Most people—even lawyers—choose to do business in some corporate form, rather than individually, in order to protect personal assets from business liabilities. The most common forms of business entities are corporations and limited liability companies. The choice of entity often depends on which entity offers the best tax attributes for the particular business and its owner(s).
Regardless of the choice of entity, a business is still run by people. However, the people are acting as directors of a corporation or as managers of a limited liability company when they make decisions and act on behalf of the business entity.
The “Business Judgment Rule” is a well established principle of law that affords directors and managers protection from the constant threat of lawsuits as a result of corporate decisions and actions. Generally, a court will not impose liability on directors or managers for any decision made in good faith and with reasonable diligence—even if the decision turns out to be a horrible business decision. The rationale is that directors and managers should be free to take reasonable business risks without the fear of lawsuits.
It is very difficult to overcome the protection of the Business Judgment Rule. However, it is the process of decision making, and not necessarily the decision itself, that is often the focus of court scrutiny. Without a decision making process, there may be no protection from the Business Judgment Rule.
Good governance is the key, which requires attention to the most basic corporate formalities. At a minimum, this requires establishing and documenting a process for decision making, periodically electing or appointing officers, directors or managers and filing annual reports, minutes and resolutions reflecting business decisions. Specific record keeping requirements exist under law, including a requirement to keep minutes or records of business decisions.
It is easy to overlook, shortcut or even ignore what may seem to be unnecessary and tedious paperwork. However, good governance should be routine business practice. Every business owner should adopt and follow a process for decision making and keep records of the decision making process. Legal nightmares can be avoided with just a few easy preventative measures.
For more information on issues of business, estate and tax planning, please contact the author, J. Graves Theus, Jr.
The contents of this article are not intended to serve as legal advice relating to individual situations or as legal opinions concerning any such situation. Counsel should be consulted for legal planning and advice.