business decisions.

If an executive makes a decision in good faith, with due care, and with a reasonable belief that they were acting in the company’s best interests, the business judgment rule (“BJR”) shields them from legal liability for the economic or other consequences of their actions. The BJR applies to those who have operational control of a business; for example, a manager in an LLC, the board of directors or officers of a corporation, or the managing partner in a partnership. While every state’s business judgment rule may have its own nuances and limitations, including distinctions between officers and directors, the formulation and application of the rule in Illinois are representative of the protections that exist under the BJR.

General Duties of Corporate Officers and Directors in Illinois

By way of example, corporate officers and directors in Illinois occupy fiduciary roles relative to the corporation. They may also if owners owe fiduciary duties to other shareholders. The fiduciary duties owed to a corporation or shareholder are comprised of two distinct obligations:

  • Duty of loyalty: This duty requires each officer or director of an Illinois corporation to put the interests and success of the business before any personal interests. This includes acting honestly, avoiding conflicts of interest, and not diverting opportunities from the company to themselves or third parties.
  • Duty of care: This duty requires each officer and director to act in good faith and use reasonable care when making decisions or while acting for or on behalf of the company.

If an officer or director engages in self-dealing or makes business decisions based on personal interests rather than what is in the best interests of the corporation, a breach of fiduciary duty will undoubtedly be at the forefront of any corporate dispute. In such cases, the presumption of good faith and the protections afforded by the BJR would not apply.

The Duty of Care

The duty of care owed by Illinois corporate officers and directors requires them to discharge their corporate responsibilities:

  • In good faith,
  • With the care that an ordinary person in a similar situation  would reasonably believe to be appropriate under the circumstances, and
  • In a way that the director or officer reasonably believes to be in the corporation’s best interests.

So long as a director or officer complies with the foregoing duties and has not otherwise breached their duty of loyalty, they should not be liable to the corporation or its shareholders for any decision they make or don’t make or any action they take or don’t take. That is the essence of the BJR  – including in Illinois.

“Reasonably Believes”

Often, the battle over whether a director or officer breached their duty of care such that the business judgment rule can be set aside involves the “reasonableness” of the decisions they made given the circumstances.

This means that the duty of care that officers and directors owe the company involves doing some baseline level of due diligence before making decisions or taking corporate action. Accordingly, satisfying the duty of care and availing oneself of the protection provided by the BJR  is not about the ultimate wisdom or outcome of a decision or the director or officer’s underlying competence. Instead, it is a matter of process and the steps taken to make informed decisions, consistent with the best interests of the company.

In their efforts to become sufficiently informed, directors and officers do not need to become subject matter experts. They may rely on information, opinions, documents, financial data, and the like when prepared or presented by:

  • One or more corporate officers or employees believed to be reliable and competent in the matters at hand;
  • Counsel, independent accountants, or others believed to be within their professional or expert competence; or
  • A committee of the board upon which the director does not serve, as to matters within its designated authority.

Shareholders Are Not The Only Ones Who Matter

Good faith business decisions made with the corporation’s best interests in mind can involve considerations beyond profits and losses. For example, companies of all sizes have had to make countless business decisions during the COVID-19 pandemic that focus on the health and safety of employees, customers, or communities in which they operate.

These, plus other significant decisions that can affect, for example, the future direction of the business, facility closures, or a significant number of job losses, should first ensure that they are consistent with specific statutory provisions, such as Section 8.85 of the Illinois Business Corporation Act, that explicitly provides that when “considering the best long term and short term interests of the corporation,” officers and directors can:

“consider the effects of any action (including without limitation, an action which may involve or relate to a change or potential change in control of the corporation) upon employees, suppliers, and customers of the corporation or its subsidiaries, communities in which offices or other establishments of the corporation or its subsidiaries are located, and all other pertinent factors.”

Similarly, when making these kinds of business decisions, executives – managers, corporate officers and directors, CEOs, and otherwise – are well-advised to ensure that the decision has been fully vetted by competent, independent professional advice, especially that of counsel, to further support the application of the BJR.

If you have questions or concerns about the application of the business judgment rule or the fiduciary duties of officers, directors, LLC managers, or other similar persons, generally, don’t hesitate to get in touch with me at 312-840-7004 or fmendelsohn@burkelaw.com.  

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