No Business Judgment Rule for Corporate Officers

As if corporate officers didn’t have enough to worry about, i.e. properly evaluating the market place, making strategic moves, evaluating business transactions, divining future trends, and getting and keeping customers, here in California, decisions by corporate officers that turn bad are a little more risky to that corporate officer.

Years ago, in order to encourage companies to innovate, States adopted the “Business Judgment Rule” (“BJR”). The BJR simply states that if a business decision is made in good faith, the fact that such decision, in hindsight, ends-up being poorly reasoned or even negligent, the decision makers won’t be held personally liable. In general, the BJR creates a presumption that if the decision maker used reasonable care, including reasonable diligence, in making the decision, and the decision is made in good faith, then the decision maker will not be liable if such decision turns out badly unless there if proof of gross negligence or fraud. In California the BJR is codified in California Corporations Code §309.

However, §309 as written, only extends the BJR presumptions and protections to directors of a corporation but does not mention officers. Most other state courts and commentators, either explicitly (i.e. written in the BJR statute) or implicitly (i.e. intended to be covered by the BJR statute) have extended the BJR to include corporate directors and officers. Unfortunately, California has taken a different, more restrictive position. In a recent decision in the case of FDIC as Receiver for IndyMac Bank FSB v. Matthew Perry, a federal District Court in California has ruled that since the California BJR statute (§309) only refers to “directors”, the BJR is not available to corporate officers. In the FDIC v. Perry case, Mr. Perry was both a director and CEO of IndyMac Bank and in those capacities, made certain investment decisions which eventually created huge losses for the Bank. The Bank eventually failed and the FDIC sued Mr. Perry for the investment losses sustained by the Bank. Mr. Perry sought to assert the BJR in his defense but the Court ruled that he made the investment decisions in his officer capacity as CEO (not as a director) and went on to rule that §309 does not apply to corporate officers. Consequently, Mr. Perry could not claim the protections of the BJR.

What this means for officers of California companies is that, absent the protections of the BJR, corporate officers can be second-guessed and held liable for decisions that don’t produce the intended results or result in losses to the company, even if such decisions, when made, were made in good faith and with the best of intentions. On the other hand, corporate directors can rely on the BJR to protect themselves from liability for the same bad decisions.

The take-away is that corporate officers in California must be careful to make informed, considered decisions and be prepared to defend those decisions if they eventually prove to fall short of their intended goal or, worse yet, result in losses to the company. With regard to such a defense, corporate officers should make sure they are indemnified by the corporation or by Officer/Director liability insurance to the maximum extent permitted by California law under California Corporations Code §317.

Article by Roger D. Linn © Barnett & Linn