A pair of recent decisions by the United States District Court for the Central District of California challenge the strength of the business judgment rule. To summarize, the cases hold that the business judgment rule does not protect corporate officers (as opposed to directors).

The business judgment rule is a presumption that a corporate director or officer acted on an informed basis, in good faith and in the honest belief that the action was in the best interests of the company. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). The business judgment rule is a defense to allegations of breach of the duty of care but not the duty of loyalty, which also cannot be waived under Delaware Code Section 102(b)(7). Stone v. Ritter, 911 A.2d 362 (Del. 2006).

In FDIC v. Van Dellen, 2012 WL 4815159 (C.D. Cal. October 5, 2012), the court held that the business judgment rule does not apply to protect officers of a corporation. The court found that California Corporations Code Section 309 did not apply, and it also declined to extend to officers the California common law rule that “insulat[es] from court intervention those management decisions which are made by directors in good faith in what the directors believe is the organization’s best interest.”

More recently, in FDIC v. Faigan, 2013 WL 3389490 (C.D. Cal. July 8, 2013), the court declined to apply the business judgment rule to officers. In addition, the court ruled that the business judgment rule is not a defense against allegations of “receiving improper personal benefits” or “abdication of corporate responsibility.” The decision assumes that California Corporations Code Section 309 codifies the business judgment rule under California law. However, the official comments to Model Business Corporations Act Sections 8.30 and 8.31 caution courts against assuming that a state’s implementing statute is a codification of the business judgment rule itself. California’s statute is practically identical to the model rule.

Both decisions involve choice of law issues, and both courts appear to assume that the choice not to apply Delaware law is determinative of the outcome.

Although Delaware corporate officers “owe fiduciary duties of care and loyalty” to the corporation (Gantler v. Stephens, 965 A.2d 695, 708-709 & n.37 (Del. 2009)), no Delaware court has explicitly held that the business judgment rule applies to officers.

This article was first published on the California Bankruptcy Blog at http://calbk.blogspot.com/2013/11/the-business-judgment-rule-in-central.html

About the author:

Reno F.R. Fernandez III is a partner with Macdonald Fernandez LLP, a bankruptcy, turnaround and insolvency litigation firm with offices in San Francisco and Modesto, California.  Mr. Fernandez is also the chair of BASF’s Commercial Law & Bankruptcy Section.