In an interesting October 14, 2011 post-trial opinion, Delaware Chancellor Leo Strine entered a $1.263 billion award in the Southern Peru Copper Corporation Shareholder Derivative Litigation. The lawsuit relates to Southern Peru’s April 2005 acquisition of Minerva México, a Mexican mining company, from Groupo México, Southern Peru’s controlling shareholder. Chancellor Strine concluded that as a result of a “manifestly unfair transaction,” Southern Peru overpaid for Minerva Mexico. A copy of Chancellor Strine’s 106-page opinion can be found here.
Southern Peru is a NYSE company. (After the events involved in this lawsuit, Southern Peru changed its name to Southern Copper Corporation. Its shares trade on the NYSE under the symbol “SCCO.”) Groupo México is the controlling shareholder of Southern Peru. In 2004, Groupo México owned 54.17% of Southern Peru’s outstanding stock and 63% of the voting power. In February 2004, Groupo México proposed that Southern Peru buy its 99.15% share stake in Minerva in exchange for 72.3 shares of newly-issued Southern Peru stock. At market price of Southern Peru’s stock then, the proposed deal had an “indicative” value of $3.05 billion.
The Southern Peru board appointed a special committee to assess the proposed transaction. The special committee in turn hired numerous outside experts, including Goldman Sachs, to assist the committee in assessing the transaction. As Chancellor Strine later concluded, when it became clear that Minerva’s value was substantially less than the value of proposed amount of Southern Peru stock, “the special committee and its financial advisor instead took strenuous efforts to justify a transaction at the level originally demanded by the controller.”
As a result, “the controller got what it originally demanded: $3.1 billion in real value in exchange for something worth much, much less — hundreds of millions of millions of dollars less.” Even worse, the special committee agreed to a fixed exchange ratio. Because Southern Peru’s stock price rose between the date the parties entered the deal and the date the deal closed, the actual value of the transaction was $3.75 billion. Even though the special committee had the ability to rescind the deal, the special committee did not seek to update the fairness opinion or otherwise alter the transaction. The upshot was 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 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.”
Shareholders then filed a derivative lawsuit alleging that the transaction was unfair to Southern Peru and its minority shareholders. By the time of trial, the defendants remaining in the case were Group México and its eight affiliate directors who were on the Southern Peru board at the time of the transaction. The plaintiffs argued that the 67.2 million shares of Southern Peru stock that Groupo México received in the transaction were worth substantially more that the 99.15% interest in Minerva that Southern Peru received.
The October 14 Opinion
Following trial, Chancellor Strine concluded that “the process by which the Merger was negotiated and approved was not fair and did not result in the payment of a fair price.” He found that “from inception, the Special Committee fell victim to a controlled mindset and allowed Groupo México to dictate its terms and structure of the Merger.”
Strine also concluded that the committee was “not ideally served by its financial advisors,” Goldman Sachs, which having concluded that the value of what Southern Peru would receive in the transaction was substantially less than the value of stock Groupo México was to receive, “helped its client rationalize the one strategic option available within the controlled mindset that pervaded the Special Committee’s process.” But, as Strine found, “Goldman and the Special Committee could not generate any responsible estimate of the value of Minerva that approached the value of what Southern Peru was asked to hand over.”
Strine found that as a result, the transaction was “unfair” to Southern Peru, because the special committee’s “cramped perspective” resulted in a “strange deal dynamic,” in which “a majority shareholder kept its eye on the ball – actual value benchmarked to cash – and a Special Committee lost sight of market reality in an attempt to rationalize doing a deal of the kind the majority stockholder proposed.” As a result of this “game of controlled mindset twister,” the committee “agreed to give away over $3 billion worth of actual cash value in exchange for something worth demonstrably less, and to do so on terms that by consummation made the value gap even worse, without using any of its contractual leverage to stop the deal or renegotiate its terms.” Because the deal was “unfair,” Strine concluded that “the defendants breached their fiduciary duty of loyalty.”
Since the time of the merger, Southern Peru’s share price has continued to climb. For that reason, and because of “the plaintiff’s delay in litigating the case,” Strine concluded that a rescission-based approach would be “inequitable.” Instead, Strine, utilizing a “panoply of equitable remedies,” crafted “a damage award that approximates the differences between the price that the Special Committee would have approved had the Merger been entirely fair (i.e., absent a breach of fiduciary duties) and the price that the Special Committee actually agreed to pay.” Strine noted that given the differences in values involved, the record arguably could support a damages award of $2 billion or more.”
However, taking into account the “imponderables” involved in many of the valuations, Strine took an approach he characterized as “more conservative.” His approach basically consisted of coming up with a value for Minerva based on an average of three possible valuation methodologies. This method came up with a valuation for Minerva of $2.409 billion. The 67.2 million shares Groupo México received were worth $3.672 billion.
Based on the difference between these two figures, Strine entered an award of $1.263 billion. Strine also awarded interest, without compounding, at the statutory rate from the merger date, and also from the date of judgment until payment. He also awarded plaintiffs’ attorneys’ fees, to come out of the award, in an amount he directed the parties to agree upon. Strine added that Groupo México could satisfy the judgment by agreeing to return to Southern Peru the number of shares necessary to satisfy the award.
The addition of pre- and post-judgment interest could as much as another $100 million to the value of this award, meaning that the total value of this award is arguably as much as $1.36 billion (and counting). But as massive as this amount is, it does not represent the largest amount awarded in a shareholder derivative suit. As far as I am aware, that distinction belongs to the $2.876 billion awarded in the shareholder derivative lawsuit filed against former HealthSouth CEO Richard Scrushy, about which refer here. (Actually, the total amount of the damages in Scrushy case was $3.115 billion. It was only the application of $239 million credit for judgments entered against other defendants that brought the number down to the $2.876 billion.) The Southern Peru award does likely represent the largest award in a derivative suit in Delaware Chancery Court.
In light of the dollars involved, Groupo México has a strong incentive to appeal, although the accumulation of post-judgment interest could provide a reason to carefully assess the likelihood of success on appeal.
If it comes down to payment of the award, it looks to me like Groupo México’s best option would be to return the number of Southern Peru shares required to satisfy the award. The shares have dramatically escalated since the transaction closed (at current market valuations, and allowing for stock splits, the shares appear to be worth more then ten times what they were in April 2005). Paying the award with an inflated currency would appear to allow Groupo México to retain substantial benefits of this transaction.
There are at least a couple of important things to be drawn from the outcome of this case. First, this case represents a very substantial refutation to the many commentators who regularly complain that derivative litigation in Delaware courts provide shareholders’ with a toothless remedy. This case shows that the Delaware derivative litigation definitely can have bite.
Second, this case has some very important implications for board’s duties when considering a transaction proposed by a controlling shareholder. In particular, Chancellor Strine seemed particularly concerned that the special committee considered only the deal that the controlling shareholder proposed, suggesting that in these circumstances, boards and the committees must consider all alternatives and not just the one proposed by the controlling shareholder. More broadly, the board and its committee have a duty to consider more than just trying to figure out a way to complete the transaction that the controlling shareholder has proposed.
In view of the massive size of the award, the presence or absence of D&O insurance to pay part of the cost of this award is unlikely to be a material consideration. Were Groupo México to try to get its D&O insurer to pay a part of this award, it would face at lest a couple of likely objections from its carrier(s). First the carrier would contend that its policy provides coverage if at all for Groupo México itself only for “securities claims,” a term that is usually defined with reference to the insured company’s own securities. Since this transaction involved Southern Peru’s securities not Groupo México’s, the carrier would contend that there is no coverage for the award against Groupo México, because the award did not arise out a securities claim.
The carrier would likely also contend that in any event, because of the rescissionary nature of the award, there is no coverage under the policy, nor is there coverage under the policy for the return of amount for which the insured is not legally entitled.
This latter argument would likely also take care of any contentions by the individual defendants that they are entitled to coverage. An interesting issue though is the question of which company’s policy is the relevant policy. Though the individual defendants were affiliated with Groupo México, they were sued in their capacities as directors of Southern Peru. Accordingly, it would look as though the relevant policy for them to seek to access would be Southern Peru’s (although they might have also potentially have outside directorship liability coverage under Groupo México’s policy on an excess basis, a likelihood that is probably remote because that coverage is usually restricted to service on nonprofit boards).
The individuals’ prospects for obtaining coverage for the award under the Southern Peru policy would depend as an initial matter on their ability to overcome the carrier’s likely objections that there is no coverage under its policy for rescissionary damages. Those objections may well be insurmountable, but assuming for the sake of argument that that obstacle could be circumvented, the question would then be whether the policy’s Side A coverage would kick in, as providing coverage for nonindemifiable loss.
Given the size of the award and the hurdles the defendants would have to overcome in order to establish coverage, these insurance questions could all be more theoretical than real.
In any event, the eye-popping amount of the award here makes this case a noteworthy, and Chancellor Strine’s analysis makes these circumstances interesting. I suspect this decision will occasion a great deal of discussion, particularly around the duties boards’ face when forced to assess transactions that will benefit a controlling shareholder.
Special thanks to a loyal reader for providing me with a copy of this opinion.
Alison Frankel has a very interesting October 17, 2011 commentary on this case on her blog on Thomson Reuters News & Insight (here). Professor Davidoff also has an interesting commentary about the case on the Dealbook blog (here).