This article is from the Photographic Lenses FAQ, by David Jacobson with numerous contributions by others.
When a lens is defocused, a object point gets rendered as a small circle, called the circle of confusion. (Ignoring diffraction.) If the circle of confusion is small enough, the image will look sharp. There is no one circle "small enough" for all circumstances, but rather it depends on how much the image will be enlarged, the quality of the rest of the system, and even the subject. Nevertheless, for 35mm work c=.03mm is generally agreed on as the diameter of the acceptable circle of confusion. Another rule of thumb is c=1/1730 of the diagonal of the frame, which comes to .025mm for 35mm film. (Zeiss and Sinar are known to be consistent with this rule.)