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The Business Judgment Rule as Abstention Doctrine

Stephen M. Bainbridge

University of California, Los Angeles (UCLA) - School of Law

July 29, 2003

UCLA, School of Law, Law and Econ. Research Paper No. 03-18

The business judgment rule is corporate law's central doctrine, pervasively affecting the roles of directors, officers, and controlling shareholders. Increasingly, moreover, versions of the business judgment rule are found in the law governing the other types of business organizations, ranging from such common forms as the general partnership to such unusual ones as the reciprocal insurance exchange. Yet, curiously, there is relatively little agreement as to either the theoretical underpinnings of or policy justification for the rule. This gap in our understanding has important doctrinal implications. As this paper demonstrates, a string of recent decisions by the Delaware supreme court based on a misconception of the business judgment rule's role in corporate governance has taken the law in a highly undesirable direction.

Two conceptions of the business judgment rule compete in the case law. One views the business judgment rule as a standard of liability under which courts undertake some objective review of the merits of board decisions. This view is increasingly widely accepted, especially by some members of the Delaware supreme court. The other conception treats the rule not as a standard of review but as a doctrine of abstention, pursuant to which courts simply decline to review board decisions. The distinction between these conceptions matters a great deal. Under the former, for example, it is far more likely that claims against the board of directors will survive through the summary judgment phase of litigation, which at the very least raises the settlement value of shareholder litigation and even can have outcome-determinative effects.

Like many recent corporate law developments, the standard of review conception of the business judgment rule is based on a shareholder primacy-based theory of the corporation. This article extends the author's recent work on a competing theory of the firm, known as director primacy, pursuant to which the board of directors is viewed as the nexus of the set of contracts that makes up the firm. In this model, the defining tension of corporate law is that between authority and accountability. Because one cannot make directors more accountable without infringing on their exercise of authority, courts must be reluctant to review the director decisions absent evidence of the sort of self-dealing that raises very serious accountability concerns. In this article, the author argues that only the abstention version of the business judgment rule properly operationalizes this approach.

Number of Pages in PDF File: 53

Keywords: business judgment rule, board of directors, corporate law

JEL Classification: K22

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Date posted: July 31, 2003  

Suggested Citation

Bainbridge, Stephen M., The Business Judgment Rule as Abstention Doctrine (July 29, 2003). UCLA, School of Law, Law and Econ. Research Paper No. 03-18. Available at SSRN: https://ssrn.com/abstract=429260 or http://dx.doi.org/10.2139/ssrn.429260

Contact Information

Stephen Mark Bainbridge (Contact Author)
University of California, Los Angeles (UCLA) - School of Law ( email )
385 Charles E. Young Dr. East
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Los Angeles, CA 90095-1476
United States
310-206-1599 (Phone)
310-825-6023 (Fax)
HOME PAGE: http://www.professorbainbridge.com
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