What is the Business Judgement Rule?

Back near the start of Innov8Social, I overviewed the case and story behind Dodge v. Ford. To summarize, in legal analysis circles the case is prominent for articulating an immutable rule for corporation law—i.e. a corporation has a duty to maximize shareholder wealth. Dodge v. Ford took place in 1919 and just as the past century has seen significant changes in the we travel, how we communicate, and the kinds of toppings that are acceptable on pizza—so too have there been advents affecting a court’s right to assess a corporation’s actions.

Corporate Directors 101

It is well-established that directors of a corporation (i.e. the elected or appointed individuals who oversee and direct the activities of a corporation) are bound by fiduciary duties of good faith, care, and loyalty to the corporation’s shareholders.

What does that mean?

Essentially corporate directors are barred from actions that would jeopardize the corporation or that would put an individual director above the corporation (i.e. self-dealing).

Business Judgment Rule: A Coming of Age

The Business Judgment Rule (BJR) provides a buffer between the court and the actions taken by a corporate board of directors. For example, corporations may have found Dodge v. Ford troublesome not for its ruling in favor of shareholders, but for the court’s intrusion into a board of directors’ decision-making.

BJR states that business decisions are presumed to be outside of the review of court where the board of directors acts in good faith, in a manner that a reasonable person would act under similar circumstances, and in the best interest of the corporation. BJR requires that board of directors do not commit waste (i.e. overpaying for assets).

But, Why?

Arguably, successful businesspersons are often skilled risk-takers. And they would argue that though they require the capital investments that shareholders provide, they don’t want their actions or calculated risks to be limited by shareholder interests. Enter, the Business Judgement Rule.

It was devised to protect business decisionmaking by corporate directors. And, as articulated by various scholarly publications including Professor David Rosenburg’s law review article “Galactic Stupidity and the Business Judgment Rule” (2006), “[it] is a truth almost universally acknowledged that American courts will not review the substance of the business decisions of corporate directors except under extraordinary

circumstances.”

How Business Judgment Rule Impacts Social Innovation

An excellent law review article that traces the relationship between corporate law and social innovation principles is Anthony Bisconti’s 2009 article in the Loyola Law Review titled “The Double Bottom Line: Can Constituency Statutes Protect Socially Responsible Corporations Stuck in Revlon Land?”

In short, by protecting the business judgement of corporate directors, BJR also gives a foot-hole to social innovators to make decisions that endeavor to achieve a successful triple bottom line.

In the absence of court acknowledgment of BJR, Henry Ford was barred by from taking an action for public good that did not maximize shareholder wealth (i.e. building a large expensive factory that would make cars more affordable, create employment, raise the standard of living for employees).

And though Ford’s plan may not reach muster in terms of today’s concern for social and environmental impact, the BJR can today be employed to protect decisions that may not necessarily maximize shareholder profits today but may maximize triple bottom line.

Is the BJR Enough to Protect and Promote Social Innovation?

The BJR is a step. So are constituency statutes, but we may find that these tools may be forcing a system designed to make profit above other concerns fit the shifting paradigms of social business and informed consumerism.

At the end of the day, we may be ready for a new corporate structure that can expand our conception of stakeholders and that can create quantifiable ways to measure progress of the bottom line (profits), double bottom line (community, profits), and triple bottom line (environment, community, profits).

And, this discussion is vital today, as new corporate structures are making their way into law across the U.S. in the form of the benefit corporation.

What do you think of the BJR? Has it paved the way for social entrepreneurship?

What should we write about next?

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