Van Gorkom's legacy: The limits of judicially enforced constraints and the promise of proprietary incentives

Northwestern University Law Review

Volumn 96, Issue 2, 2002, Pages 579-593

  Elson, Charles M ^a   Thompson, Robert B ^a  

^a NONE

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EID: 0040669877     PISSN: 00293571     EISSN: None     Source Type: Journal    
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References (67)

1. 488 A.2d 858 (Del. 1985).
2. 473 A.2d 805 (Del. 1984) (setting out conditions when shareholders filing derivative suit must make demand on directors).
3. 457 A.2d 701 (Del. 1983) (setting out appraisal as the basic remedy in cash-out mergers and the "fair dealing" and "fair price" aspects that make up a director's fiduciary duty in that context).
4. 493 A.2d 946 (Del. 1985) (describing enhanced judicial review of defensive tactics via a two-part test of threat and proportional response as a threshold for obtaining business judgment review to a challenge of takeover defenses).
5. 506 A.2d 173 (Del. 1986) (describing alteration of board's responsibilities and its duty to get the best price for shareholders when break up became inevitable). The opinion was published in 1986 but appeared before the end of 1985.
6. Other notable opinions also came out during 1985. See, e.g., Moran v. Household Int'l, Inc., 500 A.2d 1346 (Del. 1985); Rosenblatt v. Getty Oil Co., 493 A.2d 929 (Del. 1985). See also the history of the court's decisions in Chief Justice Veasey's remarks in this Symposium (on file with the authors).
7. Smith v. Van Gorkom, 488 A.2d 858, 873 (Del. 1985).
8. 404 U.S. 6, 11-12 (1971) (holding that "Congress made clear that 'disregard of trust relationships by those whom the law should regard as fiduciaries are all part of a single seamless web' along with manipulation, investor's ignorance and the like" (quoting H.R. REP. NO. 73-1383, at 6, reprinted in 5 LEGISLATIVE HISTORY OF THE SECURITIES ACT OF 1933 AND SECURITIES EXCHANGE ACT OF 1934, at 6 (1973))).
9. The Supreme Court's decisions in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), and Santa Fe Indus., Inc. v. Green, 430 U.S. 462 (1977), established more narrow limits for Rule 10b-5, a trend in federal law that continues to the present.
10. The corporate form separates entity functions between directors, shareholders, and officers, in contrast to the partnership where the statutory form anticipates all of those functions to be performed by one group - partners.
11. See DEL. CODE ANN. tit. 8, § 141(a) (1991) ("The business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors . . . .").
12. Blasius Indus. Inc. v. Atlas Corp., 564 A.2d 651, 659 (Del. Ch. 1988).
13. See generally Robert B. Thompson, The Law's Limits on Contracts in a Corporation, 15 J. CORP. L. 377 (1990).
14. For a broad discussion of the impacts of norms on corporate law, see Symposium, Norms & Corporate Law, 149 U. PA. L. REV. 1607 (2001). See also Donald C. Langevoort, The Human Nature of Corporate Boards: Laws, Norms and Unintended Consequences of Independence and Accountability, 89 GEO. L.J. 797, 800 (2000) ("I share the sense of many commentators that the law has played a relatively minor role in the evolution of board structure and behavior, markets and other social forces are far more important. Indeed I suggest leaving the matter of board independence and accountability largely to these extralegal incentives.").
15. For a broad discussion of the impacts of norms on corporate law, see Symposium, Norms & Corporate Law, 149 U. PA. L. REV. 1607 (2001). See also Donald C. Langevoort, The Human Nature of Corporate Boards: Laws, Norms and Unintended Consequences of Independence and Accountability, 89 GEO. L.J. 797, 800 (2000) ("I share the sense of many commentators that the law has played a relatively minor role in the evolution of board structure and behavior, markets and other social forces are far more important. Indeed I suggest leaving the matter of board independence and accountability largely to these extralegal incentives.").
16. See MODEL BUS. CORP. ACT §§ 8.30-31(1999); see also Melvin Aron Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 FORDHAM L. REV. 437, 437 (1993) ("A standard of conduct states how an actor should conduct a given activity or play a given role. A standard of review states the test a court should apply when it reviews an actor's conduct to determine whether to impose liability or grant injunctive relief.").
17. See, e.g., Jonathan R. Macey & Geoffrey P. Miller, Trans Union Reconsidered, 98 YALE L.J. 127 (1988).
18. See Chief Justice Veasey and former Chancellor Allen, Remarks at this Symposium (May 18-19, 2001) (transcript on file with authors).
19. See Part IV.A of Aronson v. Lewis, 473 A.2d 805, 811-17 (Del. 1984), where the court presents a clear statement of the role of directors and the function of the business judgment rule. It is here, as well, where the court for the first time uses "gross negligence" as the applicable standard of care, id. at 812, a concept developed in more detail in Van Gorkom.
20. DEL. CODE ANN. tit. 8, § 102(b)(7) (1991).
21. More than 40 states have exculpation provisions. See MODEL BUS. CORP. ACT ANN. § 2.02, Statutory Comparison, note 6, at 2-31.
22. Lawrence A. Hamermesh, Why I Do Not Teach Van Gorkom, 34 GA. L. REV. 477 app. a (1999).
23. They included Loral Corporation and Xerox Corporation incorporated in New York, PepsiCo incorporated in North Carolina, and State Farm Insurance Companies, a mutual company rather than a stock company, incorporated in Illinois. Of course, those corporations referred to in the previous sentence of the text that incorporated in one of the few states that have not provided exculpation are free to reincorporate in a state that does provide such protection upon a vote of their shareholders, so to that extent those companies choosing not to provide protection for their directors include both of these last groups.
24. For an earlier study that found that more than 90% of a sample of180 companies incorporated in Delaware had included an exculpation provision in their charter, see Roberta Romano, Corporate Governance in the Aftermath of the Insurance Crisis, 39 EMORY L.J. 1155, 1160-61 (1990).
25. See Smith v. Van Gorkom, 488 A.2d 858, 876 (Del. 1985) ("[T]here was no call by the board . . . for any valuation study or documentation of the $55 price as a measure of the fair value of the Company in a cash-out context."). Though the court did say, "[w]e do not imply that an outside evaluation study is essential to support an informed business judgment, nor do we state that fairness opinions by independent investment bankers are required as a matter of law," id., many have read the opinion as strongly tilting the Delaware law toward such a requirement.
26. See id. at 869 (discussing a two hour board meeting based on oral presentation with merger agreement executed by Van Gorkom during a formal social event he hosted for the opening of the Chicago Lyric Opera).
27. Aronson v. Lewis, 473 A.2d 805 (Del. 1984).
28. Scattered Corp. v. Chi. Stock Exch., 701 A.2d 70 (Del. 1997).
29. Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981).
30. See Broz v. Cellular Info. Sys., Inc., 673 A.2d 148, 158 n. 10 (Del. 1996) (refusing to support Chancellor's decision below requiring formal presentation of corporate opportunity to the board but noting that "formal presentation to the board is often the preferred - or 'safe' - approach, and we note that this litigation might have been unnecessary had this precaution been observed"); see also Northeast Harbor Golf Club, Inc. v. Harris, 661 A.2d 1146, 1152 (Me. 1995) (adopting the ALI structure); PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS § 5.05 (1992) (requiring notice to the board).
31. 726 A.2d 1215, 1223 (Del. 1999).
32. See William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 BUS. LAW 1287, 1304-05 (2001) ("Imposing the burden to establish the exculpation defense upon the directors perversely requires them to disprove all of the duty of loyalty-related exceptions to the defense to be relieved of liability for due care claims. That is not how the exculpation defense should work.").
33. See In re Caremark Inc. Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996). What should be understood, but may not be widely understood by courts or commentators who are too often required to face such questions, is that compliance with a director's duty of care, can never appropriately be judicially determined by reference to the content of the board's decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed. Id. In Gagliardi v. Tri-Foods Int'l, Inc., 683 A.2d 1049 (Del. Ch. 1996), Chancellor Allen wrote: [I]n the absence of facts showing self-dealing or improper motive, a corporate officer or director is not legally responsible to the corporation for losses that may be suffered as a result of a decision that an officer made or that directors authorized in good faith. There is a theoretical exception to this general statement that holds that some decisions may be to "egregious" the liability for losses they cause may follow even in the absence of proof of conflict of interest or improper motivation. The exception, however, has resulted in no awards of money judgments against corporate officers or directors in this jurisdiction . . . . Thus, to allege that a corporation has suffered a loss as a result of a lawful transaction, within the corporation's powers, authorized by a corporate fiduciary acting in a good faith pursuit of corporate purposes, does not state a claim for relief against that fiduciary no matter how foolisn the investment may appear in retrospect. Id. at 1051-52.
34. See Committee on Corporate Laws, Changes in the Model Business Corporation Act Pertaining to the Standards of Conduct and Standards of Liability-Final Adoption, 53 BUS. LAW. 813 (1998); Committee on Corporate Laws, Changes in the Model Business Corporation Act - Amendments Pertaining to Electronic Filings/Standards of Conduct and Standards of Liability for Directors, 53 BUS. LAW. 157 (1997).
35. See Committee on Corporate Laws, Changes in the Model Business Corporation Act Pertaining to the Standards of Conduct and Standards of Liability-Final Adoption, 53 BUS. LAW. 813 (1998); Committee on Corporate Laws, Changes in the Model Business Corporation Act - Amendments Pertaining to Electronic Filings/Standards of Conduct and Standards of Liability for Directors, 53 BUS. LAW. 157 (1997).
36. MODEL BUS. CORP. ACT § 8.30 official cmt., § 8.31 official cmt. (1999).
37. For earlier calls for an aspirational approach, see John C. Coffee, Jr., Litigation and Corporate Governance: An Essay on Steering Between Scylla and Charybdis, 52 GEO. WASH. L. REV. 789, 798 (1984) (arguing that duty of care has "socializing and exhortative impact" and should be left intact because of its "aspirational" potential); see also Melvin Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 FORDHAM L. REV. 437, 437 (1993).
38. For earlier calls for an aspirational approach, see John C. Coffee, Jr., Litigation and Corporate Governance: An Essay on Steering Between Scylla and Charybdis, 52 GEO. WASH. L. REV. 789, 798 (1984) (arguing that duty of care has "socializing and exhortative impact" and should be left intact because of its "aspirational" potential); see also Melvin Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 FORDHAM L. REV. 437, 437 (1993).
39. Roundtable: The Legacy of Smith v. Van Gorkom, DIRECTORS & BOARDS, Spring 2000, at 3.
40. Id.
41. Transcript of Symposium, May 19, 2001 (on file with the authors).
42. Charles M. Elson, The Duty of Care, Compensation and Stock Ownership, 63 U. CIN. L. REV. 649, 683 (1995).
43. Margaret Blair & Lynn Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. PA. L. REV. 1735 (2001); see also Lynn Stout, In Praise of Procedure: An Economic and Behavioral Defense of Smith v. Van Gorkom and the Business Judgment Rule, 96 NW. U. L. REV. 675 (2002).
44. Margaret Blair & Lynn Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 U. PA. L. REV. 1735 (2001); see also Lynn Stout, In Praise of Procedure: An Economic and Behavioral Defense of Smith v. Van Gorkom and the Business Judgment Rule, 96 NW. U. L. REV. 675 (2002).
45. See, e.g., Joy v. North, 692 F.2d 880, 886 (2d Cir. 1982) ("[C]ourts recognize that after-the-fact litigation is a most imperfect device to evaluate corporate business decisions.").
46. Smith v. Van Gorkom, 488 A.2d 858, 894 (Del. 1985) (McNeilly, J., dissenting).
47. R. Franklin Balotti, Charles M. Elson & J. Travis Lester, Equity Ownership and the Duty of Care: Convergence, Revolution, or Evolution, 55 BUS. LAW. 661 (2000).
48. For a discussion of path dependence, see generally S.J. Lebowitz & Stephen E. Margolis, Path Dependence, Lock-in and History, 11 J.L. ECON. & ORG. 205 (1995).
49. Balotti, Elson & Lester, supra note 44, at 686 (suggesting that a director wishing to invoke the substantial equity ownership presumption must prove ownership of equity, having a value that is material "in the context of the director's economic circumstance").
50. NAT'L ASS'N OF CORP. DIRS., REPORT OF THE NACD BEST PRACTICES COUNCIL, COPING WITH FRAUD AND OTHER ILLEGAL ACTIVITIES (1998) [hereinafter NACD REPORT]. Professor Elson served on the NACD Council. It was set up in 1997 to provide guidance and counsel to fast-growing, entrepreneurial companies. NACD includes 2000 members who are chairs of the board, chief executive officers, presidents, vice presidents, chief financial officers and others who serve on, or deal with, corporate boards of directors.
51. Smith v. Van Gorkom, 488 A.2d 858, 866 (Del. 1985).
52. Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156 (Del. 1995) (upholding the Chancellor's judgment that the transaction met the entire fairness test, though the court had only one of its five members available to sit on the panel).
53. Indeed the litigation in the case continues as of this writing through numerous published opinions.
54. See Technicolor, 663 A.2d at 1177 ("The Court of Chancery found the 'fact that major shareholders, including Kamerman and Bjorkman who had the greatest insights into the value of the company, sold their stock to MAF at the same price paid to remaining shareholders also powerfully implies that the price received was fair.'" (quoting Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1143 (Del. Ch. 1994)).
55. In re The Walt Disney Co. Derivative Litig., 731 A.2d 343, 356 (Del. Ch. 1998), aff'd in part and rev'd in part sub nom, Brehm v. Eisner, 746 A.2d 244 (2000); see also In re IXT Communications, Inc. v. Cincinnati Bell, Inc., No. C.A. 17324, 17334, 1999 WL 1009174, at *5 (Del. Ch. 1999) ("It bears noting that GEPT's representation on the board and [three] Directors . . . collectively represent the economic interest of 30% of the company's stock directly as well as the entire community of shareholders indirectly.").
56. Aronson v. Lewis, 473 A.2d 805, 815 n.8 (Del. 1984) ("We recognize that drawing the line at a majority of the board may be an arguably arbitrary dividing point.").
57. This echoes the language of In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), a duty of care case settled prior to judicial ruling on defendant's motion to dismiss that was based on two grounds, including the section 102(b)(7) exculpation provision in the company's charter.
58. See generally Balotti, Elson & Lester, supra note 44.
59. OLIVER WILLIAMSON, THE MECHANISMS OF GOVERNANCE 176-77 (1996).
60. More generally, this suggests why participants will bring activities inside of the firm and rely on governance structures instead of judicial enforcement of contract rights. It can also explain why participants would prefer self-help and incentives that make self-help an alternative to after-the-fact judging. See id. at 176-77 ("Rather than assume that disputes are routinely submitted to and efficaciously decided by the courts, [transaction cost economics] maintains that court ordering is a very crude instrument and that most disputes, including many that under current rules could be brought to account [can be] resolved by avoidance, self-help and the like.").
61. Unocal, Inc. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).
62. Id. at 955. In Unocal, the court used the term "enhanced duty," id. at 954, but quickly modified its terminology in Revlon to "enhanced scrutiny," Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 184(Del. 1985), which seems to capture more precisely the judicial role that is at issue.
63. See Robert B. Thompson & D. Gordon Smith, Toward a New Theory of the Shareholder Role: "Sacred Space" in Corporate Takeovers, 80 TEX. L. REV. 261, 263 (2001) (showing that the use of Unocal has decreased to about one case per year in the 1990s from about 3.5 cases per year in the 1980s, even though takeovers have remained in the same range, and that the doctrine is almost never used by the Delaware Supreme Court to strike down a defensive tactic).
64. Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1388 (Del. 1995).
65. Frank H. Easterbrook & Daniel R. Fischel, The Proper Role of a Target's Management in Responding to a Tender Offer, 94 HARV. L. REV. 1161, 1175 (1981).
66. See Thompson & Smith, supra note 60 (describing "sacred space" within which shareholders are free to act via self-help to override defensive tactics of directors).
67. Letter from Thomas Jefferson to James Madison (Jan. 30, 1787), quoted in JEFFERSON HIMSELF, THE PERSONAL NARRATIVE OF A MANY SIDED AMERICAN at 43 (Bernard Mayo ed., 1970) ("I hold that a little rebellion now and then is a good thing and as necessary in the political world as storms in the physical.").