On Oct. 14, 2011, the Delaware Court of Chancery issued a 105-page post-trial opinion in In re Southern Peru Copper Corporation Shareholder Derivative Litigation, which involved a challenge to Southern Peru Copper Corp.’s purchase of Minera Mexico, S.A. de C.V. from Southern Peru’s controlling stockholder, Grupo Mexico, S.A.B. de C.V., for an implied value of $3.1 billion.
Chancellor Leo E. Strine Jr. applied the “entire fairness” standard, which applies to transactions with controlling stockholders and puts the burden of proof on the board of directors to show that both the transaction price and the process leading to the transaction were fair. The court:
Also troubling to the court was the fact that one of the special committee members was employed by a 14.2 percent stockholder who held “founders shares” in Southern Peru that needed to be registered. Grupo Mexico, as controlling stockholder of Southern Peru, controlled the decision to register those shares. The facts showed that while the special committee was negotiating the substantive terms of the transaction, that large stockholder was negotiating for registration rights.
This case is an example of why most cases settle once a court determines that “entire fairness” is to be the standard of review. Historically, it has proven to be a difficult standard for corporate defendants to meet because unlike application of the business judgment rule, in which the court focuses on whether a board is independent/disinterested and well-informed (and defers to its judgment if that is so), the entire fairness standard involves an inquiry into the actual substantive decisions of the board.
Though the case law applying the business judgment rule to a conflict-free and well-informed board does not use the phrase “well functioning,” it is a functionally equivalent determination. Once a court determines that a special committee is conflict-free, informed and well-qualified, burden shifting should be automatic, without substantive inquiry. The court can then take “into consideration the substantive decision of the special committee” – it has to under the “entire fairness” standard – but with the burden of proof on the plaintiffs, not defendants. This is an issue only the Delaware Supreme Court can conclusively resolve.
The court’s criticism of the resolution language forming and setting the mandate of the special committee also warrants discussion. Generally, “alternatives” refers to the exploration of transactions with other parties. Board resolutions creating special committees to review controlling-stockholder transactions often lack language granting power to pursue alternatives because it would be an act of futility as the controlling stockholder can veto any alternative.