Questions: Did the Board of Directors fail in their fiduciary duty to the shareholders? Why or why not? If all directors were held to the standards set by the Delaware Supreme Court, what positive and negative effects would this standard have on their performance as directors? Do you agree with the standards set by the Delaware Supreme Court? Why or why not? What might Kant say about these high standards? What might a utilitarian like John Stuart Mills say about these high standards?

Case:

Promptly at noon on Saturday, September 20, 1980, nine members of the board of directors of Trans Union Corporation gathered for a hastily called special meeting.56 None of the five outside directors had been informed of the meeting’s purpose or had been provided in advance with any materials to study. Only one hour earlier did any of the top executives learn of the plan to be proposed to the board by the chairman and CEO, Jerome W. Van Gorkom. The plan was to sell the company for a price of $688 million to the Marmon Group, headed by Jay A. Pritzker, a prominent takeover specialist and chairman of the Hyatt hotel chain.

Planning the Sale: Trans Union Corporation was a publicly traded, diversified holding company, located on LaSalle Street in Chicago. Founded in 1968 out of the Union Tank Car Company, Trans Union was engaged primarily in the business of leasing railroad cars. Although the company was doing well, it could not match the lower rates of its competitors in the railroad-car leasing business due, in large part, to its inability to benefit from an investment tax credit. Because the credit was offered as an offset on the company’s taxable income, Trans Union could not realize the full benefit since deductions for depreciation reduced its taxable income below the full amount of the credit. Lobbying efforts in Congress for a change in the tax code to permit the receipt of the credit in cash had proved fruitless. Among the other solutions to this problem examined by company executives were a leveraged buyout by management and a sale to a larger company with more taxable income. On his own, without consulting the board or any other executives except one, Van Gorkom arranged to meet with Pritzker at the latter’s home on Saturday, September 13. The two men had been acquainted socially for more than 10 years and had worked together on the Chicago School Finance Authority to rescue the city school system from a financial crisis. Rather than merely seeking to discern Pritzker’s interest, Van Gorkom presented him with a detailed proposal based on a $55-per-share price, which represented a premium of 48 percent over the current price and 62 percent over the average of the high and low prices during 1980. Van Gorkom explained how Pritzker could finance the deal so as to realize the extra value reflected in the premium. Pritzker was interested in the deal, and after several more meetings over the next few days to settle certain details, he announced that he was ready to make a $55-pershare all-cash offer for the company. However, Pritzker insisted that the deal had to be completed by Sunday of that week, September 21. At an 11:00 a.m. meeting of top executives on Saturday morning, September 20, the reaction was decidedly negative. Van Gorkom gave an oral account of the proposed agreement to his management team with no supporting documentation. Several of the executives questioned how the $55 price had been determined and whether it was too low. Objections were also made to several conditions that Pritzker had inserted that would discourage any rival bidders for the company. Some executives also expressed concern about the adverse tax consequences of an all-cash buyout for certain shareholders. The executives realized, though, that the decision was not theirs to make: The board of directors had the responsibility of deciding whether to approve the proposed agreement and submit it to the shareholders for a vote.

Board Consideration: During the two-hour special board meeting on September 20, immediately following the session with company executives, Van Gorkom gave a 20-minute oral presentation of the proposed agreement, again without providing written copies. He did not offer any analysis to support the $55-per-share price. He did not claim that this was the highest price that could be obtained but only that it was a fair price, which the shareholders should be allowed to accept or reject. It is common in such situations to seek a fairness opinion from an investment advisory firm to attest that the price placed on a company for sale is fair, but no such opinion had been sought in this case. Van Gorkom did not mention that he had proposed the $55 price to Pritzker rather than receiving an offer at this price from him. He defended the price on the ground that once the Pritzker offer was announced, other bidders could come forth, thus allowing the market to determine the highest price that could be obtained. The chief financial officer of Trans Union, who had not been aware of the proposed agreement until that morning, told the board that he had not attempted to determine the company’s value. The studies he had done were aimed, rather, at analyzing the feasibility of a management buyout at different share price levels in the $50 to $60 range. He explained that this methodology would not yield a valid price for the company but would produce only a reasonable approximation. He told the board that, in his opinion, $55 was “in the range of a fair price” but “at the beginning of the range.” An outside lawyer, who had been retained by Van Gorkom to advise the company on the sale, told the board, correctly, that a fairness opinion was not legally required and that they might be sued by shareholders if they did not allow the shareholders to vote on the offer. At the end of two hours, the directors voted to accept the proposed agreement, without having read it. The board members later claimed that they had attached two conditions to the agreement that reserved the right to accept a better offer if one were made before the deal was completed, and that committed the company to provide any potential bidder with confidential financial information. However, these conditions were not recorded in the meeting minutes nor incorporated into the final agreement. Moreover, the board did not reserve the important right to actively solicit other bids. That evening was the opening night of the Chicago Lyric Opera season. Following tradition, Van Gorkom and his wife hosted a formal pre-opera gala party on the 25th floor penthouse of the Trans Union Building for a large number of Chicago’s elite, including the Pritzkers. During the celebration, Van Gorkom and Pritzker, attired in tuxedos, slipped down to the floor below where a team of lawyers was putting the final touches on the sale documents. Before leaving for the opera—a production of Modest Moussorgsky’s “Boris Godunov”—they signed the agreement to sell Trans Union to Pritzker’s Marmon Group. This agreement, which still had to be presented for a shareholder vote, was not yet complete, though. Pritzker was forced to make some concessions to keep key Trans Union executives from leaving, but he also added some provisions that further limited the board’s ability to obtain a better offer or withdraw from the deal. Van Gorkom reconvened the board for a meeting on October 8. However, the final agreement, executed on October 10, contained provisions that differed from what Van Gorkom had told the directors. No member of the board had read the final agreement, and Van Gorkom himself apparently failed to appreciate the implications of some of the changes.

Shareholder Challenge: On January 26, 1981, the board met and voted to proceed with the sale. The shareholders approved the sale with 69.9 percent in favor, 7.25 percent against, and 22.8 percent not voting. Before the vote, a group of shareholders brought a class-action suit challenging the sale. These shareholders sought to hold the individual board members personally liable for failing to fulfill their fiduciary duty in approving the sale, citing specifically the duty of candor to disclose fully all relevant information and a duty of care to inform themselves fully before taking action. The monetary award sought was the difference between the sale price of $55 per share and the true value of the company. Although directors and officers of publicly held corporations have a fiduciary duty to shareholders, they also have the benefit of the business judgment rule, which protects them from shareholder suits alleging a breach of fiduciary duty as long they act reasonably and there is no evidence of negligence, bad faith, fraud, or self-dealing. The purpose of the business judgment rule is to insulate corporate decision making from second-guessing by the courts and to avoid unnecessary personal risk for individual officers and directors, which might make them unduly cautious. According to this rationale, shareholder interests are better served if the fiduciary duty of corporate actors is not excessively stringent but is tempered by the business judgment rule. The Delaware Supreme Court reversed a lower court ruling and found that Van Gorkom and the other directors guilty of a breach of their fiduciary duty. The opinion of the judge writing for the majority stated the following: Under the business judgment rule there is no protection for directors who have made “an unintelligent or unadvised judgment.” A director’s duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders. Since a director is vested with the responsibility for the management of the affairs of the corporation, he must execute that duty with the recognition that he acts on behalf of others. Such obligation does not tolerate faithlessness or self-dealing. But fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. This decision provoked a strong, immediate reaction, with one critic calling it “surely one of the worst decisions in the history of corporate law.” One dissenting judge in the case opined that while the board may not have read the material, they were experienced men of business who knew the company thoroughly, had confidence in its top executives, and understood the need, in this case, for quick action. The five outside directors on the board were very knowledgeable about mergers and acquisitions and had a thorough grasp of Trans Union’s financial condition and strategic direction. Four of them were CEOs of other companies, and the fifth was a former dean of the University of Chicago business school. While $55 per share may not have been the highest amount obtainable, it was still a fair price. Other critics have stressed the cost involved in gathering and processing information compared with the benefit for shareholders and the need to rely on the expert opinion of company management and professional advisers. In response to this negative reaction, the Delaware General Assembly passed legislation that allowed corporations chartered in the state to protect directors and officers from shareholder suits for failure to fulfill the standard of fiduciary duty employed in the Trans Union case. The effect of this legislation was to permit corporations, with shareholder approval, to bypass the decision in the Trans Union case, and, subsequently, virtually all large Delawareincorporated companies have done this. As a result, successful suits for breach of fiduciary duty today can be brought only for egregious cases of fraud, bad faith, or selfdealing and not merely for the kind of conduct exhibited by the directors of Trans Union Corporation.