Americas Mining Corp. v. Theriault, 2012 Del. Lexis 459 (Del. August 27, 2012) got a great deal of press if for no other reason than the eye popping numbers. The Chancery Court found (and the Supreme Court affirmed) that Southern Peru overpaid for the purchase of a company from a controlling shareholder. The trial court awarded damages of $2 billion and attorneys fees of $304 million.
The case also, however, contains some very interesting commentary on special committees. In general, boards considering proposals from a controlling shareholder understand that the transaction will be reviewed under the entire fairness standard. A review of entire fairness entails an examination of both amount paid and the process employed (fair price and fair dealing).
To ensure proper process, directors commonly form a special committee. The committee typically consists entirely of independent directors and the directors retain independent experts. Where the company uses a special committee in this manner, the Delaware courts shift the burden to shareholders. Rather than the board having to show that the transaction was fair, shareholders have to show that the transaction was unfair. The shift in the burden, however, is based on the efficacy of the procedural protections provided by the special committee. To the extent the process is somehow flawed, courts will not defer and the burden will not shift.
For the most part, it is enough to form a special committee consisting of independent directors and allow them to rely on independent advisors. In those circumstances, the committee typically receives a high degree of deference. Shareholders have little or no ability to challenge the decision, even if the committee more or less accepts the offer from the controlling shareholder.
The court in Americas Mining, however, did not follow the usual script. The board of Southern Peru formed a Special Committee and staffed it entirely with independent directors. Moreover, the Committee was "given the resources to hire outside advisors, and it hired not only respected, top tier of the market financial and legal counsel, but also a mining consultant and Mexican counsel."
Nonetheless, the trial court refused to defer to the Committee's decision. Despite the independence of the directors and the use of independent consultants, the trial court found that the Committee was under the grip of "a controlled mindset" and, as a result, allowed the controlling shareholder "to dictate the terms and structure of the merger." Said another way, the Chancery Court determined that "although the Special Committee members were competent businessmen and may have had the best of intentions, they allowed themselves to be hemmed in by the controlling stockholder's demands."
The conclusion of a "controlled mindset" did not really arise from any evidence of untoward influence by the controlling shareholder. It mostly arose out of what the Chancery Court viewed as an inexplicable result. The Special Committee had apparently been told by its financial advisor that under the terms of the proposed transaction, "Southern Peru would 'give' stock with a market price of $3.1 billion to Grupo Mexico and would 'get' in return an asset worth no more than $1.7 billion."
Rather than negotiate a change in the sales price, the Special Committee sought to change the assorted valuations. As the Chancery Court noted: "[I]nstead of pushing back on [the controlling shareholder's] analysis, the Special Committee and Goldman devalued Southern Peru and topped up the value of Minera." The result was a valuation placed on Southern Peru that was $1.1 billion below the NYSE market price. The Chancery Court had this to say about the approach:
A reasonable special committee would not have taken the results of those analyses by Goldman and blithely moved on to relative valuation, without any continuing and relentless focus on the actual give-get involved in real cash terms. But, this Special Committee was in the altered state of a controlled mindset. Instead of pushing Grupo Mexico into the range suggested by Goldman's analysis of Minera's fundamental value, the Special Committee went backwards to accommodate Grupo Mexico's asking price—an asking price that never really changed.
The Chancery Court, therefore, expected the Committee to ignore the "relative" valuation and somehow go back to the "fundamental" valuation originally provided. Then, with two disparate sets of valuations, the Committee was supposed to negotiate a better deal with the controlling shareholder.
In effect, therefore, the court found an inexplicable result and concluded that it could only have arisen because of a "controlled mindset." In truth, however, the Special Committee's actions were not very different from those of most other special committees. Special committees often approve offers from a controlling shareholder and often rely on advisors that support the terms set out by the controlling shareholder.
The defendants objected to the trial court's approach. We'll look at the Supreme Court's reasoning in the next post. Some primary materials from the Chancery Court are posted on the DU Corporate Governance web site.