The Place of the Trans Union Case in the Development of Delaware Corporate Law

Robert T. Miller is a Professor of Law and the F. Arnold Daum Fellow in Corporate Law at the University of Iowa College of Law, as well as a Fellow and Program Affiliated Scholar at the Classical Liberal Institute at the New York University School of Law. This post is based on his recent article, published in the William & Mary Business Law Review, and is part of the Delaware law series; links to other posts in the series are available here.

Although it is dangerous to attempt to say anything new about Smith v. Van Gorkom, this article tries to do so in two distinct ways. First, I provide a more comprehensive account of the facts of the case than that recounted by the Delaware Supreme Court. For example, virtually unmentioned in the vast scholarly commentary on the case are the following facts:

  1. After Trans Union agreed to be acquired for $55 per share by Pritzker in September of 1980, interest rates increased extremely sharply. By the end of January of 1981 and on the eve of the Trans Union shareholders meetings, rates had risen by 800 basis points. This tremendous increase in rates resulted from the extraordinary tightening of monetary policy under Federal Reserve Chairman Paul Volcker in the final months of the Carter Administration and was aimed at reducing the very high inflation rates of that period. Since, in January of 1981, Henry Kravis thought KKR could finance an acquisition of Trans Union at $60 per share, it is virtually certain that an acquirer could have paid substantially more than $55 per share for Trans Union in September of 1980 when the Pritzker deal was signed at that price and interest rates were so much lower. In other words, $55 per share was almost certainly not the best price reasonably available for Trans Union in September of 1980.
  2. When the Trans Union executives rebelled following the announcement of the transaction with Pritzker, their primary concern was not price. Although a few thought the price was too low, the true sources of discontent were different. One group of executives believed (correctly, as it turned out) that the Pritzkers would be much less generous employers than Trans Union had been as an independent company. One irate senior executive told Van Gorkom to his face that the company should be run first for the benefit of the employees, second for the benefit of the customers, and only third for the benefit of the shareholders. To his credit, Van Gorkom was flabbergasted and appalled. A second group of executives rebelled at the Pritzker transaction because they felt they should have been included in the process of selling the company, and Van Gorkom had “disenfranchised” them. Their gripe was about process, not price. Overall, the anger at Van Gorkom, who had previously been popular with the company’s employees, was fierce, with the general feeling being that Van Gorkom was “a cross between Faust and Darth Vader.”
  3. Van Gorkom’s objection to the offer KKR presented on December 2 was primarily that he personally had not been involved in the process of its formulation. Amazingly, the Trans Union board had expressly instructed Van Gorkom that he should be involved in the formulation of any LBO even though he was not going to participate in the buy-out group. By his own account, Van Gorkom had “invited himself” to meetings between Romans and other executives in the buy-out group and KKR. Romans understandably objected that, since Van Gorkom would be the chief negotiator for the company on the sell-side, he ought not participate in the buy-side’s internal meetings, but this point was utterly lost on Van Gorkom. Accordingly, Romans began meeting with KKR without Van Gorkom’s knowledge. When Kravis presented the KKR offer, Van Gorkom was shocked and felt betrayed that some of his senior officers had been working on an LBO without his participation, contrary to his (and the board’s) instructions.
  4. In an article he wrote after the case was settled, Van Gorkom excoriated the Delaware Supreme Court and defended the transaction on the extraordinary basis that, in approving the merger agreement with Pritzker, the board was not approving a sale of the company, whether at $55 per share or any other price. In Van Gorkom’s view, the board had merely secured an option (apparently, he thought of it as a free option) for the shareholders to put the company to Pritzker at $55 per share.

Besides exploring the significance of the new facts discussed above, the article argues that the great development of Delaware law since the time of the case allows us a perspective on Van Gorkom not available when the case was decided in 1985 or, indeed, for a long time thereafter. In particular, the article argues that in Van Gorkom the Delaware Supreme Court was attempting to devise a regime of directorial fiduciary duties to regulate negotiated transactions. Van Gorkom should have been Revlon, and what the Supreme Court got wrong in Van Gorkom in January of 1985—the creation of a new duty of care based on dicta from the 1984 case of Aronson v. Lewis—it got right in Revlon in November of 1985 by creating what we now call Revlon duties.

Nevertheless, Van Gorkom was not simply a botched first attempt at articulating duties for directors selling their company. The reasoning in Van Gorkom was in many ways inadequate, but its essential holding—that the directors breached their duties—was correct and would have been the same under the reasoning in Revlon.  What was disastrous about Van Gorkom was the remedy the court imposed on the breaching directors—enormous monetary damages.

Since Revlon was a pre-closing action, the court could order relief by means of a preliminary injunction, but since Van Gorkom was a post-closing action decided long after the merger was completed, that option was not available. Rather, when the Van Gorkom court found that the directors breached their duties, the axiom of the common law that every right has a remedy required imposing liability on the directors. We now know that such a system was untenable, for it made the expected costs of serving as a director greatly exceed the expected benefits. Neither the justices of the Delaware Supreme Court, nor anyone else, could have known it in 1985, but in reality there was no right answer the court could have reached in Van Gorkom. If the court got the holding on the merits right (the directors breached their duties), it had to get the holding on remedies wrong (enormous monetary damages). Smith v. Van Gorkom was the Kobayashi Maru of Delaware corporate law—a problem in which all the possible solutions prove disastrous.

Moreover, just as in the fictional Kobayashi Maru in Star Trek, a solution to the problem did exist, but it required action from outside the system, action that would violate the fundamental terms of the problem as previously understood. In Van Gorkom, that action was the Delaware General Assembly’s enactment of Section 102(b)(7), allowing corporations to eliminate personal liability in damages for directors breaching their duty of care. This extraordinary statute abridges the common-law rule that every right has a remedy. By eliminating the possibility of monetary damages post-closing, Section 102(b)(7) creates strong incentives for shareholders bringing fiduciary claims under Revlon to sue before the merger closes, thus creating a pre-clearance system of fiduciary-duty compliance similar to the pre-clearance system for antitrust compliance under the Hart-Scott-Rodino Act. Such a system would have been impossible without Section 102(b)(7), and Section 102(b)(7) would have been impossible without Van Gorkom. Van Gorkom was in many ways a mistake, but it was a mistake that had to be made to produce the current system of Delaware law. In its own way, it was as important a step forward in Delaware law as Revlon or Unocal or Household International, the other landmark cases in the Delaware Supreme Court’s miracle year of 1985.

The complete article is available here.

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