The Business Judgment Rule in Florida â on Paper and in the Trenches
Enron, Worldcom, Tyco Industries (of $15,000 umbrella-stand fame) and other corporate scandals notwithstanding, the business judgment rule remains alive and kicking in Florida. The business judgment rule protects directors from personal liability for most of their actions. The rule seemed headed for life support after numerous highly publicized corporate boardroom scandals and passage of the federal Sarbanes-Oxley Act of 2002, but in August 2005 it seemed to gain a new lease on life thanks to a significant Delaware court decision.
Although its tenets are business-friendly, the business judgment rule presents hard challenges in litigation for counsel representing defendant directors as well as counsel representing shareholders or other plaintiffs. In the practical litigation world (the trenches), the protections of the business judgment rule are not always what they are cracked up to be. Motions to dismiss and motions for summary judgment attacking claims implicating the business judgment rule often are an uphill climb. At trial, a lawyer may face a judge with modest experience in the business judgment rule’s operation, and a jury with no experience at all (but with lots of experience hearing about Enron and other infamous corporate abuses). Practioners must plan accordingly.
The Business Judgment Rule Today
The business judgment rule is a principle of substantive corporate law that presumes a corporate director has acted in good faith. The rule evolved in Florida from common law. Now it is mostly codified in Florida Statutes §§ 607.0830 and 607.0831, and primarily in the latter.1
Section 607.0830 provides that a director must discharge his or her duties in good faith, with ordinary care, and in a manner he or she believes in the best interests of the corporation. F.S. §607.0830 (1997). Breaching one of these duties does not appear to make a director liable for damages, however. A director cannot be liable for money damages unless the plaintiff shareholder or corporation also proves that the director’s breach of his or her duties (whether in a statement, vote, decision, or failure to act) consists of one of the following: 1) a knowing criminal violation; 2) a transaction involving an “improper personal benefit” (e.g., self-dealing); 3) an improper distribution to shareholders; 4) conscious disregard for the best interest of the corporation; or 5) willful misconduct.2 Proving gross negligence is not enough to overcome the business judgment rule’s protections.3 Section 607.0831 applies only in actions for money damages, not actions in equity such as for injunctive relief or rescission.4
As it developed in the common law, and as now codified by statute, the business judgment rule generally prevents a court from calling directors to account for their actions or inactions, no matter how poor their business judgment. The theory underlying the rule is that judges have less business expertise than corporate directors, and, therefore, ought not to mettle in director’s business decisions.5
The business judgment rule has been described as a “presumption” against director liability, but it is not a classical evidentiary presumption. “In using the word ‘presumption’ or ‘presumed’ in articulating the business judgment rule, the courts have not intended to create a presumption in the classical procedural sense…. Rather, the courts are merely expressing the substantive rule of director liability.”6 In other words, “presumption” in the context of the business judgment rule means that it is going to be hard for the plaintiff to prove that a director breached his or her fiduciary duties or committed some other wrong for which he or she may be held liable.
Although it is a substantive rule of law concerning director liability, the business judgment rule as codified in §607.0831 does not state elements of a cause of action against directors. It imposes no duties and creates no causes of action.7 The fiduciary duties that a director owes the corporation and its shareholders derive from case law and from §607.0830, not from §607.0831. A creditor of a corporation has no cause of action against a director, even if the director has committed an act that falls outside the protections of the business judgment rule, because directors do not owe duties to the corporation’s creditors.8 The purpose of the business judgment rule is not to create causes of action against directors, but instead to protect them from personal liability and identify the situations in which the protection could be lost.9
Principles similar to the business judgment rule apply to the actions of officers, but as a matter of common law rather than pursuant to §607.0831.10
Historically, Delaware has led in the development of corporate law and Florida has followed, including in the area of director and officer responsibilities and the business judgment rule.11 The passage of the federal Sarbanes-Oxley Act in 2002 threatened to change things, however. Sarbanes-Oxley was enacted to head off corporate abuses by making directors and officers more accountable to investors. With its passage, the relevance of Delaware courts in the area of corporate director and officer law looked like it might start to slip. Perhaps to combat that looming possibility, Delaware courts responded initially after Sarbanes-Oxley with strong words, including hints that they would cut back on the business judgment rule’s presumptions of legality and apply stricter director and officer conduct standards.
In re The Walt Disney Co. Derivative Litigation, 825 A.2d 275, 290 (Del. Ch. 2003) (Disney I) exemplified the Delaware courts’ initial tough stance. In Disney I, Disney Chairman Michael Eisner had given fired president Michael Ovitz a $140 million severance package without board approval, and the board let it stand after finding out. Denying a motion to dismiss a shareholder action attacking the board’s inaction, the Delaware Chancery Court said that the board’s passivity in the Ovitz matter may have violated their duty of good faith: “[T]he facts alleged … suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a ‘we don’t care about the risks’ attitude concerning a material corporate decision.”12 Disney I was ominous for Florida directors because under Florida law, actions in bad faith or in conscious disregard of a director’s responsibility are not protected by the business judgment rule.13
In addition to the Disney I decision, then-Chief Justice of the Delaware Supreme Court, E. Norman Veasey, confirmed in a 2003 speech that the Delaware Supreme Court intended to crack down on directors who give officers cart blanche in managing their companies. “Directors need to do their homework and realize that they’re the boss,” he said.14
Now, however, three years later, it looks like the crackdown may have fizzled. Chief Justice Veasey has left the bench, and in August 2005 the Delaware Court of Chancery in In re The Walt Disney Co. Derivative Litigation, 2005 WL 2056651 (Del. Ch. Aug. 9, 2005) (Disney II), after a full trial issued in a 174-page decision exonerating the entire Disney board of directors, including Eisner, in the Ovitz severance matter. The court held that even though Disney’s corporate governance policies were terrible, neither the monumentally passive Disney board nor Eisner had acted in bad faith.
Disney II is on appeal, but for now it seems to have reconfirmed the business judgment rule’s basic protections of directors against liability for bad business judgment, including in Florida, which routinely follows Delaware’s lead. Had the court in Disney II found that the board’s passiveness in the Ovitz matter constituted bad faith, it could have been catastrophic for directors. It could have left members of both passive boards and aggressive, risk-taking boards vulnerable to personal liability for bad faith or “conscious disregard for the best interest of the corporation,” which are not shielded by the business judgment rule.15 D&O insurance policies routinely exclude bad faith conduct from coverage, and F.S. §607.0850 generally precludes indemnification of directors who have acted in bad faith. The liability could be disastrous for a director.
The Business Judgment Rule in the Trenches
While under Disney II and F.S. §607.0831 the business judgment rule still protects a director from personal liability, in the real litigation world that protection usually costs a lot in attorneys’ fees, related expenses, time, effort, and hassle. In addition, lawsuits against directors implicating the business judgment rule can be a challenge to try to dispose of before trial, whether through a motion to dismiss or a motion for summary judgment.
• Motions to Dismiss — A number of courts have questioned whether the business judgment rule can even be considered in a motion to dismiss.16
In addition to courts’ conceptual resistance to dismissing cases asserting the business judgment rule, complaints in cases asserting director mismanagement can be hard to attack on a motion to dismiss because the complaints often contain allegations that the director acted in conscious disregard for the best interest of the corporation. As conscious disregard is not protected under the business judgment rule, the allegation can save the complaint from dismissal.17 After Disney I, passiveness alone seemed to put a director in danger of being found in conscious disregard of a corporation’s best interests, and therefore in danger of losing business judgment protection. Under Disney II, the passive director’s vulnerability to a “conscious disregard” charge seems to have decreased. But shareholders and derivative claimants likely will continue to assert “conscious disregard” in mismanagement cases, and director defendants contemplating motions to dismiss will have to confront it.
•Motions for summary judgment — Business judgment rule cases clearly can be won by the director on summary judgment, but Florida state courts’ hostility to summary judgment in tort cases generally is an obstacle.18 In addition, a state court judge’s 1000-plus caseload may not leave him or her a lot of time in a significant business-judgment-rule case to digest voluminous motion papers and supporting materials and feel comfortable enough to terminate the plaintiff’s case at the summary judgment stage. The defendant director or officer may have a better chance at summary judgment in federal court. Federal courts in Florida seem less hesitant to enter summary judgment than the state courts.19
Possibilities for Efficient Resolution
the time an action against a director or officer has gotten to the summary judgment motion stage, it is likely significant amounts of money have been spent on attorneys’ fees, discovery (including e-discovery), investigation, and experts. The fees and expenses tab is often increased because of the number of attorneys separately representing individual directors, officers, the company, or others. the time of trial, expenses in litigation where the business judgment rule is involved can approach the stratosphere. Frequently, the stakes in such litigation are high and the expenses unavoidable, as in Disney. But in many cases the stakes are much lower. Predictably high litigation costs in relation to the amount at stake warrants exploration at the outset of the possibility of an early, efficient resolution of dispute. Set forth below are a few methods to help achieve early resolution in the appropriate business judgment rule case.
The logical place to start is mediation. Any worry about “showing weakness” by proposing to mediate early on is probably illusory. Mediation of course is one’s chance before trial to tell the opponent and his or her client face-to-face about the strength of one’s case and the weakness of theirs. Sometimes it can be more productive to use that chance at the beginning, rather than just at the end, months or years later, when everybody may be more heavily invested emotionally and monetarily in the case.
Even if resolution is not possible at the outset, often cases can be brought to a head sooner rather than later, and expenses saved. One tool is the case management conference under Fla. R. Civ. P. 1.200.20 Under Rule 1.200 one can unilaterally require all parties and the judge to meet to set a discovery schedule and other deadlines, and the judge can be asked to require the parties to mediate sooner. Under Federal Rule 16, one can only ask for the case management conference, but usually the request will be granted, and in any event the federal courts in Florida generally make the proceedings before trial go faster than in state court.
Another tool to move things along quicker and potentially encourage more efficient resolution is to notice the case for trial 20 days after the defendant answers the complaint (or the plaintiff answers a counterclaim).21 This by no means is the proper course in every case. But when it is done in state court, it causes the trial court to promptly issue an order scheduling the case for trial, setting early discovery and pretrial deadlines. It also forces the parties to prepare the case now, rather than at a leisurely — and more expensive — pace, and to consider alternative dispute resolution much earlier.
One also can bring things to a head sooner by deposing parties or key witnesses early rather than at the bitter end. Of course this can work only if counsel makes sure that there will be an opportunity to follow up later. Although it is typically assumed that a party or witness can only be deposed once, neither the Florida Rules nor the Federal Rules strictly limit a party to one deposition of another party or witness in a case. The Federal Rules limit depositions to seven hours, but that limit is flexible, and the Federal Rules explicitly allow a second deposition of a person upon leave of court.22 One must ensure the opportunity to depose the party or key witness again later will be there by getting a stipulation or a court order. An early deposition of a party or key witness can help greatly in positioning a case for early resolution, before huge dollars and hours are spent on full-blown discovery, investigation, experts, and other trial preparation.
In a business judgment rule case with less than an enormous amount at stake, if resolution is not seriously explored early on, counsel might wake up two years later having spent too much in relation to the amount at stake, and still be mired in discovery and motion practice,23 the end of which may not be in sight.
The business judgment rule in Florida remains the salvation of the passive as well as the risk-taking director. But the salvation can be pricey, time-consuming, and somewhat uncertain. Counsel will want to prepare accordingly.
1 See U.S. v. De La Mata, 266 F.3d 1275, 1297 (11th Cir. 2001), cert. denied, 535 U.S. 989 (2002) (“[W]e read F.S. §607.0831 as codifying the ‘business judgment rule’ in Florida”)(citing In re Toy King Distr. Inc., 256 B.R. 1, 173 (M.D. Fla. 2000)).
2 Fla. Stat. §607.0831(1)(b) (1997). If the plaintiff is not a shareholder or the corporation itself, the plaintiff must prove 1) a knowing criminal violation; 2) a transaction involving an “improper personal benefit” (e.g., self-dealing); or 3) recklessness or an act/omission committed in bad faith or maliciously or with wanton and willful disregard of rights, safety, or property. Fla. Stat. §607.0831(1)(b) (1997). Items 1 and 2 are the same as what the shareholder or corporation must prove; item 3 is slightly different.
3 See F.D.I.C. v. Gonzalez-Gorrondona, 833 F. Supp. 1545, 1556 (S.D. Fla.1993)(with the enactment of Fla. Stat. §§607.0830 and 607.0831, “Florida [has] imposed liability only for acts constituting more than gross negligence” (emphasis added)); In re Toy King Distr. Inc., 256 B.R. at 168.
4 This being Florida, it’s worth noting that the business judgment rule applies to the actions of directors of condominium associations. See, e.g., Sonny Boy, L.L.C. v. Asnani, 879 So. 2d 25, 28 (Fla. 5th DCA 2004); Perlow v. Goldberg, 700 So. 2d 148, 150 (Fla. 3d DCA1997).
5 See Kloha v. Duda, 246 F. Supp. 2d 1237, 1244 (M.D. Fla. 2003) (citations omitted); Pittman v. Groveowners Coop of Loxahatchee, Inc., 534 So. 2d. 1207, 1210-1211 (Fla. 4th D.C.A. 1989) (citing Lake Region Packing Association v. Furze, 327 So. 2d 212, 216 (Fla.1976)).
6 In re Bal Harbour Club, Inc., 316 F.3d 1192, 1195 (11th Cir.2003)).
7 Connolly v. Agostino’s Ristorante, Inc., 775 So. 2d 387, 388 (Fla. 2d D.C.A. 2000).
8 See Id. at 388 (citing Geyer v. Ingersoll Publications Co., 621 A.2d 784, 787 (Del. Ch.1992)). It’s a different story when the corporation is insolvent. “Generally, an officer or director owes fiduciary duties exclusively to the corporation’s shareholders. When a corporation becomes insolvent, however, the officer or director’s fiduciary duties shift to the creditors of the corporation.” In re Toy King Distr. Inc., 256 B.R. at 166 (decided under Florida law).
9 Connolly, 775 So. 2d at 388.
10 See De La Mata, 266 F.3d at 1293 (fiduciary duty, or duty of loyalty, obligates corporate officers as well as directors to avoid fraud, bad faith, usurpation of corporate opportunities, and self-dealing); In re Toy King Distr. Inc., 256 B.R. at 166; see also In re The Walt Disney Company Derivative Litigation, 2005 WL 2056651, at *51 n.588 (Del.Ch. August 9, 2005).
11 See Connolly, 775 So. 2d at 388 n.1 (“The Florida courts have relied upon Delaware corporate law to establish their own corporate doctrines.”)
12 Disney I, 825 A.2d at 289 (emphasis in original); see also In re Emerging Communications Inc. Shareholders Litigation, 2004 WL 1305745, *43 (Del. Ch. May 3, 2004) (applying Disney I).
13 See Fla. Stat §607.0831(1)(b)(4),(5) (1997).
14 See John Gibeaut, Stock Responses: Shareholders Ask for Changes in Corporate Governance, and the Courts are Starting to See It Their Way, ABA J. 38, 42 (September 2003).
15 See Fla. Stat. §607.0831(1)(b)(4),(5) (1997).
16 See, e.g., Talib v. Skyway Communications Holding Corp., 2005 WL 1610707 at *6 (M.D. Fla. July 7, 2005) (“It is debatable whether a court should consider the protection of the business judgment rule on a motion to dismiss. … It is, therefore, premature for the business judgment rule to be applied at this stage of the case, as discovery has not commenced.”); In re Southeast Banking Corp., 827 F. Supp. 742, 754-55 (S.D. Fla.1993), rev’d in part on other grounds, 69 F.3d 1539 (11th Cir.1995) (“[T]he fact-based Business Judgment Rule defense should not be considered on a Motion to Dismiss” (citations omitted)); In re Luxottica Group S.P.A., Securities Litigation, 293 F. Supp. 2d 224, 238 (E.D.N.Y. 2003) (applying Florida law). Of course, motions to dismiss for failure to state a claim or cause of action generally focus only on the allegations contained within the complaint (including attachments), with all of the factual allegations taken as true and all inferences interpreted in the light most favorable to the plaintiff. See Salit v. Ruden, McClosky, Smith, Schuster & Russell, P.A., 742 So. 2d 381, 383 (Fla. 4th D.C.A. 1999); Fla. R. Civ. P. 1.140(b)(6); Fed. R. Civ. P. 12(b)(6).
17 See Fla. Stat. §607.0831(1)(b)(4) (1997). Focusing on the business judgment rule as it evolved from case law, the court in Kloha concluded that if there is no evidence of “bad faith, abuse of discretion, fraud, or illegal acts,” the business judgment rule applies and the director is exonerated. See Kloha, 246 F. Supp. 2d at 1244 n.18. The Kloha court went on to say that if there is evidence of one of those four types of bad conduct, a director still might be exonerated in a shareholder action, if the shareholder does not also show that the conduct constituted “conscious disregard for the best interest of the corporation” under §607.0831(1)(b)(4). See id. n.18, n.20. Implicit in Kloha’s analysis is a distinction between bad faith conduct and conduct in conscious disregard of the corporation’s best interests. But the court did not explain what that distinction might be.
18 See, e.g., Garcia v. Crescent Plaza Condominium Ass’n, Inc., 813 So. 2d 975, 978 (Fla. 2d D.C.A. 2002) (reversing a summary judgment entered based on the business judgment rule, the court stated, “If the record reflects the existence of any genuine issue of material fact, or the possibility of any issue, or if the record raises even the slightest doubt that an issue might exist, summary judgment is improper.’”(citation omitted)).
19 See, e.g., Kloha, 246 F. Supp. 1237 (M.D. Fla. 2003) (summary judgment granted).
20 See also Fed. R. Civ. P. 16.
21 See Fla. R. Civ. P. 1.440(a), (b).
22 See Fed. R. Civ. P. 30(d)(2), 30(a)(2)(B).
23 This is less of a problem in federal court, where detailed federal and local rules regarding discovery and pretrial scheduling tend to keep everybody’s noses to the grindstone. See Fed. R. Civ. P. 26(a)(1); U.S.D.C.S.D. Fla. Local Rule 26.1.
James F. Carroll is a partner at Conrad & Scherer, L.L.P., in Ft. Lauderdale. His primary areas of practice are corporate and securities litigation and general business litigation and counseling, including health care, computer data, and other fields. He also does intellectual property and noncompete agreement litigation and counseling.