The Duty of Care and the Business Judgment Rule

• Pages: 127-177
• Author: Stephen M. Bainbridge

127

Chapter 6

THE DUTY OF CARE AND THE

BUSINESS JUDGMENT RULE

§ 6.1 Introduction

The duty of care requires corporate directors to exercise “that

amount of care which ordinarily careful and prudent men would use

in similar circumstances.”

1

Because the corporate duty of care thus

resembles the tort law concept of reasonable care, one might assume

the duty of care is violated when directors act negligently. At this

point, however, one encounters the business judgment rule and the

one thing about the business judgment rule on which everyone agrees

is that it insulates directors from liability for negligence. “While it is

often stated that corporate directors and officers will be liable for

negligence in carrying out their corporate duties, all seem agreed that

such a statement is misleading. . . . Whatever the terminology, the

fact is that liability is rarely imposed upon corporate directors or

officers simply for bad judgment and this reluctance to impose

liability for unsuccessful business decisions has been doctrinally

labeled the business judgment rule.”

2

Beyond this point, however, agreement ceases. Two basic ways

of reconciling the duty of care and the business judgment rule

compete in the case law. One treats the rule as a standard of review.

Hence, for example, some courts and commentators argue that the

business judgment rule shields directors from liability so long as they

act in good faith. Others conte nd that the rule simply raises the

liability bar from mere negligence to, say, gross negligence or

recklessness.

The other conception one sees in the case law treats the rule as

an abstention doctrine that creates a presumption against judicial

review of duty of care claims. The court will abstain from reviewing

the substantive merits of the directors’ conduct unless the plaintiff

can rebut the business judgment rule by showing that one or more of

its preconditions are lacking.

3

1

See, e.g., Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del.1963).

2

Joy v. North, 692 F.2d 880, 885 (2d Cir.), cert. denied, 460 U.S. 1051 (1983).

3

See, e.g., Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del.2000) (stating that

“directors’ decisions will be respected by courts unless the directors are interested or

lack independence relative to the decisio n, do not act in good faith, act in a ma nner

that cannot be attributed to a rational business purpose or reach their decision by a

grossly negligent process that includes the failure to consider all material facts

reasonably available”).

128

THE DUTY OF CARE AND THE BUSINESS

JUDGMENT RULE

Ch. 6

A. Shlensky and Abstention

In Shlensky v. Wrigley, plaintiff-shareholder Shlensky

challenged Philip K. Wrigley’s famous refusal to install lights in

Wrigley Field.

4

Shlensky was a minority shareholder in the

corporation that owned the Chicago Cubs and operated Wrigley

Field. Wrigley was the majority stockholder (owning 80% of the stock)

and president of the company. In the relevant period, 1961–1965, the

Cubs consistently lost money. Shlensky alleged that the losses were

attributable to their poor home attendance. In turn, Shlensky alleged

that the low attendance was attributable to Wrigley’s refusal to

permit installation of lights and night baseball. Shlensky contended

Wrigley refused to institute night baseball because the latter believed

(1) that baseball was a day-time sport and (2) that night baseball

might have a negative impact on the neighborhood surrounding

Wrigley Field. The other defendant directors allegedly were so

dominated by Wrigley that they acquiesced in his policy of day -only

baseball, which allegedly violated their duty of care.

The defendants moved to dismiss for failure to state a claim,

asserting a strong abstention version of the business judgment rule:

“defendants argue that the courts will not step in and interfere with

honest business judgment of the directors unless there is a showing

of fraud, illegality or conflict of interest.” The court’s analysis of that

claim opened by extracting “certain ground rules” from prior

precedents:

• “[C]ourts of equity will not undertake to control the

policy or business methods of a corporation although it

may be seen that a wiser policy might be adopted and

the business more successful if other methods were

pursued.”

• “We have then a conflict in view between the

responsible managers of a corporation and an

overwhelming majority of its stockholders on the one

hand and a dissenting minority on the other a conflict

touching matters of business policy, such as has

occasioned innumerable applications to courts to

intervene and determine which of the two conflicting

views should prevail. The response which courts make

4

Shlensky v. Wrigley, 237 N.E.2d 776, 777–78 (Ill.App.1968). The court also

found Shlensky’s claim defective for failure to allege damages. This is mainly an issue

of causation. To be sure, the Cubs’ poor atte ndance probably contributed to the firm’s

losses, but was poor home attendance attributable to the lack of night baseball or to

the Cubs’ performance? During the relevant time period, the Cubs were pretty

consistent losers. In any event, this portion of the court’s opinion is dicta. Once the

court decided the business judgment rule was applicable, the inquiry could have (and

should have) ended.

§ 6.1

INTRODUCTION

129

to such applications is that it is not their function to

resolve for corporations questions of policy and

business management. The directors are chosen to

pass upon such questions and their judgment unless

shown to be tainted with fraud is accepted as final.”

• “In a purely business corporation . . . the authority of

the directors in the conduct of the business of the

corporation must be regarded as absolute when they

act within the law, and the court is without authority

to substitute its judgment for that of the directors.”

Collectively, these “ground rules” describe the business judgment

rule in action. From them, moreover, we can distill a basic statement

of that rule: absent a showing of fraud, illegality, or conflict of

interest, the court must abstain from reviewing the directors’

decision.

The Shlensky court thus could have (and, perhaps, should have)

dismissed plaintiff’s claim without touching on the substantive

merits of the defendants’ decision or the motivation behind that

decision. Curiously, however, the court took some pains to posit

legitimate business reasons for that decision. The court opined, for

example, that “the effect on the surrounding neighborhood might well

be considered by a director.” Likewise, the court asserted that “the

long run interest” of the firm “might demand” consideration of the

effect night baseball would have on the neighborhood. Does this mean

that courts will examine the substantive merits of a board de cision?

No. The court did not require defendants to show either that such

considerations motivated their decisions or that the decision in fact

benefited the corporation. To the contrary, the court acknowledged

that its speculations in this regard were irrelevant dicta:

By these thoughts we do not mean to say that we have

decided that the decision of the directors was a correct one.

That is beyond our jurisdiction and ability. We are merely

saying that the decision is one properly before directors and

the motives alleged in the amended complaint showed no

fraud, illegality or conflict of interest in their making of that

decision.

5

In sum, if we may invoke an appropriate metaphor, the Illinois court

did not even allow Shlensky to get up to bat.

5

The principle so announced is a very old one, indeed. See, e.g., Leslie v.

Lorillard, 18 N.E. 363, 365 (N.Y.1888) (opining that “courts will not interfere unless

the [directors’] powers have been illegally or unconscientiously executed; or unless it

be made to appear that the acts were fraudulent or collusive, and destructive of the

rights of the stockholders. Mere errors of judgment are not sufficient. . . .”).