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Smith v. Van Gorkom: The Duty of Care [No. 86]

One of the most important standards in corporate governance is the duty of care. A corporate board of directors is responsible for acting in the best interests of shareholders, and considering all aspects of important transactions. Professor Todd Henderson discusses the landmark case of Smith v. Van Gorkom, where a board seemed to make a good decision on behalf of the shareholders but failed to exercise proper duty of care. https://youtube.com/watch?v=sQYVL1kWtAM


Another canonical case that is essential to understanding corporate law is a case from Delaware in 1985, called Smith versus Van Gorkom. In this case, a company called TransUnion, you may know it now as the company that does a lot of the credit reporting services, but back then they were a kind of failing logistical railroad company. And TransUnion was the object of a potential takeover by a guy named Jay Pritzker. This is the Pritzker family who now has as one of its representatives, the governor of the State of Illinois. And Jay Pritzker wanted to buy TransUnion because it would be more valuable in his hands, with him as the owner, than it was with its current ownership. That had to do with some tax rules and some other complicated things. But he was the best owner of those particular assets. TransUnion was trading at about $35 a share and Jay Pritzker offered $55 per share. Shareholders were understandably very excited about this. And the CEO of TransUnion, a guy named Jerome Van Gorkom, he was very excited about this prospect too. Not least of which, because he was looking to retire and this would be a big payday for him as his going away present. Eventually, the deal is presented to the board of directors, who reviews it in a perfunctory manner. They had a 20 minute oral presentation. This transaction requires approval of the shareholders. We don't just trust the board to make this kind of decision because after all the shareholders are going to be bought out. The shareholders overwhelmingly approved this transaction. One shareholder, a Mr. Smith, does not like this deal and sues, claiming that the board of directors didn't fulfill its obligations to look after the best interest of shareholders. This eventually works its way up to the Delaware Supreme Court. In a three to two decision, the Supreme Court of Delaware said that the board of directors did not fulfill its fiduciary obligations to look after the best interest of shareholders. And that's a head scratcher. Well, the Delaware Supreme Court didn't like the fact that the board considered the case or the Delaware Supreme Court did consider the transaction in such a loose goosey fashion. They didn't take it seriously enough. And the Delaware Supreme Court invoked a fiduciary duty principle known as the duty of care. Directors have to be careful when they are deciding what to do with what after all is the shareholders' money. Shareholders invest capital in a corporation, they hire the board of directors effectively to manage that capital, and they have an obligation to do so as one would if you were investing your own money. And the Delaware Supreme Court believed that this was too sloppy a transaction. They held directors personally liable. So Smith versus Van Gorkom stands for the proposition that board members have to be careful and act prudently as if they were investing their own money, even if from an outside perspective it seems kind of like a no brainer.

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