Business owners know there are consequences to every decision they make. Good strategic, operational, and financial choices can spur profits and growth. Conversely, poor business decisions can send a company on a downward spiral from which it may never recover.

Poor business decisions can also lead to lawsuits, usually by shareholders disappointed in the performance of the company. California, like most other states, has laws that insulate corporate directors from liability for decisions based on the directors’ reasonable business judgment even when those decisions result in negative outcomes.

But if you’re a corporate officer (who may or may not also be a director), this “business judgment rule,” offers no such protection from claims arising out of the exercise of reasonable judgment, and can leave officers exposed to personal liability for damage that results from the decisions they make in their capacity as an officer.

“Business Judgment Rule” Only Applies to Corporate Directors

California’s “business judgment rule,” as codified in Section 309 of California’s Corporations Code, states that a director shall not be liable for actions based on a reasonable exercise of business judgment if done “in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.”

Even though the fiduciary duties, including the duty of care, owed by corporate directors and officers are very similar, the legislators who drafted Section 309 clarified that “the standard of care [in Section 309] does not include officers.” They were not providing “business judgment rule” protection to corporate officers because:

“Although a non-director officer may have a duty of care similar to that of a director, his ability to rely on factual information, reports, or statements may, depending upon the circumstances of the particular case, be more limited than in the case of a director in view of the greater obligation he may have to be familiar with the affairs of the corporation.”

Cal. Corp. Code § 309 (Legislative Committee Comment). In other words, an officer is expected to have hands-on operational experience and knowledge, while a director normally relies only on reports or other information provided to them when making business decisions. The information on which the directors customarily rely likely was provided by the corporate officers, who are in a better position to ensure that the information is complete and accurate.

Notwithstanding the efforts of many corporate officer defendants to assert the business judgment rule as a defense, courts have repeatedly refused such application, noting the legislature’s explicit exclusion of officers from the protections of Section 309. In the definitive case of Gaillard v. Natomas Co., the Court of Appeal again distinguished between the responsibilities and positions of officers and directors:

“An officer-director may be liable for particular conduct because of his capacity as an officer, whereas the other directors would not… This result is in accord with the premise of the business judgment rule that courts should defer to the business judgment of disinterested directors who presumably are acting in the best interests of the corporation.”

Gaillard v. Natomas Co. (1989) 208 Cal.App.3d 1250.

California corporate officers must be cognizant that they have exposure for their corporate decisions because they are not protected by the business judgment rule. Prudent and thoughtful decision-making is one way for officers to protect themselves, but so too is a comprehensive Directors’ and Officers’ insurance policy. Officers may also be able to pass on any personal liability they may have, under Labor Code Section 2802, which requires, under appropriate circumstances, that an employer indemnify an employee for losses incurred by the employee in direct consequence to the discharge of the employee’s duties.

The Cohen Law Firm in Westlake Village serves the unique needs of business owners. From formation to restructuring, and in an ever-changing legal, regulatory and economic landscape, businesses must constantly evolve to survive. To talk about your business’s goals and challenges or to make an appointment, please call the Cohen Law Firm today at (805) 267-7147 or send an e-mail to Randall Cohen at racohen@racohenlawfirm.com.

This article has been prepared by Cohen Law Firm for informational purposes only and does not, and is not intended to, constitute legal advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.