Smith v. Van Gorkom
Encyclopedia
Smith v. Van Gorkom 488 A.2d 858 (Del. 1985) is an important Delaware Supreme Court
decision, primarily because of its discussion of a director's duty of care
. It is often called the "Trans Union case".
by Marmon Group
which was controlled by Jay Pritzker
. Defendant Jerome W. Van Gorkom
, who was the 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
. Van Gorkom and the CFO did not determine an actual total value of the company. 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.
was unavailable.
The Court stated,
288 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.
Nine out of 10 Delaware companies use a provision to this effect in their charters. 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.
Criticism
Daniel Fischel
, 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." 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 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.
Delaware Supreme Court
The Supreme Court of Delaware 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 decisions, particularly in the area of mergers and...
decision, primarily because of its discussion of a director's duty of care
Duty of care (business associations)
In United States corporation and business association law , a duty of care is part of the fiduciary duty owed to a corporation by its directors...
. It is often called the "Trans Union case".
Facts
The case involved a proposed leveraged buy-out merger of TransUnionTransUnion
TransUnion is the third largest credit bureau in the United States, which offers credit-related information to potential creditors. Like major competitors Equifax and Experian, TransUnion markets credit reports directly to consumers.- History :...
by Marmon Group
Marmon Group
Marmon Group is a United States holding company headquartered in Chicago, Illinois.Marmon Group owns companies that produce electrical components, industrial components and transportation equipment, and provide services including construction and retail solutions.- History :In 1953 Jay Pritzker and...
which was controlled by Jay Pritzker
Jay Pritzker
Jay Arthur Pritzker was an American entrepreneur and conglomerate organizer.-Biography:Pritzker was born in Chicago, Illinois, the son of Fanny and A. N. Pritzker. His brother was Robert Pritzker...
. Defendant Jerome W. Van Gorkom
Jerome W. Van Gorkom
Jerome William Van Gorkom was a United States businessman who was U.S. Under Secretary of State for Management 1982-83. He served as the CEO of TransUnion for eighteen years. Van Gorkom is probably best known as the named plaintiff in the landmark corporate law case of Smith v. Van Gorkom, 488...
, who was the 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
Leveraged buyout
A leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage...
. Van Gorkom and the CFO did not determine an actual total value of the company. 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
The Court found that the directors were grossly negligent, 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 ruleBusiness judgment rule
The business judgment rule is a US case law-derived concept in corporations law whereby the "directors of a corporation . . . are clothed with [the] presumption, which the law accords to them, of being [motivated] in their conduct by a bona fide regard for the interests of the corporation whose...
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.
288 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.
Significance
The case prompted an outcry from boards of directors of public companies, a sharp increase in insurance premiums for directors and officers' insurance, and the eventual adoption by the Delaware legislature of Delaware General Corporation Law §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.
Nine out of 10 Delaware companies use a provision to this effect in their charters. 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.
Criticism
Daniel Fischel
Daniel Fischel
Daniel R. Fischel is the emeritus Lee and Brena Freeman Professor of Law and Business and former Dean of University of Chicago Law School, and a co-founder of Lexecon...
, 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." 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 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.