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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.
(lexis.com subscribers may view the Jury Verdict Report for this case)
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
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
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
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
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.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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