When the Court of Common Pleas of Philadelphia County issued an order dismissing a case brought by a shareholder challenging a proposed merger by Penn Millers Holding Corporation in November, it spelled a victory for businesses in the Keystone State.

The ruling demonstrates the significant protections afforded to Pennsylvania companies and their boards in change of control transactions under Pennsylvania law. These protections are substantially greater than those afforded companies incorporated in Delaware and could become a significant draw for companies to change their state of incorporation, particularly in light of the increase in merger challenge litigation in recent years.

Ballard Spahr litigators M. Norman Goldberger, Justin P. Klein, and Laura Krabill analyzed the decision, a rare ruling for a Pennsylvania court considering a challenge to a proposed merger transaction, for Insights Magazine.

Litigation follows virtually every merger transaction. Most companies are organized in Delaware, where the law requires company board members to seek the maximum price per share for the company being sold. Pennsylvania law is different. Pennsylvania statutes state that directors of corporations owe fiduciary duties to the corporation, not the shareholders. That means board members here can consider other issues—such as employment conditions and charitable obligations—when deciding whether to merge. These strong legal protections are designed to thwart buyers who don’t have a company’s best interests at heart.

In addition, Pennsylvania statute mandates that any challenges to directors’ decisions, particularly mergers or acquisitions, can only be brought derivatively and must comply with the procedural prerequisites applicable to derivative claims. Challenges to board merger and acquisition decisions are much more difficult to establish substantively in Pennsylvania than in many other states, particularly Delaware. Pennsylvania law also provides greater procedural protections that minimize unwarranted derivative claims.

When the board members of Penn Millers, a Pennsylvania company, decided to merge the company with Ace Insurance, a shareholder filed suit, claiming that the share price was inadequate. This case was the first-ever challenge to the actions of a board of directors in a merger case brought in Philadelphia.

The opinion rejected derivative claims based on the conclusion of the special litigation committee, made up of board members of Penn Millers, that the claims asserted in the complaint lacked merit and that litigation was not in the best interests of Penn Millers. The court also rejected the one purportedly non-derivative claim asserted for “intentional interference with voting rights,” holding that no such direct claim could be brought against directors of Pennsylvania companies.

The conclusion? Plaintiffs are not entitled to maintain derivative suits without making a demand on the board and then waiting for a corporate response. Furthermore, plaintiffs and courts must defer to a company’s decision whether to pursue claims raised in the demand. Where independent and disinterested directors of a corporate board undertake a reasonable investigation and conclude in good faith that the demanded action or plaintiff’s litigation is not in the company’s best interests, a Pennsylvania court must accept the board’s conclusion and dismiss any action that has been brought in contravention of that decision.