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October 20, 2021

Legal Update
Christine M. Netski

Bad Call v. Bad Act: Understanding the Business Judgment Rule For Corporate Directors In Massachusetts

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Business is all about making decisions. When corporate directors make the right ones, shareholders and their fellow board members hail them as heroes, or at least savvy and smart businesspeople. But when they make the wrong decisions, and a company’s fortunes decline, finger-pointing and recrimination usually follow.

Often, when a company finds itself in dire straits, wholly or partly because of corporate leadership’s choices, disgruntled shareholders and other interested parties may accuse a director of misconduct or breach of fiduciary duty. Bad calls, however, do not necessarily equal bad acts that might subject directors to personal liability for the fallout of their business decisions.

When directors make decisions in good faith, with due care, and with the reasonable belief that they are acting in the company’s best interests, the Massachusetts business judgment rule insulates them from legal responsibility for the economic or other consequences of their actions. And determining what is in a company’s “best interests” when making business decisions may involve considering factors far beyond the value of its shares or the health of its balance sheet.

General Duties of Corporate Directors in Massachusetts

Corporate directors in Massachusetts stand in a fiduciary relationship with the corporation. The fiduciary duties they owe to the corporation include two distinct obligations:

Needless to say, if directors engage in self-dealing or make corporate decisions based on what’s best for them and not what’s best for the company, they breach the duty of loyalty. In such cases, the protections afforded by the business judgment rule do not apply.

But most claims against corporate directors based on decisions they make involve alleged breaches of the duty of care.

The Duty of Care 

The duty of care owed by corporate directors is codified in the Massachusetts Business Corporation Act (the “Act”). Section 8.30 of the Act provides that directors must perform their duties as directors, including duties as a member of a committee:

So long as directors comply with these duties, they “shall not be liable for any action taken as a director, or any failure to take any action.”

That is the essence of the business judgment rule.

“Reasonably Believes”

Often, the battle over whether a director breached the duty of care and whether the business judgment rule applies involves the “reasonableness” of the decisions at issue under the particular circumstances. According to legislative comments to the Act, a director is not to be held to “some undefined degree of expertise” in business but is to be judged on the “basic attributes of common sense, practical wisdom and informed judgment.”

This means, in part, that the duty of care that directors owe involves doing at least some basic level of due diligence before making decisions or taking action. The comments instruct that they should “take steps to become informed about the background facts and circumstances before taking action on the matter at hand.” Accordingly, fulfilling the duty of care and availing oneself of the business judgment rule’s protection is not about the ultimate wisdom of a decision or the director’s underlying competence. It is instead a matter of process and the steps taken to make informed decisions.

Shareholders Aren’t The Only Ones Who Matter 

The COVID-19 pandemic has changed the ways companies do business in countless ways. But it has also highlighted the fact that many good faith business decisions made with the company’s best interests in mind involve considerations beyond profits, losses, and dividends, such as the health and safety of its employees, its customers, or the community in which it operates.

Section 8.30(a)(3) of the Act recognizes the validity of such factors when making business decisions. It provides that when directors are determining what they reasonably believe to be in the best interests of the corporation, they may consider not only the interests of the corporation but also:

“the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.”

Likewise, Section 65 of the Act, in defining the “good faith and prudence” defense, enumerates these same, broad interests that may appropriately be considered by directors in exercising their business judgment. These protections are important reminders, particularly as companies continue to navigate the myriad challenges of a global pandemic.

If you have questions about the business judgment rule or the fiduciary duties of corporate directors in Massachusetts, please contact one of the business dispute attorneys at Sugarman Rogers.