Smith v Van Gorkom - case law summary PDF

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Smith v Van Gorkom (Share holders of Trans Union Corporation v Board of Directors) Issue:  Whether directors of the company violated their fiduciary duty towards the stakeholders? In the context of this case, the issue is whether the Directors made an informed business decision regarding the merger with a third party, namely Pritzker. o Sub issue: whether director’s subsequent action (amendment to merger) constitute an informed business decision? Short point: 

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If the board of directors had made an informed business decision, then the business judgement rule would apply and the court cannot interfere. If the Court finds that there was no informed business decision, it can interfere. The shareholders allege that the Directors failed to make an informed business decision. Directors argue the opposite.

Court of Chancery held against the directors. Appellate court reversed and remanded to consider share value. Facts/Timeline:   

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Trans Union was a diversified holding company, the principal earning were generated by its railcar leasing business. Company had a cash flow of hundreds of millions of dollars but had trouble generating a taxable income, hence they could not use the benefit of income tax credits. Due to this financial position, On August 27, 1980, the CEO/board member-Van Gorkon met with the senior management and suggested they explore the possibility of selling trans union to a company with larger taxable income. Donald Romans, CFO had stated that his department had done a preliminary study on the issue. On September 5th, Romans and Chelberg(president and COO) brought up the issue of a leveraged buy-out. However, they did not come up with a price for the shares to be valued at, and merely estimated 50$ and 60$. At this meeting Van Gorkon said he would be willing to take 55$ for his 75,000 shares. However, due to a conflict of interest (since he was chairman of the board, he had been CEO for more than 17 yrs etc) this did not go through.

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Van Gorkon approached a corporate take-over specialist and friend, Jay Pritzker regarding the leveraged buy-out. He proposed a per share price for sale of the company and a financing structure. He also asked Carl Peterson, Trans Unions controller to determine the feasibility of the buy-out at 55$ per share. However, he did not inform anyone on the board or management and told Carl Peterson not to tell anyone on the board either. September 13th- After ascertaining details regarding the feasibility of pricing the share value at 55$, and other aspects of financing the deal, Van Gorkon approached Pritzker with a presentation.

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He proposed the price at 55$/share. Although he retained the right to accept any offer that is higher. However, he conceded that Trans Union would not be allowed to solicit higher offers during the market period. Pritzker demurred that his organisation would serve as a “stalking horse” for an auction contest only if Trans Union permitted Pritzker to buy 1,750,000 shares of trans union at market price. Sept 15th- Pritzker informs van gorkon that he is interested. Van Gorkon is surprised at how fast its moving. Spet 18th- Pritzker’s attorney starts drafting the deal at 55$ per share for the buy out; pritzkers shares to be sold at market value was negotiated down to 1 million shares. Market value was set at 38.75$. At this point, pritzker stated that TU board had to accept no later than September 21st evening. Sept-19th Van Gorkon, Chelberg and Pritzker met with the bank to set up financing. Van Gorkon then called a meeting of senior management at 11am the following day, and a board meeting at 12pm Sept 20th- 11am meeting with senior management- senior managements reaction to van gorkon’s proposal was completely negative. At the board meeting, he made a 20 minute oral presentation listing out the key portions of the deal ( TU would be merged with a new T company, a subsidiary wholly owned by Pritzker; for a period of 90 days TU could receive competing offers but not actively solicit offers.) He told the board that the free market would be able to decide if 55$ was a fair price. The meeting lasted two hours, chelbergTU president supported the presentation, Roman described the feasibility study previously undertaken and on Brennan’s legal advice and their knowledge of market history of the company’s the Board approved the merger. However, on two conditions: a) TU reserved the right to accept better offers. B) it could share its proprietary information with prospective bidders. The deal was signed at a formal social event, neither gorkon nor the other directors read the deal prior to signing it. Within 10 days, there was dissent among senior management who threatened to resign. Under such circumstances, Van Gorkom met with Pritzker who agreed to certain changes. Van Gorkon reconvened the board on October 8th and secured the amendments to the deal. The board appointed the Salomon brothers, its banker, to solicit other offers for Trans Union during the proposed market test period. During this time they received only one serious- from GE credit. However, GE Credit was unwilling to formally make an offer unless TU rescinded its contract with Pritzker. When Pritzker refused GE credit ended all discussions. In the mean time, another firm called KKR made an offer which it later withdrew. On February 10, the stockholders of TU approved the Prizker merger proposal. (70 percent in favour; 7.25 against, 22.85 not voting)

Analysis of the business judgement rule: 

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The Rule (captured under s.14 of Delaware statute) is a presumption that in making a business decision, the directors have acted on an informed basis, in good faith, in the best interests of the company. Whether a decision is an informed decision or not turns on the questions of whether the directors were informed prior to making a business decision, of all material information available to them.

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Appellate court held that directors did not inform themselves of the decision prior to making it on the basis that: o Directors did not inform themselves on van gorkon’s role in forcing the sale of the company and in establishing the per share price. o Were uninformed about the intrinsic value of the company o Were grossly negligent in approving the sale of the company upon two hours’ consideration, without prior notice, and without the exigency of a crisis or emergency. Main reason for holding against directors- the directors solely placed their decision on Van Gorkon’s representations. No senior management was present, other than Chelberg, Romans, and Peterson. The directors did not scrutinise. Section 141(e) delware statute- “directors are fully protected in relying in good faith on reports made by officers.” However, court held that as a minimums for a report to enjoy the status of 141(e), it must be the subject matter upon which a board is called to act.

Defendant’s argument: Defendant argues the following four points prove that the board made an informed business decision.    

The magnitude of premium between 55$/share and the market value of 38$ The amendment of the merger agreement allowed the board to accept better offers during the market test period Collective expertise of the boards consisting of inside and outside directors. Reliance on Brennan’s legal advice.

Court hold that the facts do not support the defendant’s arguments since a) no scrutiny regarding the valuation of share, b) no evidence to support the claim that merger agreement was amended to allow the board to put TU up for auction to the highest bidder c) board’s unfounded reliance on the market test and premium as the basis for accepting pritzkers proposal undermines the weight of their collective experience. With regard to the sub-issue 

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On October 8th, in a brief session, the directors approved Van Gorkom’s oral presentation of the substance of the amendments to be made. However, the amendments were not put down to writing until October 10th. The most significant change was to the definition of third party offer. After the amendments, a better-offer was no longer sufficient to permit Trans Union’s withdrawal. The “extension” of the market period to Feb 10, 1981 was circumscribed by other amendments which required Trans Union to file a preliminary proxy on the Pritzker merger by December 5 th and mail the statement to its shareholders by January 5th.

DISSENT: 

First error made by the majority was the assessment of the director’s knowledge of the state of affairs.

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The inside and outside directors are people with tremendous experience in this case. Directors of this order are not taken by “fast shuffle”. The outside directors had a cumulative experience of 78 years as directors and 53 years as directors of TU alone. They knew TU like the back of their hands and were well qualified as well as well informed to make the business decision....