Galactic Stupidity and the Business Judgment Rule

I. INTRODUCTION II. IS SUBSTANTIVE DUE CARE "FOREIGN" TO THE BUSINESS JUDGMENT RULE? III. THE "REINVIGORATION" OF SUBSTANTIVE DUE CARE IV. SUBSTANTIVE DUE CARE AND THE REASONABLE DIRECTOR V. THE APPLICATION OF SUBSTANTIVE DUE CARE ANALYSIS VI. DISNEY V IGNORED THE SUBSTANTIVE DUE PROCESS ISSUE VII. APPLYING THE "GALACTIC STUPIDITY" STANDARD VIII. CONCLUSION The only real difference I detect in various formulations of the [business judgment] rule involves the question whether if good faith and due care are established, there nevertheless remains room for a judicial judgment concerning the wisdom of the decision. (1) I. INTRODUCTION It is a truth almost universally acknowledged that American courts will not review the substance of the business decisions of corporate directors except under extraordinary circumstances. Embodied in the much-debated (2) "business judgment rule," the deference displayed towards the decisions of corporate directors arises not from a belief that directors are always right, or even always honorable, but from a belief that "investors' wealth would be lower if managers' decisions were routinely subjected to strict judicial review." (3) Corporate directors take the kind of risks that investors want them to take because the directors know that, whatever the outcome, stockholders will not have any legal recourse for losses arising from those actions unless the decision makers violated a duty such as loyalty or good faith. The belief in this general principle of the business judgment rule is so widespread that, despite the recent scandals and negative publicity surrounding the conduct of corporate directors, few participants in the debate are calling for significant changes to the rule's deference to actions taken by corporate decision makers. (4) There is plainly broad agreement that shareholders make more money when directors know they can make decisions--especially risky decisions--without the fear that they (5) or the company will be the subject of successful legal actions should those decisions not ultimately benefit the company or the shareholders themselves. This does not mean that the legislative, judicial, legal, financial, academic, and investor communities do not view with disdain directors who make bad decisions, foolish decisions, or excessively risky decisions. It simply means that these communities do not wish to impose legal liability on directors, or the corporations they oversee, for the negative consequences of such decisions. (6) A board of directors that pig-headedly leads a corporation in the wrong direction is worthy of our contempt and deserves to be voted out or abandoned by investors. But our corporate law does not allow the aggrieved to seek legal action against a corporation just because its directors made a bad decision. As such, the business judgment rule does not seem to have a moral or ethical dimension. Rather, it is one of our most utilitarian rules. Wealth is maximized when corporations are run by directors who know that their decisions will be reviewed by investors, by analysts, by stockholders, and by business partners--but not by the courts. (7) Practically speaking, the business judgment rule is "simply a policy of judicial non-review." (8) It is--except when it allows review. The problem is, as a noted scholar has put it, "to identify the circumstances in which review is necessary." (9) While many academics and judges repeatedly assert that the business judgment rule does not allow for review of the substance of director decision making, Delaware courts nonetheless display an apparent willingness to do just that when the directors' actions approach the borderline of good faith. (10) Indeed, in eases in which the plaintiffs allege bad faith but the facts do not present evidence of disloyalty or a knowing breach of duty, courts review the substance of the directors' decision in order to determine whether or not the directors have complied with all of their fiduciary obligations and therefore, whether the plaintiffs have successfully rebutted the presumptions of the business judgment rule. …