'Smith v. Van Gorkom' on its 15th anniversary.

• Author: RADIN, STEPHEN A.
• Position: Landmark decision on corporate governance

Ruled the court: Here was a board that did not exercise informed business judgment. What happened to warrant this landmark decision? And what has been its enduring importance?

IN ADDITION to marking a new millennium, the year 2000 marks the 15th anniversary of the Delaware Supreme Court's landmark decision in 1985 in Smith v. Van Gorkom. In that decision, the Delaware Supreme Court startled the corporate world by holding that a board of directors acting in good faith was grossly negligent in recommending to shareholders a merger providing shareholders a 39% to 62% premium (depending upon the method of calculation) over market price. As a result, the court held, the directors' decision to recommend the merger was not protected by the business judgment rule, a legal principle pursuant to which courts do not second guess a business decision made by disinterested directors acting in good faith so long as the decision can be attributed to a rational business purpose.

The court's three-to-two opinion was labeled a "comedy of errors" by one of the dissenting justices. Extensive commentary, much of which "predict[ed] dire consequences," quickly filled both general media publications and legal newspapers and journals. Experts attacked the decision as "dumbfounding" and a "serious mistake," "surely one of the worst decisions in the history of corporate law," and "a distinct threat to the ability of companies to attract responsible directors." Jerome Van Gorkom, the central figure in the case, offered his views in the Fall 1987 issue of DIRECTORS & BOARDS under the title "The 'Big Bang' for Director Liability" (the subtitle of that article was "How the court in the Trans Union case showed a serious lack of understanding of even the basic functioning of the business and financial worlds").

The 15 years that have followed Smith v. Van Gorkom have produced a mass of case law discussing the decision. According to a recent check of the LEXIS legal research computer data base, the Van Gorkom decision has been cited in close to 250 court decisions. The resulting body of case law demonstrates that the reports of the business judgment rule's demise following Van Gorkom, like those of Mark Twain's death, were exaggerated.

What transpired

As the facts were described in the court's majority opinion, Trans Union's senior management became convinced by the summer of 1980 that the corporation's stock was undervalued due to Trans Union's inability to utilize large tax writeoffs. Without consulting the corporation's board of directors, Jerome Van Gorkom, chairman and chief executive officer of Trans Union Corp., suggested to a fellow Chicago businessman, Jay Pritzker, a $55 per share cashout merger with a company Pritzker controlled. Following several meetings over the course of a week, Pritzker made a $55 per share offer on Thursday, September 18, 1980, conditioned upon acceptance within three days. The stock had traded at prices ranging from $24 1/4 to $39 1/2 per share over a five-year period.

That Friday, September 19, Van Gorkom called a special meeting of Trans Union's board for Saturday, September 20, without telling the directors the purpose of the meeting. Van Gorkom told his senior management team about the proposed transaction for the first time an hour before the board meeting. Other than two officers with whom Van Gorkom had consulted concerning the transaction before September 20, the reaction of Trans Union senior management team was "completely negative."

Van Gorkom proceeded to the board meeting as scheduled. He began the meeting with a 20 minute presentation outlining the terms of the proposed merger. Because the proposed agreement permitted Trans Union to receive (but not actively solicit) competing offers for 90 days, Van Gorkom stated that the free market would judge whether $55 was a fair price...