Clarifying the Reach of California’s Business Judgment Rule

The “business judgment rule” (the “BJR”) generally protects a corporate director from his or her business decisions when made in good faith, with due care and inquiry, and in a manner the director reasonably believes to be in the company’s best interest.

What does that actually mean?

It means directors are protected for most decisions they make that turn out badly. It allows businesses to take risks without every decision being second-guessed by shareholders and judges.

Without getting into all of the nuances of the standards directors are held to under the BJR, there has to be a pretty egregious business decision or one that clearly involves a breach of a director’s fiduciary duty (e.g. self-interested transactions).

Whom does the BJR cover? Directors, but not officers.

There has been some debate about whether the BJR extends to corporate officers as well as directors. But a recent federal court in California ruled that California’s BJR, codified in Corporations Code Section 309, does not protect decisions made by officers of a corporation.

In FDIC v. Perry, CV 11-5561 (C.D. Cal. Dec. 13, 2011), the defendant Perry, a former director and CEO of Indymac Bank, argued that certain decisions he made for the bank were protected by the BJR. The federal district court analyzed the history of California’s BJR and found that it does not extend to protect corporate officers.

Implications.

Perry’s motion to dismiss the FDIC’s complaint failed because he was an officer of the bank even though he was also a director. The court left open the possibility that Perry might prove he was acting in his capacity as a director, but the FDIC’s allegations said he was acting in his capacity as CEO, so the case was allowed to proceed. This ruling illustrates that corporate officers  who are also directors may not be entitled to the heightened protection of the BJR. How does a CEO, who actively manages the business of the corporation, show that he or she was acting solely in his or her capacity as a director? The answer to that question may determine Perry’s fate, as well as other corporate directors who concurrently serve as corporate officers.