On October 14, 2011, the Delaware Court of Chancery entered a $1.26 billion damages award in In re Southern Peru Copper Corp. S’holder Derivative Litig., a derivative action challenging the fairness of a merger involving a controlling stockholder. This eye-popping award is a stark reminder of the Court’s heightened focus on the conflicts associated with transactions involving controlling stockholders, and, as detailed below, it highlights the importance of ensuring adequate procedural protections in such transactions.
The case arises out of the 2005 acquisition by Southern Peru Copper Corporation of Minera Mexico, a Mexican mining company, from Southern Peru’s own controlling stockholder, Grupo Mexico. In 2004, Grupo Mexico first proposed that Southern Peru acquire Grupo Mexico’s 99.15% interest in Minera in exchange for shares of Southern Peru common stock valued at approximately $3 billion. The Southern Peru board of directors created a special committee of independent directors whose “duty and sole purpose” was to “evaluate” Grupo Mexico’s proposal. The resolutions creating the Committee did not provide it with the express power to negotiate, nor did they authorize the Committee to explore other strategic alternatives.
As detailed in Chancellor Strine’s 105-page opinion, the Committee’s financial advisor performed an initial “give/get” analysis, which showed the value of the Southern Peru stock (based on its NYSE trading prices) to be issued in the transaction to be worth roughly $1.4 billion more than the value of the non-publicly traded Minera (generated through DCF and other analyses). The financial advisor and the Committee subsequently focused on valuing the companies on a relative basis, using various metrics to compare the intrinsic (rather than market) value of the Southern Peru shares to the intrinsic value of Minera in an “apples-to-apples” approach. Following receipt of a fairness opinion from its financial advisor, the Committee approved the transaction. Between signing and closing, the trading price of Southern Peru shares (and thus the price Southern Peru paid to acquire Minera) increased by roughly $650 million.
A stockholder of Southern Peru brought a derivative suit challenging the fairness of the transaction and alleging that Southern Peru substantially overpaid for Minera. Following trial (during which all parties stipulated to the application of the “entire fairness” standard), Chancellor Strine concluded that the defendants were not entitled to a shift of the burden of demonstrating the fairness of the transaction (notwithstanding the use of a special committee advised by well-respected legal and financial advisors and inclusion of a supermajority vote) because, among other things, (i) the Committee had a narrow mandate, failed to explore potential strategic alternatives and could not be deemed “well-functioning”; (ii) the supermajority vote was not “conditioned up front”; and (iii) the supermajority vote was based on a proxy statement that omitted material information, including an initial counteroffer by the Committee to purchase Minera for $2.095 billion in response to Grupo Mexico’s $3.1 billion ask.
Chancellor Strine concluded that “[a] focused, aggressive controller extracted a deal that was far better than market, and got real, market-tested value of over $3 billion for something that no member of the Special Committee, none of its advisors, and no trial expert was willing to say was worth that amount of actual cash.” In determining that Grupo Mexico and its affiliate directors had breached their fiduciary duties of loyalty, the Court focused on, among other things:
The Court awarded damages in an amount equal to the difference between the market value of the stock issued to Grupo Mexico as of the closing date and the price that would have been paid in an entirely fair transaction (as determined by the Court based on the standalone DCF value, the equity value derived from a comparable companies analysis, and a value implied by an initial counteroffer by the Committee). The Court indicated that Grupo Mexico could satisfy the award by returning shares of Southern Peru common stock to the company.
Chancellor Strine’s opinion highlights a number of key considerations for special committees in controlling stockholder transactions and with respect to conflicts of interest more generally.
Click here to view In re Southern Peru Copper Corp. S'holder Derivative Litig., C.A. No. 961-CS (Oct. 14, 2011).