Court Sends Message That Form Doesn’t Trump Substance

One of the things that aggravate many people is that high priced corporate lawyers seem to find legal loopholes in almost any regulation designed to protect the public or investors. Then, they use these loopholes to make it appear they are following the rules, but it is only in form, not in substance.

We, as securities fraud attorneys, understand that aggravation. However, a recent case in Delaware, the home of many corporations, appears to be saying enough to to these legal shenanigans, if the recent case of In re Southern Peru Copper Corporation Shareholder Derivative Litigation is any indication.

In that case the plaintiffs, minority shareholders of the Southern Peru Copper Corporation, brought a shareholder derivative lawsuit challenging a transaction between Southern Peru and its controlling shareholder, GrupoMexico, S.A.B. de C.V. In that transaction Southern Peru was to buy another mining company, MineralMexico, S.A, and merge the companies. Of course, Grupo also owner MineralMexico making this a classic example of a self-interested transaction, and one that should be carefully monitored for fairness.

Because Grupo was the controlling shareholder of Southern Peru, and would benefit from the sale of its other stock from MineralMexico, under Delaware’s corporation laws, the company was supposed to follow certain procedural rules to ensure that it only undertook transactions that were fair. One of those rules in this case was the appointment of a special committee of disinterested directors who was supposed to evaluate the transaction for fairness, to determine that the company would not be paying more for the stock than what it was really valued at. This procedure were put in place under Delaware law to protect minority shareholders from the majority shareholder who wielded all the power for its own financial benefit, to the detriment of the minority.

Unfortunately, what was supposed to a procedure designed to assure the fairness of any such transactions had become, in the eyes of Southern Peru and Grupo, just another hoop to jump through to get to the result the majority wanted, at the price they dictated, and which the court later determined was over $1 billion too high.

What happened in that case is that a Special Committee was formed, and was backed by high priced lawyers and financial advisors. However, although this isn’t stated exactly in the opinion itself, it appears these advisors jobs (although unstated) weren’t really to make sure the transaction was fair, but instead to dot all the “i’s” and cross all the “t’s” to make sure all the procedural hoops were really jumped through to clear that way for the transaction to proceed as planned. Plus, the advantage of going through this procedure for the corporation and majority shareholder was that it was supposed to shift the burden of persuasion to the plaintiff, minority shareholders, to show the transaction was not fair, an added bonus.

Until the shareholder derivative lawsuit, and the court’s ruling in it, all appeared to be going smoothly for Southern Peru and Grupo. The Special Committee was convened, and even initially determined that the selling price was $1 billion too much. However, instead of trying to negotiate a more fair price based on the valuation or reject the deal the committee began to undertake some fancy financial wizardry to justify the amount of money that was to be paid for the stock, and ultimately the deal went through.

Once the judge in the Delaware court began to examine the shareholder derivative action he came down hard on the actions of Southern Peru and Grupo, as well as the Special Committee. He held that notwithstanding the review and approval of the merger by the Special Committee, it was unfair to the company. He further refused to shift the burden of persuasion from the Defendants to the Plaintiffs, holding that Southern Peru’s special committee was ineffective because it had a “controlled mindset” that was more like a rubber stamp than a real check on the power of the corporation and the majority shareholder.

What this recent court decision suggests is several things for the future of corporate litigation. First, it shows that form does not trump substance when it comes to special committees anymore in Delaware. In this case the special committee should have been more adversarial in nature, and taken on their role more broadly to actually confirm the fairness of the transaction before approving it. Further, though, this case suggests that courts, just like much of the rest of America, will no longer tolerate those who just go through the procedural motions without also engaging in a rigorous effort to comply with the substance of the law.