October 19, 2011
The Zapata of Acquisitions?: Special Committees Must Act Like Third Parties
As noted in an earlier post, a Delaware court (pdf here) determined that Southern Peru Copper Corp.'s directors were improper (to the tune of $1.2 billion in damages) in following its special committee's recommendation to purchase Minera for $3.1 billion in Southern Peru stock. The court explained that the special committee violated its fiduciary obligations by not leveraging its position in the same way a third party would in that situation. The court explains:
In other words, the Special Committee did not respond to its intuition that Southern Peru was overvalued in a way consistent with its fiduciary duties or the way that a third-party buyer would have. As noted, it did not seek to have Grupo Mexico be the buyer. Nor did it say no to Grupo Mexico’s proposed deal. What it did was to turn the gold that it held (market-tested Southern Peru stock worth in cash its trading price) into silver (equating itself on a relative basis to a financially-strapped, non-market tested selling company), and thereby devalue its own acquisition currency. Put bluntly, a reasonable third-party buyer would only go behind the market if it thought the fundamental values were on its side, not retreat from a focus on market if such a move disadvantaged it. If the fundamentals were on Southern Peru’s side in this case, the DCF value of Minera would have equaled or exceeded Southern Peru’s give. But Goldman and the Special Committee could not generate any responsible estimate of the value of Minera that approached the value of what Southern Peru was being asked to hand over.
Note that the court here was evaluating this case for entire fairness, and not considering the applicablity of the business judgment rule. Here, "the defendants with a conflicting self-interest [had to] demonstrate that the deal was entirely fair to the other stockholders." They failed.
The court specifically states, "[T]here is no need to consider whether room is open under our law for use of the business judgment rule standard in a circumstance like this, if the transaction were conditioned upon the use of a combination of sufficiently protective procedural devices." In essence, the court (appropriately) declines to answer here whether there might be a similar circumstance where the court might treat a special acquisition committee like a special litigation committee. If so, in this instance, I'm thinking a Zapata-like test might be the right call.
That is, when (like in Southern Peru) "a controlling stockholder stands on both sides of a transaction" (to parallel Zapata):
First, the Court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. . . . The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness. . . . .
[Second, t]he Court should determine, applying its own independent business judgment, whether the [acquisition price was reasonable.] . . . The second step is intended to thwart instances where corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or where corporate actions would simply [ratify an improper valuation to the detriment of disinterested shareholders.]
On the one hand, this might be over broad and limit the ability of a company to take advantage of an opportunity uniquely available to it by virtue of the controlling shareholder. Still, it seems to me that, just as in Southern Peru, the court is capable of making this assessment. If the special committee can justify the transaction, then it should have before supporting the deal. If not, the court will take a closer look. Note that this would only apply where there was a controlling shareholder on both sides of the transaction, and not in other arm's length deals, where the business judgment rule is the proper test.
Perhaps this is giving the court too much of a role, but I think they got it right in Southern Peru, and that may translate in other contexts, too.