Texas Business Judgment Rule Defense

“The business judgment rule in Texas generally protects corporate officers and directors, who owe fiduciary duties to the corporation, from liability for acts that are within the honest exercise of their business judgment and discretion.” 

Business Judgment Rule in Texas

Application of Business Judgment Rule Defense

The business judgment rule protects corporate officers and directors from being held liable to the corporation based on actions that are “negligent, unwise, inexpedient, or imprudent if the actions were ‘within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved.’”  “[T]he business judgment rule applies as a defense to the merits of a shareholder’s derivative lawsuit that asserts claims against the corporation’s officers or directors for breach of duties that result in injury to the corporation.”

The business judgment rule is the inverse of duty of loyalty. A self-interested transaction would never qualify as the “honest” or “uncorrupted” use of business judgment. Rather, as the El Paso court of appeals recently held, the business judgment rule is a defense to a claim for mismanagement—i.e., a claim based on the duty of care.  This is necessarily true, notwithstanding the Texas Supreme Court’s cagey footnote in Sneed v. Weber that seemed to leave open the question of to which duty the business judgment rule applied: “We refer to breach of duty claims generally because this case does not require us to consider which duties are subject to the business judgment rule.”  Nevertheless, it seems clear that the business judgment rule would never provide a defense to a breach of the duty of loyalty—which would not be an honest use of business judgment—or to a breach of the duty of obedience—which would involve actions outside the scope of an officer’s or director’s legitimate discretion. The business judgment rule deals only with claims based on the duty of care. As the Texas Supreme Court noted, “courts will not interfere with the officers or directors in control of the corporation’s affairs based on allegations of mere mismanagement, neglect, or abuse of discretion.”

Although the caselaw addressing the business judgment rule in Texas is quite limited, Texas courts frequently look to Delaware for guidance.  Texas courts routinely utilize Delaware corporate law on issues that have not yet been decided in Texas,  including business judgment rule issues.  The Delaware Supreme Court is regarded as the “mother court” for corporate law.  Under Delaware law, the business judgment rule is a rebuttable presumption that “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”  The business judgment rule in Delaware is comprised of four elements: (1) a business decision; (2) disinterestedness and independence; (3) due care; and (4) good faith. The presumption of the business judgment rule can be rebutted by demonstrating that one of these elements is not present.

This post is taken from HCWD, PLLC recently published White Paper, The Duty of Loyalty and the Business Judgment Rule in Texas. Download the entire paper with complete legal analysis and citations.

Texas Business Judgment Rule