Data Breach and Business Judgment

Quang Trang, MJLST Staffer

Data breaches are a threat to major corporations. Corporations such as Target Co. and Wyndham Worldwide Co. have been victim of mass data breaches. The damage caused by such breaches have led to derivative lawsuits being filed by shareholders to hold board of directors responsible.

In Palkon v. Holmes, 2014 WL 5341880 (D. N.J. 2014), Wyndham Worldwide Co. shareholder Dennis Palkon filed a lawsuit against the company’s board of directors. The judge granted the board’s motion to dismiss partially because of the Business Judgment Rule. The business judgement rule governs when boards refuse shareholder demands. The principle of the business judgment rule is that “courts presume that the board refused the demand on an informed basis, in good faith and in honest belief that the action taken was in the best interest of the company.” Id. The shareholder who brings the derivative suit has the burden to rebut the presumption that the board acted in good faith or that the board did not base its decision on reasonable investigation.

Cyber security is a developing area. People are still unsure how prevalent the problem is and how damaging it is. It is difficult to determine what a board needs to do with such ambiguous information. In a time when there is no set corporate cyber security standards, it is difficult for a shareholder to show bad faith or lack of reasonable investigation. Until clear standards and procedures for cyber security are widely adopted, derivative suits over data breaches will likely be dismissed such as in Palkon.

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