Delineating the mandate of special committees
Special committees are amorphous creatures. Their term, constituency and mandate can be as varied as the tasks delegated to them, ranging from the evaluation of a potential transaction to the search for a new executive. Broadly, they consist of independent directors established by the board to undertake a delegated task, often in consultation with lawyers and industry experts. Given that the terms of their appointment and general characteristics will be specific to a given fact situation, special committees cannot be subject to definitive guidelines stipulating the manner in which they are constituted or the means by which they discharge their mandate. However, when board decisions are challenged, courts and tribunals will scrutinize the process by which a board came to its determination, often beginning with the decisions of the special committee if one is appointed. In doing so, they will not only examine the contested decisions of the committee, but reach further back to the establishment of the committee itself. They will inquire into the circumstances surrounding the special committee’s fundamental elements, including its membership, mandate and procedures, evaluating its suitability for the task it was charged with by the board. For their decisions to withstand such scrutiny, boards must ensure that, when they appoint a special committee, the mandate of the special committee allows it to fully and fairly evaluate the transaction put before it without unduly limiting its capacity to investigate and negotiate the deal terms.
This was one of the central issues in the Delaware Chancery Court’s recent judgment In re Southern Peru Copper Corporation Shareholder Derivative Litigation (“Southern Peru”). In the judgment, Chancellor Strine awarded Southern Peru Copper Corporation (“Southern Peru”) 1.26 billion dollars following a transaction between the controlling shareholder, Grupo Mexico, and its subsidiary, Southern Peru, for the acquisition of another of Grupo Mexico’s subsidiaries, Minera Mexico (“Minera”).
In examining the actions of the special committee appointed by the Southern Peru board of directors, the Delaware Chancery Court found that the process undertaken and the price paid for Minera to Grupo Mexico was not entirely fair, stating that the special committee entered “the altered state of a controlled mindset.” This “controlled mindset” was reflected in the narrow parameters of the special committee’s mandate. The special committee was not able to negotiate with Grupo Mexico or contemplate an alternative transaction or deal structure. This handcuffed the special committee and gave it few options other than formulating a reasoned justification for the deal terms proposed by Grupo Mexico. This limited the real bargaining power of the special committee and any ability it may have had to exercise independent judgment or extract benefits for minority shareholders. The court’s decision makes it clear that a special committee must be rigorous and display real bargaining power, including the capacity to reject a proposed transaction.
In Canada, courts and tribunals will exercise similar inquiries into the process of special committees when evaluating a contested transaction. In reviewing the plan of arrangement of Magna International Inc. (“Magna”) in its decision of June 24, 2010, the Ontario Securities Commission (“OSC”) heard arguments from the commission’s staff that the disclosure related to the proposed arrangement was deficient and the process followed by the board was inadequate. Opposing shareholders asked the OSC to enjoin the transaction entirely as it was abusive to shareholders.
The OSC ordered that Magna amend its disclosure to include a full description of the board and special committee’s process. Specifically, Magna was ordered to disclose how the management and the board of Magna arrived at the consideration to be paid and how they determined the benefits to shareholders. The OSC also ordered disclosure of a review of the special committee’s approval process and the advice given by financial advisers, including details on how they assessed the transaction.
The OSC also criticized the special committee’s mandate which it found “too narrow” and “fundamentally flawed.” In effect, the special committee was limited to reviewing and considering the proposal developed by management; it was presented with a “done deal” that had been negotiated by management. It was also only to determine whether the transaction should be submitted to a shareholder vote and was not permitted to negotiate or suggest alternative deal structures. The OSC largely found that “the Special Committee process appears to have been tainted by the involvement of executive management at the start of and during the process.”
The crafting of a special committee’s mandate requires discipline. As much as various parties may strongly endorse a given transaction and apply significant pressure on the board to approve it, the need to properly delineate a special committee’s mandate when one is appointed will lend far greater credibility to any conclusion it reaches. In Southern Peru, the special committee was presented with a deal and given little to no power to negotiate. Similarly, in the Magna decision, the special committee’s mandate was limited to reviewing the proposed transaction as structured without the latitude to contemplate alternative arrangements. A helpful regulatory guide is found in the Companion Policy to Multilateral Instrument 61-101 (Protection of Minority Security Holders in Special Transactions) which states that the board and special committee should address the desirability and the fairness of a proposed transaction and the process by which they arrived at those determinations:
In reaching a conclusion as to the fairness of a transaction, the directors should disclose in reasonable detail the material factors on which their beliefs regarding the transaction are based. Their disclosure should discuss fully the background of deliberations by the directors and any special committee, and any analysis of expert opinions obtained.
These general guidelines can obviate the pitfalls of appointing special committees with narrow mandates whose conclusions will be the subject of subsequent attack. Although specific mandates will be tailored to a specific set of facts, a special committee should be given the freedom to consider alternatives available to the company and negotiate proposals prior to making a recommendation.
The content of this article is intended to provide general information for the reader and is not intended as advice or an opinion to be relied upon in relation to any particular circumstance. For specific applications of the law to a particular set of circumstances, the reader should seek professional advice.
*Sam Carsley practices in the areas of corporate and securities law with McLean & Kerr LLP, a law firm based in Toronto.