Trans Union Corporation faced limitations on using investment tax credits due to insufficient taxable income, constraining its growth strategy. In September 1980, Trans Union's CEO and Chairman, Jerome W. Van Gorkom, without board direction, initiated and negotiated with Jay Pritzker a cash-out merger at $55 per share. The $55 figure was not derived from a comprehensive valuation; it stemmed largely from a back-of-the-envelope assessment tied to the feasibility of a leveraged buyout and tax considerations, and from a CFO tax study that did not purport to value the company. On short notice, Van Gorkom convened a special board meeting on September 20, 1980. Over approximately two hours, with no written valuation materials, no investment banker's fairness opinion, little discussion of intrinsic value or alternatives, and without the directors reading the merger agreement, the board approved the merger at $55 per share. The agreement included restrictive deal-protection terms (e.g., a no-shop and option rights favoring the bidder) while allowing a limited post-signing "market check." After public announcement and in the face of criticism, the board later met again and sought an investment banker's opinion, but that occurred after the initial approval. Shareholders were solicited via a proxy statement that did not fully disclose the price's origin, the lack of prior valuation analysis, or the extent of deal protections. A class of shareholders led by Smith sued the directors, including Van Gorkom, alleging breach of the duty of care in approving the merger and in issuing a materially misleading proxy. The Delaware Court of Chancery ruled for the directors, applying the business judgment rule. The shareholders appealed.
Whether the Trans Union directors breached their duty of care—and thereby lost the protection of the business judgment rule—by approving a merger at $55 per share without adequately informing themselves and by disseminating a proxy statement that omitted material information about the board's decision-making process and the basis for the price.
Under Delaware law, the business judgment rule presumes that directors of a corporation act on an informed basis, in good faith, and in the honest belief that their decisions are in the company's best interests. The presumption may be rebutted by evidence of director gross negligence—i.e., a reckless indifference to or a deliberate disregard of the whole body of stockholders or actions without the bounds of reason—particularly a failure to inform themselves of all material information reasonably available before making a decision of significance. Directors must also ensure that shareholder disclosures are full and fair; material omissions or misstatements violate the duty of care in the disclosure context. If the presumption is rebutted, the burden shifts to directors to demonstrate the entire fairness of the transaction or otherwise face liability for resulting damages.
The Delaware Supreme Court reversed the Court of Chancery and held that the directors of Trans Union were grossly negligent in approving the merger without an informed process and in issuing a proxy statement that omitted material facts, thereby rebutting the business judgment rule's presumption and establishing a breach of the duty of care.
The Court emphasized that the business judgment rule protects substantive outcomes only when the process is sufficiently informed. Here, the record showed the board approved a company-transforming cash-out merger after a brief meeting with no prior notice of the transaction's specifics, no written valuation data, no independent financial advisor's fairness opinion, and without reading or understanding the key merger terms. The $55 price originated with the CEO from tax-driven feasibility views rather than an enterprise valuation; the CFO's input did not constitute a valuation analysis. Directors asked few probing questions, failed to negotiate for more time, and accepted restrictive deal protections that could chill competing bids. These facts collectively evidenced gross negligence in the decision-making process. The Court also found disclosure violations. The proxy soliciting shareholder approval did not candidly state that the board had not performed or received any valuation prior to approval, that the $55 price was not the product of investment-bank analysis, and that the agreement contained significant protective provisions for the bidder. Because shareholder approval was premised on incomplete and misleading disclosures, it did not cleanse the process deficiencies. The directors' later efforts—seeking a fairness opinion and considering alternatives after public announcement—did not cure the original failure to inform themselves. The Court reiterated that the relevant inquiry focuses on what the board knew and did at the time it made the decision. Having rebutted the business judgment presumption, defendants did not carry the burden of showing entire fairness. Accordingly, the Court held the directors breached their duty of care and remanded for further proceedings on remedy.
Smith v. Van Gorkom is a cornerstone of corporate governance doctrine. It operationalizes the duty of care by tying business judgment deference to a demonstrably informed process and robust disclosure, not to the eventual wisdom of the outcome. The decision accelerated best practices: boards now routinely obtain fairness opinions, build an evidentiary record of deliberation, demand time to review deal documents, consider alternatives, and ensure full and fair proxy disclosures. The backlash to potential monetary liability for care breaches led to widespread adoption of Delaware General Corporation Law § 102(b)(7) charter provisions, which exculpate directors from monetary damages for duty of care violations (while preserving liability for loyalty, bad faith, and other misconduct). For law students, the case illustrates the primacy of process in corporate law and the mechanics of rebutting the business judgment rule.
Smith v. Van Gorkom reshaped corporate law by tethering the business judgment rule to a demonstrably informed decision-making process and robust shareholder disclosure. It underscores that courts will not second-guess substantive outcomes if directors fulfill their process-based duty of care; conversely, they will not defer when directors act hastily and without adequate information.