Realigning the Standard of Review of Director Due Care with Delaware Public Policy: A Critique of Van Gorkom and Its Progeny as a Standard of Review Problem

By Allen, William T.; Jacobs, Jack B. et al. | Northwestern University Law Review, Winter 2002 | Go to article overview

Realigning the Standard of Review of Director Due Care with Delaware Public Policy: A Critique of Van Gorkom and Its Progeny as a Standard of Review Problem


Allen, William T., Jacobs, Jack B., Strine, Leo E., Jr., Northwestern University Law Review


In this commentary,1 we examine the role of Smith v. Van Gorkom2 as part of a continuum of Delaware judicial decisions that, we submit, gives insufficient weight to the substantive policy judgments underlying the gross negligence standard of review that governs whether corporate directors should be found liable for breaching their duty of care. The gross negligence standard is consistent with Delaware's long-standing policy of deferring to business decisions made by well-motivated fiduciaries.

That deference furthers important public policy values and underscores the social utility of encouraging corporate directors to make decisions that may create corporate wealth but that are also risky. If law-trained judges are permitted to make after-the-fact judgments that businesspersons have made "unreasonable" or "negligent" business decisions for which they must respond in monetary damages, directors may, in the future, avoid committing their companies to potentially valuable corporate opportunities that have some risk of failure. Highly qualified directors may also avoid service if they face liability risks that are disproportionate to the benefits of service.

Therefore, as a normative matter, corporate directors are expected to act with the ordinary care expected of a reasonably prudent fiduciary. Despite that, the standard of judicial review for determining whether directors should be held financially liable (or whether their actions should be enjoined) for violating their duty of care is purposely set at the more lenient level of "gross negligence." The more lenient review standard creates a greater arena of freedom for directors, because the standard is purposefully designed to encourage directors to act without undue inhibition.

The gross negligence standard also limits the ability of judges to intervene in business decisions made by properly motivated directors. By intruding on the protected space that the business judgment rule accords such decisions, courts create disincentives for businesses to engage in the risk-- taking that is fundamental to a capitalist economy. Such intrusiveness also prolongs litigation without offsetting social utility.

Courts therefore play a critical role in preserving the public policy values that are furthered by the divergence between (1) the standard of conduct expected of directors as a normative matter, and (2) the standard of conduct that is judicially enforceable and that is embodied in the gross negligence standard of review. In the pages that follow, we argue that Van Gorkom and two of its important progeny run counter to Delaware public policies restricting the judicial enforcement of the duty of care to cases where directors have acted in a manner that represents an extreme departure from expected normative behavior, and, if damages are sought, have not been exculpated by the firm's certificate of incorporation.

We conclude by proposing that to better align judicial decision-making with those public policies, courts should apply a true gross negligence liability standard, which would require plaintiffs to prove that a director caused quantifiable damage. We further propose that courts respect decisions by stockholders that insulate directors from liability for violating that standard.

I. THE DELAWARE CONCEPTION OF DUE CARE

Preliminarily, we note that courts deciding Delaware corporate law cases have only recently viewed the director's duty of care as being judicially enforceable. Indeed, it is arguable that the pre-Van Gorkom case law reflected a judicial aversion to reviewing director action for any purpose other than identifying (and remedying) breaches of the duty of loyalty.

The pre-1985 Delaware (and the American and English) tradition was highly deferential to decisions made by well-motivated corporate directors who acted without any conflicting self-interest.3 Judicial decisions that addressed director liability for non-self-dealing transactions suggested that the imposition of liability would require a showing akin to subjective bad faith. …

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