Van Gorkom's Legacy: The Limits of Judicially Enforced Constraints and the Promise of Proprietary Incentives

Smith v. Van Gorkom1 is at the center of the most remarkable period of judicial activity in corporate law in the twentieth century. Its appearance in January 1985 came eleven months after Aronson v. Lewis and twenty-three months after Weinberger v. UOP, Inc.,3 Unocal, Inc. v. Mesa Petroleum Co.,4 and Revlon, Inc. v. Mac.Andrews & Forbes Holdings, Inc.5 appeared before the end of 1985.6 Along with these other landmark decisions commonly found in most corporations casebooks, Van Gorkom illustrates the twin pillars of Delaware corporate law-the primacy of the board of directors in the law's approach to corporate governance, and the centrality of common-law courts (and their interpretations of fiduciary duty) in setting the limits on director power in corporations. For this handful of decisions the second point is particularly noticeable. Three of the cases-Van Gorkom, Unocal, and Revlon-expand the level of judicial review of director actions, and Weinberger, while ostensibly making appraisal the plaintiffs primary remedy in a cash-out merger, provides the "fair dealing/fair price" structure that has become the standard legal test for extensive judicial review in a variety of merger settings. Even Aronson, which produced the standard most likely to short circuit litigation, contains a second prong that permits open-ended judicial review of the substantive nature of a challenged transaction. The preference for judicial review over alternative constraints on directors, including ex ante state or federal legislation, shareholder self-help, markets, private ordering or norms, is most pronounced in Van Gorkom. There the Delaware Supreme Court subjected directors to personal liability even though there were no "allegations of fraud, bad-faith or self-dealing or proof thereof. "7 Viewed with the benefit of hindsight, Van Gorkom stands as the apogee in the reach of judicial corporate governance via fiduciary duty, parallel to Superintendent of Insurance v. Bankers Life & Casualty Co. as the apogee in the reach of Rule lOb-5 under federal law securities regulation as a means to address corporate governance.9 The impact of Van Gorkom lies not in its holding, which has been eviscerated by subsequent legislative action, but in its refocusing the corporate governance debate on deficiencies in the role of directors and unleashing a richer array of alternative constraints that include markets, contracts, and norms. This Article has three parts. The first places fiduciary duty in the context of the array of possible constraints on director action and Van Gorkom's place in the development of those various constraints. The second Part then addresses the common-law portion of the post-Van Gorkom world: how governance behavior has changed to come within Van Gorkom's holding. The third Part addresses alternative regimes that do not depend on common-law judicial determinations. These include, for example, the rising importance of equity-based ownership for directors as an alternative incentive for appropriate director action, and shareholder self-help via voting or selling instead of relying on judges to enforce fiduciary duty. 1. CORPORATE GovERNANcE AND THE ROLE OF CommoN-LAW JUDGES APPLYING FIDUCIARY DUTY The corporation provides a form of business that facilitates a firm's adaptability to new economic conditions. The legal structure anticipates both separation of function and specialization among various groups.10 Within this specialized business form, the fulcrum for almost all legal power is the board of directors." Directors' control over "vast aggregations of property that they do not own"12 not surprisingly triggers discussion of constraints on such power. Van Gorkom illustrates the most visible constraint in corporate law-directors have common-law fiduciary duties, primarily of care and loyalty, in the decisions they make on behalf of the collective enterprise. These duties are usually enforced by shareholderinitiated derivative suits or class actions, leading to judicial orders where necessary to rein in improper director action. …