The Enduring Legacy of Smith v. Van Gorkom

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Delaware Journal of Corporate Law (DJCL), Vol. 33, No. 2, pp. 287-309, 2008

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Bernard S. Sharfman
Van Gorkom; business judgment rule; duty of care; directors; accountability; authority; corporate governance; corporate law
paper description
It is hard to envision an introductory law school course in corporate law that does not devote at least one or two classes to the study of Smith v. Van Gorkom (Van Gorkom), possibly the most famous corporate law case decided by the Delaware Supreme Court. It has become such a foundation case for the beginning study of corporate law that one prominent corporate law commentator has likened the failure to teach Van Gorkom to the omission of Brown v. Board of Education in a first year constitutional law course. The challenge for teachers of Van Gorkom is to explain why shareholders were correct in approving exculpation clauses even as our thinking about corporate law evolves and corporate scandals (Enron, Tyco, WorldCom, etc.) continue to influence our perspective on the correct level of corporate accountability. As this paper tries to demonstrate, applying the creative approaches taken by legal scholars such as Professor Michael P. Dooley, who introduced Kenneth Arrow's understanding of the value of centralized authority into the study of corporate law, and Stephen M. Bainbridge who has so aptly applied Professor Dooley's work in the development of his director primacy model, and Margaret M. Blair and Lynn A. Stout, who introduced the concept of the board of directors as a mediating hierarchy gives Van Gorkom new and greater meaning and reaffirms the correctness of insulating directors from duty of care liability. The basic premise underlying this article is that the real value of the corporate form is its hierarchical nature as reflected in the centralized authority of the corporate board. This value is manifested by the corporate board's ability to: 1) efficiently filter information in its decision-making process; and 2) act as a mediating hierarchy. Such organizational efficiencies create a strong presumption that the laws of corporate governance should not interfere with the corporate board's decision making process. In contrast to the approach taken by both Dooley and Bainbridge, this article does not utilize a contractarian framework. More importantly, this article does not require that shareholder wealth maximization be a norm underlying the laws of corporate governance. By relaxing this standard assumption, we can, for the first time, utilize the efficiency arguments of Dooley and Bainbridge on one hand and those of Blair and Stout on the other, as two complementary, instead of competing, approaches supporting the position that corporate board decisions need to be protected from judicial review. This paper reflects my continuing interest in Van Gorkom and was heavily influenced by my previous work, Being Informed Does Matter: Fine Tuning Gross Negligence Twenty Plus Years after Van Gorkom, The Business Lawyer, Vol. 62, No. 1, pp. 135-160 (November 2006).