Those involved in business leadership—such as owners, directors, and LLC managers—owe a particular level of responsibility and care to their business. This level of responsibility takes the form of a number of particular duties, often referred to as “fiduciary duties.” You may have heard your lawyer talk about these duties, which include things like the duty of care, the duty of loyalty, and the duty of good faith. These duties all work together to ensure that business leadership makes decisions and operates the business in a way that is in the business’s best interest. This post will focus in on one of these specific duties, the duty of care, as well as the Business Judgment Rule standard that governs whether the duty of care was met.
Duty of Care
The duty of care requires those in positions of leadership in a business, such as the owners, officers, directors, and LLC managers, to exercise a reasonable amount of care and prudence in the operation and decision-making process of their business. In other words, business leadership is required to act in a way that exercises the level of care an ordinary, reasonable person would use in the same situation. Acting in a way that does not exercise this basic level of care could result in personal liability for the individual who failed to uphold their duty of care, either because of that breach of their fiduciary duties to a business or because of a finding of negligence in their treatment of the public.
To avoid this breach of fiduciary duties, business leadership must be sure to consider all available or reasonably available information in making important decisions that could affect the business or the public. No matter what, it is important for those in leadership roles to take the time necessary to consider their decisions instead of making snap judgements. Depending on the situation and the gravity of the decision at hand, the careful consideration of a decision could also mean specifically seeking out all relevant information rather than simply relying on what’s already known, or even hiring a lawyer or accountant who can help guide compliance with laws, regulations, and the expectations of the so-called “reasonable person.”
For business owners, properly upholding their duty of care will likely include things like educating themselves about the transactions that need their approval. A good business owner is one who has taken the time to actually understand the details of important transactions before approving them—understanding how the deal will fit into the business’s project flow, financial projection, and more. Meanwhile, the duty of care for members of the board of directors will involve more attention paid to the day-to-day operations of the business. Board members will need to do things like monitor and supervise executive officers and institute policies and procedures to ensure smooth and legal business operations.
Business Judgement Rule
The Business Judgment Rule is the standard that courts use to evaluate decisions made by corporate leadership when an allegation of a lack of duty of care is made. Under this standard, courts look to whether the decisions of the individual were made (a) in good faith, (b) with the care that an objectively reasonably prudent person would use, and (c) with the subjective reasonable belief that the action in question was taken with the best interest of the business at heart. In other words, courts applying the Business Judgment Rule look at whether, at the time the decision-in-question was made, that decision was both reasonable to third parties and truly believed to be reasonable by the individual making the decision. While hindsight is 20/20 and future information may prove that a decision was incorrect, if the choice was made in good faith with adequate information, then the individual who made the decision will likely not be found to have breached their duty of care to the business
Many industries have “best practices” that the directors, managers, and employees of a business try to follow. Acting contrary to these “best practices” is, by itself, not enough to give rise to a breach of the duty of care when considered according to the Business Judgment Rule. Because of this reasonableness standard, such a breach generally requires gross negligence or an act taken in reckless disregard of the business’s interests. Examples of reckless disregard, for example, are a board that does not gather all the facts before making a merger decision or a business that ignores notifications from regulatory agencies about safety and health violations.
However, this does not mean that “best practices” are useless. If you are following industry “best practices” in the administration and supervision of your business, you are much less likely to even run into a claim that you have breached your fiduciary duties in the first place. If everyone doing it, then it is very likely to be found to at least be objectively reasonable.
The team of experienced business attorneys at Chase Law Group, P.C., can help you better understand the fiduciary duties you have to a business when you start a business or join a board of directors. Call (310) 545-7700 to schedule a consultation today.