Smith v. Van Gorkom
(The Trans Union Case)
488 A.2d 858 (Del. 1985)
A corporation called Marmon
was attempting a leveraged buy-out of TransUnion. TransUnion's CEO, Van
Gorkom proposed a price of $55 a share.
Turns out, Van Gorkom and
his CFO didn't bother to do any research to see how much the company was
actually worth. He didn't even inform TransUnion's legal department
about the transaction.
$55 a share was only about
60% of what the company was later appraised at.
In Van Gorkom's defense, at
the time of the merger, the stock was only selling for $37.25 a share,
so $55 seemed like a lot.
Van Gorkom called an emergency
meeting of the board of directors, proposed the merger, and the directors
gave preliminary approval.
Van Gorkom failed to
disclose a number of things at the board meeting where the vote was
taken, including the fact that there was no basis for the $55 price, and
that there had been objections by TransUnion management regarding the
merger. Van Gorkom didn't even provide the directors with copies of the
The facts get a little
complicated, but basically, there was some wheeling and dealing and the
directors eventually wound up recommending that the shareholders approve
the merger, even though the directors never really bothered to learn if
the terms of the merger were a good deal for the company or not.
Some shareholders instituted a
derivative lawsuit against the directors for breach of fiduciary duty.
The Trial Court found for Van
Gorkom. The shareholders appealed.
The Trial Court found that
Van Gorkom's actions fell within the business judgment rule.
The business judgment
rule says that the courts should not
second guess business decisions made by directors.
The Appellate Court reversed.
The Appellate Court found
that the directors were grossly negligent because they approved the
merger without substantial inquiry or any expert advice. Therefore they
breached their duty to care.
The Court found that the
directors breached their fiduciary duty by their failure to inform themselves of all information
reasonably available to them and relevant to their decision to recommend
the merger, and
The Court found that there
was a failure to disclose all material information such as a reasonable
stockholder would consider important in deciding whether to approve the
The Court found that Van
Gorkom breached his duty to care
by offering $55 a share because, "the record is devoid of any
competent evidence that $55 represented the per share intrinsic value of
The Court found that the business
judgment rule was not a defense
because the directors and Van Gorkom didn't use any "business
judgment" when they came to their decision.
"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."
"Under the business
judgment rule there is no protection for directors who have made an
unintelligent or unadvised judgment."
Basically, the actual
decision is not so important, what the courts will look to is whether
there was an adequate decision-making process.
In this case, the Court
basically said that in order to hide behind the business judgment rule, you have to show that you made an informed
decision based on some principle of business. If you pull numbers out of
thin air or cast votes without doing due diligence, then the courts can
overturn your decisions.
The idea behind the business
judgment rule is that people who work
in the business have more experience and are better judges of what a
corporation should do than a court would be. But when businessmen show
that they didn't use any of that experience to make a decision, then
there is no reason for the courts to defer to them.
Almost immediately after this
decision, Delaware passed a law (DGCL §102(b)(7)) that allows corporations to limit the
liability of their directors for breaches of the duty of care.