In re S. Peru Copper Corp. S’holder Derivative Litig., C.A. No. 961-CS (Del. Ch. Oct. 14, 2011) (Strine, C.)
In this memorandum opinion, Chancellor Strine held that the sale of a controlling shareholder’s 99.15% interest in a non-public Mexican mining company to its subsidiary was unfair. As a result, the Court awarded damages in the amount of $1.263 billion, plus interest.
Grupo México, S.A.B. de C.V. (“Grupo Mexico”) is a Mexican mining company that, before the completion of the challenged transaction (the “Merger”), owned 99.15% of a non-publicly traded Mexican mining company, Minera México, S.A.B. de C.V. (“Minera”). Before the Merger, Grupo Mexico also owned a controlling interest in Southern Peru Copper Corp. (“Southern Peru”), with 54.17% of the outstanding capital stock and 63.08% of the voting power. In 2004, Grupo Mexico approached Southern Peru, offering to sell its entire interest in Minera through an all-stock merger in a deal valuing Minera at nearly $3.05 billion. Given Grupo Mexico’s self-interest in any sale of Minera to Southern Peru, Southern Peru formed a Special Committee of disinterested directors to evaluate the proposed transaction. After eight months of negotiations, the Special Committee approved the Merger, and the transaction closed nearly five months later. By the time the Merger closed, the value of the Southern Peru shares acquired by Grupo Mexico had risen to $3.75 billion.
Plaintiff, a stockholder of Southern Peru, brought a derivative action on behalf of Southern Peru, alleging that the Merger was unfair to Southern Peru and its minority stockholders because the value of what Grupo Mexico received in the Merger far exceeded what Grupo Mexico contributed. Before trial, on a motion for summary judgment, the Court dismissed the Special Committee defendants from the action after finding that, in light of Southern Peru’s exculpatory provision adopted under 8 Del. C. § 102(b)(7), plaintiff had failed to present evidence showing a non-exculpated breach of their fiduciary duty of loyalty.
In connection with the trial, the Court accepted the parties’ agreement that the entire fairness standard applied to the Court’s review of the Merger. Under the well-established entire fairness standard, the Court was therefore required to review the fairness of the Merger both as to process and price. Although the parties agreed that entire fairness was the appropriate standard of review, defendants argued that the burden of demonstrating the Merger was unfair should be shifted to plaintiff because of the special committee process and the stockholder vote. While noting the limited benefits of a burden shift and the problems associated with determining the burden at trial, the Court explained that the decision of which party bears the burden of persuasion nevertheless should involve not only the Special Committee’s composition and mandate, but also a factual look at the effectiveness of the Special Committee. In support of its holding, the Court cited the Delaware Supreme Court’s decision in Kahn v. Tremont, which considered both the facial independence of a special committee (e.g., the special committee members’ previous business relationships with the controlling stockholder and the affiliation of its advisors with the controlling stockholder) and the substance of the special committee’s actual efforts (e.g., the materials relied upon and the level of participation in the process) before determining whether the burden should shift to the plaintiff. The Court held that the burden remained with defendants because the evidence showed the Special Committee was not “well functioning.” The Court also rejected defendants’ argument that the burden shifted because a majority of disinterested stockholders approved the Merger. The Court held that the disinterested stockholders’ approval of the Merger had little meaning because the Merger was not conditioned upfront on the approval of a majority of disinterested stockholders. Instead, the voting power of the interested parties, combined with vote tying agreements, made approval of the Merger a certainty, and any disinterested stockholder’s vote against the Merger was a mere “form of protest.” In addition, the Court cited numerous disclosure problems that materially misled stockholders and prevented them from making a fully informed decision on the Merger.
The Court then turned its analysis to whether the Merger was entirely fair to Southern Peru’s minority stockholders. In finding that the Merger was not entirely fair, the Court detailed a litany of problems associated with the Merger. The Court noted that Grupo Mexico had control of the process from the outset because the Special Committee had an unclear mandate regarding whether it was empowered to negotiate with Grupo Mexico or merely evaluate its proposals. As a result, the Special Committee was never able to pursue aggressively negotiations with Grupo Mexico. The Court held that although the Special Committee was able to negotiate “weak” concessions such as a debt cap, a special dividend, corporate governance changes, a fixed exchange ratio, and condition the Merger on a favorable vote by two-thirds of the outstanding stock, the Special Committee failed to secure a walk-away right, a majority-of-the-minority vote, or a collar, even though the Merger involved a fixed exchange ratio.
The Court also found that the evidence demonstrated that the Special Committee “was not ideally served” by its financial advisor, Goldman Sachs. The Court focused on defendants’ admission that none of the financial analyses initially employed by Goldman Sachs, including a standalone DCF analysis, a sum-ofthe-parts analysis, a contribution analysis, a comparable companies analysis, and an ore reserve analysis, justified paying Grupo Mexico’s asking price for Minera. The Court found that because the Special Committee could not find a way to justify Grupo Mexico’s asking price with the standalone valuations of Minera, the Special Committee and Goldman Sachs decided to employ a relative valuation instead of focusing on the actual value in “real cash terms” of what was being exchanged. The Court held that relative valuation shifted the focus “to an increasingly non-real world set of analyses that obscured the actual value of what Southern Peru was getting and that was inclined toward pushing up, rather than down, the value in the negotiations of what Grupo Mexico was seeking to sell.” Defendants argued that a relative valuation using the same set of assumptions and methodologies was a more appropriate method to determine the fairness of the Merger, as opposed to comparing Southern Peru’s market capitalization to the DCF value of Minera. The Court, however, held that this approach ignored the actual cash value of Southern Peru shares. The Court found that the relative valuation problems were compounded further by the Special Committee’s use of aggressive multiples for analyses of Minera, a company suffering from a variety of financial and operational problems, but conservative estimates for Southern Peru, the company on whose behalf the Special Committee was negotiating. The Court viewed the decision as further evidence of the Special Committee’s attempt to “rationalize” Grupo Mexico’s asking price.
The Court also viewed the Special Committee’s decision to discount Southern Peru’s market value as inconsistent with its fiduciary duties. The Court questioned why, if the Special Committee believed that Southern Peru was trading at a premium over its “fundamental value,” the Special Committee did not capitalize on this perceived premium by selling at the top of the market, declaring a special dividend, or proposing that Grupo Mexico make a premium to market offer for Southern Peru. The Court found that an attempted sale of Southern Peru would have probed Grupo Mexico’s weaknesses or resulted in a premium for the minority stockholders. In addition, a sale of Southern Peru to Grupo Mexico could have had the effect of aligning the interests of the minority stockholders. For example, one Special Committee member represented a group of stockholders that had an incentive to reach a deal with Grupo Mexico because the Merger allowed the group to obtain the rights to sell previously unregistered shares.
Lastly, the Court found “curious” the failure to seek an updated fairness opinion to determine whether the deal was still fair five months after the Merger was approved. The Court noted that (1) Southern Peru’s stock price had gone up substantially, an important consideration in a fixed exchange ratio merger given no collar and no walk-away right, and (2) that while the actual financial results for both Southern Peru and Minera exceeded the financial projections that were used in Goldman Sachs’ fairness opinion, Southern Peru beat expectations by a much wider margin. The Court noted that if the Special Committee had sought an updated opinion that caused it to change its recommendation on the Merger, the two thirds voting requirement may have prevented consummation of the deal. However, because a large minority stockholder had agreed to tie its vote to the Special Committee’s recommendation and the Special Committee never undertook efforts that caused it to reconsider the Merger, the condition was meaningless and Grupo Mexico was assured of reaching the two-thirds vote requirement.
Having found that the Merger was unfair, the Court held that defendants breached their duty of loyalty, and plaintiff was entitled to appropriate relief. Although the Court had dismissed the Special Committee defendants on summary judgment because no evidence suggested they had a self-dealing interest, the Court held that the exculpatory provision did not similarly protect the remaining director defendants (the “affiliated directors”). The Court reasoned that because the affiliated directors were employed by Grupo Mexico, which had a direct self-dealing interest in the Merger, the affiliated directors’ liability was linked to the issue of fairness absent a showing at trial that they acted in good faith and were entitled to exculpation. Because the affiliated directors did not present any evidence during the trial to support this argument, the Court held that both Grupo Mexico and the affiliated directors were liable to plaintiff.
Plaintiff requested an equitable remedy in the form of the return or cancellation of the Southern Peru shares that were issued in excess of Minera’s fair value, or the present market value of those shares. Defendants argued that no damages were warranted, but if they were, they should be reduced given the six years plaintiff took to prosecute the claim. The Court noted that, in addition to plaintiff’s delay, both parties’ took an approach to valuing the companies at trial that made it difficult to craft an award. The Court, however, decided that the most appropriate relief would be a damages award approximating the difference between the price that the Special Committee actually paid for Minera and the price the Special Committee would have paid had the Merger been entirely fair. To determine the fair value of Minera, the Court calculated and equally weighted (1) a standalone DCF value of Minera, (2) the market value of the counteroffer made by the Special Committee at the time it approved the Merger, and (3) the equity value of Minera using Goldman Sachs’ comparable companies analysis. The Court then multiplied this “fair value” ($2.43 billion) by the amount of Grupo Mexico’s interest (99.15%), and then subtracted the number from the value of Southern Peru shares that were actually paid in the Merger ($3.672 billion). This calculation resulted in a $1.263 billion damages award. The Court required defendants to pay interest on the damages award, but held that plaintiff’s delay limited any interest to simple interest calculated at the statutory rate. The Court also stated that Grupo Mexico could satisfy the judgment by returning a number of Southern Peru shares equal in value to the damages award, and that attorneys’ fees would be paid out of the damages award. The Court noted that the record could have supported a damages award greater than $2 billion, but the award was “conservative” given several “imponderables,” including the uncertainties related to market reaction to the Merger and the fact that the Merger had not prevented Southern Peru’s stock from rising since the Merger.