By Colby W. Smith
Special to the Legal
A change-of-control transaction is a transformative juncture in the life cycle of any publicly traded corporation. Similar to many states, Pennsylvania – recognizing the significance of this event – has an evolved body of law governing the fiduciary duties applicable to a target company’s board of directors in the context of such a transaction. In this inaugural post in a series of blogs discussing M&A and litigation issues specific to Pennsylvania publicly traded companies in change-of-control transactions, we examine distinguishing characteristics of these fiduciary duties under Pennsylvania’s Business Corporation Law of 1988.
In the wake of the evolving standards similar to those articulated in Delaware’s Revlon decision, which imposed an obligation on the company’s board of directors to achieve the highest shareholder value reasonably available, the drafters of the BCL observed as Delaware courts wrestled with the variety of factors surrounding change-of-control transactions. Seeking to create as much certainty as possible, the BCL’s drafters made clear that the decision-making authority for Pennsylvania corporations is firmly vested with their boards of directors and subject only to Pennsylvania’s business judgment rule. The BCL provides that the boards of directors of Pennsylvania corporations have the power “to accept, reject, respond to or take no action in respect of an actual or proposed . . . takeover or other fundamental change.” In their rejection of the judicial standards similar to those in Revlon, the drafters’ commentary indicates that “it is intended that any decision by the board in this context will be subject only to the business judgment rule . . . and not to some special rule created for situations involving a potential change of control.”
Against the backdrop of these principles, the codification of Pennsylvania’s business judgment rule not only provides for a general tone of deference to a board’s decision-making authority, but also provides further clarification of the appropriateness of the board’s consideration of the facts and circumstances surrounding a change of control. Not surprisingly, the BCL provides that a director of a Pennsylvania corporation must act “in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.”
In exercising this general decision-making authority, however, a director is afforded broad discretion to consider the effects on any number of constituencies, including but not limited to the company’s shareholders. Thus, while a board may consider the value provided to shareholders, maximization of shareholder value is not the single determinative factor.
To further entrench decision-making authority with a board alone, the drafters codified a deferential standard of judicial review of a board’s decision. In a rejection of Revlon’s heightened scrutiny, the BCL provides that disinterested director approval of a sale transaction “shall be presumed to satisfy the [business judgment rule], unless it is proved by clear and convincing evidence that the disinterested directors did not assent to such act in good faith after reasonable investigation.” Similar to the commentary described above related to the BCL’s enabling provisions, the commentary to this standard of judicial review states that “case law imposing a stricter standard or heightened level of scrutiny with respect to director action in these circumstances . . . is rejected.”
It is not surprising that, in light of the deferential standards codified in the BCL (and further explained in commentary), shareholder challenges to a transaction approved by the board of a Pennsylvania corporation often face an uphill battle. The next post in this series will focus on the unique challenges to shareholder suits in this context.
Colby W. Smith is a partner in Morgan, Lewis & Bockius’ business and finance practice, resident in Philadelphia. He counsels public and private company clients on various matters, with an emphasis on merger and acquisition transactions and securities offerings. He represents clients in a variety of industries, including technology, health care, manufacturing and consumer products.