Courts and boards: the top 10 cases.

• Author: Elson, Charles M.

Each creating judicial precedent, here are the most significant court decisions that influenced the way directors should think and boards should work.

The number of judicial decisions having an impact upon corporate law and, more particularly, corporate governance, is substantial. To summarize each individually would easily fill a multi-volume treatise, much less an article in DIRECTORS & BOARDS. However, as in all subjects, some cases historically have been more important than others in the development of the modern corporate governance movement. Although any gathering of legal academics, practitioners, business school professors, chief executive officers, and directors would produce somewhat varying conclusions as to which were the most significant, a listing and discussion of my own "top 10" candidates for most influential follows.

1. Dodge v. Ford Motor Company

   This was the earliest and perhaps most seminal corporate governance decision reached by an American court in this century. The Dodge brothers, shareholders in the newly formed and prosperous Ford Motor Co., brought suit to compel the declaration of a large dividend, which controlling shareholder Henry Ford had announced he was canceling. Ford, among other reasons, had stated that he believed the company had been too profitable and that he wanted to lower the price of his cars for social and altruistic reasons so that more people could afford his product for less and he could employ more people for more money. Essentially, he felt that his shareholders had made enough and it was time to return some of their good fortune to the American public.

   The Michigan court deciding the case in 1919 saw otherwise. It sharply rebuked Ford, stating what became the quintessential American corporate mantra: "A business corporation is organized and carried on primarily for the profit of the shareholders." While it was perfectly acceptable for Ford to give his own money away, it was not acceptable to do so with corporate funds. The corporation was created to maximize profits for its investors and was not an "eleemosynary" institution, designed to benefit all mankind. The court did not rule, however, that a corporation was prohibited from making charitable donations, only that one must have some valid long-term corporate motive for doing so - the ultimate maximization of corporate profitability and consequent shareholder wealth. Dodge v. Ford Motor Company, 204 Mich. 459, 170 N.W. 668 (1919)

2. Smith v. Van Gorkom

   This 1985 decision by the Delaware Supreme Court has had more impact on the course of corporate and director behavior than probably any other ruling of the last 50 years. While affirming the protection of most director decisionmaking by the business judgment rule, the court, nevertheless, prescribed certain procedures to be followed by a board to avail itself of that rule's protection. But as most commentators would agree, these procedures have led not to more effective management oversight and better business decisions but, instead, to a classic triumph of form over function - where, although prescribed procedure has been followed, decisionmaking appears to be little more than staged play-acting, absent critical engaged oversight.

   Traditionally, for a board to avail itself of the protection of the business judgment rule, it had to demonstrate that its decision in a particular instance was made in good faith, in an informed manner, and with a rational belief that the decision was in the company's best interest. In Van Gorkom, the board's decision to sell its company for certain price was ruled to be actionable because the decision was made on an "uninformed" basis. The court pointed to, among other things, the very brief amount of time the board had deliberated on the sale and its failure to obtain an expert outside opinion. As a result, the directors were held personally liable for the difference between the price paid and what shareholders could have received had an "informed" decision been made.

   The ruling had a major impact on board behavior. It was responsible for the now common use of third-party advisers to provide expert opinions to boards. And it has led to far more elaborate decisionmaking procedures, involving lengthy meetings, voluminous documentation and the like. While a boost to third-party advisers, it also created a decisionmaking process that was primarily designed to produce a liability-precluding paper trail rather than a truly informed and deliberated business decision. Staged like a good play, board meetings, post Van Gorkom, now simply evoke a recitation of the required emotions on the part of the actors that, in the final analysis, when the stage lights dim, have only been an illusion. Nothing is gained by such a charade. Entertaining, maybe; shareholder value-enhancing, absolutely not. Such is the legacy left by Smith v. Van Gorkom.

   Popular disdain with the seemingly valueless procedures created by this case explains the excitement generated by the current trend toward requiring board members to own equity in their respective corporations through both equity compensation schemes and affirmative entry...