Over at Conglomerate, Gordon Smith is discussing the view which treats the corporate directors' duty of care and the business judgment rule as a standard of conduct and a standard of review, respectively:
In this short symposium paper, I borrow from the work of Meir Dan-Cohen, Mel Eisenberg, and others to discuss the difference between "standards of conduct" [edited: see comments] and "standards of liability." The basic idea is that we want directors to hear this message: be diligent and make wise decisions. This is the standard of conduct. But we don't want to hold directors liable merely for a failure of diligence or wisdom. (Why? Two reasons: because we want directors to be bold and because we want to preserve the value of centralized decision making.) Before imposing liability, we want some evidence of wrongdoing, such as a conflict of interest. This is the standard of liability.
According to this conception, the duty of care is a standard of conduct, which specifies how directors should conduct themselves. In contrast, the business judgment rule is a standard of review, which sets forth the test courts will use in determining whether the directors’ conduct gives rise to liability. Unlike typical negligence tort cases, in which the standard of review and the standard of conduct are identical, in corporate law they purportedly diverge. The function of the business judgment rule thus is to create a less demanding standard of review than the (largely aspirational) standard of conduct created by the duty of care. But what is the standard? It may be mere subjective good faith, it may be a requirement of rationality, it may be gross negligence. No one seems to know for sure.
In my article The Business Judgment Rule as Abstention Doctrine, I argued against that approach to understanding the BJR. If the business judgment rule is treated as a standard of liability, rather than an abstention doctrine, judicial intervention readily could become the norm rather than the exception. It implies that the business judgment rule does not preclude judicial review of cases in which the board failed to exercise reasonable care. Yet, if the business judgment rule is to have teeth, it is precisely those cases in which it is especially important for courts to abstain. No matter how gingerly courts apply the standard of liability, trying to measure the “quantity” of negligence is a task best left untried. Courts will be tempted constantly to apply the standard in ways that sanction honest decisions that, with the benefit of hindsight, proved unfortunate and/or appear inept.
If the business judgment rule is framed as an abstention doctrine, however, judicial review is more likely to be the exception rather than the rule. The court begins with a presumption against review. It then reviews the facts to determine not the quality of the decision, but rather whether the decisionmaking process was tainted by self-dealing and the like. The requisite questions to be asked are more objective and straightforward: Did the board commit fraud? Did the board commit an illegal act? Did the board self-deal? Whether or not the board exercised reasonable care is irrelevant, as well it should be. The business judgment rule thus builds a prophylactic barrier by which courts pre-commit to resisting the temptation to review the merits of the board’s decision.
