The Enduring Legacy of Smith v. Van Gorkom

Bernard S. Sharfman

Smith v. Van Gorkom (Van Gorkom) is possibly the most famous corporate law case ever decided by the Delaware Supreme Court. The enduring legacy of Van Gorkom is the understanding that corporate directors should not be held financially liable for corporate board decisions that lack due care. Of course, it was not the holding of Van Gorkom that established this, but the chain of events that occurred in its wake.

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 article demonstrates, applying the innovative approaches taken by legal scholars such as 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 the one hand and those of Blair and Stout on the other, as two complementary, instead of competing, arguments supporting the position that corporate board decisions need to be protected from judicial review.