On Friday, now-Chancellor Leo E. Strine Jr. issued a lengthy post-trial opinion, In re Southern Peru Copper Corp. Shareholder Derivative Litigation, available here, in which he required a controlling stockholder to return $1.2B in stock in connection with a transaction between it and a corporation it controlled. The case has a number of details of interest to those who advise as to or litigate such transactions or otherwise have an interest on Delaware corporate law.
Controlling stockholder Grupo Mexico ultimately owned about 54% of the stock of Southern Peru Copper Corp. stock and almost all of Minera Mexico’s. Each of Cerro Trading Company, Inc. (owned in turn by the Pritzker family) and Phelps Dodge Corporation owned about 14% of Southern Peru, although such shares were unregistered and could not easily be sold under federal securities laws.
Grupo Mexico proposed to Southern Peru’s board of directors that the latter buy the former’s shares in Minera Mexico in exchange for approximately $3 billion in Southern Peru stock. While Southern Peru’s stock was publicly traded, allowing a ready calculation of its value, Minera Mexico’s was not.
Southern Peru formed a special committee of four directors to evaluate the proposal. The Special Committee hired Latham & Watkins as legal, and Goldman Sachs as financial, advisor (among others). The Special Committee did not lack for credentials and included a Columbia Law grad who had worked at Wachtell Lipton, a Ph.D. in finance from the Wharton School, and another individual with both an MBA and a JD who had managed multi-billion dollar companies. The most active member, Harold Handelsman, was an attorney for the Pritzker family.
After several months of due diligence Goldman Sachs concluded in an “Illustrative Give/Get Analysis” presented to the Special Committee that Southern Peru was being asked to “give” stock with a market price of $3.1B to “get” an asset worth no more than $1.7B. The Special Committee was not specifically given the mandate to negotiate the deal but did so anyway. It made a counterproposal (not reported in the proxy statement) to issue about $2B of Southern Peru stock. Grupo Mexico eventually proposed to acquire $2.76B in shares. Ultimately Goldman Sachs issued a fairness analysis and opinion and the Special Committee agreed to recommend the revised proposal to the board.
The Court criticized the Special Committee for operating “in the confined mindset of directors of a controlled company” and not proposing other alternative transactions to Grupo. The Court acknowledged that Grupo Mexico could always veto such transactions but suggested that it would have been a positive factor in the legal analysis.
According to the Court, after Grupo Mexico stood pat on its demands, the Special Committee and Goldman Sachs adopted a number of arguments to get to the desired result that the transaction was fair, each of which the Court rejected (including an early argument, later abandoned, that Southern Peru’s stock price did not represent that stock’s real value).
In side-deals, Southern Peru stockholders Cerro and Phelps Dodge, who wanted to monetize their holdings, agreed to support the deal if Southern Peru would register their shares. While the Special Committee chose not to take part in the negotiations on this, Handelsman was very much involved. Handelsman was also heavily involved with the Special Committee but decided not to participate in its final vote on the advice of Goldman Sachs’ counsel.
Because the deal was conditioned on a two-thirds vote of all stockholders, not a majority-of-the-minority vote, Grupo Mexico only needed the additional vote of either Cerra or Phelps Dodge. While the Cerro agreement was conditioned on the approval of the underlying deal by the Special Committee the Phelps Dodge agreement was not, leaving the Special Committee without veto power.
By the time of the stockholder vote five months later Southern Peru had significantly exceeded the projections upon which Goldman’s fairness opinion had been based and its stock price had risen substantially. The Court criticized the Special Committee for not seeking to renegotiate the deal or ask Goldman to update its analysis.
In a post-trial opinion the Court held that entire fairness was the appropriate standard of review and the transaction was not entirely fair to Southern Peru. The Court then awarded damages in the amount of Southern Peru stock in excess of that which Grupo Mexico should have received. The Court refused to award rescissory damages (which would have been larger given Southern Peru’s subsequent performance) because of plaintiff’s six-year delay in proceeding to trial.
Notable points other than those already mentioned:
- Once again the opinion demonstrates the skill with which Chancery judicial personnel will evaluate economic arguments on valuation.
- The Court held that, with respect to a controlling stockholder transaction, even a special committee with independent and disinterested members must show that it functioned well and the Court will examine its conclusion substantively.
- The Court held a disclosure materially incomplete for not reporting the Special Committee’s counteroffer, which was materially higher than the eventual price and made after due diligence and a presentation by the financial advisor.
- Even a lengthy special committee negotiating process, including well-credentialed members and financial and legal advisors, will not immunize a large controlling stockholder deal if it fundamentally does not make economic sense.
- Interestingly, the Court noted derivative plaintiff’s failure to attend trial, although it rejected a motion to disqualify him as inadequate.
- The Court noted its earlier dismissal of the Special Committee members themselves including Handelsman and reaffirmed its holding that neither bad faith nor self-dealing had been shown. Nevertheless, it held that the interest of Handelsman in obtaining liquidity for Cerro had compromised his effectiveness on behalf of the Special Committee.
- The Court criticized current Delaware law allowing an effective special committee process as to a controlling stockholder transaction to shift the burden of proof at most (as opposed to restoring business judgment rule). The Court noted that while measures such as special committees are seen as beneficial to Delaware corporations and to be encouraged, burden shifting may not be much of an encouragement as it is almost never outcome-determinative because the Court is rarely in equipoise.
- The Court again proposed that a combination of sufficient protective procedural devices (use of a special committee with negotiation, approval, and veto authority; and a fully informed majority-of-the-minority vote by stockholders) cause the business judgment rule to be restored. But the Court also suggested that the Delaware Supreme Court would have to modify its precedent (e.g. the venerable Kahn v. Lynch) to do so.
Filed under: Controlling Stockholder, Court of Chancery, Derivative Actions, Fiduciary Duties