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ANALYSIS: Can the Business Judgment Rule Serve Multiple Masters?

Nov. 4, 2019, 11:28 AM

How flexible is the business judgment rule? The Business Roundtable recently issued a new standard (Statement) by which corporations commit to operate in service to a broad range of stakeholders, including customers, employees, suppliers, and communities. This announcement raises legal questions for corporate directors: May they now make decisions that put shareholders in second place, behind other stakeholders? If they do so, will the business judgment rule protect them? To which stakeholders do directors owe their fiduciary duty?

Since Delaware is home to most major U.S. corporations, it’s a good framework to help with these queries.

Impact on the Business Judgment Rule

Like most states, Delaware has codified the business judgment rule used to protect directors and shield them from liability for their business decisions (Aronson v. Lewis). Directors enjoy these protections when they act in good faith, on a disinterested and informed basis, and in the rational belief that the decision is in the best interests of the corporation.

But how does the Statement impact this rule? There are two opposing views, but they share a common requirement that, in either case, corporate decisions should promote the value of the corporation. One view affords the business judgment rule’s protections only if shareholder interests are considered (shareholder primacy). The other view is that the business judgment rule would still protect directors factoring in non-shareholder interests.

Even now, states and courts have shown explicit and implicit acceptance that directors may take into account stakeholder considerations. More states are adopting “constituency statutes” or the creation of benefit corporations that allow directors to consider non-shareholder interests when making business decisions.

In fact, courts rarely second-guess well-intentioned directors or deny them the protections of the business judgment rule unless the facts clearly show intentional wrongdoing or unreasonable failures.

Impact on Director’s Fiduciary Duties

How would the Statement impact a director’s fiduciary duty? In Delaware, directors have a fiduciary duty to the corporation and its shareholders. This fiduciary duty includes both a duty of care and a duty of loyalty. The duty of care requires directors to be reasonably informed when making decisions on behalf of the corporation. The duty of loyalty requires directors to act in good faith and the best interests of the corporation and its shareholders, never using their position to advance personal interests.

The Statement’s consideration of other constituencies does not appear to conflict with these duties, and likely can be consistent with Delaware’s fiduciary duties. However, directors should be prepared to articulate why decisions factoring other constituencies benefit the enterprise in the long-term.

What Do Lawyers Do Now?

The legal impacts of the Statement—and, for that matter, benefit corporations, the World Economic Forum’s New Paradigm, and other shifts away from shareholder primacy—will require more study and clarification in 2020, including: 1) weighing interests of shareholder versus non-shareholders, 2) dealing with conflicting interests of the various constituencies, 3) codifying duties owed to non-shareholder constituencies, and 4) properly grouping constituencies.

What Do Directors Do Now?

In the interim, directors would be prudent to document their decisions. These records should readily show how the director: 1) acted in good faith, 2) on a fully informed basis, and 3) can justify how the outcome is expected to be a long-term benefit to the company (even if the short-term impact is not beneficial). If any of these elements are missing, so too will go the protections of the business judgment rule, let alone alignment with fiduciary duties.

Read about other trends our analysts are following as part of our Bloomberg Law 2020 series.