The Delaware Supreme Court recently affirmed Chancellor Strine's opinion in Americas Mining Corp. v. Theriault (copy of opinion here). The headline news is that the Court thus upheld a $2 billion-plus judgment and a whopping $300 million-plus legal fee for plaintiff's counsel. I guess the welcome mat for plaintiff lawyers in Delaware is now a red carpet.
The Delaware Supreme Court has upheld the largest attorney fee award in Delaware history. In doing so, the Court has squarely upheld the use of percentages to award fees out of the common fund created by the litigation and disclaimed the so-called "lodestar" approach.
The decision is also noteworthy for its upholding of the Court of Chancery's damages award, also probably the largest in Delaware history.
The Delaware Supreme Court today, in the case of Americas Mining Corp. v. Theriault, No. 29, 2012 (Del. Aug. 27, 2012), read here, in a 110-page opinion, upheld the Court of Chancery’s 100-plus page decision awarding over $2 billion in damages based on a breach of fiduciary duty claim in connection with the sale of a company. Delaware’s High Court also upheld an award of attorneys’ fees in the amount of $300 million. The trial court decision, styled as In re Southern Peru Copper Corporation Shareholder Derivative Litigation, C.A. No. 961-CS (Del. Ch. Oct. 14, 2011), was highlighted on these pages here and here.
I want to focus on the court's treatment of the burden of proof in cases governed by the entire fairness standard. Specifically, the Court's holding that, if the record does not permit a pretrial determination that the defendants are entitled to a burden shift, the burden of persuasion will remain with the defendants throughout the trial to demonstrate the entire fairness of the interested transaction.
As I explain in my book Mergers and Acquisitions, 3d:
... a freeze out merger must satisfy an "entire fairness" standard. In turn, entire fairness has two components: fair price and fair dealing. …
If a freeze out merger is approved by a majority of the disinterested shareholders—the so called "majority of the minority," however, the burden of proof shifts to the plaintiff to show that the merger was unfair. The standard of review remains entire fairness, with its integral fair price and fair dealing components, but the burden is now on plaintiff to show lack of fairness on one or both grounds.
The deal in question here was not a freeze-out merger, but rather an acquisition of a company controlled by a majority shareholder of the acquirer. As such, the majority shareholder stood on both sides of the deal--as is the case in a freeze-out merger--and the entire fairness standard therefore applied, as the Court explained:
The Court of Chancery held that the defendants-appellants, Americas Mining Corporation (“AMC”), the subsidiary of Southern Copper Corporation’s (“Southern Peru”) controlling shareholder, and affiliate directors of Southern Peru (collectively, the “Defendants”), breached their fiduciary duty of loyalty to Southern Peru and its minority stockholders by causing Southern Peru to acquire the controller’s 99.15% interest in a Mexican mining company, Minera México, S.A. de C.V. (“Minera”), for much more than it was worth, i.e., at an unfair price. ...
When a transaction involving self-dealing by a controlling shareholder is challenged, the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion.
Jim Hamilton explains that :
Applying the entire fairness doctrine, the Delaware Supreme Court upheld the Chancellor’s ruling that a board special committee formed to evaluate a proposition by the company’s controlling shareholder engaged in a deal that was unfair to the company and breached its fiduciary duty of loyalty. Chancellor Strine found that the cramped perspective of the special committee put it in a position where there was only one strategic option to consider, the one proposed by the controlling shareholder. This resulted in a strange deal dynamic in which a majority stockholder 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 wanted, which was for the company to buy its non-public company for approx $3.1 million of the company’s stock. ...
The special committee was trapped in a controlled mindset where the only options to be considered were those proposed by the controlling stockholder. This mindset took off the table other options that would have generated a real market check, noted the Chancellor, and also deprived the special committee of negotiating leverage to extract better terms. In fact, said the court, the negotiations were stilted and influenced by the committee’s uncertainty about whether it was actually empowered to negotiate.
When a special committee confines itself to this world, reasoned the Chancellor, it engages in the self-defeating practice of negotiating with itself, perhaps without even realizing it, through which it nixes certain options before even putting them on the table. Although the special committee members were competent businessmen and may have had the best intentions, said the court, they allowed themselves to be hemmed in by the controlling stockholder’s demands. Throughout the negotiation process, the special committee and its outside advisor only focused on finding a way to get the terms of the merger structure proposed by the controlling shareholder to make sense, rather than aggressively testing the assumption that the merger was a good idea in the first place.
One question presented on appeal was whether the Chancellor should have shifted the burden of proof to the plaintiffs in light of the existence of the special committee. As the Supreme Court explained:
In Kahn v. Lynch Communication Systems, Inc., this Court held that when the entire fairness standard applies, the defendants may shift the burden of persuasion by one of two means: first, they may show that the transaction was approved by a well-functioning committee of independent directors; or second, they may show that the transaction was approved by an informed vote of a majority of the minority shareholders.
Unfortunately for defendants, their special committee failed to meet the required standards. Again, to quote the Supreme Court:
... “[t]o obtain the benefit of a burden shifting, the controlling shareholder must do more than establish a perfunctory special committee of outside directors.” Rather, the special committee must “function in a manner which indicates that the controlling shareholder did not dictate the terms of the transaction and that the committee exercised real bargaining power ‘at an arms-length.’”
The failures by the committee noted by Hamilton thus precluded a shift in the burden of proof.
Now is when things get interesting (at least to me). The Court held that:
The failure to shift the burden is not outcome determinative under the entire fairness standard of review. We have concluded that, because the only “modest” effect of the burden shift is to make the plaintiff prove unfairness under a preponderance of the evidence standard, the benefits of clarity in terms of trial presentation outweigh the costs of continuing to decide either during or after trial whether the burden has shifted. Accordingly, we hold prospectively that, if the record does not permit a pretrial determination that the defendants are entitled to a burden shift, the burden of persuasion will remain with the defendants throughout the trial to demonstrate the entire fairness of the interested transaction.
- I suppose one outcome of this case will be the need for a mini-trial/evidentiary hearing pre-trial to determine whether the burden shifts to plaintiffs. After all, as Alison Frankel observes, "unless there's a pretrial ruling to the contrary, defendants must show the transaction was fair to minority shareholders, regardless of whether an independent committee oversaw the deal." The justification offered for this development is that there are "benefits of clarity in terms of trial presentation." But Chancery is not a jury court. Cases are tried to the bench. Surely, the expert members of the Chancery Court could handle a trial in which the issue of burden of proof was one of the issues to be litigated.
- How do you now keep the pre-trial proceedings on the burden of proof from duplicating much of what would have happened at trial? Presumably, the Chancery Court will have to undertake an extensive evidentiary hearing, which will cover much the same ground as will later be covered at trial. It seems duplicative and burdensome.
- The court also justifies its holding by stating that a shift in the burden of proof is not outcome determinative. I find this hard to square with both other cases and aspects of this opinion. As to the former, have we not been told elsewhere that the burden of entire fairness review is so “onerous” that its application “frequently is determinative of the outcome of the litigation.” AC Acquisition Corp. v. Anderson, Clayton & Co., 519 A.2d 103, 111 (Del. Ch. 1986). Granted, that was in the context of a choice between the entire fairness and business judgment rule as a standard of review. Even so, it suggests that the burden of proof matters. Elsewhere in the present opinion, moreover, we are told that "This Court has repeatedly held that any board process is materially enhanced when the decision is attributable to independent directors. Accordingly, judicial review for entire fairness of how the transaction was structured, negotiated, disclosed to the directors, and approved by the directors will be significantly influenced by the work product of a properly functioning special committee of independent directors." If the defendant's case is "materially enhanced" by use of a special committee and the existence of such a committee "significantly" influences the court's analysis, why is the benefit of the burden shift modest? I find those statements hard to square.
- If the effect of the shift in the burden of proof were more than "modest," a pre-trial determination would make sense because it would encourage settlements. The party with the burden of proof would be more willing to settle--conserving judicial resources--if that burden were truly onerous. But if the effect is modest, however, one might as well roll the dice at trial.
- What will be the impact of this case on transaction planning? Here, I agree with Paul Regan, who observes that "the Supreme Court’s ruling is likely in keeping with the advice of counsel to controlling stockholders in such cases already, i.e., establish a special committee process that is unassailable but prepare for trial as if the burden of proof remains on the defendants. For transaction planners and litigation counsel alike, Southern Peru appropriately reinforces the practical reality that defendants in these cases need to protect the transaction with good process irrespective of whether they get the burden shift before, at or after trial."
- As Paul Weiss notes, "The Supreme Court did not directly address the viability of the so- called “unified standard” that has gained some currency in the Court of Chancery. Under that standard, entire fairness is not at issue and defendants may rely instead on the protection of the business judgment rule, provided that both an independent special committee and a majority of the minority stockholders approves the transaction after full disclosure."