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Business Judgement Rule Inapplicable if Director is Engaged in Self-Dealing, Unconscionable, or Fraudulent Activities/Decisions

Pursuant to New Jersey corporate law, directors are trustees for the entire body of the owners. Directors owe loyalties to all shareholders. If they disregard the rights of the majority shareholders, minority shareholders, or the corporation itself they could be liable for a breach of fiduciary obligations or duties.

New Jersey law affords directors certain protections if their decision making falls within the Business Judgement Rule. In re PSE&G Shareholder Litigation, 173 N.J. 258, 276 (2002); Daloisio v. Penunsual Land Co., 43 N.J. Super. 79, 93-94 (App. Div. 1956). Under that rule, individual shareholders cannot question, in a judicial proceeding the corporate acts of directors, if those decisions/acts are within the powers of the corporation and in furtherance of the corporation’s purposes. They must not be an unlawful exercise of judgment. That is because to hold otherwise would result in the substitution of the director’s judgement and discretion in the scheme of the corporation.

Although the Business Judgement Rule may serve as a defense to directors, it is inapplicable if the Court were to determine that the decisions/actions are fraudulent, unconscionable, or that the director is engaged in self-dealing. Not only will the court not apply the Business Judgement Rule in cases where it finds that the plaintiff has made a prima facie case that a director has engaged in self-dealing, fraudulent, or unconscionable decisions/actions, the law requires that the Director must demonstrate by “clear and convincing evidence” that the entire transaction is “entirely fair and not inimical” to the corporation and all of its shareholders. Daloisio v. Penunsual Land Co., 43 N.J. at 94.

When rendering decisions on behalf of a corporation, directors must always put the interests of the corporation and its shareholders first. If the director does that, they will enjoy protections under the Business Judgement Rule. If they award themselves favorable contracts, grant themselves excessive salaries, and make other decisions that are deemed “self-dealing” by the Court, then they will have the burden of proof to demonstrate that their decision making was entirely fair to all shareholders and the corporation. Because the “clear and convincing” burden is so high, it will is likely to be extremely difficult to convince a Court not to find that they breached fiduciary duties or acted oppressively.

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About this Author

Scott Unger, Litigation Attorney, Stark Law Firm
Shareholder

Scott I. Unger is a Shareholder and member of Stark & Stark’s Litigation Group where he concentrates his practice on litigation arising out of business and commercial disputes. Mr. Unger regularly counsels business owners on the prosecution and defense of minority oppression litigation (corporate divorces), breach of contract cases, uniform commercial code (U.C.C.) litigation, consumer fraud claims, appellate practice, and estate litigation. Mr. Unger has extensive experience litigating cases in a variety of jurisdictions, including, New Jersey, New York, Pennsylvania, Ohio,...

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