Bad Call v. Bad Act: Understanding the Business Judgment Rule in Michigan
Business is all about making decisions. When corporate officers or directors make the right ones, shareholders and their fellow executives and board members hail them as heroes, or at least savvy and smart businesspeople. But when they make the wrong ones, and a company’s fortunes go south, finger-pointing and recrimination are rarely far behind.
Often, when a company finds itself in dire straits, in whole or in part because of choices made by corporate leadership, disgruntled shareholders and other interested parties may accuse an officer or director of malfeasance or breach of their fiduciary duties. However, a bad call does not necessarily equate to a bad act that would subject a director or officer to personal liability for the consequences of their business decisions.
If an officer or director made such a decision in good faith, with due care, and with the reasonable belief that they were acting in the company’s best interests, Michigan’s business judgment rule insulates them from legal responsibility for the economic or other consequences of their actions. While the rule provides critical decision-making latitude for a company’s leadership, it is not without limits. Here is what executives and shareholders alike need to know about this important legal principle.
What Is the Business Judgment Rule?
As noted, the business judgment rule in Michigan, which mirrors similar protections in other states, is a legal presumption that shields corporate directors and officers from liability for their business decisions. Essentially, it recognizes that courts should not play Monday-morning quarterback for a company’s business decisions and that a company’s officers and directors should be able to take reasonable business risks without fear of personal liability every time a move doesn’t work out as hoped.
When Does the Business Judgment Rule Apply?
Michigan’s business judgment rule finds its statutory foundation in Section 450.1541a of the Michigan Business Corporation Act, which provides that directors must discharge their duties:
- In good faith,
- With the care an ordinarily prudent person would exercise in similar circumstances, and
- In a manner they reasonably believe to be in the best interests of the corporation.
Subject to several conditions, Michigan courts have consistently applied this standard to shield directors who act in the prescribed manner from liability. The first condition is that the directors or officers must be disinterested and independent and cannot have a personal financial interest in the transaction beyond their general interest as shareholders. Second, they must be adequately informed before making their decision. This doesn’t require perfection or consideration of every factor, possibility, permutation, or outcome, but directors and officers should inform themselves of material information reasonably available to them. Finally, directors must act in good faith, believing their decision serves the corporation’s best interests.
When these elements are satisfied, the business judgment rule creates a nearly insurmountable barrier to liability. Plaintiffs challenging a board decision must overcome this presumption by showing that one of these elements was absent.
Limits of Michigan’s Business Judgment Rule
Certain decisions and conduct clearly fall outside the protections provided by the business judgment rule. Fraud, self-dealing, or conflicts of interest can negate any attempt to rely on the rule. Beyond such intentional malfeasance, an abject failure to make reasonably informed decisions can eviscerate the business judgment shield. This can be proven if, say, a director approves a major transaction without reviewing relevant documents, seeking the advice of counsel, accountants, or other professionals, or asking basic questions about the deal, its terms, and its implications.
Shareholders or others with minority interests in a Michigan corporation can find 1,001 reasons to question the choices and decisions made by company leadership when they go sideways. But unless that decision-making process was tainted by improper factors or gross negligence, Michigan’s business judgment rule will significantly hamstring any efforts to hold directors or officers personally liable for the fallout from a disappointing or even catastrophic outcome.
If you have questions or concerns about the business judgment rule in Michigan, please contact Michael Hamblin at Maddin Hauser.