Smith v. Van Gorkom
Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), stands as among the most consequential decisions in the history of Delaware corporate law, establishing a landmark ruling by the Delaware Supreme Court on the fiduciary duty of care owed by corporate directors to shareholders. Decided in 1985, the case arose from a class action brought by shareholders of Trans Union Corporation challenging the board of directors' approval of a merger transaction. The court's ruling shocked the corporate world by finding that a board of experienced directors had breached their duty of care, demonstrating that even well-intentioned business decisions can give rise to serious legal liability when proper deliberative procedures are not followed. The case prompted immediate legislative responses and continues to shape how corporate boards conduct their affairs in Delaware and across the United States.[1]
Background and Parties
The case originated as a class action lawsuit filed in the Delaware Court of Chancery by Trans Union Corporation shareholders. The named plaintiffs, Alden Smith and John Gosselin, brought the action on behalf of the class against Trans Union and its board of directors following the board's approval of a merger agreement.[2] The defendant Jerome Van Gorkom served as the chief executive officer and chairman of Trans Union's board. The case's common name, Smith v. Van Gorkom, derives from plaintiff Alden Smith and defendant Van Gorkom as the principal representative parties on each side of the litigation.
Trans Union Corporation was a large, publicly held company incorporated under Delaware law. Its shareholders alleged that the board had approved a merger transaction without adequately informing itself about the value of the company and the fairness of the proposed merger price. The central question presented to the courts was whether the directors had satisfied their fiduciary duty of care in approving the transaction under the circumstances in which the decision was made.
The case proceeded through the Court of Chancery before reaching the Delaware Supreme Court on appeal. The Supreme Court's review of the chancery court's findings would ultimately produce a decision that reversed the lower court and found the directors liable, a result that surprised many observers and practitioners in the field of corporate law.[3]
Legal Issues and the Duty of Care
At the heart of Smith v. Van Gorkom lies the fiduciary duty of care, one of the primary obligations owed by corporate directors under Delaware law. The duty of care requires that directors act on an informed basis when making decisions on behalf of the corporation. It is distinct from the duty of loyalty, which addresses conflicts of interest and self-dealing, though both duties form the core of a director's fiduciary obligations.
Delaware corporate law generally provides directors with significant protection from liability through the business judgment rule, a doctrine that presumes directors act on an informed basis, in good faith, and in the honest belief that the action taken is in the best interests of the company. Under ordinary circumstances, courts applying the business judgment rule will defer to the board's decision without second-guessing the substance of the business choice itself. However, the business judgment rule does not apply where directors fail to inform themselves adequately before making a decision.
In this case, the Delaware Supreme Court found that the Trans Union board had not adequately informed itself before approving the merger agreement. The court examined the circumstances surrounding the board's decision, including the amount of time spent deliberating, the information available to directors at the time of the vote, and the process by which the merger price was established. The court concluded that the directors had acted in a grossly negligent manner, which was sufficient to establish a breach of the duty of care and to strip them of the protection that the business judgment rule would otherwise provide.[4]
The Court's Analysis
The Delaware Supreme Court's analysis in Smith v. Van Gorkom was notable for its thoroughness and its refusal to defer to the business judgment of the Trans Union directors despite their collective experience and apparent good faith. The court examined in detail how the merger proposal had been initiated, how the board had been presented with information, and how quickly the board had moved to approve the transaction.
Among the factors the court considered significant were the limited duration of the board meeting at which the merger was approved, the absence of any written summary of the terms of the agreement for directors to review in advance, and the lack of a formal valuation study or fairness opinion from an investment banker before the board voted. The court noted that the board had relied primarily on the oral presentation of Van Gorkom himself, who had been instrumental in structuring the proposed transaction, raising concerns about the objectivity and completeness of the information provided to the directors.
The court's holding that gross negligence was the applicable standard for determining whether the duty of care had been breached was itself an important pronouncement. By establishing that gross negligence—rather than ordinary negligence—was required to override the business judgment rule's protections, the court attempted to balance the protection of directors from hindsight-driven liability against the need to ensure that directors exercise meaningful care in reaching their decisions. Nevertheless, the court found that the conduct in this case met even that elevated threshold.
The decision was rendered by a divided court, with the majority and dissenting justices disagreeing about the characterization of the board's conduct and the proper application of the business judgment rule to the facts. The dissent argued that the majority had imposed an unrealistically demanding standard on the deliberative processes of corporate boards. This internal disagreement within the court reflected broader tensions in corporate law between encouraging entrepreneurial risk-taking and protecting shareholder interests.
Impact and Aftermath
The reaction to Smith v. Van Gorkom in the corporate and legal communities was swift and significant. The decision alarmed many directors of Delaware corporations, who feared that even careful, experienced, and well-intentioned boards could be exposed to personal liability for good-faith business decisions made without following specific procedural protocols. The ruling raised serious concerns about the attractiveness of serving on corporate boards and about Delaware's reputation as a favorable state for incorporation.
Scholars and practitioners have described Smith v. Van Gorkom as something akin to an impossible problem for those navigating Delaware corporate law—a situation in which every available path carries serious risks and pitfalls. As one academic commentary put it, the case was "the Kobayashi Maru of Delaware corporate law—a problem in which all the possible solutions prove disastrous."[5] This vivid framing captures the sense in which the decision left directors, lawyers, and lawmakers struggling to identify a satisfactory response.
The Delaware General Assembly responded to the ruling with notable speed. In 1986, the legislature amended the Delaware General Corporation Law to add what is now Section 102(b)(7), a provision that allows corporations to include in their certificates of incorporation a clause eliminating or limiting the personal liability of directors for breaches of the duty of care. This legislative fix gave corporations a practical tool to protect directors from the kind of personal financial liability that the Trans Union board faced, while preserving the duty of care as a legal standard and leaving intact liability for breaches of the duty of loyalty, bad faith conduct, and other specified categories of misconduct.
The Section 102(b)(7) amendment became among the most consequential provisions in Delaware corporate law, and its adoption was directly attributable to the anxiety generated by the Smith v. Van Gorkom decision. Virtually all major Delaware corporations subsequently amended their charters to include exculpation clauses under this provision, fundamentally altering the landscape of director liability in the state.
Significance for Delaware Corporate Law
Smith v. Van Gorkom occupies an enduring place in the canon of Delaware Supreme Court decisions because it simultaneously clarified and complicated the relationship between the duty of care and the business judgment rule. The case demonstrated that Delaware courts would not simply rubber-stamp board decisions as a matter of deference, but would instead scrutinize the process by which directors reached their conclusions.
The decision also reinforced the importance of procedural safeguards in corporate decision-making, including the use of independent advisors, fairness opinions from qualified financial experts, and adequate time for deliberation. In the decades following Smith v. Van Gorkom, boards of directors—particularly those evaluating significant transactions such as mergers and acquisitions—routinely sought formal fairness opinions and allowed for more extensive deliberative processes, in part to satisfy the standards articulated by the court in this case.
The case is regularly taught in law schools across the United States as a foundational example of director liability under state corporate law. It illustrates the tension between courts' desire to respect business judgment and their responsibility to ensure that the exercise of that judgment meets minimum standards of care and process. For students of Delaware law, Smith v. Van Gorkom serves as a reminder that the state's courts take seriously the obligations that directors assume when they accept fiduciary responsibility for managing a corporation on behalf of its shareholders.
Within the broader context of Delaware's role as the preeminent state for corporate formation and governance, the case also underscores how a single judicial decision can reverberate through legislative chambers, boardrooms, and legal practice. The interplay between the court's ruling, the legislature's response, and the subsequent evolution of corporate governance norms makes Smith v. Van Gorkom a study in how law adapts to unexpected judicial outcomes.