Mid-Atlantic Health Law TOPICS

Everyday, another hospital merger is announced, but what are the duties of hospital directors in approving such a merger? Similarly, everyday another mega-medical group is formed or dissolved, but what are the duties of the physician directors who vote in favor of their group joining the mega-group, or who vote in favor of the dissolution?

These questions, at least in Maryland, are now a little easier to answer, because Maryland's intermediate appellate court, in Wittman v. Crooke, recently decided that the directors of Baltimore Gas and Electric Company (BGE) did not breach their duties to BGE stockholders in approving a proposed merger with Potomac Electric Power Company (PEPCO).

A. The Business Judgment Rule in Maryland

Directors of a corporation have a fiduciary duty to the corporation and its stockholders. This fiduciary duty is comprised of two elements: a duty of care and a duty of loyalty. So long as a director has not breached these fiduciary duties, courts will not second guess the business judgment of the directors-this is known as the business judgment rule.

Maryland has codified the business judgment rule as follows: a director shall perform his or her duties as a director, including his duties as a member of a committee of the board on which he or she serves: (1) in good faith; (2) in a manner he or she reasonably believes to be in the best interests of the corporation; and (3) with the care that an ordinarily prudent person in a like position would use.

In evaluating a significant proposed transaction, a board of directors must obtain advice from outside professionals and experts to fulfill their duty of care to act on an informed basis. A director may rely on information provided by a professional or expert, including a lawyer, investment banker or certified public accountant, as to a matter that the director reasonably believes to be within that person's professional or expert competence.

The courts generally will not interfere with the actions of directors unless it appears that they are the result of fraud, dishonesty or incompetence. If directors properly exercise their business judgment, they will not be liable unless their acts constitute gross negligence, waste of corporate assets or culpable negligence.

B. Interested Director Transactions

 In considering a proposed transaction, a director may be faced with a conflict of interest between that director's interests and the best interests of the corporation. The applicable Maryland statute provides in the case of an "interested director" that the taint of conflict may be removed by (1) approval or ratification, following full disclosure, by (a) a majority of disinterested directors or (b) a majority of disinterested shareholders; or (2) proof by the interested director that the transaction was fair and reasonable to the corporation.

C. The Facts of Wittman v. Crooke

On September 25, 1995, BGE announced that it had entered into a merger agreement with PEPCO. That same day a BGE stockholder filed suit against BGE's board of directors alleging that they had breached their duties of care and loyalty in approving the merger.

The stockholder based her claim on the theory that all of BGE's directors were "interested directors" and thus prohibited from deciding on the merger because each director had the potential of being named to the new company's board of directors. The stockholder further alleged that the investment advisors retained by the board, Goldman Sachs & Co. (Goldman), were "interested" because if a merger were concluded Goldman would earn an $8,500,000 fee; thus, the board could not rely on Goldman's advice.

Subsequently, the merger was approved at a special meeting of BGE's stockholders by more than 97% of the votes cast.

D. The Holding of Wittman

The Wittman court stated that the prospect of being appointed as an officer or director of a larger, more prestigious company is not a "special benefit" that results in a conflict of interest. Since every director of BGE had the same "interest," the court held that, as a matter of law, the mere potential to become a director of the merged corporation was not a sufficient interest to brand the transaction as an "interested director transaction."

As to the assertion that the directors breached their duty of care by relying on the advice of Goldman, which would receive a large fee upon the successful completion of the merger, the court held that this allegation was not supported by the facts or by a fair inference under the circumstances.

The court also went a step further and stated that, even if the directors should not have relied on the advice of an "interested" advisor, after full and fair disclosure "the stockholder vote ratified the transaction" and therefore extinguished the duty of care claim.

The court's ruling in Wittman demonstrates the value of full disclosure when seeking stockholder approval of proposed corporate transactions. Directors can also find solace in knowing that insubstantial benefits will not be viewed as impinging on their duty of loyalty.