Continued Trends in the Business Judgment Rule

By Styskal, Wiese & Melchione

We have previously written and updated an Emerging Issues article on the Business Judgment Rule and have continued to watch the law develop. This article provides an update to this ever-changing area of the law.

Generally, directors and senior management officers (“officers”) of a financial institution owe fiduciary duties to the financial institution (a duty of loyalty and a duty of care). The Business Judgment Rule (“BJR”) precludes courts from “second guessing” decisions by (at least) directors where it is clear that the directors were not self dealing and the decision was made in good faith. In essence, the BJR establishes a presumption of decisional legitimacy that shields directors from judicial scrutiny of the results of their decisions, unless there are indications of fraud, bad faith or gross dereliction of responsibility. In short, absent clear indications that directors did something really stupid or in their own self interest in the process of making a decision, that decision cannot be challenged in court even if the result of the decision turns out to be spectacularly bad.  The BJR can functionally change a negligence standard into a gross negligence standard.

Thus, the BJR often functions as a “front end” legal protection and is routinely used by defense lawyers to attempt to get a dismissal of director defendants at an early stage of a lawsuit. In recent decisions, California has decided that this powerful “front end” BJR protection does not extend beyond directors, to officers.  In more recent cases, the FDIC, OCC and NCUA have argued that the BJR does not apply to ordinary negligence cases at all. One recent example, while applicable only to the state of Georgia, shows the larger trends in BJR jurisprudence in action.

In a case in the Supreme Court of Georgia, FDIC v. Laudermilk, the FDIC attempted to argue that the BJR offered too much protection to officers and directors and that if a bank director or officer fails to exercise ordinary care, s/he is liable regardless of the BJR.  The court rejected the argument and found that the “business judgment rule is a fixture in American law” and it is a “settled part of our common law in Georgia.”  Historically, courts required a showing of gross negligence in order to overcome the BJR. The Georgia Court swayed away from this tradition and recognized that the BJR generally protects an officer or director from an ordinary negligence claim but it does not automatically bar all ordinary negligence claims.  An ordinary negligence claim can survive a motion to dismiss where it is alleged that a decision was made without sufficient deliberation or the requisite due diligence or made in bad faith.  The presumption is that the directors have acted in good faith and with ordinary care; the plaintiffs must rebut the presumption in order to withstand a motion to dismiss. The court concluded that the BJR was never meant to protect “mere dummies or figureheads” from liability.  In the future, credit unions should be aware of suits challenging Board decisions aimed at the deliberative process in order to survive a motion to dismiss based on the BJR.

This case is important given that the FDIC is seeking to hold both directors and officers to scrutiny under a simple negligence standard without the protection of the BJR.  The trend is leaning towards limiting the BJR, as we have previously seen in California decisions limiting BJR protection to only directors.  Directors and officers should ensure they are properly engaging in sufficient deliberation and due diligence for all business decisions. Courts will likely focus on the process of discussions, deliberation, due diligence, and good faith when determining whether the BJR will offer protection.  Financial Institutions should also ensure they are properly documenting the process when making a business decision.  With a lesser possibility of precluding negligence claims at the motion to dismiss stage, the directors and officers will be more likely to incur the expenses of defending the claims. Such risk may result in more pressure to settle and increase the amount of settlement.

With the FDIC, OCC, and NCUA pushing an ordinary negligence standard in managerial and Board decisions, more cases could arise where there could be decisions that weaken the BJR and increase the possibility for personal liability.  Financial Institutions should continue to maintain a watchful eye as new law surrounding the BJR emerges.