Smith v. Van Gorkom: Insights About C.E.O.s, Corporate Law Rules, and the Jurisdictional Competition for Corporate Charter

INTRODUCTION After fifteen years, Smith v. Van Gorkom remains intellectually frustrating. The annoyance stems from the fact that, while the decision may have dramatically improved the quality of deliberations in corporate boardrooms, the imposition of liability on the defendants in the case seems profoundly unjust. When Smith v. Van Gorkom was decided, the mergers and acquisitions ("M&A") industry was in its infancy. The Trans Union board made its decision in 1980. At that time, when making a decision about a control transaction, industry practice called for directors to evaluate three things: premium to market, price to book, and price/earnings ratio. That was the guts of what was done, and all the firms created the database from scratch. There weren't EBITDA multiples or detailed DCF analysis. There were occasionally some industry comparables... but M&A valuation was rather unsophisticated by current standards.1 By today's standards, the board's procedures seem woefully inadequate. There was no modem third-party valuation analysis of any kind, No investment bankers were hired. The analysis that was done by management was not thorough. The board did not read the merger agreement, much less But although the board's decision was not cloaked in the same elabodiscuss and deliberate its contents in any detail.2 But although the board's decision was not cloaked in the same elaborate procedural framework that has become the norm in modern boardrooms when directors are considering actions that involve organic changes to the corporate structure, this alone does not mean it was a bad decision from the economic perspective of the shareholders,3 or even that it was legally inadequate4 On the directors' side of the ledger, of course, is the fact that the board of directors was acting in good faith, and in a manner it thought was in the best interests of the firm's shareholders. The board's decision was not tainted by even a hint of self-dealing or conflict of interest. There has never been a serious argument that Smith v. Van Gorkom was a duty of loyalty case in disguise. These directors were not inept, lazy, or corrupt. In addition, the board of Trans Union consisted of a group of men with a vast wealth of experience. The five inside directors had been with the company an average of 23.2 years each, and had an average of 13.6 years of experience as corporate directors.5 The outside directors included Alan Wallis, the highly respected dean of the University of Chicago Business School, and four chief executive officers of Chicago-- based companies. These distinguished directors brought their expertise and experience to bear on the decision about whether to approve the merger. For the Delaware Supreme Court to fail to respect their decision seems fundamentally inconsistent with the basic principles of the business judgment rule. This inconsistency, combined with the harsh tone of the decision and the debilitating threat of financial ruin from the personal liability to which the directors were exposed, are what make the decision such a profoundly frustrating intellectual challenge for corporate law scholars. This Article explores three under-analyzed aspects of the decision. First, it examines the relationship between Jerome Van Gorkom, the Trans Union CEO, and the rest of the Trans Union board. Part I argues that a particularly odd aspect of the case is the way the entire board was punished for Mr. Van Gorkom's failure to follow adequate procedures and inform the board fully about certain critical aspects of the transaction. Part II explains that the case is less frustrating once we realize that Delaware law, like corporate law generally, provides a set of one-size-fitsall, "cookie cutter" rules that apply to all corporations. This means the same set of rules that apply to honest upstanding boards like Trans Union also must be made to work for the small but troubling set of corporations with pathological boards whose directors are inept, lazy, corrupt, or some combination of the three. …