Fiduciary Duties and the Business Judgment Rule: Bad Judgment Without Bad Faith Does Not Create Liability for Directors, Officers and Owners

Our attorneys represents businesses and the people who own and run them.  One source of significant conflict in New Jersey business law are the fiduciary duties of the directors, officers and owners of businesses.

New Jersey business law imposes fiduciary duties on a company’s directors and officers.  This also applies to joint owners, including shareholders in corporations, partners in partnerships and members  in limited liability companies (also known as “LLCs”).  Essentially, under New Jersey law directors, officers and joint owners act as trustees to all of the business’s owners.  They owe a duty of loyalty to the owners, including both the majority and minority owners.  As effective trustees, they must place the interests of the owners ahead of their own.  They also owe a fiduciary duty of care – they must exercise reasonable care in carrying out their duties.

Breach of these fiduciary duties open directors, officers and owners up to personal liability.  They may be sued for violation of these duties if any of the owners allege that they suffered harm, financial or otherwise, because of a breach of these fiduciary duties.

However, directors, officers and joint owners do have a level of protection through New Jersey’s “Business Judgment Rule.”  Under the Business Judgment Rule, directors, officers and joint owners will not be liable if they acted reasonably and in good faith unless they engaged in fraud, self-dealing or unconscionable conduct.  The Chancery Division of New Jersey’s Superior Court explained that the Business Judgment Rule  creates the assumption that they are acting “on an informed basis, in good faith and in the honest belief that their actions are in the [business’s] best interest.”  The disaffected owners may overcome this rebuttable presumption, but the burden of proof remains on them.  They must show that the directors, officers or owners abused their discretion in managing the company.

Simply demonstrating mismanagement is not enough to overcome the Business Judgment Rule.  If a person in a fiduciary position makes a decision which costs the business losses, she still will not be liable if she made the decision “in good faith” and were “reasonable.”

The Appellate Division of New Jersey’s Superior Court explained the Business Judgment Rule this way.

The business judgment rule protects a [fiduciary] from being questioned or second-guessed on conduct of corporate affairs except in instances of fraud, self-dealing, or unconscionable conduct.  The rule exists to promote and protect the full and free exercise of the power of management given to the directors. So, bad judgment, without bad faith, does not ordinarily make officers individually liable. The rule is a rebuttable presumption, and the burden of proof shifts to the defendant to show the intrinsic fairness of the transaction in question upon the showing of self-dealing or “other disabling factor.”

What this means is that the people who run companies have latitude to run the business in good faith.  Every decision they make does not have to be correct, it just has to be taken for what they reasonably believe is in the best interests of the business.

Our business attorneys represent the directors and officers who run companies, and the shareholders, LLC members and partners who own them, in a wide variety of negotiations and business litigation.  Likewise, we represent partners, shareholders and LLC members. Please call us at (973) 890-0004 or email us to speak with one of our attorneys.