Smith v. Van Gorkom

The business judgment rule presumes that directors act in good faith, on an informed basis, and in the honest belief that their decision serves the corporation. A plaintiff challenging a decision as uninformed must rebut that presumption, but directors must first have informed themselves of all material information reasonably available before making the decision. The applicable standard for an uninformed decision is gross negligence, even where there is no allegation of fraud, bad faith, self-dealing, or disloyalty.

In the merger context, directors have an affirmative statutory and fiduciary duty to approve an agreement of merger in an informed and deliberate manner before submitting it to stockholders. They may not simply leave the substantive decision to the stockholders. The question was therefore whether the Board had sufficient information when it committed Trans Union to the Pritzker transaction on September 20, not whether the directors were generally sophisticated or knowledgeable about the company's operations.

The Board approved the sale after a hastily called meeting lasting about two hours, without prior notice of the meeting's purpose, without a written summary of the transaction, and without meaningful opportunity to review the merger agreement. The directors relied largely on Van Gorkom's twenty-minute oral presentation, even though he had not read the agreement and had not disclosed that he himself originated the $55 figure.

The directors lacked competent information concerning Trans Union's intrinsic value as a going concern. They did not seek a fairness opinion, a valuation analysis, an appraisal, or advice from Salomon Brothers. An outside fairness opinion was not legally indispensable, but some reliable valuation basis was necessary. The CFO's rough leveraged-buyout calculations did not value the company; they only examined whether projected cash flow could support debt at assumed prices.

The $55 price was especially unreliable because Van Gorkom derived it from what a leveraged buyer could finance and repay, rather than from an assessment of what Trans Union was worth. The Board did not learn that he had proposed that price to Pritzker or inquire into its basis. Nor did it investigate management's view that the price was at the low end of a possible range and that the timing was poor.

A premium over the market price did not cure the informational deficiency. The directors themselves knew that Trans Union's market price had been depressed and did not reflect its inherent value. A premium is meaningful only when assessed against sound valuation information about the enterprise, not merely against a market price known to be an inadequate measure of the company's value in a sale of control.

The directors could not invoke Delaware General Corporation Law section 141(e)'s protection for good-faith reliance on officer reports. Van Gorkom's incomplete oral account of an agreement he had not read and the CFO's nonvaluation feasibility calculations were not pertinent, reliable reports on the question the Board had to decide: whether $55 was a fair price for selling Trans Union. Legal advice that a fairness opinion was not legally required also did not excuse the Board's failure to obtain enough information to make an informed decision.

Whether the September 20 decision was informed had to be judged by the information reasonably available when the Board made that decision. Although an initially uninformed board may sometimes cure a prior defect through a timely, informed reconsideration, later events cannot retroactively make the original approval informed.

The purported market test did not provide a reliable check on the $55 price. The original agreement restricted Trans Union from actively soliciting competing bids and from sharing nonpublic information with potential bidders. The Board's claimed reservations of a right to accept a better offer and disclose proprietary information were not reflected in the meeting minutes or clearly incorporated into the executed agreement, which no director read before it was signed.

The October 8 Board meeting did not cure the defect. The directors approved proposed amendments based on Van Gorkom's oral description before the amendments were drafted. The actual October 10 amendments allowed solicitation of offers but imposed conditions that made withdrawal from the Pritzker agreement difficult: Trans Union could terminate only after entering a more favorable definitive agreement, within a compressed period, with a third party. Those terms effectively locked the company into the Pritzker transaction.

The ensuing market test was not free and effective. KKR's potential $60-per-share proposal was withdrawn, and GE Credit would not make an offer without more time and a release from the Pritzker agreement. Given the contractual restrictions and impending stockholder vote, the absence of a superior completed offer did not demonstrate that $55 was fair.

The January 26 meeting also did not constitute a valid cure. By then the Board remained contractually committed to Pritzker and did not seriously consider its legally meaningful alternatives: either proceed with a recommended merger or rescind its approval and risk contractual consequences. The Board could not continue supporting the agreement while recommending that stockholders reject it, nor could it lawfully take a neutral position and delegate its unadvised decision to stockholders.

A majority stockholder vote may ratify an otherwise voidable board action only when the electorate is fully informed. Directors therefore owed stockholders a fiduciary duty of complete candor: they had to disclose all material facts that a reasonable stockholder would consider important in deciding whether to approve the merger.

The proxy materials misleadingly suggested that the Board had assessed Trans Union's intrinsic or inherent value. In fact, the Board had conducted no study or analysis of the company's value as a whole and had no adequate valuation information beyond the market price, even though it believed that market price was depressed.

The supplemental proxy materially misstated the significance of the CFO's work. It represented that his preliminary report reflected a company value of $55 to $65 per share, but did not disclose that the work was a rough leveraged-buyout feasibility exercise, undertaken to search for ways to justify assumed prices rather than to determine what the company or its shares were worth.

The materials also emphasized the supposedly substantial premium without disclosing that the Board had not evaluated the premium against a reliable measure of enterprise value. That omission was material because the premium was the Board's central stated justification for recommending the deal.

Stockholders needed to know that Van Gorkom had suggested the $55 price to Pritzker and that he chose it because it made a leveraged acquisition financially feasible for the buyer. The proxy disclosed the first point only incompletely and concealed the second, more consequential point. That information cast doubt on whether the sale price resulted from a valuation of Trans Union rather than from the buyer's financing capacity.

The supplemental proxy added significant information shortly before the vote, including management's concerns that $55 was inadequate and the absence of an independent fairness opinion. The Court did not need to decide whether the statutory twenty-day notice period applied to the supplement, because the disclosures remained incomplete and misleading. It nevertheless noted that even a candid disclosure may be inequitable if it is so late that stockholders cannot meaningfully use it.

The Court treated the directors as a unified group because they had presented a unified defense and did not timely seek individualized treatment. Their reliance on good faith and the lack of self-dealing missed the point: those considerations do not answer the threshold question whether the Board acted on an informed basis.

Because the directors breached their duty of care in approving the merger and their duty of candor in seeking stockholder approval, the Court reversed the judgment for the directors. The proper remedy was not automatic rescission of a consummated merger, but an evidentiary hearing to determine the intrinsic fair value of Trans Union as of September 20, 1980 under Weinberger v. UOP, Inc.

The Court directed the Court of Chancery to award damages to the class to the extent Trans Union's fair value exceeded the $55-per-share merger price.