The Business Judgment Rule and Monday Morning Quarterbacking
The Seattle Seahawks had the ball, 2nd and goal on the New England Patriots’ one yard line. Only 26 seconds remained in Super Bowl XLIX. Down by four points but with a spare timeout, they needed a touchdown to win.
Everyone knew what was going to happen. The Seahawks had Pro Bowl running back Marshawn Lynch, who ran for 1306 yards and a league-leading 13 touchdowns that year. Already in the Super Bowl, Lynch had rushed for over 100 yards.
Then, as the ball was snapped to quarterback Russell Wilson in the shotgun formation, something surprising happened. Instead of handing the ball to Lynch, Wilson passed to the other side. Patriots cornerback Malcolm Butler jumped the route and intercepted the ball, sealing the victory for the Patriots.
After the game, it wasn’t hard to find a football expert who would call the decision THE … WORST … CALL … IN … NFL … HISTORY.
In hindsight, it’s easy to criticize the decision to pass. After all, we know the outcome. But, in the moment, the outcome was not known. With the Patriots defense selling out to stop the run, the coaches opted to use a play that had the element of surprise. In fact, past history supported the coach’s decision. Five times that season, the Seahawks had let Lynch run the ball from the opposing team’s one yard line. On those five carries, Lynch had only scored a touchdown once.
Michigan’s Business Judgment Rule
Despite the overuse of football metaphors in legal writing, there is an apt comparison to after-the-fact public criticism of football coaches and after-the-fact lawsuits against directors and officers for their business decisions. Michigan’s business judgment rule recognizes that courts should be reluctant to interfere with the business judgment and discretion of directors in the conduct of corporate affairs. In re Butterfield Estate, 418 Mich. 241, 255; 341 N.W.2d 453 (1983). Courts are reluctant to intervene in the affairs of corporate bodies absent a clear showing of actual or impending wrong. Reed v. Burton, 344 Mich. 126, 130, 73 N.W.2d 333 (1955).
The same is true in virtually every jurisdiction. Thus, for example, in Smith v. Brown-Borhek Co., 414 Pa. 325, 332-333; 200 A.2d 398, 401 (1964), the Pennsylvania Supreme Court held:
[I]t is too often forgotten that all businesses do not flourish, nearly every business has some losses and some bad accounts, and many insolvencies and bankruptcies frequently occur even in these prosperous times. If the test of negligence which is applicable in the field of torts or in the Estate field were similarly applicable in the business or banking field, it would realistically be very difficult if not almost impossible to secure the services of able and experienced corporate directors. Such persons would rarely ever accept a directorship if they could be held liable for every ‘bad’ account or every mistake of judgment. From an early date this Court has consistently and realistically recognized the danger of subjecting corporate directors to liability whenever any of the transactions of the company did not meet with success.
Similarly, the New York Court of Appeals held in Auerbach v. Bennett, 47 N.Y.2d 619, 629, 393 N.E.2d 994, 1000 (1979) that:
Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.
Closer to home, the Michigan Court of Appeals held that claims that a manager was “incompetent,” failed to pay bills on time, engaged in self-dealing by unilaterally more than doubling her own salary, and other allegations of breach of the duty of loyalty and care were properly dismissed under the business judgment rule. Ventimiglia v. Mancini, 2022 WL 12071400 (Mich. App., 2022) (unpublished).
Author Bernard S. Sharfman posited that without the business judgment rule, a court’s equitable power could require all corporate decisions to undergo a fairness review. The Importance of the Business Judgment Rule, Bernard S. Sharfman, N.Y.U. J. Law & Business, Fall 2017, Vol. 14:1, p. 27. Three policy drivers support the business judgment rule: 1) protecting the authority to run a company without fear of being held liable for honest mistakes in judgment; 2) respect for the private ordering of corporate governance arrangements; and 3) the courts’ recognition that they are not business experts. Id.
Recent Directors and Officers Defense in Bankruptcy Court
How does use of the business judgment defense operate in an actual case? Recently, we were retained to defend an Adversary Complaint in Bankruptcy Court in which the business judgment defense played a prominent role. The debtor was a company that had started a wildly successful craft beer restaurant in Michigan that expanded into a regional chain. The initial expansion was profitable, but later site locations proved disastrous, forcing the company into bankruptcy.
The Trustee, who was represented by one of Michigan’s largest firms, filed an Adversary Complaint against the founder of the craft beer chain, alleging that the overexpansion was not only ill-fated, but also motivated by a personal concern: satisfaction of the founder’s pre-expansion divorce judgment requiring several million dollars of payments to the founder’s ex-wife. The Trustee was assisted by multiple experts who attended every deposition and produced a report alleging that the founder’s conduct had caused over $28 million in damages.
Despite the Trustee’s decision to bring three law partners and two experts to the Court-ordered mediation, we believed firmly that the business judgment rule protected our client and a second corporate officer who was a Co-Defendant. We argued that nothing was more quintessentially business judgment than a corporate decision to expand operations and where to do so. Our client’s decision to adhere to a negotiating strategy based on the strength of the business judgment rule ultimately produced a settlement. When the Trustee and his numerous counsel concluded that we were not budging, their settlement demands dropped – and then plunged – resulting in a settlement of less than 1% of the amount claimed in their expert report. Apparently, they believed, as we did, that the business judgment defense was likely to prevail.
The business judgment rule grew out of a recognition that it is easy in hindsight to know that a strategy has failed. What is much more difficult, whether in business, on the gridiron or in our personal lives, is to know in advance what the best strategy will be. When you or your insured get accused of the lawsuit equivalent of the lament, “you should have given the ball to Marshawn,” know that the business judgment rule provides broad protection to the strategic decisions of corporations and their officers and directors.