Smith v. Van Gorkom
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''Smith v. Van Gorkom'' 488 A.2d 858 ( Del. 1985) is a United States corporate law case of the
Delaware Supreme Court The Delaware Supreme Court is the sole appellate court in the United States state of Delaware. Because Delaware is a popular haven for corporations, the Court has developed a worldwide reputation as a respected source of corporate law decision ...
, discussing a director's
duty of care In tort law, a duty of care is a legal obligation that is imposed on an individual, requiring adherence to a standard of reasonable care while performing any acts that could foreseeably harm others. It is the first element that must be establi ...
. It is often called the "Trans Union case". ''Van Gorkom'' is sometimes referred to as the most important case regarding business organizations because it shows a unique scenario when the board is found liable even after applying the business judgment rule. The decision "stripped corporate directors and officers of the protective cloak formerly provided by the business judgment rule, rendering them liable for the tort of gross negligence for the violation of their duties under the rule."


Facts

The case involved a proposed leveraged buy-out merger of
TransUnion TransUnion is an American consumer credit reporting agency. TransUnion collects and aggregates information on over one billion individual consumers in over thirty countries including "200 million files profiling nearly every credit-active consume ...
by
Marmon Group Marmon Group is an American industrial holding company headquartered in Chicago, Illinois; founded by Jay Pritzker and Robert Pritzker in 1953 (as Colson Corporation), it has been held by the Berkshire Hathaway group since 2013. It owns compani ...
which was controlled by
Jay Pritzker Jay Arthur Pritzker (August 26, 1922 – January 23, 1999) was an American entrepreneur, conglomerate organizer, and member of the Pritzker family. Early life and education Pritzker was born in Chicago, Illinois to Jewish parents who emi ...
.Ribstein, L. E., & Letsou, P. V. (2003). Business associations. Analysis and skills series. ew York, N.Y. M. Bender. Defendant Jerome W. Van Gorkom, who was TransUnion's chairman and CEO, chose a proposed price of $55 without consultation with outside financial experts. He only consulted with the company's CFO, and that consultation was to determine a per share price that would work for a
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...
. Van Gorkom and the CFO did not determine an actual total value of the company. The board approved the sale of TransUnion because it suffered accelerated depreciation and a reduced income; in other words, it had more tax credits than income. The court was highly critical of this decision, writing that "the record is devoid of any competent evidence that $55 represented the per share intrinsic value of the Company." The proposed merger was subject to Board approval. At the Board meeting, a number of items were not disclosed, including the problematic methodology that Van Gorkom used to arrive at the proposed price. Also, previous objections by management were not discussed. The Board approved the proposal.


Judgment


Majority

The Court found that the directors were
grossly negligent Gross negligence is the "lack of slight diligence or care" or "a conscious, voluntary act or omission in reckless disregard of a legal duty and of the consequences to another party." In some jurisdictions a person injured as a result of gross negl ...
, because they quickly approved the merger without substantial inquiry or any expert advice. For this reason, the board of directors breached the duty of care that it owed to the corporation's shareholders. As such, the protection of the
business judgment rule The business judgment rule is a case law-derived doctrine in corporations law that courts defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation... are clothed with hepresumpti ...
was unavailable. The Court stated,
The rule itself "is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." ... Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one.
488 A.2d at 872. Furthermore, the court rejected defendant's argument that the substantial premium paid over the market price indicated that it was a good deal. In so doing, the court noted the irony that the board stated that the decision to accept the offer was based on their expertise, while at the same time asserting that it was proper because the price offered was a large premium above market value. The decision also clarified the directors' duty of disclosure, stating that corporate directors must disclose all facts germane to a transaction that is subject to a shareholder vote.


Dissent

Justices McNeilly and Christie wrote dissenting opinions. McNeilly hotly dissented, calling the majority's opinion a "comedy of errors," and saying it "reads like an advocate's closing address to a hostile jury. And I say that not lightly." Particularly, McNeilly argues the facts show the board made an informed decision:
I have no quarrel with the majority's analysis of the business judgment rule. It is the application of that rule to these facts which is wrong. An overview of the entire record, rather than the limited view of bits and pieces which the majority has exploded like popcorn, convinces me that the directors made an informed business judgment which was buttressed by their test of the market.
Christie also argues the business judgment rule protects the board in this case.


Significance

The case prompted an outcry from boards of directors of public companies, a sharp increase in insurance premiums for
directors and officers' insurance Directors and officers liability insurance (also written directors' and officers' liability insurance; often called D&O) is liability insurance payable to the directors and officers of a company, or to the organization itself, as indemnification (re ...
, and the eventual adoption by the Delaware legislature of
Delaware General Corporation Law The Delaware General Corporation Law (Title 8, Chapter 1 of the Delaware Code) is the statute of the Delaware Code that governs corporate law in the U.S. state of Delaware. Adopted in 1899, the statute has since seen Delaware become the most im ...
§102(b)(7) as extracted below. This permits Delaware companies (with shareholder approval) to adopt charter amendments that exculpate directors from personal liability for breaches of the duty of care.
(7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. All references in this paragraph to a director shall also be deemed to refer (x) to a member of the governing body of a corporation which is not authorized to issue capital stock, and (y) to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with § 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.
The vast majority of Delaware corporations now have a 102(b)(7) provision in their certificate of incorporation. Nevertheless, the case lives on as a reminder that directors should take reasonable actions to inform themselves before acting. After the court's decision to remand the case back to the Court of Chancery the defendants agreed to a settlement. The directors agreed to pay $23.5 million in damages, of which $10 million was covered by insurance with Pritzker then paying the remainder of the settlement even though he was not a party to the lawsuit. Pritzker paid as he did not agree with the court and some of the defendants were unable to pay the settlement. Ultimately, the main significance of the Trans Union case is that fairness opinions, typically provided by investment banks, are effectively now a legal requirement of any public company merger.


Criticism

Daniel Fischel Daniel R. Fischel (born December 10, 1950) is the emeritus Lee and Brena Freeman Professor of Law and Business and former Dean of University of Chicago Law School. He co-founded Lexecon, and is now chairman and president of Compass Lexecon. Earl ...
, a leading scholar in the regulation of corporations, described the ''Smith v. Van Gorkom'' opinion as "one of the worst decisions in the history of corporate law."Daniel Fischel, The Business Judgment Rule and the Trans Union Case, 40 Bus. Law. 1437, 1455 (1985) This criticism stems in part from the fact that the court made independent directors potentially liable for millions of dollars in damages for selling a company for approximately a 60% premium to its market value. Such liability provides a strong disincentive for the best potential directors to serve on the board, and one would expect such a disincentive to result in worse corporate governance. The decision has also been derided as the "Investment Banker's Relief Act of 1985" because of all the business it has generated for investment bankers from boards seeking to avoid liability or other legal entanglements.


See also

*
Pritzker family The Pritzker family is an American family engaged in entrepreneurship and philanthropy, and one of the wealthiest families in the United States of America (staying in the top 10 of ''Forbes'' magazine's "America's Richest Families" list since the ...
*
US corporate law United States corporate law regulates the governance, finance and power of corporations in US law. Every state and territory has its own basic corporate code, while federal law creates minimum standards for trade in company shares and governanc ...


Notes


References

* Lynn A. Stout, In Praise of Procedure: An Economic and Behavioral Defense of Smith v. Van Gorkom and the Business Judgment Rule, 96 Nw. U. L. REv. 675 (2002) * Daniel Fischel, The Business Judgment Rule and the Trans Union Case, 40 Bus. Law. 1437, 1455 (1985)


External links

{{wikisource
case summary

case summary 2
United States corporate case law Delaware state case law 1985 in United States case law 1985 in Delaware