7 Shareholder litigation 7 Shareholder litigation

7.1 Reference Readings 7.1 Reference Readings

7.1.1. Kandell v. Niv (FXCM) [Knowing Breaches of Law]

Kandell v. Niv (FXCM) [Knowing Breaches of Law]

7.1.2 Graham v. Allis-Chalmers Manufacturing Co. 7.1.2 Graham v. Allis-Chalmers Manufacturing Co.

Delaware Court of Chancery

41 Del. Ch. 78

1963-01-24

John P. Graham and Yvonne M. Graham, on behalf of themselves and the other shareholders of Allis-Chalmers Manufacturing Company who may be entitled to intervene herein, Plaintiffs Below, Appellants, vs. Allis-Chalmers Manufacturing Company et al., Defendants Below, Appellees.

Supreme Court, On Appeal,

January 24, 1963.

*79 H. James Conaway, Jr., of Morford, Young & Conaway, Wilmington, and Marvin Katz and Harry Norman Ball, Philadelphia, Penna., for appellants.

*80 George Tyler Coulson, of Morris, Nichols, Arsht & Tunnell, Wilmington, and Charles S. Quarles, of Quarles, Herriott & Clemons, Milwaukee, Wis., for individual defendants.

Richard F. Corroon, of Berl, Potter & Anderson, Wilmington, for Allis-Chalmers Manufacturing Co.,

Southerland, C. J., and Wolcott and Terry, JJ., sitting.

Wolcott, Justice:

This is a derivative action on behalf of Allis-Chalmers against its directors and four of its non-director employees. The complaint is based upon indictments of Allis-Chalmers and the four non-director employees named as defendants herein who, with the corporation, entered pleas of guilty to the indictments. The indictments, eight in number, charged violations of the Federal antitrust laws. The suit seeks to recover damages which Allis-Chalmers is claimed to have suffered by reason of these violations.

The directors of Allis-Chalmers appeared in the cause voluntarily. The non-director defendants have neither appeared in the cause nor been served with process. Three of the non-director defendants are still employed by Allis-Chalmers. The fourth is under contract with it as a consultant.

The complaint alleges actual knowledge on the part of the director defendants of the anti-trust conduct upon which the indictments were based or, in the alternative, knowledge of facts which should have put them on notice of such conduct.

However, the hearing and depositions produced no evidence that any director had any actual knowledge of the anti-trust activity, or had actual knowledge of any facts which should have put them on notice that anti-trust activity was being carried on by some of their company’s employees. The plaintiffs, appellants here, thereupon shifted the theory of the case to the proposition that the directors are liable as a matter of law by reason of their failure to take action designed to learn of and prevent anti-trust activity on the part of any employees of Allis-Chalmers.

By this appeal the plaintiffs seek to have us reverse the Vice Chancellor’s ruling of non-liability of the defendant directors upon *81this theory, and also seek reversal of certain interlocutory rulings of the Vice Chancellor refusing to compel pre-trial production of documents, and refusing to compel the four non-director defendants to testify on oral depositions. We will in this opinion pass upon all the questions raised, but, as a preliminary, a summarized statement of the facts of the cause is required in order to fully understand the issues.

Allis-Chalmers is a manufacturer of a variety of electrical equipment. It employs in excess of 31,000 people, has a total of 24 plants, 145 sales offices, 5000 dealers and distributors, and its sales volume is in excess of $500,000,000 annually. The operations of the company are conducted by two groups, each of which is under the direction of a senior vice president. One of these groups is the Industries Group under the direction of Singleton, director defendant. This group is divided into five divisions. One of these, the Power Equipment Division, produced the products, the sale of which involved the anti-trust activities referred to in the indictments. The Power Equipment Division, presided over by McMullen, non-director defendant, contains ten departments, each of which is presided over by a manager or general manager.

The operating policy of Allis-Chalmers is to decentralize by the delegation of authority to the lowest possible management level capable of fulfilling the delegated responsibility. Thus, prices of products are ordinarily set by the particular department manager, except that if the product being priced is large and special, the department manager might confer with the general manager of the division. Products of a standard character involving repetitive manufacturing processes are sold out of a price list which is established by a price leader for the electrical equipment industry as a whole.

Annually, the Board of Directors reviews group and departmental profit goal budgets. On occasion, the Board considers general questions concerning price levels, but because of the complexity of the company’s operations the Board does not participate in decisions fixing the prices of specific products.

The Board of Directors of fourteen members, four of whom are officers, meets once a month, October excepted, and considers a pre*82viously prepared agenda for the meeting. Supplied to the Directors at the meetings are financial and operating data relating to all phases of the company’s activities. The Board meetings are customarily of several hours’ duration in which all the Directors participate actively. Apparently, the Board considers and decides matters concerning the general business policy of the company. By reason of the extent and complexity of the company’s operations, it is not practicable for the Board to consider in detail specific problems of the various divisions.

The indictments to which Allis-Chalmers and the four non-director defendants pied guilty charge that the company and individual non-director defendants, commencing in 1956, conspired with other manufacturers and their employees to fix prices and to rig bids to private electric utilities and governmental agencies in violation of the anti-trust laws of the United States. None of the director defendants in this cause were named as defendants in the indictments. Indeed, the Federal Government acknowledged that it had uncovered no probative evidence which could lead to the conviction of the defendant directors.

The first actual knowledge the directors had of anti-trust violotions by some of the company’s employees was in the summer of 1959 from newspaper stories that TVA proposed an investigation of identical bids. Singleton, in charge of the Industries Group of the company, investigated but unearthed nothing. Thereafter, in November of 1959, some of the company’s employees were subpoenaed before the Grand Jury. Further investigation by the company’s Legal Division gave reason to suspect the illegal activity and all of the subpoenaed employees were instructed to tell the whole truth.

Thereafter, on February 8, 1960, at the direction of the Board, a policy statement relating to anti-trust problems was issued, and the Legal Division commenced a series of meetings with all employees of the company in possible areas of anti-trust activity. The purpose and effect of these steps was to eliminate any possibility of further and future violations of the anti-trust laws.

As we have pointed out, there is no evidence in the record that the defendant directors had actual knowledge of the illegal antitrust actions of the company’s employees. Plaintiffs, however, point *83to two FTC decrees of 1937 as warning to the directors that anti-trust activity by the company’s employees had taken place in the past. It is argued that they were thus put on notice of their duty to ferret out such activity and to take active steps to insure that it would not be repeated.

The decrees in question were consent decrees entered in 1937 against Allis-Chalmers and nine others enjoining agreements to fix uniform prices on condensors and turbine generators. The decrees recited that they were consented to for the sole purpose of avoiding the trouble and expense of the proceeding.

None of the director defendants were directors or officers of Allis-Chalmers in 1937. The director defendants and now officers of the company either were employed in very subordinate capacities or had no connection with the company in 1937. At the time, copies of the decrees were circulated to the heads of concerned departments and were explained to the Managers Committee.

In 1943, Singleton, officer and director defendant, first learned of the decrees upon becoming Assistant Manager of the Steam Turbine Department, and consulted the company’s General Counsel as to them. He investigated his department and learned the decrees were being complied with and, in any event, he concluded that the company had not in the first place been guilty of the practice enjoined.

Stevenson, officer and director defendant, first learned of the decrees in 1951 in a conversation with Singleton about their respective areas of the company’s operations. He satisfied himself that the company was not then and in fact had not been guilty of quoting uniform prices and had consented to the decrees in order to avoid the expense and vexation of the proceeding.

Scholl, officer and director defendant, learned of the decrees in 1956 in a discussion with Singleton on matters affecting the Industries Group. He was informed that no similar problem was then in existence in the company.

Plaintiffs argue that because of the 1937 consent decrees, the directors were put on notice that they should take steps to ensure that no employee of Allis-Chalmers would violate the anti-trust laws. *84The difficulty the argument has is that only three of the present directors knew of the decrees, and all three of them satisfied themselves that Allis-Chalmers had not engaged in the practice enjoined and had consented to the decrees merely to avoid expense and the necessity of defending the company’s position. Under the circumstances, we think knowledge by three of the directors that in 1937 the company had consented to the entry of decrees enjoining it from doing something they had satisfied themselves it had never done, did not put the Board on notice of the possibility of future illegal price fixing.

Plaintiffs have wholly failed to establish either actual notice or imputed notice to the Board of Directors of facts which should have put them on guard, and have caused them to take steps to prevent the future possibility of illegal price fixing and bid rigging. Plaintiffs say that as a minimum in this respect the Board should have taken the steps it took in 1960 when knowledge of the facts first actually came to their attention as a result of the Grand Jury investigation. Whatever duty, however, there was upon the Board to take such steps, the fact of the 1937 decrees has no bearing upon the question, for under the circumstances they were notice of nothing.

Plaintiffs are thus forced to rely solely upon the legal proposition advanced by them that directors of a corporation, as a matter of law, are liable for losses suffered by their corporations by reason of their gross inattention to the common law duty of actively supervising and managing the corporate affairs. Plaintiffs rely mainly upon Briggs v. Spaulding, 141 U.S. 132, 11 S.Ct. 924, 35 L.Ed. 662.

From the Briggs case and others cited by plaintiffs, e.g., Bowerman v. Hamner, 250 U.S. 504, 39 S.Ct. 549, 63 L.Ed. 1113; Gamble v. Brown, 4 Cir., 29 F.2d 366, and Atherton v. Anderson, 6 Cir., 99 F.2d 883, it appears that directors of a corporation in managing the corporate affairs are bound to use that amount of care which ordinarily careful and prudent men would use in similar circumstances. Their duties are those of control, and whether or not by neglect they have made themselves liable for failure to exercise proper control depends on the circumstances and facts of the particular case.

*85The precise charge made against these director defendants is that, even though they had no knowledge of any suspicion of wrongdoing on the part of the company’s employees, they still should have put into effect a system of watchfulness which would have brought such misconduct to their attention in ample time to have brought it to an end. However, the Briggs case expressly rejects such an idea. On the contrary, it appears that directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on suspicion that something is wrong. If such occurs and goes unheeded, then liability of the directors might well follow, but absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.

The duties of the Allis-Chalmers Directors were fixed by the nature of the enterprise which employed in excess of 30,000 persons, and extended over a large geographical area. By force of necessity, the company’s Directors could not know personally all the company’s employees. The very magnitude of the enterprise required them to confine their control to the broad policy decisions. That they did this is clear from the record. At the meetings of the Board in which all Directors participated, these questions were considered and decided on the basis of summaries, reports and corporate records. These they were entitled to rely on, not only, we think, under general principles of the common law, but by reason of 8 Del.C. § 141(f) as well, which in term's fully protects a director who relies on such in the performance of his duties.

In the last analysis, the question of whether a corporate director has become liable for losses to the corporation through neglect of duty is determined by the circumstances. If he has recklessly reposed confidence in an obviously untrustworthy employee, has refused or neglected cavalierly to perform his duty as a director, or has ignored either willfully or through inattention obvious danger signs of employee wrongdoing, the law will cast the burden of liability upon him. This is not the case at bar, however, for as soon as it became evident that there were grounds for suspicion, the Board acted promptly to end it and prevent its recurrence.

*86Plaintiffs say these steps should have been taken long before, even in the absence of suspicion, but we think not, for we know of no rule of law which requires a corporate director to assume, with no justification whatsoever, that all corporate employees are incipient law violators who, but for a tight checkrein, will give free vent to their unlawful propensities.

We therefore affirm the Vice Chancellor’s ruling that the individual director defendants are not liable as a matter of law merely because, unknown to them, some employees of Allis-Chalmers violated the anti-trust laws thus subjecting the corporation to loss.

Plaintiffs concede that they did not prove affirmatively that the Directors knew of the anti-trust violations of the company’s employees, or that there were any facts brought to the Directors’ knowledge which should have put them on guard against such activities. They argue, however, that they were prevented from doing so by unreasonable restrictions put upon their pre-trial discovery by the Vice Chancellor. They argue before us that this restriction was an abuse by the Vice Chancellor of judicial discretion and, hence, reversible error.

The argument made under this phase of the appeal breaks down into three categories, vis., first, the refusal to order the production of certain documents; second, the refusal to order the production of statements taken by the company’s Legal Division in connection with its investigations of the anti-trust violations and in preparation for the company’s defense to the indictments, and, third, the refusal to order the four non-appearing defendants whose depositions were being taken in Wisconsin to answer certain questions, or, in the alternative, to impose sanctions on the appearing defendants. We will take these subjects up in the order stated.

The documents which the Vice Chancellor refused to order production of are described in paragraphs 3 and 5(a) of the plaintiffs’ motion to produce of January 23, 1961. Paragraph 3 of the motion asks production of all correspondence, notes, memoranda, etc., arising out of meetings, conferences and conversations in which company personnel participated dealing with the anti-trust activity, limited to the subject matter of the criminal indictments. Paragraph 5(a) of *87the motion asks the production of all such documents submitted to the Board of Directors.

With respect to the request contained in paragraph 5(a), it appears that earlier plaintiffs had sought and obtained such documents. We are concerned, therefore, solely with the denial of an order to produce those documents specified in paragraph 3.

The Vice Chancellor refused to order the production of the called-for documents on the grounds that the request was so broad as to open up a cumbersome and time-consuming examination of all aspects of the corporation’s business within the field of inquiry, and would involve the disclosure, contrary to a long-established company policy, of precise sales information. He was of the opinion that the documents sought possibly would constitute evidence in a later accounting phase of the cause which, however, would be reached only if the liability of the Directors had been established. In his opinion, the sought-for documents would not support the theory of director liability and, consequently, at the then juncture of the cause were not the proper subject of discovery.

We must bear in mind that this motion was made under Chancery Rule 34, Del.C.Ann. which requires a showing of good cause before an order for production will be made. This means that the movant must demonstrate a need beyond the relevancy or materiality of the documents, and that no other avenue is open to him to obtain discovery. Empire Box Corporation of Stroudsburg v. Illinois Cereal Mills, 8 Terry 283, 90 A2d 672. As we read this record, no other avenue to get the sought-for documents was explored by plaintiffs.

We note, furthermore, that the request of paragraph 3 was not limited or particularized. The request is for all correspondence, etc., arising out of or pertaining to meetings, conferences, telephone or other conversations in which the company’s officers, directors or employees participated “on any and all occasions from 1951 to the present,” dealing with the subject matter of the indictments. The request sweeps within its embrace what could well be, in the language of the Vice Chancellor, “a vast assemblage of documents” and amounts in effect to a fishing expedition. Furthermore, we agree with the *88Vice Chancellor that the director defendants might well have no knowledge of these documents, and that they probably had no duty to have any knowledge of them.

The cause was tried below on the theory that preliminarily some showing of director liability must be made before Allis-Chalmers would be ordered to throw open its files to an untrammeled inspection by plaintiffs. They failed to make such a showing in fact as well as in law and, consequently, we think the Vice Chancellor committed no abuse of discretion in refusing to subject Allis-Chalmers to the harassment of unlimited and time-consuming inspection of records, which, except for broad generality of statement made by plaintiffs, bore no relation to. the issue of director liability.

The order denying the motion to produce the documents described in paragraph 3 is affirmed.

The second subject urged as error is the refusal of the Vice Chancellor to order the production of statements taken from the non-director defendants in connection with its investigation of the antitrust violations and in preparation for the defense of the indictments. It appears that the statements in question were taken by Allis-Chalmers’ attorneys as the result of interviews seeking to ascertain acts which, if imputed to Allis-Chalmers, might constitute anti-trust violations. The written memoranda made as the result of such interviews have remained in the exclusive possession of the company’s attorneys.

Plaintiffs seek production of these memoranda upon the authority of Hickman v. Taylor, 329 US. 495, 67 S.Ct. 385, 91 L.Ed. 451, which held that the attorney-client privilege does not apply to information and statements which a lawyer secures from a witness while acting for his client in preparation for litigation.

The rule of Hickman v. Taylor, however, has not been followed in this state. Prior to that decision, in Wise v. Western Union Telegraph Co., 6 W.W.Harr. 456, 178 A. 640, an accident report made by defendants’ agents as a result of interviews with defendant’s employees was held to be privileged if taken for the purpose of the guidance of an attorney in pending litigation. In so holding, the *89court adopted the so-called English Rule on the subject. Thereafter, Hickman v. Taylor was decided but in Reeves v. Pennsylvania R. R. Co., D.C., 8 F.R.D. 616, sitting in the Federal District Court for Delaware, the same judge who wrote the opinion in the Wise case held that the adoption of the 1948 Superior Court Rules, patterned on the Federal Rules of Civil Procedure, had not changed the rule of the Wise case. The same result was reached in Zenith Radio Corp. v. Radio Corp. of America, D.C. 121 F.Supp. 792, in which the Federal District Court for Delaware applied the Wise rule. Similarly, in Winter v. Pennsylvania R. R. Co., 6 Terry 108, 68 A.2d 513, and Empire Box Corp. of Stroudsburg v. Illinois Cereal Mills, supra, the Wise case was considered as controlling authority, and in Sparks Co. v. Huber Baking Co., 10 Terry 267, 114 A.2d 657, the continuing authority of the Wise case was recognized.

The statements sought by this motion fall within the rule of the Wise case as privileged documents obtained by reason of an attorney-client relationship. As such, an inspection of them may not be enforced.

Thirdly, the plaintiffs complain against the refusal of the Vice Chancellor to order the four non-appearing defendants to answer certain questions they had refused to answer during the taking of their depositions in Wisconsin, or, in the alternative, to impose sanctions on the appearing defendants.

The refusal to answer took place during the taking in Wisconsin of the depositions of the four non-appearing defendants. These four men were represented during the depositions by their own separate counsel on whose advice they refused to answer on the ground of possible self-incrimination. They were at the time under indictment for violation of the anti-trust laws. At this time they had pleaded guilty to the indictments and were awaiting sentence. The refusal to answer was based upon possible self-incrimination under the Federal Anti-Trust Laws and under the Wisconsin Anti-trust Laws.

The Vice Chancellor did not rule on the validity of the constitutional privilege claimed, but refused to order the witnesses to answer on the ground that he was without power to compel answers from individuals over whom no jurisdiction had been obtained.

*90Plaintiffs argue that answers could have been forced by the imposition of sanctions under Chancery Rule 37(b) which applies to parties or managing agents of parties. It is, of course, true that the four non-appearing defendants were managing agents of Allis-Chalmers, and that, strictly speaking, the rule would seem to authorize the imposition of sanctions against Allis-Chalmers. The question immediately presents itself, however, as to what form the sanctions would take since, while a nominal defendant, Allis-Chalmers is the party on whose behalf this action has been brought. It would seem to aid the plaintiffs very little to penalize the corporation which their action seeks to benefit.

There is, however, a complete answer to the argument. Plaintiffs had a remedy to obtain a ruling on the propriety of the refusal to answer, and, if that ruling was favorable, to force answers under the ruling of a court. Plaintiffs could have examined the four witnesses in Wisconsin under a Commission issued pursuant to 10 Del.C. § 368, and thus obtained the aid of a Wisconsin court in compelling answers. This, we think, is a complete answer to plaintiffs’ argument and supports the ruling of the Vice Chancellor.

Finally, plaintiffs argue that error was committed by the failure of the Vice Chancellor to even consider whether or not an inference unfavorable to the Directors should be drawn from their failure to produce as witnesses at the trial the Allis-Chalmers employees named as defendants in the indictments. To be sure, no mention of the argument is made in the opinion below, but this does not necessarily mean that the argument was not considered. It may have been and discarded. In any event, we think, in the absence of any evidence telling against the Directors, any justifiable inference to be drawn from the failure to produce the witnesses could not rise to the height necessary to supply the plaintiffs’ deficiency of proof.

The judgment of the court below is affirmed.

7.1.3 In re Caremark International Inc. Derivative Litigation 7.1.3 In re Caremark International Inc. Derivative Litigation

In re CAREMARK INTERNATIONAL INC. DERIVATIVE LITIGATION.

Civil Action No. 13670.

Court of Chaneery of Delaware, New Castle County.

Submitted: Aug. 16, 1996.

Decided: Sept. 25, 1996.

*960Joseph A. Rosenthal, of Rosenthal, Mon-hait, Gross & Goddess, P.A., Wilmington; (Lowey Dannenberg Bemporad & Selinger, P.C., White Plains, NY; Goodkind Labaton Rudoff & Sucharow, L.L.P., New York City, of Counsel); for Plaintiffs.

Kevin G. Abrams, Thomas A. Beck and Richard I.G. Jones, Jr., of Richards, Layton & Finger, Wilmington; (Howard M. Pearl, Timothy J. Rivelli and Julie A. Bauer, of Winston & Strawn, Chicago, IL, of Counsel), for Caremark International, Inc.

Kenneth J. Nachbar, of Morris, Nichols, Arsht & Tunnell, Wilmington; (William J. Linklater, of Baker & McKenzie, Chicago, IL, of Counsel), for Individual Defendants.

OPINION

ALLEN, Chancellor.

Pending is a motion pursuant to Chancery Rule 23.1 to approve as fair and reasonable a proposed settlement of a consolidated derivative action on behalf of Caremark International, Inc. (“Caremark”). The suit involves claims that the members of Caremark’s board of directors (the “Board”) breached their fiduciary duty of care to Caremark in connection with alleged violations by Care-mark employees of federal and state laws and regulations applicable to health care providers. As a result of the alleged violations, Caremark was subject to an extensive four year investigation by the United States Department of Health and Human Services and the Department of Justice. In 1994 Care-mark was charged in an indictment with multiple felonies. It thereafter entered into a number of agreements with the Department of Justice and others. Those agreements included a plea agreement in which Caremark pleaded guilty to a single felony of mail fraud and agreed to pay civil and criminal fines. Subsequently, Caremark agreed to make reimbursements to various private and public parties. In all, the payments that *961Caremark has been required to make total approximately $250 million.

This suit was filed in 1994, purporting to seek on behalf of the company recovery of these losses from the individual defendants who constitute the board of directors of Caremark.1 The parties now propose that it be settled and, after notice to Caremark shareholders, a hearing on the fairness of the proposal was held on August 16,1996.

A motion of this type requires the court to assess the strengths and weaknesses of the claims asserted in light of the discovery record and to evaluate the fairness and adequacy of the consideration offered to the corporation in exchange for the release of all claims made or arising from the facts alleged. The ultimate issue then is whether the proposed settlement appears to be fair to the corporation and its absent shareholders. In this effort the court does not determine contested facts, but evaluates the claims and defenses on the discovery record to achieve a sense of the relative strengths of the parties’ positions. Polk v. Good, Del.Supr., 507 A.2d 531, 536 (1986). In doing this, in most instances, the court is constrained by the absence of a truly adversarial process, since inevitably both sides support the settlement and legally assisted objectors are rare. Thus, the facts stated hereafter represent the court’s effort to understand the context of the motion from the discovery record, but do not deserve the respect that judicial findings after trial are customarily accorded.

Legally, evaluation of the central claim made entails consideration of the legal standard governing a board of directors’ obligation to supervise or monitor corporate performance. For the reasons set forth below I conclude, in light of the discovery record, that there is a very low probability that it would be determined that the directors of Caremark breached any duty to appropriate- ■ ly monitor and supervise the enterprise. Indeed the record tends to show an active consideration by Caremark management and its Board of the Caremark structures and programs that ultimately led to the company’s indictment and to the large financial losses incurred in the settlement of those claims. It does not tend to show knowing or intentional violation of law. Neither the fact that the Board, although advised by lawyers and accountants, did not accurately predict the severe consequences to the company that would ultimately follow from the deployment by the company of the strategies and practices that ultimately led to this liability, nor the scale of the liability, gives rise to an inference of breach of any duty imposed by corporation law upon the directors of Care-mark.

I. BACKGROUND

For these purposes I regard the following facts, suggested by the discovery record, as material. Caremark, a Delaware corporation with its headquarters in Northbrook, Illinois, was created in November 1992 when it was spun-off from Baxter International, Inc. (“Baxter”) and became a publicly held company listed on the New York Stock Exchange. The business practices that created the problem pre-dated the spin-off. During the relevant period Caremark was involved in two main health care business segments, providing patient care and managed care services. As part of its patient care business, which accounted for the majority of Care-mark’s revenues, Caremark provided alternative site health care services, including infusion therapy, growth hormone therapy, HIV/ AIDS-related treatments and hemophilia therapy. Caremark’s managed care services included prescription drug programs and the operation of multi-specialty group practices.

A Events Prior to the Government Investigation

A substantial part of the revenues generated by Caremark’s businesses is derived from third party payments, insurers, and Medicare and Medicaid reimbursement programs. The latter source of payments are subject to the terms of the Anti-Referral Payments Law (“ARPL”) which prohibits health care providers from paying any form of remuner-*962atíon to induce the referral of Medicare or Medicaid patients. From its inception, Care-mark entered into a variety of agreements with hospitals, physicians, and health care providers for advice and services, as well as distribution agreements with drug manufacturers, as had its predecessor prior to 1992. Specifically, Caremark did have a practice of entering into contracts for services (e.g., consultation agreements and research grants) with physicians at least some of whom prescribed or recommended services or products that Caremark provided to Medicare recipients and other patients. Such contracts were not prohibited by the ARPL but they obviously raised a possibility of unlawful “kickbacks.”

As early as 1989, Caremark’s predecessor issued an internal “Guide to Contractual Relationships” (“Guide”) to govern its employees in entering into contracts with physicians and hospitals. The Guide tended to be reviewed annually by lawyers and updated. Each version of the Guide stated as Care-mark’s and its predecessor’s policy that no payments would be made in exchange for or to induce patient referrals. But what one might deem a prohibited quid pro quo was not always clear. Due to a scarcity of court decisions interpreting the ARPL, however, Caremark repeatedly publicly stated that there was uncertainty concerning Care-mark’s interpretation of the law.

To clarify the scope of the ARPL, the United States Department of Health and Human Services (“HHS”) issued “safe harbor” regulations in July 1991 stating conditions under which financial relationships between health care service providers and patient referral sources, such as physicians, would not violate the ARPL. Caremark contends that the narrowly drawn regulations gave limited guidance as to the legality of many of the agreements used by Caremark that did not fall within the safe-harbor. Caremark’s predecessor, however, amended many of its standard forms of agreement with health care providers and revised the Guide in an apparent attempt to comply with the new regulations.

B. Government Investigation and Related Litigation

In August 1991, the HHS Office of the Inspector General (“OIG”) initiated an investigation of Caremark’s predecessor. Care-mark’s predecessor was served with a subpoena requiring the production of documents, including contracts between Caremark’s predecessor and physicians (Quality Service Agreements (“QSAs”)). Under the QSAs, Caremark’s predecessor appears to have paid physicians fees for monitoring patients under Caremark’s predecessor’s care, including Medicare and Medicaid recipients. Sometimes apparently those monitoring patients were referring physicians, which raised ARPL concerns.

In March 1992, the Department of Justice (“DOJ”) joined the OIG investigation and separate investigations were commenced by several additional federal and state agencies.2

C. Caremark’s Response to the Investigation

During the relevant period, Caremark had approximately 7,000 employees and ninety branch operations. It had a decentralized management structure. By May 1991, however, Caremark asserts that it had begun making attempts to centralize its management structure in order to increase supervision over its branch operations.

The first action taken by management, as a result of the initiation of the OIG investigation, was an announcement that as of October 1, 1991, Caremark’s predecessor would no longer pay management fees to physicians for services to Medicare and Medicaid patients. Despite this decision, Caremark asserts that its management, pursuant to advice, did not believe that such payments were illegal under the existing laws and regulations.

*963During this period, Caremark’s Board took several additional steps consistent with an effort to assure compliance with company policies concerning the ARPL and the contractual forms in the Guide. In April 1992, Caremark published a fourth revised version of its Guide apparently designed to assure that its agreements either complied with the ARPL and regulations or excluded Medicare and Medicaid patients altogether. In addition, in September 1992, Caremark instituted a policy requiring its regional officers, Zone Presidents, to approve each contractual relationship entered into by Caremark with a physician.

Although there is evidence that inside and outside counsel had advised Caremark’s directors that their contracts were in accord with the law, Caremark recognized that some uncertainty respecting the correct interpretation of the law existed. In its 1992 annual report, Caremark disclosed the ongoing government investigations, acknowledged that if penalties were imposed on the company they could have a material adverse effect on Care-mark’s business, and stated that no assurance could be given that its interpretation of the ARPL would prevail if challenged.

Throughout the period of the government investigations, Caremark had an internal audit plan designed to assure compliance with business and ethics policies. In addition, Caremark employed Price Waterhouse as its outside auditor. On February 8, 1993, the Ethics Committee of Caremark’s Board received and reviewed an outside auditors report by Price Waterhouse which concluded that there were no material weaknesses in Caremark’s control structure.3 Despite the positive findings of Price Waterhouse, however, on April 20, 1993, the Audit & Ethics Committee adopted a new internal audit charter requiring a comprehensive review of compliance policies and the compilation of an employee ethics handbook concerning such policies.4

The Board appears to have been informed about this project and other efforts to assure compliance with the law. For example, Caremark’s management reported to the Board that Caremark’s sales force was receiving an ongoing education regarding the ARPL and the proper use of Caremark’s form contracts which had been approved by in-house counsel. On July 27, 1993, the new ethics manual, expressly prohibiting payments in exchange for referrals and requiring employees to report all illegal conduct to a toll free confidential ethics hotline, was approved and allegedly disseminated.5 The record suggests that Caremark continued these policies in subsequent years, causing employees to be given revised versions of the ethics manual and requiring them to participate in training sessions concerning compliance with the law.

During 1993, Caremark took several additional steps which appear to have been aimed at increasing management supervision. These steps included new policies requiring local branch managers to secure home office approval for all disbursements under agreements with health care providers and to certify compliance with the ethics program. In addition, the chief financial officer was appointed to serve as Caremark’s compliance officer. In 1994, a fifth revised Guide was published.

D. Federal Indictments Against Care-mark and Officers

On August 4,1994, a federal grand jury in Minnesota issued a 47 page indictment charging Caremark, two of its officers (not the firm’s chief officer), an individual who had been a sales employee of Genentech, *964Inc., and David R. Brown, a physician practicing in Minneapolis, with violating the ARPL over a lengthy period. According to the indictment, over $1.1 million had been paid to Brown to induce him to distribute Protropin, a human growth hormone drug marketed by Caremark.6 The substantial payments involved started, according to the allegations of the indictment, in 1986 and continued through 1993. Some payments were “in the guise of research grants”, Ind. ¶20, and others were “consulting agreements”, Ind. ¶ 19. The indictment charged, for example, that Dr. Brown performed virtually none of the consulting functions described in his 1991 agreement with Care-mark, but was nevertheless neither required to return the money he had received nor precluded from receiving future funding from Caremark. In addition the indictment charged that Brown received from Caremark payments of staff and office expenses, including telephone answering services and fax rental expenses.

In reaction to the Minnesota Indictment and the subsequent filing of this and other derivative actions in 1994, the Board met and was informed by management that the investigation had resulted in an indictment; Care-mark denied any wrongdoing relating to the indictment and believed that the OIG investigation would have a favorable outcome. Management reiterated the grounds for its view that the contracts were in compliance with law.

Subsequently, five stockholder derivative actions were filed in this court and consolidated into this action. The original complaint, dated August 5, 1994, alleged, in relevant part, that Caremark’s directors breached their duty of care by failing adequately to supervise the conduct of Care-mark employees, or institute corrective measures, thereby exposing Caremark to fines and liability.7

On September 21, 1994, a federal grand jury in Columbus, Ohio issued another indictment alleging that an Ohio physician had defrauded the Medicare program by requesting and receiving $134,600 in exchange for referrals of patients whose medical costs were in part reimbursed by Medicare in violation of the ARPL. Although unidentified at that time, Caremark was the health care provider who allegedly made such payments. The indictment also charged that the physician, Elliot Neufeld, D.O., was provided with the services of a registered nurse to work in his office at the expense of the infusion company, in addition to free office equipment.

An October 28,1994 amended complaint in this action added allegations concerning the Ohio indictment as well as new allegations of over billing and inappropriate referral payments in connection with an action brought in Atlanta, Booth v. Rankin. Following a newspaper article report that federal investigators were expanding their inquiry to look at Caremark’s referral practices in Michigan as well as allegations of fraudulent billing of insurers, a second amended complaint was filed in this action. The third, and final, amended complaint was filed on April 11, 1995, adding allegations that the federal indictments had caused Caremark to incur significant legal fees and forced it to sell its home infusion business at a loss.8

After each complaint was filed, defendants filed a motion to dismiss. According to de*965fendants, if a settlement had not been reached in this action, the case would have been dismissed on two grounds. First, they contend that the complaints fail to allege particularized facts sufficient to excuse the demand requirement under Delaware Chancery Court Rule 23.1. Second, defendants assert that plaintiffs had failed to state a cause of action due to the fact that Care-mark’s charter eliminates directors’ personal liability for money damages, to the extent permitted by law.

E. Settlement Negotiations

In September, following the announcement of the Ohio indictment, Caremark publicly announced that as of January 1, 1995, it would terminate all remaining financial relationships with physicians in its home infusion, hemophilia, and growth hormone lines of business.9 In addition, Caremark asserts that it extended its restrictive policies to all of its contractual relationships with physicians, rather than just those involving Medicare and Medicaid patients, and terminated its research grant program which had always involved some recipients who referred patients to Caremark.

Caremark began settlement negotiations with federal and state government entities in May 1995. In return for a guilty plea to a single count of mail fraud by the corporation, the payment of a criminal fine, the payment of substantial civil damages, and cooperation with further federal investigations on matters relating to the OIG investigation, the government entities agreed to negotiate a settlement that would permit Caremark to continue participating in Medicare and Medicaid programs. On June 15, 1995, the Board approved a settlement (“Government Settlement Agreement”) with the DOJ, OIG, U.S. Veterans Administration, U.S. Federal Employee Health Benefits Program, federal Civilian Health and Medical Program of the Uniformed Services, and related state agencies in all fifty states and the District of Columbia.10 No senior officers or directors were charged with wrongdoing in the Government Settlement Agreement or in any of the prior indictments. In fact, as part of the sentencing in the Ohio action on June 19, 1995, the United States stipulated that no senior executive of Caremark participated in, condoned, or was willfully ignorant of wrongdoing in connection with the home infusion business practices.11

The federal settlement included certain provisions in a “Corporate Integrity Agreement” designed to enhance future compliance with law. The parties have not discussed this agreement, except to say that the negotiated provisions of the settlement of this claim are not redundant of those in that agreement.

Settlement negotiations between the parties in this action commenced in May 1995 as well, based upon a letter proposal of the plaintiffs, dated May 16,1995.12 These negotiations resulted in a memorandum of understanding (“MOU”), dated June 7, 1995, and the execution of the Stipulation and Agreement of Compromise and Settlement on June 28, 1995, which is the subject of this action.13 The MOU, approved by the Board on June *96615,1995, required the Board to adopt several resolutions, discussed below, and to create a new compliance committee. The Compliance and Ethics Committee has been reporting to the Board in accord with its newly specified duties.

After negotiating these settlements, Care-mark learned in December 1995 that several private insurance company payors (“Private Payors”) believed that Caremark was liable for damages to them for allegedly improper business practices related to those at issue in the OIG investigation. As a result of intensive negotiations with the Private Payors and the Board’s extensive consideration of the alternatives for dealing with such claims, the Board approved a $98.5 million settlement agreement with the Private Payors on March 18, 1996. In its public disclosure statement, Caremark asserted that the settlement did not involve current business practices and contained an express denial of any wrongdoing by Caremark. After further discovery in this action, the plaintiffs decided to continue seeking approval of the proposed settlement agreement.

F. The Proposed Settlement of this Litigation

In relevant part the terms upon which these claims asserted are proposed to be settled are as follows:

1. That Caremark, undertakes that it and its employees, and agents not pay any form of compensation to a third party in exchange for the referral of a patient to a Caremark facility or service or the prescription of drugs marketed or distributed by Caremark for which reimbursement may be sought from Medicare, Medicaid, or a similar state reimbursement program;

2. That Caremark, undertakes for itself and its employees, and agents not to pay to or split fees with physicians, joint ventures, any business combination in which Caremark maintains a direct financial interest, or other health care providers with whom Caremark has a financial relationship or interest, in exchange for the referral of a patient to a Caremark facility or service or the prescription of drugs marketed or distributed by Caremark for which reimbursement may be sought from Medicare, Medicaid, or a similar state reimbursement program;

3. That the full Board shall discuss all relevant material changes in government health care regulations and their effect on relationships with health care providers on a semi-annual basis;

4. That Caremark’s officers will remove all personnel from health care facilities or hospitals who have been placed in such facility for the purpose of providing remuneration in exchange for a patient referral for which reimbursement may be sought from Medicare, Medicaid, or a similar state reimbursement program;

5. That every patient will receive written disclosure of any financial relationship between Caremark and the health care professional or provider who made the referral;

6. That the Board will establish a Compliance and Ethics Committee of four directors, two of which will be non-management directors, to meet at least four times a year to effectuate these policies and monitor business segment compliance with the ARPL, and to report to the Board semi-annually concerning compliance by each business segment; and

7. That corporate officers responsible for business segments shall serve as compliance officers who must report semi-annually to the Compliance and Ethics Committee and, with the assistance of outside counsel, review existing contracts and get advanced approval of any new contract forms.

II. LEGAL PRINCIPLES

A. Principles Governing Settlements of Derivative Claims

As noted at the outset of this opinion, this Court is now required to exercise an informed judgment whether the proposed settlement is fair and reasonable in the light of all relevant factors. Polk v. Good Del.Supr., 507 A.2d 531 (1986). On an application of this kind, this Court attempts to protect the best interests of the corporation and its absent shareholders all of whom will *967be barred from future litigation on these claims if the settlement is approved. The parties proposing the settlement bear the burden of persuading the court that it is in fact fair and reasonable. Fins v. Pearlman, Del.Supr., 424 A.2d 305 (1980).

B. Directors’ Duties To Monitor Corporate Operations

The complaint charges the director defendants with breach of their duty of attention or care in connection with the on-going operation of the corporation’s business. The claim is that the directors allowed a situation to develop and continue which exposed the corporation to enormous legal liability and that in so doing they violated a duty to be active monitors of corporate performance. The complaint thus does not charge either director self-dealing or the more difficult loyalty-type problems arising from cases of suspect director motivation, such as entrenchment or sale of control contexts.14 The theory here advanced is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment. The good policy reasons why it is so difficult to charge directors with responsibility for corporate losses for an alleged breach of care, where there is no conflict of interest or no facts suggesting suspect motivation involved, were recently described in Gagliardi v. TriFoods Int'l, Inc., Del.Ch., 683 A.2d 1049, 1051 (1996) (1996 Del.Ch. LEXIS 87 at p. 20).

1. Potential liability for directo-ral decisions: Director liability for a breach of the duty to exercise appropriate attention may, in theory, arise in two distinct contexts. First, such liability may be said to follow from a board decision that results in a loss because that decision was ill advised or “negligent”. Second, liability to the corporation for a loss may be said to arise from an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss. See generally Veasey & Seitz, The Business Judgment Rule in the Revised Model Act ... 63 Texas L.Rev. 1483 (1985). The first class of cases will typically be subject to review under the director-protective business judgment rule, assuming the decision made was the product of a process that was either deliberately considered in good faith or was otherwise rational. See Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1984); Gagliardi v. TriFoods Int’l, Inc., Del.Ch., 683 A.2d 1049 (1996). What should be understood, but may not widely be understood by courts or commentators who are not often required to face such questions,15 is that compliance with a director’s duty of care can never appropriately be judicially determined by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed. That is, whether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule — one that permitted an “objective” evaluation of the decision — would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests.16 Thus, the busi*968ness judgment rule is process oriented and informed by a deep respect for all good faith board decisions.

Indeed, one wonders on what moral basis might shareholders attack a good faith business decision of a director as “unreasonable” or “irrational”. Where a director in fact exercises a good faith effort to be informed and to exercise appropriate judgment, he or she should be deemed to satisfy fully the duty of attention. If the shareholders thought themselves entitled to some other quality of judgment than such a director produces in the good faith exercise of the powers of office, then the shareholders should have elected other directors. Judge Learned Hand made the point rather better than can I. In speaking of the passive director defendant Mr. Andrews in Barnes v. Andrews, Judge Hand said:

True, he was not very suited by experience for the job he had undertaken, but I cannot hold him on that account. After all it is the same corporation that chose him that now seeks to charge him_ Directors are not specialists like lawyers or doctors_ They are the general advis-ors of the business and if they faithfully give such ability as they have to their charge, it would not be lawful to hold them liable. Must a director guarantee that his judgment is good? Can a shareholder call him to account for deficiencies that then-votes assured him did not disqualify him for his office? While he may not have been the Cromwell for that Civil War, Andrews did not engage to play any such role.17

In this formulation Learned Hand correctly identifies, in my opinion, the core element of any corporate law duty of care inquiry: whether there was good faith effort to be informed and exercise judgment.

2. Liability for failure to monitor: The second class of cases in which director liability for inattention is theoretically possible entail circumstances in which a loss eventuates not from a decision but, from unconsidered inaction. Most of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention. Legally, the board itself will be required only to authorize the most significant corporate acts or transactions: mergers, changes in capital structure, fundamental changes in business, appointment and compensation of the CEO, etc. As the facts of this case graphically demonstrate, ordinary business decisions that are made by officers and employees deeper in the interior of the organization can, however, vitally affect the welfare of the corporation and its ability to achieve its various strategic and financial goals. If this ease did not prove the point itself, recent business history would. Recall for example the displacement of senior management and much of the board of Salomon, Inc.;18 the replacement of senior management of Kidder, Peabody following the discovery of large trading losses resulting from phantom trades by a highly compensated trader;19 or the extensive financial loss and reputational injury suffered by Prudential Insurance as a result its junior officers misrepresentations in connection with the distribution of limited partnership interests.20 Financial and organizational disasters such as these raise the question, what is *969the board’s responsibility with respect to the organization and monitoring of the enterprise to assure that the corporation functions within the law to achieve its purposes?

Modernly this question has been given special importance by an increasing tendency, especially under federal law, to employ the criminal law to assure corporate compliance with external legal requirements, including environmental, financial, employee and product safety as well as assorted other health and safety regulations. In 1991, pursuant to the Sentencing Reform Act of 1984,21 the United States Sentencing Commission adopted Organizational Sentencing Guidelines which impact importantly on the prospective effect these criminal sanctions might have on business corporations. The Guidelines set forth a uniform sentencing structure for organizations to be sentenced for violation of federal criminal statutes and provide for penalties that equal or often massively exceed those previously imposed on corporations.22 The Guidelines offer powerful incentives for corporations today to have in place compliance programs to detect violations of law, promptly to report violations to appropriate public officials when discovered, and to take prompt, voluntary remedial efforts.

In 1963, the Delaware Supreme Court in Graham v. Allis-Chalmers Mfg. Co.,23 addressed the question of potential liability of board members for losses experienced by the corporation as a result of the corporation having violated the anti-trust laws of the United States. There was no claim in that case that the directors knew about the behavior of subordinate employees of the corporation that had resulted in the liability. Rather, as in this case, the claim asserted was that the directors ought to have known of it and if they had known they would have been under a duty to bring the corporation into compliance with the law and thus save the corporation from the loss. The Delaware Supreme Court concluded that, under the facts as they appeared, there was no basis to find that the directors had breached a duty to be informed of the ongoing operations of the firm. In notably colorful terms, the court stated that “absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.”24 The Court found that there were no grounds for suspicion in that case and, thus, concluded that the directors were blamelessly unaware of the conduct leading to the corporate liability.25

How does one generalize this holding today? Can it be said today that, absent some ground giving rise to suspicion of violation of law, that corporate directors have no duty to assure that a corporate information gathering and reporting systems exists which represents a good faith attempt to provide senior management and the Board with information respecting material acts, events or conditions within the corporation, including compliance with applicable statutes and regulations? I certainly do not believe so. I doubt that such a broad generalization of the Graham holding would have been accepted by the Supreme Court in 1963. The case can be more narrowly interpreted as standing for the proposition that, absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company’s behalf. See 188 A.2d at 130-31.

A broader interpretation of Graham v. Al-lis-Chalmers — that it means that a corporate board has no responsibility to assure that appropriate information and reporting sys-*970terns are established by management — would not, in any event, be accepted by the Delaware Supreme Court in 1996, in my opinion. In stating the basis for this view, I start with the recognition that in recent years the Delaware Supreme Court has made it clear— especially in its jurisprudence concerning takeovers, from Smith v. Van Gorkom through Paramount Communications v. QVC26 — the seriousness with which the corporation law views the role of the corporate board. Secondly, I note the elementary fact that relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role under Section 141 of the Delaware General Corporation Law. Thirdly, I note the potential impact of the federal organizational sentencing guidelines on any business organization. Any rational person attempting in good faith to meet an organizational governance responsibility would be bound to take into account this development and the enhanced penalties and the opportunities for reduced sanctions that it offers.

In light of these developments, it would, in my opinion, be a mistake to conclude that our Supreme Court’s statement in Graham concerning “espionage” means that corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation’s compliance with law and its business performance.

Obviously the level of detail that is appropriate for such an information system is a question of business judgment. And obviously too, no rationally designed information and reporting system will remove the possibility that the corporation will violate laws or regulations, or that senior officers or directors may nevertheless sometimes be misled or otherwise fail reasonably to detect acts material to the corporation’s compliance with the law. But it is important that the board exercise a good faith judgment that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, so that it may satisfy its responsibility.

Thus, I am of the view that a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards27. I now turn to an analysis of the claims asserted with this concept of the directors duty of care, as a duty satisfied in part by assurance of adequate information flows to the board, in mind.

III. ANALYSIS OF THIRD AMENDED COMPLAINT AND SETTLEMENT

A. The Claims

On balance, after reviewing an extensive record in this case, including numerous documents and three depositions, I conclude that this settlement is fair and reasonable. In light of the fact that the Caremark Board already has a functioning committee charged with overseeing corporate compliance, the changes in corporate practice that are presented as consideration for the settlement do not impress one as very significant. Nonetheless, that consid*971eration appears fully adequate to support dismissal of the derivative claims of director fault asserted, because those claims find no substantial evidentiary support in the record and quite likely were susceptible to a motion to dismiss in all events.28

In order to show that the Caremark directors breached their duty of care by failing adequately to control Caremark’s employees, plaintiffs would have to show either (1) that the directors knew or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent of' remedy that situation, and (4) that such failure proximately resulted in the losses complained of, although under Cede & Co. v. Technicolor, Inc., Del.Supr., 636 A.2d 956 (1994) this last element may be thought to constitute an affirmative defense.

1. Knowing violation for statute: Concerning the possibility that the Caremark directors knew of violations of law, none of the documents submitted for review, nor any of the deposition transcripts appear to provide evidence of it. Certainly the Board understood that the company had entered into a variety of contracts with physicians, researchers, and health care providers and it was understood that some of these contracts were with persons who had prescribed treatments that Caremark participated in providing. The board was informed that the company’s reimbursement for patient care was frequently from government funded sources and that such services were subject to the ARPL. But the Board appears to have been informed by experts that the company’s practices while contestable, were lawful. There is no evidence that reliance on such reports was not reasonable. Thus, this case presents no occasion to apply a principle to the effect that knowingly causing the corporation to violate a criminal statute constitutes a breach of a director’s fiduciary duty. See Roth v. Robertson, N.Y.Sup.Ct., 64 Misc. 343, 118 N.Y.S. 351 (1909); Miller v. American Tel. & Tel. Co., 507 F.2d 759 (3rd Cir.1974). It is not clear that the Board knew the detail found, for example, in the indictments arising from the Company’s payments. But, of course, the duty to act in good faith to be informed cannot be thought to require directors to possess detailed information about all aspects of the operation of the enterprise. Such a requirement would simple be inconsistent with the scale and scope of efficient organization size in this technological age.

2. Failure to monitor: Since it does appears that the Board was to some extent unaware of the activities that led to liability, I turn to a consideration of the other potential avenue to director liability that the pleadings take: director inattention or “negligence”. Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, as in Graham or in this case, in my opinion only a sustained or systematic failure of the board to exercise oversight — such as an utter failure to attempt to assure a reasonable information and reporting system exits — vail establish the lack of good faith that is a necessary condition to liability. Such a test of liability — lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight — is quite high. But, a demanding test of liability in the oversight context is probably beneficial to corporate shareholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith 'performance of duty by such directors.

Here the record supplies essentially no evidence that the director defendants were guilty of a sustained failure to exercise their oversight function. To the contrary, insofar as I am able to tell on this record, the corporation’s information systems appear to have represented a good faith attempt to be informed of relevant facts. If the directors did not know the specifics of the activities *972that lead to the indictments, they cannot be faulted.

The liability that eventuated in this instance was huge. But the fact that it resulted from a violation of criminal law alone does not create a breach of fiduciary duty by directors. The record at this stage does not support the conclusion that the defendants either lacked good faith in the exercise of their monitoring responsibilities or conscientiously permitted a known violation of law by the corporation to occur. The claims asserted against them must be viewed at this stage as extremely weak.

B. The Consideration For Release of Claim

The proposed settlement provides very modest benefits. Under the settlement agreement, plaintiffs have been given express assurances that Caremark will have a more centralized, active supervisory system in the future. Specifically, the settlement mandates duties to be performed by the newly named Compliance and Ethics Committee on an ongoing basis and increases the responsibility for monitoring compliance with the law at the lower levels of management. In adopting the resolutions required under the settlement, Caremark has further clarified its policies concerning the prohibition of providing remuneration for referrals. These appear to be positive consequences of the settlement of the claims brought by the plaintiffs, even if they are not highly significant. Nonetheless, given the weakness of the plaintiffs’ claims the proposed settlement appears to be an adequate, reasonable, and beneficial outcome for all of the parties. Thus, the proposed settlement will be approved.

TV. ATTORNEYS’FEES

The various firms of lawyers involved for plaintiffs seek an award of $1,025,000 in attorneys’ fees and reimbursable expenses.29 In awarding attorneys’ fees, this Court considers an array of relevant factors. E.g., In Re Beatrice Companies, Inc. Litigation, Del.Ch., C.A. No. 8248, Allen, C., 1986 WL 4749 (Apr. 16, 1986). Such factors include, most importantly, the financial value of the benefit that the lawyers work produced; the strength of the claims (because substantial settlement value may sometimes be produced even though the litigation added little value — i.e., perhaps any lawyer could have settled this claim for this substantial value or more); the amount of complexity of the legal services; the fee customarily charged for such services; and the contingent nature of the undertaking.

In this case no factor points to a substantial fee, other than the amount and sophistication of the lawyer services required. There is only a modest substantive benefit produced; in the particular circumstances of the government activity there was realistically a very slight contingency faced by the attorneys at the time they expended time. The services rendered required a high degree of sophistication and expertise. I am told that at normal hourly billing rates approximately $710,000 of time was expended by the attorneys.

In these circumstances, I conclude that an award of a fee determined by reference to the time expended at normal hourly rates plus a premium of 15% of that amount to reflect the limited degree of real contingency in the undertaking, is fair. Thus I will award a fee of $816,000 plus $53,000 of expenses advanced by counsel.

I am today entering an order consistent with the foregoing.30

.The vocabulary of negligence while often employed, e.g., Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1984) is not well-suited to judicial review of board attentiveness, see, e.g., Joy v. North, 692 F.2d 880, 885-6 (2d Cir.1982), especially if one attempts to look to the substance of the decision as any evidence of possible "negligence.” Where review of board functioning is involved, courts leave behind as a relevant point of reference the decisions of the hypothetical *968"reasonable person”, who typically supplies the test for negligence liability. It is doubtful that we want business men and women to be encouraged to make decisions as hypothetical persons of ordinary judgment and prudence might. The corporate form gets its utility in large part from its ability to allow diversified investors to accept greater investment risk. If those in charge of the corporation are to be adjudged personally liable for losses on the basis of a substantive judgment based upon what an persons of ordinary or average judgment and average risk assessment talent regard as "prudent” "sensible” or even "rational”, such persons will have a strong incentive at the margin to authorize less risky investment projects.

. The court has been informed by letter of counsel that after the fairness of the proposed settlement had been submitted to the court, Caremark was involved in a merger in which its stock was canceled and the holders of its stock became entitled to shares of stock of the acquiring corpo*973ration. No party to this suit, or the surviving corporation, has sought to dismiss this case thereafter on the basis that plaintiffs’ have loss standing to sue. As plaintiffs continue to have an equity interest in the entity that owns the claims and more especially because no party has moved for any modification of the procedural setting of the matter submitted, I conclude that any merger that may have occurred is without effect on the decision of the motion or the judgment to be entered.

7.1.4 Stone v. Ritter (Del. 2006) 7.1.4 Stone v. Ritter (Del. 2006)

The business judgment rule, as authoritatively stated in Aronson and applied in Disney, should provide comfort to directors and officers even in the absence of a 102(b)(7) waiver (which does not cover officers). For a long time, however, directors and officers might have been worried by the following passage from Aronson:

“However, it should be noted that the business judgment rule operates only in the context of director action. Technically speaking, it has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act.”

Aronson v. Lewis, 473 A.2d 805, at 813 (Del. 1984).
To be sure, Aronson continued that “a conscious decision to refrain from acting may nonetheless be a valid exercise of business judgment and enjoy the protections of the rule” and acknowledged in a footnote to the quoted paragraph that “questions of director liability in such cases have [nevertheless] been adjudicated upon concepts of business judgment” (emphasis added). Doubts remained, however, and were only amplified by Chancellor Allen’s famous 1996 Caremark decision, which mused that the absence of a reporting system could give rise to liability. Stone addressed this question.

1. What is the rule of Stone: what is the liability standard for oversight failures?
2. How does the rule compare to the business judgment rule – is it more or less lenient for defendants, doctrinally speaking?
3. Do you think the doctrinal difference matters in practice?
4. What is the role of DGCL 102(b)(7) in this case?

911 A.2d 362 (2006)

William STONE and Sandra Stone, derivatively on Behalf of Nominal Defendant AmSOUTH BANCORPORATION, Plaintiffs Below, Appellants,
v.
C. Dowd RITTER, Ronald L. Kuehn, Jr., Claude B. Nielsen, James R. Malone, Earnest W. Davenport, Jr., Martha R. Ingram, Charles D. McCrary, Cleophus Thomas, Jr., Rodney C. Gilbert, Victoria B. Jackson, J. Harold Chandler, James E. Dalton, Elmer B. Harris, Benjamin F. Payton, and John N. Palmer, Defendants Below, Appellees, and
AmSouth Bancorporation, Nominal Defendant Below, Appellee.

No. 93, 2006.
Supreme Court of Delaware.Submitted: October 5, 2006.Decided: November 6, 2006.

Brian D. Long (argued) and Seth D. Rigrodsky, of Rigrodsky & Long, P.A., Wilmington, DE, for appellants.

Jesse A. Finkelstein, Raymond J. DiCamillo, and Lisa Zwally Brown, of Richards, Layton & Finger, Wilmington, DE, David B. Tulchin (argued), L. Wiesel, and Jacob F.M. Oslick, of Sullivan & Cromwell, L.L.P., New York City, for appellees.

Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS, and RIDGELY, Justices (constituting the Court en Banc).

HOLLAND, Justice:

This is an appeal from a final judgment of the Court of Chancery dismissing a derivative complaint against fifteen present and former directors of AmSouth Bancorporation ("AmSouth"), a Delaware corporation. The plaintiffs-appellants, William and Sandra Stone, are AmSouth shareholders and filed their derivative complaint without making a pre-suit demand on AmSouth's board of directors (the "Board"). The Court of Chancery held that the plaintiffs had failed to adequately plead that such a demand would have been futile. The Court, therefore, dismissed the derivative complaint under Court of Chancery Rule 23.1.

The Court of Chancery characterized the allegations in the derivative complaint as a "classic Caremark claim," a claim that derives its name from In re Caremark Int'l Deriv. Litig.^[1] In Caremark, the Court of Chancery recognized that: "[g]enerally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability."^[2]

In this appeal, the plaintiffs acknowledge that the directors neither "knew [n]or should have known that violations of law were occurring," i.e., that there were no "red flags" before the directors. Nevertheless, the plaintiffs argue that the Court of Chancery erred by dismissing the derivative complaint which alleged that "the defendants had utterly failed to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention." The defendants argue that the plaintiffs' assertions are contradicted by the derivative complaint itself and by the documents incorporated therein by reference.

[365] Consistent with our opinion in In re Walt Disney Co. Deriv Litig, we hold that Caremark articulates the necessary conditions for assessing director oversight liability.^[3] We also conclude that the Caremark standard was properly applied to evaluate the derivative complaint in this case. Accordingly, the judgment of the Court of Chancery must be affirmed.

Facts

This derivative action is brought on AmSouth's behalf by William and Sandra Stone, who allege that they owned AmSouth common stock "at all relevant times." The nominal defendant, AmSouth, is a Delaware corporation with its principal executive offices in Birmingham, Alabama. During the relevant period, AmSouth's wholly-owned subsidiary, AmSouth Bank, operated about 600 commercial banking branches in six states throughout the southeastern United States and employed more than 11,600 people.

In 2004, AmSouth and AmSouth Bank paid $40 million in fines and $10 million in civil penalties to resolve government and regulatory investigations pertaining principally to the failure by bank employees to file "Suspicious Activity Reports" ("SARs"), as required by the federal Bank Secrecy Act ("BSA")^[4] and various anti-money-laundering ("AML") regulations.^[5] Those investigations were conducted by the United States Attorney's Office for the Southern District of Mississippi ("USAO"), the Federal Reserve, FinCEN and the Alabama Banking Department. No fines or penalties were imposed on AmSouth's directors, and no other regulatory action was taken against them.

The government investigations arose originally from an unlawful "Ponzi" scheme operated by Louis D. Hamric, II and Victor G. Nance. In August 2000, Hamric, then a licensed attorney, and Nance, then a registered investment advisor with Mutual of New York, contacted an AmSouth branch bank in Tennessee to arrange for custodial trust accounts to be created for "investors" in a "business venture." That venture (Hamric and Nance represented) involved the construction of medical clinics overseas. In reality, Nance had convinced more than forty of his clients to invest in promissory notes bearing high rates of return, by misrepresenting the nature and the risk of that investment. Relying on similar misrepresentations by Hamric and Nance, the AmSouth branch employees in Tennessee agreed to provide custodial accounts for the investors and to distribute monthly interest payments to each account upon receipt of a check from Hamric and instructions from Nance.

The Hamric-Nance scheme was discovered in March 2002, when the investors did not receive their monthly interest payments. Thereafter, Hamric and Nance became the subject of several civil actions brought by the defrauded investors in Tennessee and Mississippi (and in which AmSouth [366] also was named as a defendant), and also the subject of a federal grand jury investigation in the Southern District of Mississippi. Hamric and Nance were indicted on federal money-laundering charges, and both pled guilty.

The authorities examined AmSouth's compliance with its reporting and other obligations under the BSA. On November 17, 2003, the USAO advised AmSouth that it was the subject of a criminal investigation. On October 12, 2004, AmSouth and the USAO entered into a Deferred Prosecution Agreement ("DPA") in which AmSouth agreed: first, to the filing by USAO of a one-count Information in the United States District Court for the Southern District of Mississippi, charging AmSouth with failing to file SARs; and second, to pay a $40 million fine. In conjunction with the DPA, the USAO issued a "Statement of Facts," which noted that although in 2000 "at least one" AmSouth employee suspected that Hamric was involved in a possibly illegal scheme, AmSouth failed to file SARs in a timely manner. In neither the Statement of Facts nor anywhere else did the USAO ascribe any blame to the Board or to any individual director.

On October 12, 2004, the Federal Reserve and the Alabama Banking Department concurrently issued a Cease and Desist Order against AmSouth, requiring it, for the first time, to improve its BSA/AML program. That Cease and Desist Order required AmSouth to (among other things) engage an independent consultant "to conduct a comprehensive review of the Bank's AML Compliance program and make recommendations, as appropriate, for new policies and procedures to be implemented by the Bank." KPMG Forensic Services ("KPMG") performed the role of independent consultant and issued its report on December 10, 2004 (the "KPMG Report").

Also on October 12, 2004, FinCEN and the Federal Reserve jointly assessed a $10 million civil penalty against AmSouth for operating an inadequate anti-money-laundering program and for failing to file SARs. In connection with that assessment, FinCEN issued a written Assessment of Civil Money Penalty (the "Assessment"), which included detailed "determinations" regarding AmSouth's BSA compliance procedures. FinCEN found that "AmSouth violated the suspicious activity reporting requirements of the Bank Secrecy Act," and that "[s]ince April 24, 2002, AmSouth has been in violation of the anti-money-laundering program requirements of the Bank Secrecy Act." Among FinCEN's specific determinations were its conclusions that "AmSouth's [AML compliance] program lacked adequate board and management oversight," and that "reporting to management for the purposes of monitoring and oversight of compliance activities was materially deficient." AmSouth neither admitted nor denied FinCEN's determinations in this or any other forum.

Demand Futility and Director Independence

It is a fundamental principle of the Delaware General Corporation Law that "[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors. . . ."^[6] Thus, "by its very nature [a] derivative action impinges on the managerial freedom of directors."^[7] Therefore, the right of a stockholder to prosecute a derivative suit is limited to situations where either the stockholder has [367] demanded the directors pursue a corporate claim and the directors have wrongfully refused to do so, or where demand is excused because the directors are incapable of making an impartial decision regarding whether to institute such litigation.^[8] Court of Chancery Rule 23.1, accordingly, requires that the complaint in a derivative action "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors [or] the reasons for the plaintiff's failure to obtain the action or for not making the effort."^[9]

In this appeal, the plaintiffs concede that "[t]he standards for determining demand futility in the absence of a business decision" are set forth in Rales v. Blasband.^[10] To excuse demand under Rales, "a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."^[11] The plaintiffs attempt to satisfy the Rales test in this proceeding by asserting that the incumbent defendant directors "face a substantial likelihood of liability" that renders them "personally interested in the outcome of the decision on whether to pursue the claims asserted in the complaint," and are therefore not disinterested or independent.^[12]

Critical to this demand excused argument is the fact that the directors' potential personal liability depends upon whether or not their conduct can be exculpated by the section 102(b)(7) provision contained in the AmSouth certificate of incorporation.^[13] Such a provision can exculpate directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty.^[14] The standard for assessing a director's potential personal liability for failing to act in good faith in discharging his or her oversight responsibilities has evolved beginning with our decision in Graham v. Allis-Chalmers Manufacturing Company,^[15] through the Court of Chancery's Caremark decision to our most recent decision in Disney.^[16] A brief discussion of that evolution will help illuminate the standard that we adopt in this case.

Graham and Caremark

Graham was a derivative action brought against the directors of Allis-Chalmers for [368] failure to prevent violations of federal anti-trust laws by Allis-Chalmers employees. There was no claim that the Allis-Chalmers directors knew of the employees' conduct that resulted in the corporation's liability. Rather, the plaintiffs claimed that the Allis-Chalmers directors should have known of the illegal conduct by the corporation's employees. In Graham, this Court held that "absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists."^[17]

In Caremark, the Court of Chancery reassessed the applicability of our holding in Graham when called upon to approve a settlement of a derivative lawsuit brought against the directors of Caremark International, Inc. The plaintiffs claimed that the Caremark directors should have known that certain officers and employees of Caremark were involved in violations of the federal Anti-Referral Payments Law. That law prohibits health care providers from paying any form of remuneration to induce the referral of Medicare or Medicaid patients. The plaintiffs claimed that the Caremark directors breached their fiduciary duty for having "allowed a situation to develop and continue which exposed the corporation to enormous legal liability and that in so doing they violated a duty to be active monitors of corporate performance."^[18]

In evaluating whether to approve the proposed settlement agreement in Caremark, the Court of Chancery narrowly construed our holding in Graham "as standing for the proposition that, absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf."^[19] The Caremark Court opined it would be a "mistake" to interpret this Court's decision in Graham to mean that:

corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance.^[20]

To the contrary, the Caremark Court stated, "it is important that the board exercise a good faith judgment that the corporation's information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, so that it may satisfy its responsibility."^[21] The Caremark Court recognized, however, that "the duty to act in good faith to be informed cannot be thought to require directors to possess detailed information about all aspects of the operation of the enterprise."^[22] The Court of Chancery then formulated the following standard for assessing the liability of directors where the directors are unaware of employee [369] misconduct that results in the corporation being held liable:

Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, as in Graham or in this case, . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability.^[23]

Caremark Standard Approved

As evidenced by the language quoted above, the Caremark standard for so-called "oversight" liability draws heavily upon the concept of director failure to act in good faith. That is consistent with the definition(s) of bad faith recently approved by this Court in its recent Disney^[24] decision, where we held that a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence).^[25] In Disney, we identified the following examples of conduct that would establish a failure to act in good faith:

A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.^[26]

The third of these examples describes, and is fully consistent with, the lack of good faith conduct that the Caremark court held was a "necessary condition" for director oversight liability, i.e., "a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists. . . ."^[27] Indeed, our opinion in Disney cited Caremark with approval for that proposition.^[28] Accordingly, the Court of Chancery applied the correct standard in assessing whether demand was excused in this case where failure to exercise oversight was the basis or theory of the plaintiffs' claim for relief.

It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here—describing the lack of good faith as a "necessary condition to liability"—is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability.^[29] The failure to act in [370] good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty."^[30] It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.

This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty,^[31] the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."^[32]

We hold that Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.^[33] Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities,^[34] they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.^[35]

Chancery Court Decision

The plaintiffs contend that demand is excused under Rule 23.1 because AmSouth's directors breached their oversight duty and, as a result, face a "substantial likelihood of liability" as a result of their "utter failure" to act in good faith to put into place policies and procedures to ensure compliance with BSA and AML obligations. The Court of Chancery found that the plaintiffs did not plead the existence of "red flags"—"facts showing that the board ever was aware that AmSouth's internal controls were inadequate, that these inadequacies would result in illegal activity, and that the board chose to do nothing about problems it allegedly knew existed." In dismissing the derivative complaint in this action, the Court of Chancery concluded:

This case is not about a board's failure to carefully consider a material corporate decision that was presented to the [371] board. This is a case where information was not reaching the board because of ineffective internal controls. . . . With the benefit of hindsight, it is beyond question that AmSouth's internal controls with respect to the Bank Secrecy Act and anti-money laundering regulations compliance were inadequate. Neither party disputes that the lack of internal controls resulted in a huge fine—$50 million, alleged to be the largest ever of its kind. The fact of those losses, however, is not alone enough for a court to conclude that a majority of the corporation's board of directors is disqualified from considering demand that AmSouth bring suit against those responsible.^[36]

This Court reviews de novo a Court of Chancery's decision to dismiss a derivative suit under Rule 23.1.^[37]

Reasonable Reporting System Existed

The KPMG Report evaluated the various components of AmSouth's longstanding BSA/AML compliance program. The KPMG Report reflects that AmSouth's Board dedicated considerable resources to the BSA/AML compliance program and put into place numerous procedures and systems to attempt to ensure compliance. According to KPMG, the program's various components exhibited between a low and high degree of compliance with applicable laws and regulations.

The KPMG Report describes the numerous AmSouth employees, departments and committees established by the Board to oversee AmSouth's compliance with the BSA and to report violations to management and the Board:

BSA Officer. Since 1998, AmSouth has had a "BSA Officer" "responsible for all BSA/AML-related matters including employee training, general communications, CTR reporting and SAR reporting," and "presenting AML policy and program changes to the Board of Directors, the managers at the various lines of business, and participants in the annual training of security and audit personnel[;]"

BSA/AML Compliance Department. AmSouth has had for years a BSA/AML Compliance Department, headed by the BSA Officer and comprised of nineteen professionals, including a BSA/AML Compliance Manager and a Compliance Reporting Manager;

Corporate Security Department. AmSouth's Corporate Security Department has been at all relevant times responsible for the detection and reporting of suspicious activity as it relates to fraudulent activity, and William Burch, the head of Corporate Security, has been with AmSouth since 1998 and served in the U.S. Secret Service from 1969 to 1998; and

Suspicious Activity Oversight Committee. Since 2001, the "Suspicious Activity Oversight Committee" and its predecessor, the "AML Committee," have actively overseen AmSouth's BSA/AML compliance program. The Suspicious Activity Oversight Committee's mission has for years been to "oversee the policy, procedure, and process issues affecting the Corporate Security and BSA/ AML Compliance Programs, to ensure that an effective program exists at AmSouth to deter, detect, and report money laundering, suspicious activity and other fraudulent activity."

The KPMG Report reflects that the directors not only discharged their oversight [372] responsibility to establish an information and reporting system, but also proved that the system was designed to permit the directors to periodically monitor AmSouth's compliance with BSA and AML regulations. For example, as KPMG noted in 2004, AmSouth's designated BSA Officer "has made annual high-level presentations to the Board of Directors in each of the last five years." Further, the Board's Audit and Community Responsibility Committee (the "Audit Committee") oversaw AmSouth's BSA/AML compliance program on a quarterly basis. The KPMG Report states that "the BSA Officer presents BSA/AML training to the Board of Directors annually," and the "Corporate Security training is also presented to the Board of Directors."

The KPMG Report shows that AmSouth's Board at various times enacted written policies and procedures designed to ensure compliance with the BSA and AML regulations. For example, the Board adopted an amended bank-wide "BSA/AML Policy" on July 17, 2003—four months before AmSouth became aware that it was the target of a government investigation. That policy was produced to plaintiffs in response to their demand to inspect AmSouth's books and records pursuant to section 220^[38] and is included in plaintiffs' appendix. Among other things, the July 17, 2003, BSA/AML Policy directs all AmSouth employees to immediately report suspicious transactions or activity to the BSA/AML Compliance Department or Corporate Security.

Complaint Properly Dismissed

In this case, the adequacy of the plaintiffs' assertion that demand is excused depends on whether the complaint alleges facts sufficient to show that the defendant directors are potentially personally liable for the failure of non-director bank employees to file SARs. Delaware courts have recognized that "[m]ost of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention."^[39] Consequently, a claim that directors are subject to personal liability for employee failures is "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment."^[40]

For the plaintiffs' derivative complaint to withstand a motion to dismiss, "only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability."^[41] As the Caremark decision noted:

Such a test of liability—lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight—is quite high. But, a demanding test of liability in the oversight context is probably beneficial to corporate shareholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.^[42]

The KPMG Report—which the plaintiffs explicitly incorporated by reference into their derivative complaint—refutes the assertion that the directors "never took the necessary steps . . . to ensure that a reasonable BSA compliance and reporting system existed." KPMG's findings reflect [373] that the Board received and approved relevant policies and procedures, delegated to certain employees and departments the responsibility for filing SARs and monitoring compliance, and exercised oversight by relying on periodic reports from them. Although there ultimately may have been failures by employees to report deficiencies to the Board, there is no basis for an oversight claim seeking to hold the directors personally liable for such failures by the employees.

With the benefit of hindsight, the plaintiffs' complaint seeks to equate a bad outcome with bad faith. The lacuna in the plaintiffs' argument is a failure to recognize that the directors' good faith exercise of oversight responsibility may not invariably prevent employees from violating criminal laws, or from causing the corporation to incur significant financial liability, or both, as occurred in Graham, Caremark and this very case. In the absence of red flags, good faith in the context of oversight must be measured by the directors' actions "to assure a reasonable information and reporting system exists" and not by second-guessing after the occurrence of employee conduct that results in an unintended adverse outcome.^[43] Accordingly, we hold that the Court of Chancery properly applied Caremark and dismissed the plaintiffs' derivative complaint for failure to excuse demand by alleging particularized facts that created reason to doubt whether the directors had acted in good faith in exercising their oversight responsibilities.

Conclusion

The judgment of the Court of Chancery is affirmed.

[1] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959 (Del.Ch.1996).

[2] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 971; see also David B. Shaev Profit Sharing Acct. v. Armstrong, 2006 WL 391931, at *5 (Del.Ch.); Guttman v. Huang, 823 A.2d 492, 506 (Del.Ch.2003).

[3] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).

[4] 31 U.S.C. § 5318 (2006) et seq. The Bank Secrecy Act and the regulations promulgated thereunder require banks to file with the Financial Crimes Enforcement Network, a bureau of the U.S. Department of the Treasury known as "FinCEN," a written "Suspicious Activity Report" (known as a "SAR") whenever, inter alia, a banking transaction involves at least $5,000 "and the bank knows, suspects, or has reason to suspect" that, among other possibilities, the "transaction involves funds derived from illegal activities or is intended or conducted in order to hide or disguise funds or assets derived from illegal activities. . . ." 31 U.S.C. § 5318(g) (2006); 31 C.F.R. § 103.18(a)(2) (2006).

[5] See, e.g., 31 C.F.R. § 103.18(a)(2) (2006).

[6] Del.Code Ann. tit. 8, § 141(a) (2006). See Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993).

[7] Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984).

[8] Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del.2000).

[9] Ch. Ct. R. 23.1. Allegations of demand futility under Rule 23.1 "must comply with stringent requirements of factual particularity that differ substantially from the permissive notice pleadings governed solely by Chancery Rule 8(a)." Brehm v. Eisner, 746 A.2d at 254.

[10] Rales v. Blasband, 634 A.2d 927 (Del. 1993).

[11] Id. at 934.

[12] The fifteen defendants include eight current and seven former directors. The complaint concedes that seven of the eight current directors are outside directors who have never been employed by AmSouth. One board member, C. Dowd Ritter, the Chairman, is an officer or employee of AmSouth.

[13] Del.Code Ann. tit. 8, § 102(b)(7) (2006).

[14] Id.; see In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).

[15] Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del.1963).

[16] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).

[17] Graham v. Allis-Chalmers Mfg. Co., 188 A.2d at 130 (emphasis added).

[18] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del.Ch.1996).

[19] Id. at 969.

[20] Id. at 970.

[21] Id.

[22] Id. at 971.

[23] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 971.

[24] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).

[25] Id. at 66.

[26] Id. at 67.

[27] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del.Ch.1996).

[28] In re Walt Disney Co. Deriv. Litig., 906 A.2d at 67 n. 111.

[29] That issue, whether a violation of the duty to act in good faith is a basis for the direct imposition of liability, was expressly left open in Disney. 906 A.2d at 67 n. 112. We address that issue here.

[30] Guttman v. Huang, 823 A.2d 492, 506 n. 34 (Del.Ch.2003).

[31] See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993).

[32] Guttman v. Huang, 823 A.2d 492, 506 n. 34 (Del.Ch.2003).

[33] Id. at 506.

[34] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 67 (Del.2006).

[35] See Guttman v. Huang, 823 A.2d at 506.

[36] Stone v. Ritter, C.A. No. 1570-N, 2006 WL 302558, at *2 (Del.Ch.2006) (Letter Opinion).

[37] Beam ex rel. Martha Stewart Living Omnimedia Inc. v. Stewart, 845 A.2d 1040, 1048 (Del.2004).

[38] Del.Code Ann. tit. 8, § 220 (2006).

[39] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 968.

[40] Id. at 967.

[41] Id. at 971.

[42] Id. (emphasis in original).

[43] Id. at 967-68, 971.

7.1.5 UFCWU v. Zuckerberg 7.1.5 UFCWU v. Zuckerberg

Demand Futility Standard

For many years, as noted in Kandell v. Niv, Delaware had two different demand futility standards (Aronson & Rales). Application of the standards depended on the facts presented in the complaint and they could sometimes be confusing. In Zuckerberg, the Chancery Court undertook to simplify, without overturning, these standards. The Chancery Court's approach was endorsed by the Delaware Supreme Court in this opinion. The old standards (Aronson & Rales) are still good law and have not be overruled. Rather, the court has created a new, unified application of those standards that is intended to simplify and improve pleading.

UNITED FOOD AND COMMERCIAL WORKERS UNION AND PARTICIPATING FOOD INDUSTRY EMPLOYERS TRI-STATE PENSION FUND
v.
MARK ZUCKERBERG, et al

Supreme Court of Delaware.

September 23, 2021.

…

MONTGOMERY-REEVES, Justice:

In 2016, the board of directors of Facebook, Inc. ("Facebook") voted in favor of a stock reclassification (the "Reclassification") that would allow Mark Zuckerberg— Facebook's controller, chairman, and chief executive officer—to sell most of his Facebook stock while maintaining voting control of the company. Zuckerberg proposed the Reclassification to allow him and his wife to fulfill a pledge to donate most of their wealth to philanthropic causes. With Zuckerberg casting the deciding votes, Facebook's stockholders approved the Reclassification.

Not long after, numerous stockholders filed lawsuits in the Court of Chancery, alleging that Facebook's board of directors violated their fiduciary duties by negotiating and approving a purportedly one-sided deal that put Zuckerberg's interests ahead of the company's interests. The trial court consolidated more than a dozen of these lawsuits into a single class action. At Zuckerberg's request and shortly before trial, Facebook withdrew the Reclassification and mooted the fiduciary-duty class action. Facebook spent more than $20 million defending against the class action and paid plaintiffs' counsel more than $68 million in attorneys' fees under the corporate benefit doctrine.

Following the settlement, another Facebook stockholder—the United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund ("Tri-State")—filed a derivative complaint in the Court of Chancery. This new action rehashed many of the allegations made in the prior class action but sought compensation for the money Facebook spent in connection with the prior class action.

Tri-State did not make a litigation demand on Facebook's board. Instead, Tri-State pleaded that demand was futile because the board's negotiation and approval of the Reclassification was not a valid exercise of its business judgment and because a majority of the directors were beholden to Zuckerberg. Facebook and the other defendants moved to dismiss Tri-State's complaint under Court of Chancery Rule 23.1, arguing that Tri-State did not make demand or prove that demand was futile. Both sides agreed that the demand futility test established in Aronson v. Lewisapplied to Tri-State's complaint.

In October 2020, the Court of Chancery dismissed Tri-State's complaint under Rule 23.1. The court held that exculpated care claims do not excuse demand under Aronson's second prong because they do not expose directors to a substantial likelihood of liability. The court also held that the complaint failed to raise a reasonable doubt that a majority of the demand board lacked independence from Zuckerberg. In reaching these conclusions, the Court of Chancery applied a three-part test for demand futility that blended the Aronson test with the test articulated in Rales v. Blasband.

Tri-State has appealed the Court of Chancery's judgment. For the reasons provided below, this Court affirms the Court of Chancery's judgment. The second prong of Aronson focuses on whether the derivative claims would expose directors to a substantial likelihood of liability. Exculpated claims do not satisfy that standard because they do not expose directors to a substantial likelihood of liability. Further, the complaint does not plead with particularity that a majority of the demand board lacked independence. Thus, the Court of Chancery properly dismissed Tri-State's complaint for failing to make a demand on the board.

Additionally, this Opinion adopts the Court of Chancery's three-part test for demand futility. When the Court decided Aronson, raising a reasonable doubt that the business judgment standard of review would apply exposed directors to a substantial likelihood of liability for care violations. The General Assembly's enactment of Section 102(b)(7) and other developments in corporate law have weakened the connection between rebutting the business judgment standard and exposing directors to a risk that would sterilize their judgment with respect to a litigation demand. Further, the Aronson test has proved difficult to apply in many contexts, such as where there is turnover on a corporation's board. The Court of Chancery's refined articulation of the Aronson standard helps to address these issues. Nonetheless, this refined standard is consistent with Aronson, Rales, and their progeny. Thus, cases properly applying those holdings remain good law.

RELEVANT FACTS AND PROCEDURAL BACKGROUND
The Parties and Relevant Non-Parties

Appellee Facebook is a Delaware corporation with its principal place of business in California. Facebook is the world's largest social media and networking service and one of the ten largest companies by market capitalization.

Appellant Tri-State has continuously owned stock in Facebook since September 2013.

Appellee Mark Zuckerberg founded Facebook and has served as its chief executive officer since July 2014. Zuckerberg controls a majority of Facebook's voting power and has been the chairman of Facebook's board of directors since January 2012.

Appellee Marc Andreessen has served as a Facebook director since June 2008. Andreessen was a member of the special committee that negotiated and recommended that the full board approve the Reclassification. In addition to his work as a Facebook director, Andreessen is a cofounder and general partner of the venture capital firm Andreessen Horowitz.

Appellee Peter Thiel has served as a Facebook director since April 2005. Thiel voted in favor of the Reclassification. In addition to his work as a Facebook director, Thiel is a partner at the venture capital firm Founders Firm.

Appellee Reed Hastings began serving as a Facebook director in June 2011 and was still a director when Tri-State filed its complaint. Hastings voted in favor of the Reclassification. In addition to his work as a Facebook director, Hastings founded and serves as the chief executive officer and chairman of Netflix, Inc. ("Netflix").

Appellee Erskine B. Bowles began serving as a Facebook director in September 2011 and was still a director when Tri-State filed its complaint. Bowles was a member of the special committee that negotiated and recommended that the full board approve the Reclassification.

Appellee Susan D. Desmond-Hellman began serving as a Facebook director in March 2013 and was still a director when Tri-State filed its complaint. Desmond-Hellman was the chair of the special committee that negotiated and recommended that the full board approve the Reclassification. In addition to her work as a Facebook director, Desmond-Hellman served as the chief executive officer of the Bill and Melinda Gates Foundation (the "Gates Foundation") during the events relevant to this appeal.

Sheryl Sandberg has been Facebook's chief operating officer since March 2018 and has served as a Facebook director since January 2012.

Kenneth I. Chenault began serving as a Facebook director in February 2018 and was still a director when Tri-State filed its complaint. Chenault was not a director when Facebook's board voted in favor of the Reclassification in 2016.

Jeffery Zients began serving as a Facebook director in May 2018 and was still a director when Tri-State filed its complaint. Zients was not a director when Facebook's board voted in favor of the Reclassification in 2016.

Zuckerberg Takes the Giving Pledge

According to the allegations in the complaint, in December 2010, Zuckerberg took the Giving Pledge, a movement championed by Bill Gates and Warren Buffet that challenged wealthy business leaders to donate a majority of their wealth to philanthropic causes. Zuckerberg communicated widely that he had taken the pledge and intended to start his philanthropy at an early age.

In March 2015, Zuckerberg began working on an accelerated plan to complete the Giving Pledge by making annual donations of $2 to $3 billion worth of Facebook stock. Zuckerberg asked Facebook's general counsel to look into the plan. Facebook's legal team cautioned Zuckerberg that he could only sell a small portion of his stock—$3 to $4 billion based on the market price—without dipping below majority voting control. To avoid this problem, the general counsel suggested that Facebook could follow the "Google playbook" and issue a new class of non-voting stock that Zuckerberg could sell without significantly diminishing his voting power. The legal team recommended that the board form a special committee of independent directors to review and approve the plan and noted that litigation involving Google's reclassification resulted in a $522 million settlement. Zuckerberg instructed Facebook's legal team to "start figuring out how to make this happen."

The Special Committee Approves the Reclassification

At an August 20, 2015 meeting of Facebook's board, Zuckerberg formally proposed that Facebook issue a new class of non-voting shares, which would allow him to sell a substantial amount of stock without losing control of the company. Zuckerberg also disclosed that he had hired Simpson Thacher & Bartlett LLP ("Simpson Thacher") to give him personal legal advice about "what creating a new class of stock might look like."

A couple of days later, Facebook established a special committee, which was composed of three purportedly-independent directors: Andreessen, Bowles, and Desmond-Hellman (the "Special Committee").The board charged the Special Committee with evaluating the Reclassification, considering alternatives, and making a recommendation to the full board. The board also authorized the Special Committee to retain legal counsel, financial advisors, and other experts.

Facebook management recommended and the Special Committee hired Wachtell, Lipton, Rosen & Katz ("Wachtell") as the committee's legal advisor. Before meeting with the Special Committee, Wachtell called Zuckerberg's contacts at Simpson Thacher to discuss the potential terms of the Reclassification. Simpson Thacher rejected as non-starters several features from the Google playbook, such as a stapling provision that would have required Zuckerberg to sell a share of his voting stock each time that he sold a share of the non-voting stock, and a true-up payment that would compensate Facebook's other stockholders for the dilution of their voting power. By the time Wachtell first met with the Special Committee, the key contours of the Reclassification were already taking shape, and the Special Committee anticipated that the Reclassification would occur. Thus, the Special Committee focused on suggesting changes to the Reclassification rather than considering alternatives or threatening to reject the plan. …

As the negotiations progressed, the Special Committee largely agreed to give Zuckerberg the terms that he wanted and did not consider alternatives or demand meaningful concessions. …

A few weeks later, Zuckerberg published a post on his Facebook page announcing that he planned to begin making large donations of his Facebook stock. The post noted that Zuckerberg intended to "remain Facebook's CEO for many, many years to come" and did not mention that his plan hinged on the Special Committee's approval of the Reclassification. The Special Committee did not try to use the public announcement as leverage to extract more concessions from Zuckerberg. …

On April 13, 2016, the Special Committee recommend that the full board approve the Reclassification. The next day, Facebook's full board accepted the Special Committee's recommendation and voted to approve the Reclassification. Zuckerberg and Sandberg abstained from voting on the Reclassification.

Facebook Settles a Class Action Challenging the Reclassification

On April 27, 2016, Facebook revealed the Reclassification to the public. … On April 29, 2016, the first class action was filed in the Court of Chancery challenging the Reclassification. Several more similar complaints were filed, and in May 2016 the Court of Chancery consolidated thirteen cases into a single class action (the "Reclassification Class Action"). …

On June 24, 2016, Facebook agreed that it would not go forward with the Reclassification while the Reclassification Class Action was pending. The Court of Chancery certified the Reclassification Class Action in April 2017 and tentatively scheduled the trial for September 26, 2017.About a week before the trial was scheduled to begin, Zuckerberg asked the board to abandon the Reclassification.The board agreed, and the next day Facebook filed a Form 8-K with the Securities and Exchange Commission disclosing that the company had abandoned the Reclassification and mooted the Class Action.The Form-8K also disclosed that despite abandoning the Reclassification, Zuckerberg planned to sell a substantial number of shares over the coming 18 months. …

Tri-State Files a Class Action Seeking to Recoup the Money that Facebook Spent Defending and Settling the Reclassification Class Action

Facebook spent about $21.8 million defending the Reclassification Class Action, including more than $17 million on attorneys' fees. Additionally, Facebook paid $68.7 million to the plaintiff's attorneys in the Reclassification Class Action to settle a claim under the corporate benefit doctrine.

On September 12, 2018, Tri-State filed a derivative action in the Court of Chancery seeking to recoup the money that Facebook spent defending and settling the Reclassification Class Action. …

The complaint alleged that demand was excused as futile under Court of Chancery Rule 23.1 because "the Reclassification was not the product of a valid exercise of business judgment" and because "a majority of the Board face[d] a substantial likelihood of liability[] and/or lack[ed] independence.” …

Tri-State appeals the Court of Chancery's judgment dismissing the derivative complaint under Rule 23.1 for failing to make a demand on the board or plead with particularity facts establishing that demand would be futile.

STANDARD OF REVIEW

…

"A cardinal precept" of Delaware law is "that directors, rather than shareholders, manage the business and affairs of the corporation." This precept is reflected in Section 141(a) of the Delaware General Corporation Law ("DGCL"), which provides that "[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors except as may be otherwise provided in this chapter or in [a corporation's] certificate of incorporation."The board's authority to govern corporate affairs extends to decisions about what remedial actions a corporation should take after being harmed, including whether the corporation should file a lawsuit against its directors, its officers, its controller, or an outsider.

"In a derivative suit, a stockholder seeks to displace the board's [decision-making] authority over a litigation asset and assert the corporation's claim."Thus, "[b]y its very nature[,] the derivative action" encroaches "on the managerial freedom of directors" by seeking to deprive the board of control over a corporation's litigation asset."In order for a stockholder to divest the directors of their authority to control the litigation asset and bring a derivative action on behalf of the corporation, the stockholder must" (1) make a demand on the company's board of directors or (2) show that demand would be futile.The demand requirement is a substantive requirement that "`[e]nsure[s] that a stockholder exhausts his intracorporate remedies,' `provide[s] a safeguard against strike suits,' and `assure[s] that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur.'"

Court of Chancery Rule 23.1 implements the substantive demand requirement at the pleading stage by mandating that derivative complaints "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort." To comply with Rule 23.1, the plaintiff must meet "stringent requirements of factual particularity that differ substantially from . . . permissive notice pleadings."When considering a motion to dismiss a complaint for failing to comply with Rule 23.1, the Court does not weigh the evidence, must accept as true all of the complaint's particularized and well-pleaded allegations, and must draw all reasonable inferences in the plaintiff's favor.

The plaintiff in this action did not make a pre-suit demand. Thus, the question before the Court is whether demand is excused as futile. This Court has articulated two tests to determine whether the demand requirement should be excused as futile: the Aronson test and the Rales test. The Aronson test applies where the complaint challenges a decision made by the same board that would consider a litigation demand. Under Aronson, demand is excused as futile if the complaint alleges particularized facts that raise a reasonable doubt that "(1) the directors are disinterested and independent[,] [or] (2) the challenged transaction was otherwise the product of a valid business judgment." This reflects the "rule . . . that where officers and directors are under an influence which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation. Thus, demand would be futile."

The Rales test applies in all other circumstances. Under Rales, demand is excused as futile if the complaint alleges particularized facts creating a "reasonable doubt that, as of the time the complaint is filed," a majority of the demand board "could have properly exercised its independent and disinterested business judgment in responding to a demand." "Fundamentally, Aronson and Rales both `address the same question of whether the board can exercise its business judgment on the corporat[ion]'s behalf' in considering demand." For this reason, the Court of Chancery has recognized that the broader reasoning of Rales encompasses Aronson, and therefore the Aronson test is best understood as a special application of the Rales test.

While Delaware law recognizes that there are circumstances where making a demand would be futile because a majority of the directors "are under an influence which sterilizes their discretion" and "cannot be considered proper persons to conduct litigation on behalf of the corporation,"the demand requirement is not excused lightly because derivative litigation upsets the balance of power that the DGCL establishes between a corporation's directors and its stockholders. Thus, the demand-futility analysis provides an important doctrinal check that ensures the board is not improperly deprived of its decision-making authority, while at the same time leaving a path for stockholders to file a derivative action where there is reason to doubt that the board could bring its impartial business judgment to bear on a litigation demand.

In this case, Tri-State alleged that demand was excused as futile for several reasons, including that the board's negotiation and approval of the Reclassification would not be "protected by the business judgment rule" because "[t]heir approval was not fully informed" or "duly considered," and that a majority of the directors on the Demand Board lacked independence from Zuckerberg.The Court of Chancery held that Tri-State failed to plead with particularity facts establishing that demand was futile and dismissed the complaint because it did not comply with Court of Chancery Rule 23.1.

On appeal, Tri-State raises two issues with the Court of Chancery's demand-futility analysis. First, Tri-State argues that the Court of Chancery erred by holding that exculpated care violations do not satisfy the second prong of the Aronson test. Second, Tri-State argues that its complaint contained particularized allegations establishing that a majority of the directors on the Demand Board were beholden to Zuckerberg. …

This Court adopts the Court of Chancery's three-part test for demand futility

This [first] issue raises one more question—whether the three-part test for demand futility the Court of Chancery applied below is consistent with Aronson, Rales, and their progeny. The Court of Chancery noted that turnover on Facebook's board, along with a director's decision to abstain from voting on the Reclassification, made it difficult to apply the Aronson test to the facts of this case:

The composition of the Board in this case exemplifies the difficulties that the Aronson test struggles to overcome. The Board has nine members, six of whom served on the Board when it approved the Reclassification. Under a strict reading of Rales, because the Board does not have a new majority of directors, Aronson provides the governing test. But one of those six directors abstained from the vote on the Reclassification, meaning that the Aronson analysis only has traction for five of the nine. Aronson does not provide guidance about what to do with either the director who abstained or the two directors who joined the Board later. The director who abstained from voting on the Reclassification suffers from other conflicts that renders her incapable of considering a demand, yet a strict reading of Aronson only focuses on the challenged decision and therefore would not account for those conflicts. Similarly, the plaintiff alleges that one of the directors who subsequently joined the Board has conflicts that render him incapable of considering a demand, but a strict reading of Aronson would not account for that either. Precedent thus calls for applying Aronson, but its analytical framework is not up to the task. The Rales test, by contrast, can accommodate all of these considerations.

The court also suggested that in light of the developments discussed above, "Aronson is broken in its own right because subsequent jurisprudential developments have rendered non-viable the core premise on which Aronson depends—the notion that an elevated standard of review standing alone results in a substantial likelihood of liability sufficient to excuse demand. Perhaps the time has come to move on from Aronson entirely."

To address these concerns, the Court of Chancery applied the following three-part test on a director-by-director basis to determine whether demand should be excused as futile:

(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;

(ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and

(iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.

This approach treated "Rales as the general demand futility test," while "draw[ing] upon Aronson-like principles when evaluating whether particular directors face a substantial likelihood of liability as a result of having participated in the decision to approve the Reclassification."

This Court adopts the Court of Chancery's three-part test as the universal test for assessing whether demand should be excused as futile. When the Court decided Aronson, it made sense to use the standard of review to assess whether directors were subject to an influence that would sterilize their discretion with respect to a litigation demand. Subsequent changes in the law have eroded the ground upon which that framework rested. Those changes cannot be ignored, and it is both appropriate and necessary that the common law evolve in an orderly fashion to incorporate those developments. The Court of Chancery's three-part test achieves that important goal. Blending the Aronson test with the Rales test is appropriate because "both `address the same question of whether the board can exercise its business judgment on the corporat[ion]'s behalf' in considering demand";and the refined test does not change the result of demand-futility analysis.

Further, the refined test "refocuses the inquiry on the decision regarding the litigation demand, rather than the decision being challenged." Notwithstanding text focusing on the propriety of the challenged transaction, this approach is consistent with the overarching concern that Aronson identified: whether the directors on the demand board "cannot be considered proper persons to conduct litigation on behalf of the corporation" because they "are under an influence which sterilizes their discretion." The purpose of the demand-futility analysis is to assess whether the board should be deprived of its decision-making authority because there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand. That is a different consideration than whether the derivative claim is strong or weak because the challenged transaction is likely to pass or fail the applicable standard of review. It is helpful to keep those inquiries separate. And the Court of Chancery's three-part test is particularly helpful where, like here, board turnover and director abstention make it difficult to apply the Aronson test as written.

Finally, because the three-part test is consistent with and enhances Aronson, Rales, and their progeny, the Court need not overrule Aronson to adopt this refined test, and cases properly construing Aronson, Rales, and their progeny remain good law.

Accordingly, from this point forward, courts should ask the following three questions on a director-by-director basis when evaluating allegations of demand futility:

(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;

(ii) whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and

(iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.

If the answer to any of the questions is "yes" for at least half of the members of the demand board, then demand is excused as futile. It is no longer necessary to determine whether the Aronson test or the Rales test governs a complaint's demand-futility allegations.

…

The Demand Board was composed of nine directors. Tri-State concedes on appeal that two of those directors, Chenault and Zients, could have impartially considered a litigation demand. And Facebook does not argue on appeal that Zuckerberg, Sandberg, or Andreessen could have impartially considered a litigation demand. Thus, in order to show that demand is futile, Tri-State must sufficiently allege that two of the following directors could not impartially consider demand: Thiel, Hastings, Bowles, and Desmond-Hellmann.

Hastings

The complaint does not raise a reasonable doubt that Hastings lacked independence from Zuckerberg. According to the complaint, Hastings was not independent because:

"Netflix purchased advertisements from Facebook at relevant times," and maintains "ongoing and potential future business relationships with" Facebook.
According to an article published by The New York Times,Facebook gave to Netflix and several other technology companies "more intrusive access to users' personal data than it ha[d] disclosed, effectively exempting those partners from privacy rules."
"Hastings (as a Netflix founder) is biased in favor of founders maintaining control of their companies."
"Hastings has . . . publicly supported large philanthropic donations by founders during their lifetimes. Indeed, both Hastings and Zuckerberg have been significant contributors . . . [to] a well-known foundation known for soliciting and obtaining large contributions from company founders and which manages donor funds for both Hastings . . . and Zuckerberg . . . ."

These allegations do not raise a reasonable doubt that Hastings was beholden to Zuckerberg. Even if Netflix purchased advertisements from Facebook, the complaint does not allege that those purchases were material to Netflix or that Netflix received anything other than arm's length terms under those agreements. Similarly, the complaint does not make any particularized allegations explaining how obtaining special access to Facebook user data was material to Netflix's business interests, or that Netflix used its special access to user data to obtain any concrete benefits in its own business.

Further, having a bias in favor of founder-control does not mean that Hastings lacks independence from Zuckerberg. Hastings might have a good-faith belief that founder control maximizes a corporation's value over the long-haul. If so, that good-faith belief would play a valid role in Hasting's exercise of his impartial business judgment.

Finally, alleging that Hastings and Zuckerberg have a track record of donating to similar causes falls short of showing that Hastings is beholden to Zuckerberg. As the Court of Chancery noted below, "[t]here is no logical reason to think that a shared interest in philanthropy would undercut Hastings' independence. Nor is it apparent how donating to the same charitable fund would result in Hastings feeling obligated to serve Zuckerberg's interests." Accordingly, the Court affirms the Court of Chancery's holding that the complaint does not raise a reasonable doubt about Hastings's independence.

Thiel

The complaint does not raise a reasonable doubt that Thiel lacked independence from Zuckerberg. According to the complaint, Thiel was not independent because:

"Thiel was one of the early investors in Facebook," is "its longest-tenured board member besides Zuckerberg," and "has . . . been instrumental to Facebook's business strategy and direction over the years."
"Thiel has a personal bias in favor of keeping founders in control of the companies they created ..."
The venture capital firm at which Thiel is a partner, Founders Fund, "gets `good deal flow'" from its "high-profile association with Facebook."
"According to Facebook's 2018 Proxy Statement, the Facebook shares owned by the Founders Fund (i.e.,by Thiel and Andreessen) will be released from escrow in connection with" an acquisition.
"Thiel is Zuckerberg's close friend and mentor."
In October 2016, Thiel made a $1 million donation to an "organization that paid [a substantial sum to] Cambridge Analytica" and "cofounded the Cambridge Analytica-linked data firm Palantir.” Even though "[t]he Cambridge Analytica scandal has exposed Facebook to regulatory investigations" and litigation, Zuckerberg did not try to remove Thiel from the board.
Similarly, Thiel's "acknowledge[ment] that he secretly funded various lawsuits aimed at bankrupting [the] news website Gawker Media" lead to "widespread calls for Zuckerberg to remove Thiel from Facebook's Board given Thiel's apparent antagonism toward a free press." Zuckerberg ignored those calls and did not seek to remove Thiel from Facebook's board.

These allegations do not raise a reasonable doubt that Thiel is beholden to Zuckerberg. The complaint does not explain why Thiel's status as a long-serving board member, early investor, or his contributions to Facebook's business strategy make him beholden to Zuckerberg. And for the same reasons provided above, a director's good faith belief that founder controller maximizes value does not raise a reasonable doubt that the director lacks independence from a corporation's founder.

While the complaint alleges that Founders Fund "gets `good deal flow'" from Thiel's "high-profile association with Facebook," the complaint does not identify a single deal that flowed to—or is expected to flow to—Founders Fund through this association, let alone any deals that would be material to Thiel's interests. The complaint also fails to draw any connection between Thiel's continued status as a director and the vesting of Facebook stock related to the acquisition. And alleging that Thiel is a personal friend of Zuckerberg is insufficient to establish a lack of independence.

The final pair of allegations suggest that because "Zuckerberg stood by Thiel" in the face of public scandals, "Thiel feels a sense of obligation to Zuckerberg." These allegations can only raise a reasonable doubt about Thiel's independence if remaining a Facebook director was financially or personally material to Thiel. As the Court of Chancery noted below, given Thiel's wealth and stature, "[t]he complaint does not support an inference that Thiel's service on the Board is financially material to him. Nor does the complaint sufficiently allege that serving as a Facebook director confers such cachet that Thiel's independence is compromised." Accordingly, this Court affirms the Court of Chancery's holding that the complaint does not raise a reasonable doubt about Thiel's independence.

Bowles

The complaint does not raise a reasonable doubt that Bowles lacked independence from Zuckerberg. According to the complaint, Thiel was not independent because:

"Bowles is beholden to the entire board" because it granted "a waiver of the mandatory retirement age for directors set forth in Facebook's Corporate Governance Guidelines," allowing "Bowles to stand for reelection despite having reached 70 years old before" the May 2018 annual meeting.
"Morgan Stanley—a company for which [Bowles] . . . served as a longstanding board member at the time (2005-2017)—directly benefited by receiving over $2 million in fees for its work . . . in connection with the Reclassification . . . ."
Bowles "ensured that Evercore and his close friend Altman financially benefitted from the Special Committee's engagement" without properly vetting Evercore's competency or considering alternatives.

These allegations do not raise a reasonable doubt that Bowles is beholden to Zuckerberg or the other members of the Demand Board. The complaint does not make any particularized allegation explaining why the board's decision to grant Bowles a waiver from the mandatory retirement age would compromise his ability to impartially consider a litigation demand or engender a sense of debt to the other directors. For example, the complaint does not allege that Bowles was expected to do anything in exchange for the waiver, or that remaining a director was financially or personally material to Bowles.

The complaint's allegations regarding Bowles's links to financial advisors are similarly ill-supported. None of these allegations suggest that Bowles received a personal benefit from the Reclassification, or that Bowles's ties to these advisors made him beholden to Zuckerberg as a condition of sending business to Morgan Stanley, Evercore, or his "close friend Altman." Accordingly, this Court affirms the Court of Chancery's holding that the complaint does not raise a reasonable doubt about Bowles's independence.

…

For the reasons provided above, the Court of Chancery's judgment is affirmed.

7.1.6 Zapata v. Maldonado 7.1.6 Zapata v. Maldonado

Zapata is the leading case on the legal standard a court will apply to a special litigation committee's motion to take control over derivative litigation following following the 23.1 motion to dismiss and prior to going to trial. Look at the facts related to the interestedness and independence of directors on the special litigation committee. Consider whether under these same facts demand would have been deemed futile with respect to these directors at the 23.1 motion to dismiss stage.

430 A.2d 779 (1981)

ZAPATA CORPORATION, Defendant Below, Appellant,
v.
William MALDONADO, Plaintiff Below, Appellee.

Supreme Court of Delaware.
Submitted December 31, 1980^[*].
Decided May 13, 1981.

Robert K. Payson, (argued) of Potter, Anderson & Corroon, Wilmington, and Thomas F. Curnin, Thomas J. Kavaler, P. Kevin Castel and Edward P. Krugman of Cahill, Gordon & Reindel, New York City, of counsel, for defendant-appellant.

Charles F. Richards, Jr. of Richards, Layton & Finger, Wilmington, for individual defendants.

Irving Morris and Joseph A. Rosenthal of Morris & Rosenthal, Wilmington, Sidney L. Garwin (argued), and Bruce E. Gerstein of Garwin, Bronzaft & Gerstein, New York City, of counsel, for plaintiff-appellee.

Arthur G. Connolly, Jr. of Connolly, Bove & Lodge, Wilmington, for amici curiae.

Before DUFFY, QUILLEN and HORSEY, JJ.

[780] QUILLEN, Justice:

This is an interlocutory appeal from an order entered on April 9, 1980, by the Court of Chancery denying appellant-defendant Zapata Corporation's (Zapata) alternative motions to dismiss the complaint or for summary judgment. The issue to be addressed has reached this Court by way of a rather convoluted path.

In June, 1975, William Maldonado, a stockholder of Zapata, instituted a derivative action in the Court of Chancery on behalf of Zapata against ten officers and/or directors of Zapata, alleging, essentially, breaches of fiduciary duty. Maldonado did not first demand that the board bring this action, stating instead such demand's futility because all directors were named as defendants and allegedly participated in the acts specified.^[1] In June, 1977, Maldonado commenced an action in the United States District Court for the Southern District of New York against the same defendants, save one, alleging federal security law violations as well as the same common law claims made previously in the Court of Chancery.

[781] By June, 1979, four of the defendant-directors were no longer on the board, and the remaining directors appointed two new outside directors to the board. The board then created an "Independent Investigation Committee" (Committee), composed solely of the two new directors, to investigate Maldonado's actions, as well as a similar derivative action then pending in Texas, and to determine whether the corporation should continue any or all of the litigation. The Committee's determination was stated to be "final, ... not ... subject to review by the Board of Directors and ... in all respects ... binding upon the Corporation."

Following an investigation, the Committee concluded, in September, 1979, that each action should "be dismissed forthwith as their continued maintenance is inimical to the Company's best interests...." Consequently, Zapata moved for dismissal or summary judgment in the three derivative actions. On January 24, 1980, the District Court for the Southern District of New York granted Zapata's motion for summary judgment, Maldonado v. Flynn, S.D.N.Y., 485 F.Supp. 274 (1980), holding, under its interpretation of Delaware law, that the Committee had the authority, under the "business judgment" rule, to require the termination of the derivative action. Maldonado appealed that decision to the Second Circuit Court of Appeals.

On March 18, 1980, the Court of Chancery, in a reported opinion, the basis for the order of April 9, 1980, denied Zapata's motions, holding that Delaware law does not sanction this means of dismissal. More specifically, it held that the "business judgment" rule is not a grant of authority to dismiss derivative actions and that a stockholder has an individual right to maintain derivative actions in certain instances. Maldonado v. Flynn, Del.Ch., 413 A.2d 1251 (1980) (herein Maldonado). Pursuant to the provisions of Supreme Court Rule 42, Zapata filed an interlocutory appeal with this Court shortly thereafter. The appeal was accepted by this Court on June 5, 1980. On May 29, 1980, however, the Court of Chancery dismissed Maldonado's cause of action, its decision based on principles of res judicata, expressly conditioned upon the Second Circuit affirming the earlier New York District Court's decision.^[2] The Second Circuit appeal was ordered stayed, however, pending this Court's resolution of the appeal from the April 9th Court of Chancery order denying dismissal and summary judgment.

Thus, Zapata's observation that it sits "in a procedural gridlock" appears quite accurate, and we agree that this Court can and should attempt to resolve the particular question of Delaware law.^[3] As the Vice Chancellor noted, 413 A.2d at 1257, "it is the law of the State of incorporation which determines whether the directors have this power of dismissal, Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979)". We limit our review in this interlocutory appeal to whether the Committee has the power to cause the present action to be dismissed.

We begin with an examination of the carefully considered opinion of the Vice Chancellor which states, in part, that the "business judgment" rule does not confer power "to a corporate board of directors to terminate a derivative suit", 413 A.2d at 1257. His conclusion is particularly pertinent because several federal courts, applying Delaware law, have held that the business judgment rule enables boards (or their committees) to terminate derivative suits, decisions now in conflict with the holding below.^[4]

[782] As the term is most commonly used, and given the disposition below, we can understand the Vice Chancellor's comment that "the business judgment rule is irrelevant to the question of whether the Committee has the authority to compel the dismissal of this suit". 413 A.2d at 1257. Corporations, existing because of legislative grace, possess authority as granted by the legislature. Directors of Delaware corporations derive their managerial decision making power, which encompasses decisions whether to initiate, or refrain from entering, litigation,^[5] from 8 Del.C. § 141 (a).^[6] This statute is the fount of directorial powers. The "business judgment" rule is a judicial creation that presumes propriety, under certain circumstances, in a board's decision.^[7] Viewed defensively, it does not create authority. In this sense the "business judgment" rule is not relevant in corporate decision making until after a decision is made. It is generally used as a defense to an attack on the decision's soundness. The board's managerial decision making power, however, comes from § 141(a). The judicial creation and legislative grant are related because the "business judgment" rule evolved to give recognition and deference to directors' business expertise when exercising their managerial power under § 141(a).

In the case before us, although the corporation's decision to move to dismiss or for summary judgment was, literally, a decision resulting from an exercise of the directors' (as delegated to the Committee) business judgment, the question of "business judgment", in a defensive sense, would not become relevant until and unless the decision to seek termination of the derivative lawsuit was attacked as improper. Maldonado, 413 A.2d at 1257. Accord, Abella v. Universal Leaf Tobacco Co., Inc., E.D.Va., 495 F.Supp. 713 (1980) (applying Virginia law); Maher v. Zapata Corp., S.D.Tex., 490 F.Supp. 348 (1980) (applying Delaware law). See also, Dent, supra note 5, 75 Nw.U.L. Rev. at 101-02, 135. This question was not reached by the Vice Chancellor because he determined that the stockholder had an individual right to maintain this derivative action. Maldonado, 413 A.2d at 1262.

Thus, the focus in this case is on the power to speak for the corporation as to whether the lawsuit should be continued or terminated. As we see it, this issue in the current appellate posture of this case has three aspects: the conclusions of the Court below concerning the continuing right of a stockholder to maintain a derivative action; the corporate power under Delaware law of an authorized board committee to cause dismissal of litigation instituted for the benefit of the corporation; and the role of the Court of Chancery in resolving conflicts between the stockholder and the committee.

Accordingly, we turn first to the Court of Chancery's conclusions concerning the right of a plaintiff stockholder in a derivative action. We find that its determination that a stockholder, once demand is made and refused, possesses an independent, individual right to continue a derivative suit for breaches of fiduciary duty over objection by the corporation, Maldonado, 413 A.2d at 1262-63, as an absolute rule, is erroneous. The Court of Chancery relied principally upon Sohland v. Baker, Del.Supr., 141 A. [783] 277 (1927), for this statement of the Delaware rule. Maldonado, 413 A.2d at 1260-61. Sohland is sound law. But Sohland cannot be fairly read as supporting the broad proposition which evolved in the opinion below.

In Sohland, the complaining stockholder was allowed to file the derivative action in equity after making demand and after the board refused to bring the lawsuit. But the question before us relates to the power of the corporation by motion to terminate a lawsuit properly commenced by a stockholder without prior demand. No Delaware statute or case cited to us directly determines this new question and we do not think that Sohland addresses it by implication.

The language in Sohland relied on by the Vice Chancellor negates the contention that the case stands for the broad rule of stockholder right which evolved below. This Court therein stated that "a stockholder may sue in his own name for the purpose of enforcing corporate rights ... in a proper case if the corporation on the demand of the stockholder refuses to bring suit." 141 A. at 281 (emphasis added). The Court also stated that "whether ["[t]he right of a stockholder to file a bill to litigate corporate rights"] exists necessarily depends on the facts of each particular case." 141 A. at 282 (emphasis added). Thus, the precise language only supports the stockholder's right to initiate the lawsuit. It does not support an absolute right to continue to control it.

Additionally, the issue and context in Sohland are simply different from this case. Baker, a stockholder, suing on behalf of Bankers' Mortgage Co., sought cancellation of stock issued to Sohland, a director of Bankers', in a transaction participated in by a "great majority" of Bankers' board. Before instituting his suit, Baker requested the board to assert the cause of action. The board refused. Interestingly, though, on the same day the board refused, it authorized payment of Baker's attorneys fees so that he could pursue the claim; one director actually escorted Baker to the attorneys suggested by the board. At this chronological point, Sohland had resigned from the board, and it was he, not the board, who was protesting Baker's ability to bring suit. In sum, despite the board's refusal to bring suit, it is clear that the board supported Baker in his efforts.^[8] It is not surprising then that he was allowed to proceed as the corporation's representative "for the prevention of injustice", because "the corporation itself refused to litigate an apparent corporate right." 141 A. at 282.

Moreover, McKee v. Rogers, Del.Ch., 156 A. 191 (1931), stated "as a general rule" that "a stockholder cannot be permitted... to invade the discretionary field committed to the judgment of the directors and sue in the corporation's behalf when the managing body refuses. This rule is a well settled one." 156 A. at 193.^[9]

The McKee rule, of course, should not be read so broadly that the board's refusal will be determinative in every instance. Board members, owing a well-established fiduciary duty to the corporation, will not be allowed to cause a derivative suit to be dismissed when it would be a breach of their fiduciary duty. Generally [784] disputes pertaining to control of the suit arise in two contexts.

Consistent with the purpose of requiring a demand, a board decision to cause a derivative suit to be dismissed as detrimental to the company, after demand has been made and refused, will be respected unless it was wrongful.^[10] See, e. g., United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 510, 61 L.Ed. 1119, 1124 (1917); Stockholder Derivative Actions, supra note 5, 44 U.Chi. L.Rev. at 169, 191-92; Note, Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit, 73 Har.L.Rev. 746, 748, 759 (1960); 13 W. Fletcher, Cyclopedia of the Law of Private Corporations § 5969 (rev.perm.ed. 1980). A claim of a wrongful decision not to sue is thus the first exception and the first context of dispute. Absent a wrongful refusal, the stockholder in such a situation simply lacks legal managerial power. Compare Maldonado, 413 A.2d at 1259-60.

But it cannot be implied that, absent a wrongful board refusal, a stockholder can never have an individual right to initiate an action. For, as is stated in McKee, a "well settled" exception exists to the general rule.

"[A] stockholder may sue in equity in his derivative right to assert a cause of action in behalf of the corporation, without prior demand upon the directors to sue, when it is apparent that a demand would be futile, that the officers are under an influence that sterilizes discretion and could not be proper persons to conduct the litigation."

156 A. at 193 (emphasis added). This exception, the second context for dispute, is consistent with the Court of Chancery's statement below, that "[t]he stockholders' individual right to bring the action does not ripen, however, ... unless he can show a demand to be futile." Maldonado, 413 A.2d at 1262.^[11]

These comments in McKee and in the opinion below make obvious sense. A demand, when required and refused (if not wrongful), terminates a stockholder's legal ability to initiate a derivative action.^[12] But where demand is properly excused, the stockholder does possess the ability to initiate the action on his corporation's behalf.

These conclusions, however, do not determine the question before us. Rather, they merely bring us to the question to be decided. It is here that we part company with the Court below. Derivative suits enforce corporate rights and any recovery obtained goes to the corporation. Taormina v. Taormina Corp., Del.Ch., 78 A.2d 473, 476 (1951); Keenan v. Eshleman, Del.Supr., 2 A.2d 904, 912-13 (1938). "The right of a stockholder to file a bill to litigate corporate rights is, therefore, solely for the purpose of preventing injustice where it is apparent that material corporate rights would not otherwise be protected." Sohland, 141 A. at 282. We see no inherent reason why the "two phases" of a derivative suit, the stockholder's suit to compel the corporation to sue and the corporation's suit (see 413 A.2d at 1261-62), should automatically result in the placement in the hands of the [785] litigating stockholder sole control of the corporate right throughout the litigation. To the contrary, it seems to us that such an inflexible rule would recognize the interest of one person or group to the exclusion of all others within the corporate entity. Thus, we reject the view of the Vice Chancellor as to the first aspect of the issue on appeal.

The question to be decided becomes: When, if at all, should an authorized board committee be permitted to cause litigation, properly initiated by a derivative stockholder in his own right, to be dismissed? As noted above, a board has the power to choose not to pursue litigation when demand is made upon it, so long as the decision is not wrongful. If the board determines that a suit would be detrimental to the company, the board's determination prevails. Even when demand is excusable, circumstances may arise when continuation of the litigation would not be in the corporation's best interests. Our inquiry is whether, under such circumstances, there is a permissible procedure under § 141(a) by which a corporation can rid itself of detrimental litigation. If there is not, a single stockholder in an extreme case might control the destiny of the entire corporation. This concern was bluntly expressed by the Ninth Circuit in Lewis v. Anderson, 9th Cir., 615 F.2d 778, 783 (1979), cert. denied, ___ U.S. ___, 101 S.Ct. 206, 66 L.Ed.2d 89 (1980): "To allow one shareholder to incapacitate an entire board of directors merely by leveling charges against them gives too much leverage to dissident shareholders." But, when examining the means, including the committee mechanism examined in this case, potentials for abuse must be recognized. This takes us to the second and third aspects of the issue on appeal.

Before we pass to equitable considerations as to the mechanism at issue here, it must be clear that an independent committee possesses the corporate power to seek the termination of a derivative suit. Section 141(c) allows a board to delegate all of its authority to a committee.^[13] Accordingly, a committee with properly delegated authority would have the power to move for dismissal or summary judgment if the entire board did.

Even though demand was not made in this case and the initial decision of whether to litigate was not placed before the board, Zapata's board, it seems to us, retained all of its corporate power concerning litigation decisions. If Maldonado had made demand on the board in this case, it could have refused to bring suit. Maldonado could then have asserted that the decision not to sue was wrongful and, if correct, would have been allowed to maintain the suit. The board, however, never would have lost its statutory managerial authority. The demand requirement itself evidences that the managerial power is retained [786] by the board. When a derivative plaintiff is allowed to bring suit after a wrongful refusal, the board's authority to choose whether to pursue the litigation is not challenged although its conclusion — reached through the exercise of that authority — is not respected since it is wrongful. Similarly, Rule 23.1, by excusing demand in certain instances, does not strip the board of its corporate power. It merely saves the plaintiff the expense and delay of making a futile demand resulting in a probable tainted exercise of that authority in a refusal by the board or in giving control of litigation to the opposing side. But the board entity remains empowered under § 141(a) to make decisions regarding corporate litigation. The problem is one of member disqualification, not the absence of power in the board.

The corporate power inquiry then focuses on whether the board, tainted by the self-interest of a majority of its members, can legally delegate its authority to a committee of two disinterested directors. We find our statute clearly requires an affirmative answer to this question. As has been noted, under an express provision of the statute, § 141(c), a committee can exercise all of the authority of the board to the extent provided in the resolution of the board. Moreover, at lest by analogy to our statutory section on interested directors, 8 Del.C. § 141, it seems clear that the Delaware statute is designed to permit disinterested directors to act for the board.^[14] Compare Puma v. Marriott, Del.Ch., 283 A.2d 693, 695-96 (1971).

We do not think that the interest taint of the board majority is per se a legal bar to the delegation of the board's power to an independent committee composed of disinterested board members. The committee can properly act for the corporation to move to dismiss derivative litigation that is believed to be detrimental to the corporation's best interest.

Our focus now switches to the Court of Chancery which is faced with a stockholder assertion that a derivative suit, properly instituted, should continue for the benefit of the corporation and a corporate assertion, properly made by a board committee acting with board authority, that the same derivative suit should be dismissed as inimical to the best interests of the corporation.

At the risk of stating the obvious, the problem is relatively simple. If, on the one hand, corporations can consistently wrest bona fide derivative actions away from well-meaning derivative plaintiffs through the use of the committee mechanism, the derivative suit will lose much, if not all, of its generally-recognized effectiveness as an intra-corporate means of policing boards of directors. See Dent, supra note 5, 75 Nw.U. L.Rev. at 96 & n. 3, 144 & n. 241. If, on the other hand, corporations are unable to rid themselves of meritless or harmful litigation [787] and strike suits, the derivative action, created to benefit the corporation, will produce the opposite, unintended result. For a discussion of strike suits, see Dent, supra, 75 Nw.U.L.Rev. at 137. See also Cramer v. General Telephone & Electronics Corp., 3d Cir., 582 F.2d 259, 275 (1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979). It thus appears desirable to us to find a balancing point where bona fide stockholder power to bring corporate causes of action cannot be unfairly trampled on by the board of directors, but the corporation can rid itself of detrimental litigation.

As we noted, the question has been treated by other courts as one of the "business judgment" of the board committee. If a "committee, composed of independent and disinterested directors, conducted a proper review of the matters before it, considered a variety of factors and reached, in good faith, a business judgment that [the] action was not in the best interest of [the corporation]", the action must be dismissed. See, e. g., Maldonado v. Flynn, supra, 485 F.Supp. at 282, 286. The issues become solely independence, good faith, and reasonable investigation. The ultimate conclusion of the committee, under that view, is not subject to judicial review.

We are not satisfied, however, that acceptance of the "business judgment" rationale at this stage of derivative litigation is a proper balancing point. While we admit an analogy with a normal case respecting board judgment, it seems to us that there is sufficient risk in the realities of a situation like the one presented in this case to justify caution beyond adherence to the theory of business judgment.

The context here is a suit against directors where demand on the board is excused. We think some tribute must be paid to the fact that the lawsuit was properly initiated. It is not a board refusal case. Moreover, this complaint was filed in June of 1975 and, while the parties undoubtedly would take differing views on the degree of litigation activity, we have to be concerned about the creation of an "Independent Investigation Committee" four years later, after the election of two new outside directors. Situations could develop where such motions could be filed after years of vigorous litigation for reasons unconnected with the merits of the lawsuit.

Moreover, notwithstanding our conviction that Delaware law entrusts the corporate power to a properly authorized committee, we must be mindful that directors are passing judgment on fellow directors in the same corporation and fellow directors, in this instance, who designated them to serve both as directors and committee members. The question naturally arises whether a "there but for the grace of God go I" empathy might not play a role. And the further question arises whether inquiry as to independence, good faith and reasonable investigation is sufficient safeguard against abuse, perhaps subconscious abuse.

There is another line of exploration besides the factual context of this litigation which we find helpful. The nature of this motion finds no ready pigeonhole, as perhaps illustrated by its being set forth in the alternative. It is perhaps best considered as a hybrid summary judgment motion for dismissal because the stockholder plaintiff's standing to maintain the suit has been lost. But it does not fit neatly into a category described in Rule 12(b) of the Court of Chancery Rules nor does it correspond directly with Rule 56 since the question of genuine issues of fact on the merits of the stockholder's claim are not reached.

It seems to us that there are two other procedural analogies that are helpful in addition to reference to Rules 12 and 56. There is some analogy to a settlement in that there is a request to terminate litigation without a judicial determination of the merits. See Perrine v. Pennroad Corp., Del. Supr., 47 A.2d 479, 487 (1946). "In determining whether or not to approve a proposed settlement of a derivative stockholders' action [when directors are on both sides of the transaction], the Court of Chancery is called upon to exercise its own business judgment." Neponsit Investment Co. v. Abramson, Del.Supr., 405 A.2d 97, 100 (1979) and cases therein cited. In this case, [788] the litigating stockholder plaintiff facing dismissal of a lawsuit properly commenced ought, in our judgment, to have sufficient status for strict Court review.

Finally, if the committee is in effect given status to speak for the corporation as the plaintiff in interest, then it seems to us there is an analogy to Court of Chancery Rule 41(a)(2) where the plaintiff seeks a dismissal after an answer. Certainly, the position of record of the litigating stockholder is adverse to the position advocated by the corporation in the motion to dismiss. Accordingly, there is perhaps some wisdom to be gained by the direction in Rule 41(a)(2) that "an action shall not be dismissed at the plaintiff's instance save upon order of the Court and upon such terms and conditions as the Court deems proper."

Whether the Court of Chancery will be persuaded by the exercise of a committee power resulting in a summary motion for dismissal of a derivative action, where a demand has not been initially made, should rest, in our judgment, in the independent discretion of the Court of Chancery. We thus steer a middle course between those cases which yield to the independent business judgment of a board committee and this case as determined below which would yield to unbridled plaintiff stockholder control. In pursuit of the course, we recognize that "[t]he final substantive judgment whether a particular lawsuit should be maintained requires a balance of many factors — ethical, commercial, promotional, public relations, employee relations, fiscal as well as legal." Maldonado v. Flynn, supra, 485 F.Supp. at 285. But we are content that such factors are not "beyond the judicial reach" of the Court of Chancery which regularly and competently deals with fiduciary relationships, disposition of trust property, approval of settlements and scores of similar problems. We recognize the danger of judicial overreaching but the alternatives seem to us to be outweighed by the fresh view of a judicial outsider. Moreover, if we failed to balance all the interests involved, we would in the name of practicality and judicial economy foreclose a judicial decision on the merits. At this point, we are not convinced that is necessary or desirable.

After an objective and thorough investigation of a derivative suit, an independent committee may cause its corporation to file a pretrial motion to dismiss in the Court of Chancery. The basis of the motion is the best interests of the corporation, as determined by the committee. The motion should include a thorough written record of the investigation and its findings and recommendations. Under appropriate Court supervision, akin to proceedings on summary judgment, each side should have an opportunity to make a record on the motion. As to the limited issues presented by the motion noted below, the moving party should be prepared to meet the normal burden under Rule 56 that there is no genuine issue as to any material fact and that the moving party is entitled to dismiss as a matter of law.^[15] The Court should apply a two-step test to the motion.

First, the Court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries.^[16] The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness.^[17] [789] If the Court determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or, if the Court is not satisfied for other reasons relating to the process, including but not limited to the good faith of the committee, the Court shall deny the corporation's motion. If, however, the Court is satisfied under Rule 56 standards that the committee was independent and showed reasonable bases for good faith findings and recommendations, the Court may proceed, in its discretion, to the next step.

The second step provides, we believe, the essential key in striking the balance between legitimate corporate claims as expressed in a derivative stockholder suit and a corporation's best interests as expressed by an independent investigating committee. The Court should determine, applying its own independent business judgment, whether the motion should be granted.^[18] This means, of course, that instances could arise where a committee can establish its independence and sound bases for its good faith decisions and still have the corporation's motion denied. 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 prematurely terminate a stockholder grievance deserving of further consideration in the corporation's interest. The Court of Chancery of course must carefully consider and weigh how compelling the corporate interest in dismissal is when faced with a non-frivolous lawsuit. The Court of Chancery should, when appropriate, give special consideration to matters of law and public policy in addition to the corporation's best interests.

If the Court's independent business judgment is satisfied, the Court may proceed to grant the motion, subject, of course, to any equitable terms or conditions the Court finds necessary or desirable.

The interlocutory order of the Court of Chancery is reversed and the cause is remanded for further proceedings consistent with this opinion.

[*] The appeal was argued on Oct. 16, 1980 but certain procedural matters required by this Court were not accomplished until the date indicated.

[1] Court of Chancery Rule 23.1 states in part:

"The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort."

[2] Maldonado v. Flynn, Del.Ch., 417 A.2d 378 (1980). Proceedings in the Trial Court are not automatically stayed during the pendency of an interlocutory appeal. Supreme Court Rule 42(d).

[3] The District Court for the Southern District of Texas, in Maher v. Zapata Corp., S.D.Tex., 490 F.Supp. 348 (1980), denied Zapata's motions to dismiss or for summary judgment in an opinion consistent with Maldonado.

[4] Abbey v. Control Data Corp., 8th Cir., 603 F.2d 724 (1979), cert. denied, 444 U.S. 1017, 100 S.Ct. 670, 62 L.Ed.2d 647 (1980); Lewis v. Adams, N.D.Okl., No. 77-266C (November 15, 1979); Siegal v. Merrick, S.D.N.Y., 84 F.R.D. 106 (1979); and, of course, Maldonado v. Flynn, S.D.N.Y., 485 F.Supp. 274 (1980). See also Abramowitz v. Posner, S.D.N.Y., 513 F.Supp. 120, (1981) which specifically rejected the result reached by the Vice Chancellor in this case.

[5] See Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit? 75 Nw.U.L.Rev. 96, 98 & n. 14 (1980); Comment, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168, 192 & nn. 153-54 (1976) (herein Stockholder Derivative Actions).

[6] 8 Del.C. § 141(a) states:

"The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation."

[7] See Arsht, The Business Judgment Rule Revisited, 8 Hofstra L.Rev. 93, 97, 130-33 (1979).

[8] Compare Baker v. Bankers' Mortgage Co., Del.Ch., 129 A. 775, 776-77 (1925), the lower Sohland. In Baker, Chancellor Wolcott posed a rhetorical question that is entirely consistent with the result we reach today: "[W]hy should not a stockholder, if the managing body absolutely refuses to act, be permitted to assert on behalf of himself and other stockholders a complaint, not against matters lying in sound discretion and honest judgment, but against frauds perpetrated by an officer in clear breach of his trust?" 129 A. at 777.

[9] To the extent that Mayer v. Adams, Del. Supr., 141 A.2d 458, 462 (1958) and Ainscow v. Sanitary Co. of America, Del.Ch., 180 A. 614, 615 (1935), relied upon in Maldonado, 413 A.2d at 1262, contain language relating to the rule in McKee, we note that each decision is dissimilar from the one we examine today. Mayer held that demand on the stockholders was not required before maintaining a derivative suit if the wrong alleged could not be ratified by the stockholders. Ainscow found defective a complaint that neither alleged demand on the directors, nor reasons why demand was excusable.

[10] In other words, when stockholders, after making demand and having their suit rejected, attack the board's decision as improper, the board's decision falls under the "business judgment" rule and will be respected if the requirements of the rule are met. See Dent, supra note 5, 75 Nw.U.L.Rev. at 100-01 & nn. 24-25. That situation should be distinguished from the instant case, where demand was not made, and the power of the board to seek a dismissal, due to disqualification, presents a threshold issue. For examples of what has been held to be a wrongful decision not to sue, see Stockholder Derivative Actions, supra note 5, 44 U.Chi.L. Rev. at 193-98. We recognize that the two contexts can overlap in practice.

[11] These statements are consistent with Rule 23.1's "reasons for ... failure" to make demand. See also the other cases cited by the Vice Chancellor, 413 A.2d at 1262: Ainscow v. Sanitary Co. of America, supra note 9, 180 A. at 615; Mayer v. Adams, supra note 9, 141 A.2d at 462; Dann v. Chrysler Corp., Del.Ch., 174 A.2d 696, 699-700 (1961).

[12] Even in this situation, it may take litigation to determine the stockholder's lack of power, i. e., standing.

[13] 8 Del.C. § 141(c) states:

"The board of directors may, by resolution passed by a majority of the whole board, designate 1 or more committees, each committee to consist of 1 or more of the directors of the corporation. The board may designate 1 or more directors as alternative members of any committee, who may replace any absent or disqualified member at any meeting of the committee. The bylaws may provide that in the absence or disqualification of a member of a committee, the member or members present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the board of directors, or in the bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the certificate of incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, recommending to the stockholders a dissolution of the corporation or a revocation of a dissolution, or amending the bylaws of the corporation; and, unless the resolution, bylaws, or certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock."

[14] 8 Del.C. § 144 states:

"§ 144. Interested directors; quorum.
(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if:
(1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or
(2) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or
(3) The contract or transaction is fair to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee, or the shareholders.
(b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction."

[15] We do not foreclose a discretionary trial of factual issues but that issue is not presented in this appeal. See Lewis v. Anderson, supra, 615 F.2d at 780. Nor do we foreclose the possibility that other motions may proceed or be joined with such a pretrial summary judgment motion to dismiss, e. g., a partial motion for summary judgment on the merits.

[16] See, e. g., Galef v. Alexander, 2d Cir., 615 F.2d 51, 56 (1980); Maldonado v. Flynn, supra, 485 F.Supp. at 285-86; Rosengarten v. International Telephone & Telegraph Corp., S.D.N.Y., 466 F.Supp. 817, 823 (1979); Gall v. Exxon Corp., S.D.N.Y., 418 F.Supp. 508, 520 (1976). Compare Dent, supra note 5, 75 Nw.U.L.Rev. at 131-33.

[17] Compare Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 928-29, 393 N.E.2d 994 (1979). Our approach here is analogous to and consistent with the Delaware approach to "interested director" transactions, where the directors, once the transaction is attacked, have the burden of establishing its "intrinsic fairness" to a court's careful scrutiny. See, e. g., Sterling v. Mayflower Hotel Corp., Del.Supr., 93 A.2d 107 (1952).

[18] This step shares some of the same spirit and philosophy of the statement by the Vice Chancellor: "Under our system of law, courts and not litigants should decide the merits of litigation." 413 A.2d at 1263.

7.1.7 Americas Mining Corp. v. Theriault (Del. 2012) [Attorney's Fees] 7.1.7 Americas Mining Corp. v. Theriault (Del. 2012) [Attorney's Fees]

To generate a substantial amount of shareholder litigation, merely allowing shareholders suits, direct or derivative, is not sufficient. Somebody needs to have an incentive to bring the suit. If shareholder-plaintiffs only recovered their pro rata share of the recovery (indirectly in the case of a derivative suit), incentives to bring suit would be very low and, in light of substantial litigation costs, usually insufficient. Litigation would be hamstrung by the same collective action problem as proxy fights. Under the common fund doctrine, however, U.S. courts award a substantial part of the recovery to the plaintiff or, in the standard case, to the plaintiff lawyer. As Americas Mining shows, that award can be very substantial indeed.

The litigation incentives generated by such awards strike some as excessive. For a while, virtually every M&A deal attracted shareholder litigation, albeit mostly with much lower or no recovery. Corporations tried various tactics to limit the amount of litigation they face, prompting recent amendments of the DGCL (sections 102(f) and 115 – read!).

1. How does the court determine the right amount of the fee award? What criteria does it use, and what purposes does it aim to achieve? Are the criteria well calibrated to the purposes?
2. Who is opposing the fee award, and why?
3. Are the damage and fee awards sufficient to deter fiduciary duty violations similar to those at issue in this case?

Note: I excerpt here only the passages relevant to the attorney fee award. The case below was In re Southern Peru (Del. Ch. 2011).

51 A.3d 1213 (2012)

AMERICAS MINING CORPORATION, et al., Defendants Below, Appellants,
v.
Michael THERIAULT, as Trustee for the Theriault Trust, Plaintiff Below, Appellee.
Southern Copper Corporation, formerly known as Southern Peru Copper Corporation, Nominal Defendant Below, Appellant,
v.
Michael Theriault, as Trustee for the Theriault Trust, Plaintiff Below, Appellee.

Nos. 29, 2012, 30, 2012.

Supreme Court of Delaware.

Submitted: June 7, 2012.Decided: August 27, 2012.Reargument Denied: September 21, 2012.

[1218] S. Mark Hurd, Esquire and Kevin M. Coen, Esquire, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware, and Bruce D. Angiolillo, Esquire (argued), Jonathan K. Youngwood, Esquire, Craig S. Waldman, Esquire, and Daniel J. Stujenske, Esquire, Simpson, Thacher & Bartlett LLP, New York, New York, for appellants, Americas Mining Corporation, Germán Larrea Mota-Velasco, Genaro Larrea Mota-Velasco, Oscar Gonzalez Rocha, Emilio Carrillo Gamboa, Jaime Fernando Collazo Gonzalez, Xavier Garcia de Quevedo Topete, Armando Ortega Gómez, and Juan Rebolledo Gout.

Stephen E. Jenkins, Esquire (argued), Richard L. Renck, Esquire, Andrew D. Cordo, Esquire and F. Troupe Mickler, IV, Esquire, Ashby & Geddes, Wilmington, Delaware, for appellant, Nominal Defendant Southern Copper Corporation, formerly known as Southern Peru Copper Corporation.

Ronald A. Brown, Jr., Esquire (argued) and Marcus E. Montejo, Esquire, Prickett, Jones & Elliott, P.A., Wilmington, Delaware, and Kessler Topaz Meltzer & Check, LLP, Radnor, Pennsylvania, for appellee.

Before STEELE, Chief Justice, HOLLAND, BERGER and RIDGELY, Justices and VAUGHN, President Judge,^[1] constituting the Court en Banc.

HOLLAND, Justice, for the majority:

This is an appeal from a post-trial decision and final judgment of the Court of Chancery awarding more than $2 billion in damages and more than $304 million in attorneys' fees. 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.

The Plaintiff challenged the transaction derivatively on behalf of Southern Peru. The Court of Chancery found the trial evidence established that the controlling shareholder, Grupo México, S.A.B. de C.V. ("Grupo Mexico"), through AMC, "extracted a deal that was far better than market" from Southern Peru due to the ineffective operation of a special committee (the "Special Committee"). To remedy the Defendants' breaches of loyalty, the Court of Chancery awarded the difference between the value Southern Peru paid for Minera ($3.7 billion) and the amount the Court of Chancery determined Minera was worth ($2.4 billion). The Court of Chancery awarded damages in the amount of $1.347 billion plus pre- and post-judgment interest, for a total judgment of $2.0316 billion. The Court of Chancery also awarded the Plaintiff's counsel attorneys' fees and expenses in the amount of 15% of the total judgment, which amounts to more than $304 million.

Issues on Appeal

The Defendants have raised five issues on appeal. First, they argue that the Court of Chancery impermissibly denied the Defendants the opportunity to present a witness from Goldman, Sachs & Co. ("Goldman") at trial to explain its valuation process, on the grounds that the witness constituted an "unfair surprise." Second, they contend that the Court of Chancery committed reversible error by failing to [1219] determine which party bore the burden of proof before trial. They further claim the Court of Chancery erred by ultimately allocating the burden to the Defendants, because, they submit, the Special Committee was independent, well-functioning, and did not rely on the controlling shareholder for the information that formed the basis for its recommendation. Third, they argue that the Court of Chancery's determination about the "fair" price for the transaction was arbitrary and capricious. Fourth, they assert that the Court of Chancery's award of damages is not supported by evidence in the record, but rather by impermissible speculation and conjecture. Finally, the Defendants' allege that the Court of Chancery's award of attorneys' fees of more than $304 million is an abuse of discretion. Southern Peru also appeals from the award of attorneys' fees to the Plaintiff's counsel.

We have determined that all of the Defendants' arguments are without merit. Therefore, the judgment of the Court of Chancery is affirmed.

FACTUAL BACKGROUND^[2]

The controlling stockholder in this case is Grupo México, S.A.B. de C.V. The NYSE-listed mining company is Southern Peru Copper Corporation.^[3] The Mexican mining company is Minera México, S.A. de C.V.^[4]

In February 2004, Grupo Mexico proposed that Southern Peru buy its 99.15% stake in Minera. At the time, Grupo Mexico owned 54.17% of Southern Peru's outstanding capital stock and could exercise 63.08% of the voting power of Southern Peru, making it Southern Peru's majority stockholder.

Grupo Mexico initially proposed that Southern Peru purchase its equity interest in Minera with 72.3 million shares of newly-issued Southern Peru stock. This "indicative" number assumed that Minera's equity was worth $3.05 billion, because that is what 72.3 million shares of Southern Peru stock were worth then in cash. By stark contrast with Southern Peru, Minera was almost wholly owned by Grupo Mexico and therefore had no market-tested value.

Because of Grupo Mexico's self-interest in the merger proposal, Southern Peru formed a "Special Committee" of disinterested directors to "evaluate" the transaction with Grupo Mexico. The Special Committee spent eight months in an awkward back and forth with Grupo Mexico over the terms of the deal before approving Southern Peru's acquisition of 99.15% of Minera's stock in exchange for 67.2 million newly-issued shares of Southern Peru stock (the "Merger") on October 21, 2004. That same day, Southern Peru's board of directors (the "Board") unanimously approved the Merger and Southern Peru and Grupo Mexico entered into a definitive agreement (the "Merger Agreement"). On October 21, 2004, the market value of 67.2 million shares of Southern Peru stock was $3.1 billion. When the Merger closed on April 1, 2005, the value [1220] of 67.2 million shares of Southern Peru had grown to $3.75 billion.

This derivative suit was then brought against the Grupo Mexico subsidiary that owned Minera, the Grupo Mexico-affiliated directors of Southern Peru, and the members of the Special Committee, alleging that the Merger was entirely unfair to Southern Peru and its minority stockholders.

The crux of the Plaintiff's argument is that Grupo Mexico received something demonstrably worth more than $3 billion (67.2 million shares of Southern Peru stock) in exchange for something that was not worth nearly that much (99.15% of Minera).^[5] The Plaintiff points to the fact that Goldman, which served as the Special Committee's financial advisor, never derived a value for Minera that justified paying Grupo Mexico's asking price, but instead relied on a "relative" valuation analysis that involved comparing the discounted cash flow ("DCF") values of Southern Peru and Minera, and a contribution analysis that improperly applied Southern Peru's own market EBITDA multiple (and even higher multiples) to Minera's EBITDA projections, to determine an appropriate exchange ratio to use in the Merger. The Plaintiff claims that, because the Special Committee and Goldman abandoned the company's market price as a measure of the true value of the give, Southern Peru substantially overpaid in the Merger.

The Defendants remaining in the case are Grupo Mexico and its affiliate directors who were on the Southern Peru Board at the time of the Merger.^[6] These Defendants assert that Southern Peru and Minera are similar companies and were properly valued on a relative basis. In other words, the defendants argue that the appropriate way to determine the price to be paid by Southern Peru in the Merger was to compare both companies' values using the same set of assumptions and methodologies, rather than comparing Southern Peru's market capitalization to Minera's DCF value. The Defendants do not dispute that shares of Southern Peru stock could have been sold for their market price at the time of the Merger, but they contend that Southern Peru's market price did not reflect the fundamental value of Southern Peru and thus could not appropriately be compared to the DCF value of Minera.

After this brief overview of the basic events and the parties' core arguments, the Court of Chancery provided the following more detailed recitation of the facts as it found them after trial.

The Key Players

Southern Peru operates mining, smelting, and refining facilities in Peru, producing copper and molybdenum as well as silver and small amounts of other metals. Before the Merger, Southern Peru had two classes of stock: common shares that were traded on the New York Stock Exchange; and "Founders Shares" that were owned by Grupo Mexico, Cerro Trading Company, Inc., and Phelps Dodge Corporation (the "Founding Stockholders"). Each Founders Share had five votes per share versus one vote per share for ordinary common stock. Grupo Mexico owned 43.3 million Founders Shares, which translated [1221] to 54.17% of Southern Peru's outstanding stock and 63.08% of the voting power.

Southern Peru's certificate of incorporation and a stockholders' agreement also gave Grupo Mexico the right to nominate a majority of the Southern Peru Board. The Grupo Mexico-affiliated directors who are defendants in this case held seven of the thirteen Board seats at the time of the Merger. Cerro owned 11.4 million Founders Shares (14.2% of the outstanding common stock) and Phelps Dodge owned 11.2 million Founders Shares (13.95% of the outstanding common stock). Among them, therefore, Grupo Mexico, Cerro, and Phelps Dodge owned over 82% of Southern Peru.

Grupo Mexico is a Mexican holding company listed on the Mexican stock exchange. Grupo Mexico is controlled by the Larrea family, and at the time of the Merger defendant Germán Larrea was the Chairman and CEO of Grupo Mexico, as well as the Chairman and CEO of Southern Peru. Before the Merger, Grupo Mexico owned 99.15% of Minera's stock and thus essentially was Minera's sole owner. Minera is a company engaged in the mining and processing of copper, molybdenum, zinc, silver, gold, and lead through its Mexico-based mines. At the time of the Merger, Minera was emerging from — if not still mired in — a period of financial difficulties, and its ability to exploit its assets had been compromised by these financial constraints. By contrast, Southern Peru was in good financial condition and virtually debt-free.

Grupo Mexico Proposes That Southern Peru Acquire Minera

In 2003, Grupo Mexico began considering combining its Peruvian mining interests with its Mexican mining interests. In September 2003, Grupo Mexico engaged UBS Investment Bank to provide advice with respect to a potential strategic transaction involving Southern Peru and Minera.

Grupo Mexico and UBS made a formal presentation to Southern Peru's Board on February 3, 2004, proposing that Southern Peru acquire Grupo Mexico's interest in Minera from AMC in exchange for newly-issued shares of Southern Peru stock. In that presentation, Grupo Mexico characterized the transaction as "[Southern Peru] to acquire Minera [] from AMC in a stock for stock deal financed through the issuance of common shares; initial proposal to issue 72.3 million shares." A footnote to that presentation explained that the 72.3 million shares was "an indicative number" of Southern Peru shares to be issued, assuming an equity value of Minera of $3.05 billion and a Southern Peru share price of $42.20 as of January 29, 2004.

In other words, the consideration of 72.3 million shares was indicative in the sense that Grupo Mexico wanted $3.05 billion in dollar value of Southern Peru stock for its stake in Minera, and the number of shares that Southern Peru would have to issue in exchange for Minera would be determined based on Southern Peru's market price. As a result of the proposed merger, Minera would become a virtually wholly-owned subsidiary of Southern Peru. The proposal also contemplated the conversion of all Founders Shares into a single class of common shares.

Southern Peru Forms A Special Committee

In response to Grupo Mexico's presentation, the Board met on February 12, 2004 and created a Special Committee to evaluate the proposal. The resolution creating the Special Committee provided that the "duty and sole purpose" of the Special Committee was "to evaluate the [Merger] [1222] in such manner as the Special Committee deems to be desirable and in the best interests of the stockholders of [Southern Peru]," and authorized the Special Committee to retain legal and financial advisors at Southern Peru's expense on such terms as the Special Committee deemed appropriate. The resolution did not give the Special Committee express power to negotiate, nor did it authorize the Special Committee to explore other strategic alternatives.

The Special Committee's makeup as it was finally settled on March 12, 2004 was as follows:

• Harold S. Handelsman: Handelsman graduated from Columbia Law School and worked at Wachtell, Lipton, Rosen & Katz as an M & A lawyer before becoming an attorney for the Pritzker family interests in 1978. The Pritzker family is a wealthy family based in Chicago that owns, through trusts, a myriad of businesses. Handelsman was appointed to the Board in 2002 by Cerro, which was one of those Pritzker-owned businesses.

• Luis Miguel Palomino Bonilla: Palomino has a Ph.D in finance from the Wharton School at the University of Pennsylvania and worked as an economist, analyst and consultant for various banks and financial institutions. Palomino was nominated to the Board by Grupo Mexico upon the recommendation of certain Peruvian pension funds that held a large portion of Southern Peru's publicly traded stock.

• Gilberto Perezalonso Cifuentes: Perezalonso has both a law degree and an MBA and has managed multi-billion dollar companies such as Grupo Televisa and AeroMexico Airlines. Perezalonso was nominated to the Board by Grupo Mexico.

• Carlos Ruiz Sacristán: Ruiz, who served as the Special Committee's Chairman, worked as a Mexican government official for 25 years before co-founding an investment bank, where he advises on M & A and financing transactions. Ruiz was nominated to the Board by Grupo Mexico.

The Special Committee Hires Advisors And Seeks A Definitive Proposal From Grupo Mexico

The Special Committee began its work by hiring U.S. counsel and a financial advisor. After considering various options, the Special Committee chose Latham & Watkins LLP and Goldman. The Special Committee also hired a specialized mining consultant to help Goldman with certain technical aspects of mining valuation. Goldman suggested consultants that the Special Committee might hire to aid in the process; after considering these options, the Special Committee retained Anderson & Schwab ("A & S").

After hiring its advisors, the Special Committee set out to acquire a "proper" term sheet from Grupo Mexico. The Special Committee did not view the most recent term sheet that Grupo Mexico had sent on March 25, 2004 as containing a price term that would allow the Special Committee to properly evaluate the proposal. For some reason the Special Committee did not get the rather clear message that Grupo Mexico thought Minera was worth $3.05 billion.

Thus, in response to that term sheet, on April 2, 2004, Ruiz sent a letter to Grupo Mexico on behalf of the Special Committee in which he asked for clarification about, among other things, the pricing of the proposed transaction. On May 7, 2004, Grupo Mexico sent to the Special Committee [1223] what the Special Committee considered to be the first "proper" term sheet, making even more potent its ask.

The May 7 Term Sheet

Grupo Mexico's May 7 term sheet contained more specific details about the proposed consideration to be paid in the Merger. It echoed the original proposal, but increased Grupo Mexico's ask from $3.05 billion worth of Southern Peru stock to $3.147 billion. Specifically, the term sheet provided that:

The proposed value of Minera [] is US$4,3 billion, comprised of an equity value of US$3,147 million [sic] and US$1,153 million [sic] of net debt as of April 2004. The number of [Southern Peru] shares to be issued in respect to the acquisition of Minera [] would be calculated by dividing 98.84% of the equity value of Minera [] by the 20-day average closing share price of [Southern Peru] beginning 5 days prior to closing of the [Merger].^[7]

In other words, Grupo Mexico wanted $3.147 billion in market-tested Southern Peru stock in exchange for its stake in Minera. The structure of the proposal, like the previous Grupo Mexico ask, shows that Grupo Mexico was focused on the dollar value of the stock it would receive.

Throughout May 2004, the Special Committee's advisors conducted due diligence to aid their analysis of Grupo Mexico's proposal. As part of this process, A & S visited Minera's mines and adjusted the financial projections of Minera management (i.e., of Grupo Mexico) based on the outcome of their due diligence.

Goldman Begins To Analyze Grupo Mexico's Proposal

On June 11, 2004, Goldman made its first presentation to the Special Committee addressing the May 7 term sheet. Although Goldman noted that due diligence was still ongoing, it had already done a great deal of work and was able to provide preliminary valuation analyses of the standalone equity value of Minera, including a DCF analysis, a contribution analysis, and a look-through analysis.

Goldman performed a DCF analysis of Minera based on long-term copper prices ranging from $0.80 to $1.00 per pound and discount rates ranging from 7.5% to 9.5%, utilizing both unadjusted Minera management projections and Minera management projections as adjusted by A & S. The only way that Goldman could derive a value for Minera close to Grupo Mexico's asking price was by applying its most aggressive assumptions (a modest 7.5% discount rate and its high-end $1.00/lb long-term copper price) to the unadjusted Minera management projections, which yielded an equity value for Minera of $3.05 billion. By applying the same aggressive assumptions to the projections as adjusted by A & S, Goldman's DCF analysis yielded a lower equity value for Minera of $2.41 billion. Goldman's mid-range assumptions (an 8.5% discount rate and $0.90/lb long-term copper price) only generated a $1.7 billion equity value for Minera when applied to the A & S-adjusted projections. That is, the mid-range of the Goldman analysis generated a value for Minera (the "get") a full $1.4 billion less than Grupo Mexico's ask for the give.

It made sense for Goldman to use the $0.90 per pound long term copper price as a mid-range assumption, because this price [1224] was being used at the time by both Southern Peru and Minera for purposes of internal planning. The median long-term copper price forecast based on Wall Street research at the time of the Merger was also $0.90 per pound.

Goldman's contribution analysis applied Southern Peru's market-based sales, EBITDA, and copper sales multiples to Minera. This analysis yielded an equity value for Minera ranging only between $1.1 and $1.7 billion. Goldman's look-through analysis, which was a sum-of-the-parts analysis of Grupo Mexico's market capitalization, generated a maximum equity value for Minera of $1.3 billion and a minimum equity value of only $227 million.

Goldman summed up the import of these various analyses in an "Illustrative Give/Get Analysis," which made patent the stark disparity between Grupo Mexico's asking price and Goldman's valuation of Minera: Southern Peru would "give" stock with a market price of $3.1 billion to Grupo Mexico and would "get" in return an asset worth no more than $1.7 billion.

The important assumption reflected in Goldman's June 11 presentation was that a bloc of shares of Southern Peru could yield a cash value equal to Southern Peru's actual stock market price and was thus worth its market value was emphasized by the Court of Chancery. At trial, the Defendants disclaimed any reliance upon a claim that Southern Peru's stock market price was not a reliable indication of the cash value that a very large bloc of shares — such as the 67.2 million paid to Grupo Mexico — could yield in the market. Thus, the price of the "give" was always easy to discern. The question thus becomes what was the value of the "get." Unlike Southern Peru, Minera's value was not the subject of a regular market test. Minera shares were not publicly traded and thus the company was embedded in the overall value of Grupo Mexico.

The June 11 presentation clearly demonstrates that Goldman, in its evaluation of the May 7 term sheet, could not get the get anywhere near the give. Notably, that presentation marked the first and last time that a give-get analysis appeared in Goldman's presentations to the Special Committee.

The Court of Chancery described what happened next as curious. The Special Committee began to devalue the "give" in order to make the "get" look closer in value. The DCF analysis of the value of Minera that Goldman presented initially caused concern. As Handelsman stated at trial, "when [the Special Committee] thought that the value of Southern Peru was its market value and the value of Minera [] was its discounted cash flow value ... those were very different numbers."

But, the Special Committee's view changed when Goldman presented it with a DCF analysis of the value of Southern Peru on June 23, 2004. In this June 23 presentation, Goldman provided the Special Committee with a preliminary DCF analysis for Southern Peru analogous to the one that it had provided for Minera in the June 11 presentation. But, the discount rates that Goldman applied to Southern Peru's cash flows ranged from 8% to 10% instead of 7.5% to 9.5%. Based on Southern Peru management's projections, the DCF value generated for Southern Peru using mid-range assumptions (a 9% discount rate and $0.90/lb long-term copper price) was $2.06 billion. This was about $1.1 billion shy of Southern Peru's market capitalization as of June 21, 2004 ($3.19 billion). Those values "comforted" the [1225] Special Committee.^[8]

The Court of Chancery found that "comfort" was an odd word for the Special Committee to use in this context. What Goldman was basically telling the Special Committee was that Southern Peru was being overvalued by the stock market. That is, Goldman told the Special Committee that even though Southern Peru's stock was worth an obtainable amount in cash, it really was not worth that much in fundamental terms. Thus, although Southern Peru had an actual cash value of $3.19 billion, its "real," "intrinsic," or "fundamental" value was only $2.06 billion, and giving $2.06 billion in fundamental value for $1.7 billion in fundamental value was something more reasonable to consider.

The Court of Chancery concluded that the more logical reaction of someone not in the confined mindset of directors of a controlled company may have been that it was a good time to capitalize on the market multiple the company was getting and monetize the asset. The Court of Chancery opined that a third party in the Special Committee's position might have sold at the top of the market, or returned cash to the Southern Peru stockholders by declaring a special dividend. For example, if it made long-term strategic sense for Grupo Mexico to consolidate Southern Peru and Minera, there was a logical alternative for the Special Committee: ask Grupo Mexico to make a premium to market offer for Southern Peru. Let Grupo Mexico be the buyer, not the seller.

In other words, the Court of Chancery found that by acting like a third-party negotiator with its own money at stake and with the full range of options, the Special Committee would have put Grupo Mexico back on its heels. Doing so would have been consistent with the financial advice it was getting and seemed to accept as correct. The Special Committee could have also looked to use its market-proven stock to buy a company at a good price (a lower multiple to earnings than Southern Peru's) and then have its value rolled into Southern Peru's higher market multiple to earnings. That could have included buying Minera at a price equal to its fundamental value using Southern Peru's market-proven currency.

The Court of Chancery was chagrined that instead of doing any of these things, the Special Committee was "comforted" by the fact that they could devalue that currency and justify paying more for Minera than they originally thought they should.

Special Committee Moves Toward Relative Valuation

After the June 23, 2004 presentation, the Special Committee and Goldman began to embrace the idea that the companies should be valued on a relative basis. In a July 8, 2004 presentation to the Special Committee, Goldman included both a revised standalone DCF analysis of Minera and a "Relative Discounted Cash Flow Analysis" in the form of matrices presenting the "indicative number" of Southern Peru shares that should be issued to acquire Minera based on various assumptions. The relative DCF analysis generated a vast range of Southern Peru shares to be issued in the Merger of 28.9 million to 71.3 million. Based on Southern Peru's July 8, 2004 market value of $40.30 per share, 28.9 million shares of Southern Peru stock had a market value of $1.16 billion, and 71.3 million shares were worth $2.87 [1226] billion. In other words, even the highest equity value yielded for Minera by this analysis was short of Grupo Mexico's actual cash value asking price.

The revised standalone DCF analysis applied the same discount rate and long-term copper price assumptions that Goldman had used in its June 11 presentation to updated projections. This time, by applying a 7.5% discount rate and $1.00 per pound long-term copper price to Minera management's projections, Goldman was only able to yield an equity value of $2.8 billion for Minera. Applying the same aggressive assumptions to the projections as adjusted by A & S generated a standalone equity value for Minera of only $2.085 billion. Applying mid-range assumptions (a discount rate of 8.5% and $0.90/lb long-term copper price) to the A & S-adjusted projections yielded an equity value for Minera of only $1.358 billion.

The Special Committee Makes A Counterproposal Suggests A Fixed-Exchange Ratio

After Goldman's July 8 presentation, the Special Committee made a counterproposal to Grupo Mexico. The Court of Chancery noted it was "oddly" not mentioned in Southern Peru's proxy statement describing the Merger (the "Proxy Statement"). In this counterproposal, the Special Committee offered that Southern Peru would acquire Minera by issuing 52 million shares of Southern Peru stock with a then-current market value of $2.095 billion. The Special Committee also proposed implementation of a fixed, rather than a floating, exchange ratio that would set the number of Southern Peru shares issued in the Merger.

From the inception of the Merger, Grupo Mexico had contemplated that the dollar value of the price to be paid by Southern Peru would be fixed (at a number that was always north of $3 billion), while the number of Southern Peru shares to be issued as consideration would float up or down based on Southern Peru's trading price around the time of closing. But, the Special Committee was uncomfortable with having to issue a variable amount of shares in the Merger. Handelsman testified that, in its evaluation of Grupo Mexico's May 7 term sheet, "it was the consensus of the [Special Committee] that a floating exchange rate was a nonstarter" because "no one could predict the number of shares that [Southern Peru] would have to issue in order to come up with the consideration requested."

The Special Committee wanted a fixed exchange ratio, which would set the number of shares that Southern Peru would issue in the Merger at the time of signing. The dollar value of the Merger consideration at the time of closing would vary with the fluctuations of Southern Peru's market price. According to the testimony of the Special Committee members, their reasoning was that both Southern Peru's stock and the copper market had been historically volatile, and a fixed exchange ratio would protect Southern Peru's stockholders from a situation in which Southern Peru's stock price went down and Southern Peru would be forced to issue a greater number of shares for Minera in order to meet a fixed dollar value. The Court of Chancery found that position was hard to reconcile with the Special Committee and Southern Peru's purported bullishness about the copper market in 2004.

Grupo Mexico Sticks To Its Demand

In late July or early August, Grupo Mexico responded to the Special Committee's counterproposal by suggesting that Southern Peru should issue in excess of 80 million shares of common stock to purchase Minera. It is not clear on the record [1227] exactly when Grupo Mexico asked for 80 million shares, but given Southern Peru's trading history at that time, the market value of that consideration would have been close to $3.1 billion, basically the same place where Grupo Mexico had started. The Special Committee viewed Grupo Mexico's ask as too high, which is not surprising given that the parties were apparently a full billion dollars in value apart, and negotiations almost broke down.

But, on August 21, 2004, after what is described as "an extraordinary effort" in Southern Peru's Proxy Statement, Grupo Mexico proposed a new asking price of 67 million shares. On August 20, 2004, Southern Peru was trading at $41.20 per share, so 67 million shares were worth about $2.76 billion on the market, a drop in Grupo Mexico's ask. Grupo Mexico's new offer brought the Special Committee back to the negotiating table.

After receiving two term sheets from Grupo Mexico that reflected the 67 million share asking price, the second of which was received on September 8, 2004, when 67 million shares had risen to be worth $3.06 billion on the market, Goldman made another presentation to the Special Committee on September 15, 2004. In addition to updated relative DCF analyses of Southern Peru and Minera (presented only in terms of the number of shares of Southern Peru stock to be issued in the Merger), this presentation contained a "Multiple Approach at Different EBITDA Scenarios," which was essentially a comparison of Southern Peru and Minera's market-based equity values, as derived from multiples of Southern Peru's 2004 and 2005 estimated (or "E") EBITDA.

Goldman also presented these analyses in terms of the number of Southern Peru shares to be issued to Grupo Mexico, rather than generating standalone values for Minera. The range of shares to be issued at the 2004E EBITDA multiple (5.0x) was 44 to 54 million; at the 2005E multiple (6.3x) Goldman's analyses yielded a range of 61 to 72 million shares of Southern Peru stock. Based on Southern Peru's $45.34 share price as of September 15, 2004, 61 to 72 million shares had a cash value of $2.765 billion to $3.26 billion.

The Special Committee sent a new proposed term sheet to Grupo Mexico on September 23, 2004. That term sheet provided for a fixed purchase price of 64 million shares of Southern Peru (translating to a $2.95 billion market value based on Southern Peru's then-current closing price). The Special Committee's proposal contained two terms that would protect the minority stockholders of Southern Peru: (1) a 20% collar around the purchase price, which gave both the Special Committee and Grupo Mexico the right to walk away from the Merger if Southern Peru's stock price went outside of the collar before the stockholder vote; and (2) a voting provision requiring that a majority of the minority stockholders of Southern Peru vote in favor of the Merger. Additionally, the proposal called for Minera's net debt, which Southern Peru was going to absorb in the Merger, to be capped at $1.105 billion at closing, and contained various corporate governance provisions.

The Special Committee's Proposed Terms Rejected But The Parties Work Out A Deal

On September 30, 2004, Grupo Mexico sent a counterproposal to the Special Committee, in which Grupo Mexico rejected the Special Committee's offer of 64 million shares and held firm to its demand for 67 million shares. Grupo Mexico's counterproposal also rejected the collar and the majority of the minority vote provision, proposing instead that the Merger be conditioned [1228] on the vote of two-thirds of the outstanding stock. Grupo Mexico noted that conditioning the Merger on a two-thirds shareholder vote obviated the need for the walk-away right requested by the Special Committee, because Grupo Mexico would be prevented from approving the Merger unilaterally in the event the stock price was materially higher at the time of the stockholder vote than at the time of Board approval. Grupo Mexico did accept the Special Committee's proposed $1.05 billion debt cap at closing. The Court of Chancery found that was not much of a concession in light of the fact that Minera was already contractually obligated to pay down its debt and was in the process of doing so.

After the Special Committee received Grupo Mexico's September 30 counterproposal, the parties reached agreement on certain corporate governance provisions to be included in the Merger Agreement, some of which were originally suggested by Grupo Mexico and some of which were first suggested by the Special Committee. Without saying these provisions were of no benefit at all to Southern Peru and its outside investors, the Court of Chancery did say that they did not factor more importantly in its decision because they do not provide any benefit above the protections of default law that were economically meaningful enough to close the material dollar value gap that existed.

On October 5, 2004, members of the Special Committee met with Grupo Mexico to iron out a final deal. At that meeting, the Special Committee agreed to pay 67 million shares, dropped their demand for the collar, and acceded to most of Grupo Mexico's demands. The Special Committee justified paying a higher price through what the Court of Chancery described as a series of economic contortions. The Special Committee was able to "bridge the gap" between the 64 million and the 67 million figures by decreasing Minera's debt cap by another $105 million, and by getting Grupo Mexico to cause Southern Peru to issue a special dividend of $100 million, which had the effect of decreasing the value of Southern Peru's stock. According to Special Committee member Handelsman, these "bells and whistles" made it so that "the value of what was being ... acquired in the merger went up, and the value of the specie that was being used in the merger went down...," giving the Special Committee reason to accept a higher Merger price.

The closing share price of Southern Peru was $53.16 on October 5, 2004, so a purchase price of 67 million shares had a market value of $3.56 billion, which was higher than the dollar value requested by Grupo Mexico in its February 2004 proposal or its original May 7 term sheet.

At that point, the main unresolved issue was the stockholder vote that would be required to approve the Merger. After further negotiations, on October 8, 2004, the Special Committee gave up on its proposed majority of the minority vote provision and agreed to Grupo Mexico's suggestion that the Merger require only the approval of two-thirds of the outstanding common stock of Southern Peru. Given the size of the holdings of Cerro and Phelps Dodge, Grupo Mexico could achieve a two-thirds vote if either Cerro or Phelps Dodge voted in favor of the Merger.

Multi-Faceted Dimensions Of Controlling Power: Large Stockholders Who Want To Get Out Support A Strategic, Long-Term Acquisition As A Prelude To Their Own Exit As Stockholders

One of the members of the Special Committee, Handelsman, represented a large [1229] Founding Stockholder, Cerro. The Court of Chancery noted that this might be seen in some ways to have ideally positioned Handelsman to be a very aggressive negotiator. But Handelsman had a problem to deal with, which did not involve Cerro having any self-dealing interest in the sense that Grupo Mexico had. Rather, Grupo Mexico had control over Southern Peru and thus over whether Southern Peru would take the steps necessary to make the Founding Stockholders' shares marketable under applicable securities regulations. Cerro and Phelps Dodge wanted to monetize their investment in Southern Peru and get out.

Thus, while the Special Committee was negotiating the terms of the Merger, Handelsman was engaged in negotiations of his own with Grupo Mexico. Cerro and Phelps Dodge had been seeking registration rights from Grupo Mexico (in its capacity as Southern Peru's controller) for their shares of Southern Peru stock, which they needed because of the volume restrictions imposed on affiliates of an issuer by SEC Rule 144.

The Court of Chancery found that it is not clear which party first proposed liquidity and support for the Founding Stockholders in connection with the Merger. But it is plain that the concept appears throughout the term sheets exchanged between Grupo Mexico and the Special Committee, and it is clear that Handelsman knew that registration rights would be part of the deal from the beginning of the Merger negotiations and that thus the deal would enable Cerro to sell as it desired. The Special Committee did not take the lead in negotiating the specific terms of the registration rights provisions — rather, it took the position that it wanted to leave the back-and-forth over the agreement details to Cerro and Grupo Mexico. Handelsman, however, played a key role in the negotiations with Grupo Mexico on Cerro's behalf.

At trial, Handelsman explained that there were two justifications for pursuing registration rights — one offered benefits exclusive to the Founding Stockholders, and the other offered benefits that would inure to Southern Peru's entire stockholder base. The first justification was that Cerro needed the registration rights in order to sell its shares quickly, and Cerro wanted "to get out" of its investment in Southern Peru. The second justification concerned the public market for Southern Peru stock.

Granting registration rights to the Founding Stockholders would allow Cerro and Phelps Dodge to sell their shares, increasing the amount of stock traded on the market and thus increasing Southern Peru's somewhat thin public float. This would in turn improve stockholder liquidity, generate more analyst exposure, and create a more efficient market for Southern Peru shares, all of which would benefit the minority stockholders. Handelsman thus characterized the registration rights situation as a "win-win," because "it permitted us to sell our stock" and "it was good for [Southern Peru] because they had a better float and they had a more organized sale of shares."

Handelsman's tandem negotiations with Grupo Mexico culminated in Southern Peru giving Cerro registration rights for its shares on October 21, 2004, the same day that the Special Committee approved the Merger. In exchange for registration rights, Cerro expressed its intent to vote its shares in favor of the Merger if the Special Committee recommended it. If the Special Committee made a recommendation against the Merger, or withdrew its recommendation in favor of it, Cerro was bound by the agreement to vote against the Merger.

[1230] Grupo Mexico's initial proposal, which Handelsman received on October 18, 2004 — a mere three days before the Special Committee was to vote on the Merger — was that it would grant Cerro registration rights in exchange for Cerro's agreement to vote in favor of the Merger. The Special Committee and Handelsman suggested instead that Cerro's vote on the Merger be tied to whether or not the Special Committee recommended the Merger. After discussing the matter with the Special Committee, Grupo Mexico agreed.

On December 22, 2004, after the Special Committee approved the Merger but well before the stockholder vote, Phelps Dodge entered into an agreement with Grupo Mexico that was similar to Cerro's, but did not contain a provision requiring Phelps Dodge to vote against the Merger if the Special Committee did. By contrast, Phelps Dodge's agreement only provided that, [t]aking into account that the Special Committee ... did recommend ... the approval of the [Merger], Phelps Dodge "express[es] [its] current intent, to [] submit its proxies to vote in favor of the [Merger]...." Thus, in the event that the Special Committee later withdrew its recommendation to approve the Merger, Cerro would be contractually bound to vote against it, but Grupo Mexico could still achieve the two-thirds vote required to approve the Merger solely with Phelps Dodge's cooperation. Under the terms of the Merger Agreement, the Special Committee was free to change its recommendation of the Merger, but it was not able to terminate the Merger Agreement on the basis of such a change. Rather, a change in the Special Committee's recommendation only gave Grupo Mexico the power to terminate the Merger Agreement.

This issue caused the Court of Chancery concern. Although it was not prepared on this record to find that Handelsman consciously agreed to a suboptimal deal for Southern Peru simply to achieve liquidity for Cerro from Grupo Mexico, it had little doubt that Cerro's own predicament as a stockholder dependent on Grupo Mexico's whim as a controller for registration rights influenced how Handelsman approached the situation. The Court of Chancery found that did not mean Handelsman consciously gave in, but it did mean that he was less than ideally situated to press hard. Put simply, Cerro was even more subject to the dominion of Grupo Mexico than smaller holders because Grupo Mexico had additional power over it because of the unregistered nature of its shares.

Most important to the Court of Chancery was that Cerro's desires, when considered alongside the Special Committee's actions, illustrate the tendency of control to result in odd behavior. During the negotiations of the Merger, Cerro had no interest in the long-term benefits to Southern Peru of acquiring Minera, nor did Phelps Dodge. Certainly, Cerro did not want any deal so disastrous that it would tank the value of Southern Peru completely, but nor did it have a rational incentive to say no to a suboptimal deal if that risked being locked into its investments.

The Court of Chancery found that Cerro wanted to sell and sell then and there. But as a Special Committee member, Handelsman did not act consistently with that impulse for all stockholders. He did not suggest that Grupo Mexico make an offer for Southern Peru, but instead pursued a long-term strategic transaction in which Southern Peru was the buyer. Accordingly, the Court of Chancery concluded that a short-term seller of a company's shares caused that company to be a long-term buyer.

[1231] After One Last Price Adjustment, Goldman Makes Its Final Presentation

On October 13, 2004, Grupo Mexico realized that it owned 99.15% of Minera rather than 98.84%, and the purchase price was adjusted to 67.2 million shares instead of 67 million shares to reflect the change in size of the interest being sold. On October 13, 2004, Southern Peru was trading at $45.90 per share, which meant that 67.2 million shares had a dollar worth of $3.08 billion.

On October 21, 2004, the Special Committee met to consider whether to recommend that the Board approve the Merger. At that meeting, Goldman made a final presentation to the Special Committee. The October 21, 2004 presentation stated that Southern Peru's implied equity value was $3.69 billion based on its then current market capitalization at a stock price of $46.41 and adjusting for debt. Minera's implied equity value is stated as $3.146 billion, which was derived entirely from multiplying 67.2 million shares by Southern Peru's $46.41 stock price and adjusting for the fact that Southern Peru was only buying 99.15% of Minera.

No standalone equity value of Minera was included in the Goldman October 21 presentation.^[9] Instead, the presentation included a series of relative DCF analyses and a "Contribution Analysis at Different EBITDA Scenarios," both of which were presented in terms of a hypothetical number of Southern Peru shares to be issued to Grupo Mexico for Minera. Goldman's relative DCF analyses provided various matrices showing the number of shares of Southern Peru that should be issued in exchange for Minera under various assumptions regarding the discount rate, the long-term copper price, the allocation of tax benefits, and the amount of royalties that Southern Peru would need to pay to the Peruvian government.

As it had in all of its previous presentations, Goldman used a range of long-term copper prices from $0.80 to $1.00 per pound. The DCF analyses generated a range of the number of shares to be issued in the Merger from 47.2 million to 87.8 million. Based on the then-current stock price of $45.92, this translated to $2.17 billion to $4.03 billion in cash value. Assuming the mid-range figures of a discount rate of 8.5% and a long-term copper price of $0.90 per pound, the analyses yielded a range of shares from 60.7 to 78.7 million.

Goldman's contribution analysis generated a range of 42 million to 56 million shares of Southern Peru to be issued based on an annualized 2004E EBITDA multiple (4.6x) and forecasted 2004E EBITDA multiple (5.0x), and a range of 53 million to 73 million shares based on an updated range of estimated 2005E EBITDA multiples (5.6x to 6.5x). Notably, the 2004E EBITDA multiples did not support the issuance of 67.2 million shares of Southern Peru stock in the Merger. But, [1232] 67.2 million shares falls at the higher end of the range of shares calculated using Southern Peru's 2005E EBITDA multiples.

As notable, these multiples were not the product of the median of the 2005E EBITDA multiples of comparable companies identified by Goldman (4.8x). Instead, the multiples used were even higher than Southern Peru's own higher 2005E EBITDA Wall Street consensus (5.5x) — an adjusted version of which was used as the bottom end of the range. These higher multiples were then attributed to Minera, a non-publicly traded company suffering from a variety of financial and operational problems.

Goldman opined that the Merger was fair from a financial perspective to the stockholders of Southern Peru, and provided a written fairness opinion.

Special Committee And Board Approve The Merger

After Goldman made its presentation, the Special Committee voted 3-0 to recommend the Merger to the Board. At the last-minute suggestion of Goldman, Handelsman decided not to vote in order to remove any appearance of conflict based on his participation in the negotiation of Cerro's registration rights, despite the fact that he had been heavily involved in the negotiations from the beginning and his hands had been deep in the dough of the now fully baked deal. The Board then unanimously approved the Merger and Southern Peru entered into the Merger Agreement.

Market Reacts To The Merger

The market reaction to the Merger was mixed and the parties have not presented any reliable evidence about it. That is, neither party had an expert perform an event study analyzing the market reaction to the Merger. Southern Peru's stock price traded down by 4.6% when the Merger was announced. When the preliminary proxy statement, which provided more financial information regarding the Merger terms, became public on November 22, 2004, Southern Peru's stock price again declined by 1.45%. But the stock price increased for two days after the final Proxy Statement was filed.

The Court of Chancery found that determining what effect the Merger itself had on this rise is difficult because, as the Plaintiff pointed out, this was not, as the Defendants contended, the first time that Southern Peru and Minera's financials were presented together. Rather, the same financial statements were in the preliminary Proxy Statement and the stock price fell. However, the Court of Chancery noted that the Plaintiff offered no evidence that these stock market fluctuations provided a reliable basis for assessing the fairness of the deal because it did not conduct a reliable event study.

The Court of Chancery found, in fact, against a backdrop of strong copper prices, the trading price of Southern Peru stock increased substantially by the time the Merger closed. By April 1, 2005, Southern Peru's stock price had a market value of $55.89 per share, an increase of approximately 21.7% over the October 21, 2004 closing price. The Court of Chancery found this increase could not be attributed to the Merger because other factors were in play. That included the general direction of copper prices, which lifted the market price of not just Southern Peru, but those of its publicly traded competitors. Furthermore, Southern Peru's own financial performance was very strong.

Goldman Does Not Update Its Fairness Analysis

Despite rising Southern Peru share prices and performance, the Special Committee [1233] did not ask Goldman to update its fairness analysis at the time of the stockholder vote on the Merger and closing — nearly five months after the Special Committee had voted to recommend it. At trial, Handelsman testified that he called a representative at Goldman to ask whether the transaction was still fair, but the Court of Chancery found that Handelsman's phone call hardly constitutes a request for an updated fairness analysis. The Court of Chancery also found that the Special Committee's failure to determine whether the Merger was still fair at the time of the Merger vote and closing was curious for two reasons.

First, for whatever the reason, Southern Peru's stock price had gone up substantially since the Merger was announced in October 2004. In March 2005, Southern Peru stock was trading at an average price of $58.56 a share. The Special Committee had agreed to a collarless fixed exchange ratio and did not have a walk-away right. The Court of Chancery noted an adroit Special Committee would have recognized the need to re-evaluate the Merger in light of Southern Peru's then-current stock price.

Second, Southern Peru's actual 2004 EBITDA became available before the stockholder vote on the Merger took place, and Southern Peru had smashed through the projections that the Special Committee had used for it. In the October 21 presentation, Goldman used a 2004E EBITDA for Southern Peru of $733 million and a 2004E EBITDA for Minera of $687 million. Southern Peru's actual 2004 EBITDA was $1.005 billion, 37% more and almost $300 million more than the projections used by Goldman. Minera's actual 2004 EBITDA, by contrast, was $681 million, 0.8% less than the projections used by Goldman.

The Court of Chancery noted that earlier, in Goldman's contribution analysis it relied on the values (measured in Southern Peru shares) generated by applying an aggressive range of Southern Peru's 2005E EBITDA multiples to Minera's A & S-adjusted and unadjusted projections, not the 2004E EBITDA multiple, and that the inaccuracy of Southern Peru's estimated 2004 EBITDA should have given the Special Committee serious pause. If the 2004 EBITDA projections of Southern Peru — which were not optimized and had been prepared by Grupo Mexico-controlled management — were so grossly low, it provided reason to suspect that the 2005 EBITDA projections, which were even lower than the 2004 EBITDA projections, were also materially inaccurate, and that the assumptions forming the basis of Goldman's contribution analysis should be reconsidered.

Moreover, Southern Peru made $303.4 million in EBITDA in the first quarter of 2005, over 52% of the estimate in Goldman's fairness presentation for Southern Peru's 2005 full year performance. Although the first-quarter 2005 financial statements, which covered the period from January 1, 2005 to March 31, 2005, would not have been complete by the time of the stockholder vote, the Court of Chancery reasonably assumed that, as directors of Southern Peru, the Special Committee had access to nonpublic information about Southern Peru's monthly profit and loss statements. Southern Peru later beat its EBITDA projections for 2005 by a very large margin, 135%, a rate well ahead of Minera's 2005 performance, which beat the deal estimates by a much lower 45%.

The Special Committee's failure to get a fairness update was even more of a concern to the Court of Chancery because Cerro had agreed to vote against the Merger if the Special Committee changed [1234] its recommendation. The Special Committee failed to obtain a majority of the minority vote requirement, but it supposedly agreed to a two-thirds vote requirement instead because a two-thirds vote still prevented Grupo Mexico from unilaterally approving the Merger. This out was only meaningful, however, if the Special Committee took the recommendation process seriously. If the Special Committee maintained its recommendation, Cerro had to vote for the Merger, and its vote combined with Grupo Mexico's vote would ensure passage. By contrast, if the Special Committee changed its recommendation, Cerro was obligated to vote against the Merger.

The Court of Chancery found the tying of Cerro's voting agreement to the Special Committee's recommendation was somewhat odd, in another respect. In a situation involving a third-party merger sale of a company without a controlling stockholder, the third party will often want to lock up some votes in support of a deal. A large blocholder and the target board might therefore negotiate a compromise, whereby the blocholder agrees to vote yes if the target board or special committee maintains a recommendation in favor of the transaction. In this situation, however, there is a factor not present here. In an arm's-length deal, the target usually has the flexibility to change its recommendation or terminate the original merger upon certain conditions, including if a superior proposal is available, or an intervening event makes the transaction impossible to recommend in compliance with the target's fiduciary duties.

Here, by contrast, Grupo Mexico faced no such risk of a competing superior proposal because it controlled Southern Peru. Furthermore, the fiduciary out that the Special Committee negotiated for in the Merger agreement provided only that the Special Committee could change its recommendation in favor of the Merger, not that it could terminate the Merger altogether or avoid a vote on the Merger. The only utility therefore of the recommendation provision was if the Special Committee seriously considered the events between the time of signing and the stockholder vote and made a renewed determination of whether the deal was fair. The Court of Chancery found there is no evidence of such a serious examination, despite important emerging evidence that the transaction's terms were skewed in favor of Grupo Mexico.

Southern Peru's Stockholders Approve The Merger

On March 28, 2005, the stockholders of Southern Peru voted to approve the Merger. More than 90% of the stockholders voted in favor of the Merger. The Merger then closed on April 1, 2005. At the time of closing, 67.2 million shares of Southern Peru had a market value of $3.75 billion.

Cerro Sells Its Shares

On June 15, 2005, Cerro, which had a basis in its stock of only $1.32 per share, sold its entire interest in Southern Peru in an underwritten offering at $40.635 per share. Cerro sold its stock at a discount to the then-current market price, as the low-high trading prices for one day before the sale were $43.08 to $44.10 per share. The Court of Chancery found that this illustrated Cerro's problematic incentives.

Plaintiff Sues Defendants and Special Committee

This derivative suit challenging the Merger, first filed in late 2004, moved too slowly, and it was not until June 30, 2010 that the Plaintiff moved for summary judgment. On August 10, 2010, the Defendants filed a cross-motion for summary judgment, or in the alternative, to shift the burden of proof to the Plaintiff under the [1235] entire fairness standard. On August 11, 2010, the individual Special Committee defendants cross-moved for summary judgment on all claims under Southern Peru's exculpatory provision adopted under title 8, section 102(b)(7) of the Delaware Code.

At a hearing held on December 21, 2010, the Court of Chancery dismissed the Special Committee defendants from the case because the plaintiff had failed to present evidence supporting a non-exculpated breach of their fiduciary duty of loyalty. It denied all other motions for summary judgment. The Court of Chancery noted that this, of course, did not mean that the Special Committee had acted adroitly or that the remaining defendants, Grupo Mexico and its affiliates, were immune from liability.

In contrast to the Special Committee defendants, precisely because the remaining directors were employed by Grupo Mexico, which had a self-dealing interest directly in conflict with Southern Peru, the exculpatory charter provision was of no benefit to them at that stage, given the factual question regarding their motivations. At trial, these individual Grupo Mexico-affiliated director defendants made no effort to show that they acted in good faith and were entitled to exculpation despite their lack of independence. In other words, the Grupo Mexico-affiliated directors did nothing to distinguish each other and none of them argued that he should not bear liability for breach of the duty of loyalty if the transaction was unfairly advantageous to Grupo Mexico, which had a direct self-dealing interest in the Merger. Accordingly, the Court of Chancery concluded that their liability would rise or fall with the issue of fairness.

In dismissing the Special Committee members on the summary judgment record, the Court of Chancery necessarily treated the predicament faced by Cerro and Handelsman, which involved facing additional economic pressures as a minority stockholder as a result of Grupo Mexico's control, differently than a classic self-dealing interest. The Court of Chancery continued to hold that view. Although it believed that Cerro, and therefore Handelsman, were influenced by Cerro's desire for liquidity as a stockholder, it seemed counterproductive to the Court of Chancery to equate a legitimate concern of a stockholder for liquidity from a controller into a self-dealing interest.

Therefore, the Court of Chancery concluded that there had to be a triable issue regarding whether Handelsman acted in subjective bad faith to force him to trial. The Court of Chancery concluded then on that record that no such issue of fact existed and even on the fuller trial record (where the Plaintiff actually made much more of an effort to pursue this angle), it still could not find that Handelsman acted in bad faith to purposely accept an unfair deal.

Nevertheless, the Court of Chancery found that Cerro, and therefore Handelsman, did have the sort of economic concern that ideally should have been addressed upfront and forthrightly in terms of whether the stockholder's interest well positioned its representative to serve on a special committee. Thus, although the Court of Chancery continued to be unpersuaded that it could label Handelsman as having acted with the state of mind required to expose him to liability, given the exculpatory charter protection to which he is entitled, it was persuaded that Cerro's desire to sell influenced how Handelsman approached his duties and compromised his effectiveness.

TRIAL SCHEDULE PROPERLY MAINTAINED

The Defendants' first argument is that the Court of Chancery erred by excluding [1236] the testimony of James Del Favero regarding the advice given to the Special Committee by its financial advisor, Goldman, on the ground that Del Favero was identified too late and allowing him to testify would be unfair to the Plaintiff. The Plaintiff contends that the Court of Chancery exercised sound discretion by refusing to modify the stipulated trial schedule in order to permit a new Goldman witness (Del Favero) to be deposed and testify weeks after the trial was scheduled to have concluded, when a video-taped deposition of the Special Committee's actual Goldman advisor was already in the record. Both parties agree, however, that whether the trial judge's ruling is characterized as an exclusion of evidence or a refusal to change the trial scheduling order, either action is reviewed on appeal for an abuse of discretion.^[10]

The record reflects that the Plaintiff obtained commissions for deposing three of the six members of the Goldman team identified in Goldman's pitch book to the Special Committee. By agreement of the parties, the Plaintiff deposed Martin Sanchez ("Sanchez") who was the head member of the Goldman team that advised the Special Committee. Sanchez was apparently the Goldman person to whom the Special Committee spoke most often.

Sanchez was deposed on October 21, 2009. He had not worked at Goldman since 2006. Accordingly, at the time of Sanchez's 2009 deposition, the Defendants were aware that neither they nor Goldman could control whether Sanchez would appear at trial. Sanchez's deposition was videotaped. Therefore, it was not simply a cold transcript.

The June 20, 2011 trial date was stipulated to by the parties and set by order of the Court of Chancery on February 10, 2011. On May 31, 2011, the Defendants notified the Plaintiff that Sanchez may not appear to testify at trial. The Defendants assert that they immediately began a search — three weeks before trial — for an alternative Goldman witness who would be available to testify. Their initial choice, however, was not Del Favero.

On June 9, 2011, when the Defendants informed the Plaintiff that Sanchez was "definitely not showing up" for trial, they identified Martin Werner ("Werner"), another Goldman member of the Special Committee advisory team, as their witness for trial. The Plaintiff did not object to the late identification of Werner but did seek to confirm that he would be able to depose Werner before trial. The Defendants' attorney responded, "Of course. I am not optimistic that we will get him to trial, in which case we will have no live Goldman witness."

On Monday, June 13, 2011, just twenty-four hours before the pretrial stipulation was due and one week before trial was scheduled to commence, the Defendants proposed for the first time that they call Del Favero as their live Goldman witness at trial. Unlike Sanchez or Werner, Del Favero was not offered to testify about the advice Goldman provided to the Special Committee, but rather about Goldman's internal processes relating to issuing fairness opinions. In proposing to call Del Favero as a witness, the Defendants stated: "We know that Your Honor had commented on[,] at the summary judgment hearing[,] the fairness opinion review process at Goldman Sachs and had some questions about that. We believe that he [1237] would be in a position to answer those questions."

Del Favero was not available to either testify during the long-established June trial dates or to be deposed before trial began on June 20. The Defendants suggested that Del Favero be deposed after every other trial witness had testified, and that the trial schedule be modified to reconvene sometime in July to allow Del Favero to testify several weeks after the trial was scheduled to conclude.

At the pretrial conference, the Plaintiff objected to the Defendants' proposal regarding Del Favero for several reasons. First, the Plaintiff argued that allowing Del Favero to be deposed and then testify after every other trial witness had testified, and the trial was otherwise concluded, would be unfair. Second, the Plaintiff objected to Del Favero's testimony because it was not directly relevant to the issues to be presented at trial since Del Favero was not a member of the Goldman team that advised the Special Committee, and had only attended one Special Committee meeting, during which Goldman only pitched its services. Third, the Plaintiff objected to the subject matter to which Del Favero would testify because it was the same subject matter on which counsel for Goldman and the Special Committee had precluded the Plaintiff from inquiring about at Sanchez's deposition.

The Court of Chancery held that Del Favero's inability to testify during the scheduled trial dates, or even to be deposed before the trial began, would unfairly prejudice the Plaintiff. In the Court of Chancery and on appeal, the Defendants assert that a live Goldman witness was central to their defense in light of the trial judge's comments made at the December 2010 summary judgment argument. In denying the Defendants' request to depose and to call Del Favero as a witness several weeks after the trial was scheduled to end, the trial judge noted that if his comments six months earlier at the summary judgment argument had caused the Defendants to reconsider their witness selection,

[T]hen I expect that you would have promptly identified this gentleman as a relevant witness and made him available for deposition. It's simply not fair to the plaintiffs.

Because the other thing about people who want to be witnesses is they get deposed, and when they get deposed, you learn things, and you might ask other people or shape your trial strategy differently. It just adds an unfair element of surprise. And in the 1930s, we decided with the Rules of Civil Procedure to eliminate surprise, at least insofar as your opponent was diligent and asked questions.

It's regrettable that the lead banker [Sanchez] for a client, even with the passage of time, would decline coming to testify. I understand he may be at a different institution, but, you know, he was the lead banker.

So I'll watch the [Sanchez] video and we'll deal with it then. Otherwise, we have a fairly truncated set-up of live witnesses; correct?

On appeal, the Defendants assert that "[i]t is difficult to see any harm — let alone unfair harm" if the bench trial had to be reconvened after several weeks to permit Del Favero to be deposed and to testify because the Plaintiff "allowed this case to languish unprosecuted for many years." The Defendants also argue, for the first time on appeal, that if deposing Del Favero after all "other trial testimony would have been problematic, the only fair solution would have been to postpone [commencement] of the trial for a short period to avoid prejudicing the Defendants."

[1238] Accordingly, the Defendants contend that the Court of Chancery's refusal to either postpone the commencement of the trial or to reconvene the trial should be reversed because "[a]llowing a proposed trial schedule to dictate which testimony can and cannot be presented by the parties would be the `tail wagging the dog.'" That argument reflects a fundamental misunderstanding of both fact and law. First, as a matter of fact, the June 20 start date for the trial was not proposed. It had been fixed by court order months earlier in February, with the agreement of the parties. Second, as a matter of law, to use the Defendants' analogy, a trial scheduling order is the dog and not the tail.

This Court has stated that "[p]arties must be mindful that scheduling orders are not merely guidelines but have [the same] full force and effect" as any other court order.^[11] Once the trial dates are set, the trial judge (the dog's handler) determines whether there is a manifest necessity for amending the trial scheduling order (changing the pace or direction of the dog). That determination is entrusted to the trial judge's discretion.^[12]

The record reflects that the trial judge refused to change the trial scheduling order to accommodate Del Favero's availability. The trial judge did not exclude Del Favero's testimony. Nor did the trial judge exclude trial testimony from any other Goldman witness. Sanchez was deposed, and the trial judge specifically stated he would "watch the video" of Sanchez's deposition. Because the trial judge excluded no testimony, this case is significantly different from the facts in the two cases relied upon by the Defendants, Drejka v. Hitchens Tire Service, Inc.,^[13] and Sheehan v. Oblates of St. Francis de Sales.^[14]

The Defendants' contention that the Court of Chancery committed reversible error because Del Favero's availability "could easily be accommodated during a bench trial" continues its misconception of the judicial process. Trial judges are vested with the discretion to resolve scheduling matters and to control their own docket.^[15] When an act of judicial discretion is at issue on appeal, this Court cannot substitute its opinion of what is right for that of the trial judge, if the trial judge's opinion was based upon conscience and reason, as opposed to arbitrariness or capriciousness.^[16]

The Court of Chancery's decision was neither arbitrary nor capricious. The Defendants sought to modify the stipulated trial schedule at the eleventh hour by requesting that the trial proceed on June 20, as scheduled, but then be continued until "sometime" in July, and that Del Favero be deposed and testify after every other trial witness had testified. The Court of Chancery ruled this was "simply not fair to the plaintiffs." The Court of Chancery noted that when witnesses "get deposed, you learn things, and you might ask other people or shape your trial strategy differently." The Court of Chancery also noted that if the Defendants had truly been concerned about having a live Goldman witness testify at trial, they could "have [1239] promptly identified this gentleman as a relevant witness and made him available for deposition."

The Defendants' assertion that they were prejudiced by not being able to present Del Favero's live testimony at trial is undermined by the record. First, several days before the trial was scheduled to commence, the Defendants acknowledged that they might not have a live Goldman witness to present at trial. Therefore, they would have to rely on the videotaped deposition of Sanchez. Second, in making their post-trial entire fairness arguments to the Court of Chancery, the Defendants stated "the record here is replete with evidence showing what Goldman Sachs did and why."

Del Favero was not available to be deposed, let alone to offer trial testimony, until weeks after the testimony of every other trial witness concluded. The Court of Chancery found the nature of the Defendants' eleventh-hour request to modify the long-standing trial dates would have been unfair to the Plaintiff. That finding is supported by the record and the product of a logical deductive reasoning process. We hold that the Court of Chancery properly exercised its discretion by refusing to modify the stipulated trial scheduling order to accommodate Del Favero's availability.

BURDEN SHIFTING ANALYSIS

The Defendants' second argument on appeal is that the Court of Chancery committed reversible error by failing to determine which party bore the burden of proof before trial. The Defendants submit that the Court of Chancery further erred by ultimately allocating the burden to the Defendants, because the Special Committee was independent, was well-functioning, and did not rely on the controlling shareholder for the information that formed the basis for its recommendation.

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.^[17] In other words, the defendants bear the burden of proving that the transaction with the controlling stockholder was entirely fair to the minority stockholders. In the Court of Chancery and on appeal, both the Plaintiff and the Defendants agree that entire fairness is the appropriate standard of judicial review for the Merger.^[18]

The entire fairness standard has two parts: fair dealing and fair price.^[19] Fair dealing "embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained."^[20] Fair price "relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock."^[21]

[1240] In Kahn v. Lynch Communication Systems, Inc.,^[22] 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.^[23] Nevertheless, even when an interested cash-out merger transaction receives the informed approval of a majority of minority stockholders or a well-functioning committee of independent directors, an entire fairness analysis is the only proper standard of review.^[24] Accordingly, "[r]egardless of where the burden lies, when a controlling shareholder stands on both sides of the transaction the conduct of the parties will be viewed under the more exacting standard of entire fairness as opposed to the more deferential business judgment standard."^[25]

In Emerald Partners v. Berlin,^[26] we noted that "[w]hen the standard of review is entire fairness, ab initio, director defendants can move for summary judgment on either the issue of entire fairness or the issue of burden shifting."^[27] In this case, the Defendants filed a summary judgment motion, arguing that the Special Committee process shifted the burden of persuasion under the preponderance standard to the Plaintiff. The Court of Chancery found the summary judgment record was insufficient to determine that question of burden shifting prior to trial.

Lynch and its progeny^[28] set forth what is required of an independent committee for the defendants to obtain a burden shift. In this case, the Court of Chancery recognized that, in Kahn v. Tremont Corp.,^[29] this Court held that "[t]o obtain the benefit of a burden shifting, the controlling shareholder must do more than establish a perfunctory special committee of outside directors."^[30] 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.'"^[31] In this case, the Court of Chancery properly concluded that:

A close look at Tremont suggests that the [burden shifting] inquiry must focus on how the special committee actually negotiated the deal — was it "well functioning"^[32] — rather than just how the committee was set up. The test, therefore, [1241] seems to contemplate a look back at the substance, and efficacy, of the special committee's negotiations, rather than just a look at the composition and mandate of the special committee.^[33]

The Court of Chancery expressed its concern about the practical implications of such a factually intensive burden shifting inquiry because it is "deeply enmeshed" in the ultimate entire fairness analysis.

Subsuming within the burden shift analysis questions of whether the special committee was substantively effective in its negotiations with the controlling stockholder — questions fraught with factual complexity — will, absent unique circumstances, guarantee that the burden shift will rarely be determinable on the basis of the pretrial record alone.^[34] If we take seriously the notion, as I do, that a standard of review is meant to serve as the framework through which the court evaluates the parties' evidence and trial testimony in reaching a decision, and, as important, the framework through which the litigants determine how best to prepare their cases for trial,^[35] it is problematic to adopt an analytical approach whereby the burden allocation can only be determined in a post-trial opinion, after all the evidence and all the arguments have been presented to the court.

We agree with these thoughtful comments. However, the general inability to decide burden shifting prior to trial is directly related to the reason why entire fairness remains the applicable standard of review even when an independent committee is utilized, i.e., "because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny."^[36]

This case is a perfect example. The Court of Chancery could not decide whether to shift the burden based upon the pretrial record. After hearing all of the evidence presented at trial, the Court of Chancery found that, although the independence of the Special Committee was not challenged, "from inception, the Special Committee fell victim to a controlled mindset and allowed Grupo Mexico to dictate the terms and structure of the merger." The Court of Chancery concluded that "although the Special Committee members were competent businessmen and may have had the best of intentions, they allowed themselves to be hemmed in by the controlling stockholder's demands."

We recognize that there are practical problems for litigants when the issue of [1242] burden shifting is not decided until after the trial.^[37] For example, "in order to prove that a burden shift occurred because of an effective special committee, the defendants must present evidence of a fair process. Because they must present this evidence affirmatively, they have to act like they have the burden of persuasion throughout the entire trial court process."^[38] That is exactly what happened in this case.

Delaware has long adhered to the principle that the controlling shareholders have the burden of proving an interested transaction was entirely fair.^[39] However, in order to encourage the use of procedural devices that foster fair pricing, such as special committees and minority stockholder approval conditions, this Court has provided transactional proponents with what has been described as a "modest procedural benefit — the shifting of the burden of persuasion on the ultimate issue of entire fairness to the plaintiffs — if the transaction proponents proved, in a factually intensive way, that the procedural devices had, in fact, operated with integrity."^[40] We emphasize that in Cox, the procedural benefit of burden shifting was characterized as "modest."

Once again, in this case, the Court of Chancery expressed uncertainty about whether "there is much, if any, practical implication of a burden shift." According to the Court of Chancery, "[t]he practical effect of the Lynch doctrine's burden shift is slight. One reason why this is so is that shifting the burden of persuasion under a preponderance standard is not a major move, if one assumes ... that the outcome of very few cases hinges on what happens if ... the evidence is in equipoise."^[41]

In its post-trial opinion, the Court of Chancery found that the burden of persuasion remained with the Defendants, because the Special Committee was not "well functioning."^[42] The trial judge also found, "however, that this determination matters little because I am not stuck in equipoise about the issue of fairness. Regardless of who bears the burden, I conclude that the Merger was unfair to Southern Peru and its stockholders."

Nothing in the record reflects that a different outcome would have resulted if either the burden of proof had been shifted to the Plaintiff, or the Defendants had been advised prior to trial that the burden had not shifted. The record reflects that, by agreement of the parties, each witness other than the Plaintiff's expert was called in direct examination by the Defendants, and then was cross-examined by the Plaintiff. The Defendants have not identified any decision they might have made differently, if they had been advised prior to trial that the burden of proof had not shifted.

The Court of Chancery concluded that this is not a case where the evidence of fairness or unfairness stood in equipoise. It found that the evidence of unfairness was so overwhelming that the question of who had the burden of proof at trial was [1243] irrelevant to the outcome. That determination is supported by the record. The Court of Chancery committed no error by not allocating the burden of proof before trial, in accordance with our prior precedents. In the absence of a renewed request by the Defendants during trial that the burden be shifted to the Plaintiff, the burden of proving entire fairness remained with the Defendants throughout the trial.^[43] The record reflects that is how the trial in this case was conducted.

Nevertheless, we recognize that the purpose of providing defendants with the opportunity to seek a burden shift is not only to encourage the use of special committees,^[44] but also to provide a reliable pretrial guide for the parties regarding who has the burden of persuasion.^[45] Therefore, which party bears the burden of proof must be determined, if possible, before the trial begins. The Court of Chancery has noted that, in the interest of having certainty, "it is unsurprising that few defendants have sought a pretrial hearing to determine who bears the burden of persuasion on fairness" given "the factually intense nature of the burden-shifting inquiry" and the "modest benefit" gained from the shift.^[46]

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.

The Defendants argue that if the Court of Chancery rarely determines the issue of burden shifting on the basis of a pretrial record, corporations will be dissuaded from forming special committees of independent directors and from seeking approval of an interested transaction by an informed vote of a majority of the minority shareholders. That argument underestimates the importance of either or both actions to the process component — fair dealing — of the entire fairness standard. This Court has repeatedly held that any board process is materially enhanced when the decision is attributable to independent directors.^[47] Accordingly, judicial review for entire fairness of how the transaction [1244] 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.^[48] Similarly, the issue of how stockholder approval was obtained will be significantly influenced by the affirmative vote of a majority of the minority stockholders.^[49]

A fair process usually results in a fair price. Therefore, the proponents of an interested transaction will continue to be incentivized to put a fair dealing process in place that promotes judicial confidence in the entire fairness of the transaction price. Accordingly, we have no doubt that the effective use of a properly functioning special committee of independent directors and the informed conditional approval of a majority of minority stockholders will continue to be integral parts of the best practices that are used to establish a fair dealing process.

UNFAIR DEALING PRODUCES UNFAIR PRICE

Although the entire fairness standard has two components, the entire fairness analysis is "not a bifurcated one as between fair dealing and fair price. All aspects of the issue must be examined as a whole since the question is one of entire fairness."^[50] In a non-fraudulent transaction, "price may be the preponderant consideration outweighing other features of the merger."^[51] Evidence of fair dealing has significant probative value to demonstrate the fairness of the price obtained. The paramount consideration, however, is whether the price was a fair one.^[52]

The Court of Chancery found that the process by which the Merger was negotiated and approved was not fair and did not result in the payment of a fair price. Because the issues relating to fair dealing and fair price were so intertwined, the Court of Chancery did not separate its analysis, but rather treated them together in an integrated examination. That approach is consistent with the inherent non-bifurcated nature of the entire fairness standard of review.^[53]

The independence of the members of the Special Committee was not challenged by the Plaintiff. The Court of Chancery found that the Special Committee members were competent, well-qualified individuals with business experience. The Court of Chancery also found that the Special Committee was "given the resources to hire outside advisors, and it hired not only respected, top tier of the market financial and legal counsel, but also a mining consultant and Mexican counsel." Nevertheless, the Court of Chancery found that, although the Special Committee members had their "hands ... on the oars[,]" the boat went "if anywhere, backward[.]"

The Special Committee began its work with a narrow mandate, to "evaluate a transaction suggested by the majority stockholder." The Court of Chancery found that "the Special Committee members' understanding of their mandate ... evidenced their lack of certainty about whether the Special Committee could do more than just evaluate the Merger." The [1245] Court of Chancery concluded that, although the Special Committee went beyond its limited mandate and engaged in negotiations, "its approach to negotiations was stilted and influenced by its uncertainty about whether it was actually empowered to negotiate."

Accordingly, the Court of Chancery determined that "from inception, the Special Committee fell victim to a controlled mindset and allowed Grupo Mexico to dictate the terms and structure of the Merger." The Special Committee did not ask for an expansion of its mandate to look at alternatives. Instead, the Court of Chancery found that the Special Committee "accepted that only one type of transaction was on the table, a purchase of Minera by Southern Peru."

In its post-trial opinion, the Court of Chancery stated that this "acceptance" influenced the ultimate determination of unfairness, because "it took off the table other options that would have generated a real market check and also deprived the Special Committee of negotiating leverage to extract better terms." The Court of Chancery summarized these dynamics as follows:

In sum, although the Special Committee members were competent businessmen and may have had the best of intentions, they allowed themselves to be hemmed in by the controlling stockholder's demands. Throughout the negotiation process, the Special Committee's and Goldman's focus was on finding a way to get the terms of the Merger structure proposed by Grupo Mexico to make sense, rather than aggressively testing the assumption that the Merger was a good idea in the first place.

Goldman made its first presentation to the Special Committee on June 11, 2004. Goldman's conclusions were summarized in an "Illustrative Give/Get Analysis." The Court of Chancery found this analysis "made patent the stark disparity between Grupo Mexico's asking price and Goldman's valuation of Minera: Southern Peru would `give' stock with a market price of $3.1 billion to Grupo Mexico and would `get' in return an asset worth no more than $1.7 billion."

According to the Court of Chancery, the Special Committee's controlled mindset was illustrated by what happened after Goldman's initial analysis could not value the "get" — Minera — anywhere near Grupo Mexico's asking price, the "give":

From a negotiating perspective, that should have signaled that a strong response to Grupo Mexico was necessary and incited some effort to broaden, not narrow, the lens. Instead, Goldman and the Special Committee went to strenuous lengths to equalize the values of Southern Peru and Minera. The onus should have been on Grupo Mexico to prove Minera was worth $3.1 billion, but instead of pushing back on Grupo Mexico's analysis, the Special Committee and Goldman devalued Southern Peru and topped up the value of Minera. The actions of the Special Committee and Goldman undermine the defendants' argument that the process leading up to the Merger was fair and lend credence to the plaintiff's contention that the process leading up to the Merger was an exercise in rationalization.

The Court of Chancery found that, following Goldman's first presentation, the Special Committee abandoned a focus on whether Southern Peru would get $3.1 billion in value in an exchange. Instead, the Special Committee moved to a "relative valuation" methodology that involved comparing the values of Southern Peru and Minera. On June 23, 2004, Goldman advised the Special Committee that Southern Peru's DCF value was $2.06 billion and, [1246] thus, approximately $1.1 billion below Southern Peru's actual NYSE market price at that time.

The Court of Chancery was troubled by the fact that the Special Committee did not use this valuation gap to question the relative valuation methodology. Instead, the Special Committee was "comforted" by the analysis, which allowed them to conclude that DCF value of Southern Peru's stock (the "give") was not really worth its market value of $3.1 billion. The Court of Chancery found that:

A reasonable special committee would not have taken the results of those analyses by Goldman and blithely moved on to relative valuation, without any continuing and relentless focus on the actual give-get involved in real cash terms. But, this Special Committee was in the altered state of a controlled mindset. Instead of pushing Grupo Mexico into the range suggested by Goldman's analysis of Minera's fundamental value, the Special Committee went backwards to accommodate Grupo Mexico's asking price — an asking price that never really changed.

The Court of Chancery concluded "[a] reasonable third-party buyer free from a controlled mindset would not have ignored a fundamental economic fact that is not in dispute here — in 2004, Southern Peru stock could have been sold for [the] price at which it was trading on the New York Stock Exchange."

In this appeal, the Defendants contend that the Court of Chancery did not understand Goldman's analysis and rejected their relative valuation of Minera without an evidentiary basis. According to the Defendants, a relative valuation analysis is the appropriate way to perform an accurate comparison of the value of Southern Peru, a publicly-traded company, and Minera, a private company. In fact, the Defendants continue to argue that relative valuation is the only way to perform an "apples-to-apples" comparison of Southern Peru and Minera.

Moreover, the Defendants assert that Goldman and the Special Committee did actually believe that Southern Peru's market price accurately reflected the company's value. According to the Defendants, however, there were certain assumptions reflected in Southern Peru's market price that were not reflected in its DCF value, i.e., the market's view of future copper price increases. Therefore, the Defendants submit that:

If the DCF analysis was missing some element of value for [Southern Peru], it would also miss that very same element of value for Minera. In short, at the time that Goldman was evaluating Minera, its analysis of [Southern Peru] demonstrated that mining companies were trading at a premium to their DCF values. The relative valuation method allowed Goldman to account for this information in its analysis and value Minera fairly.

Accordingly, the Defendants argue that the Court of Chancery failed to recognize that the difference between Southern Peru's DCF and market values also implied a difference between Minera's DCF value and its market value.

The Defendants take umbrage at the Court of Chancery's statement that "the relative valuation technique is not alchemy that turns a sub-optimal deal into a fair one." The Court of Chancery's critical comments regarding a relative value methodology were simply a continuation of its criticism about how the Special Committee operated. The record indicates that the Special Committee's controlled mindset was reflected in its assignments to Goldman. According to the Court of Chancery, "Goldman appears to have helped its client [1247] rationalize the one strategic option available within the controlled mindset that pervaded the Special Committee's process."

The Defendants continue to argue that the Court of Chancery would have understood that "relative valuation" was the "appropriate way" to compare the values of Southern Peru and Minera if a Goldman witness (Del Favero) had testified at trial. As noted earlier, that argument is inconsistent with the Defendants' post-trial assertion that the record was replete with evidence of what Goldman did (a relative valuation analysis) and why that was done. That argument also disregards the trial testimony of the Defendants' expert witness, Professor Schwartz, who used the same relative valuation methodology as Goldman.

Prior to trial, the Defendants represented that Professor Schwartz would be called at trial to "explain that the most reliable way to compare the value of [Southern Peru] and Minera for purposes of the Merger was to conduct a relative valuation." In their pretrial proffer, the Defendants also represented that Professor Schwartz's testimony would demonstrate that "based on relative valuations of Minera and [Southern Peru] using a reasonable range of copper prices ... the results uniformly show that the Merger was fair to [Southern Peru] and its stockholders."

At trial, Professor Schwartz attributed the difference between Southern Peru's DCF value and its market value to the fact that the market was valuing Southern Peru's stock "at an implied copper price of $1.30." Professor Schwartz testified, "if I use $1.30, it gives me the market price of [Southern Peru] and it gives me a market price of Minera Mexico which still makes the transaction fair." In other words, it was fair to "give" Grupo Mexico $3.75 billion of Southern Peru stock because Minera's DCF value, using an assumed long-term copper price of $1.30, implied a "get" of more than $3.7 billion.

The Court of Chancery found that Professor Schwartz's conclusion that the market was assuming a long-term copper price of $1.30 in valuing Southern Peru was based entirely on post-hoc speculation, because there was no credible evidence in the record that anyone at the time of the Merger contemplated a $1.30 long-term copper price. In fact, Southern Peru's own public filings referenced $0.90 per pound as the appropriate long-term copper price. The Court of Chancery summarized its findings as follows:

Thus, Schwartz's conclusion that the market was assuming a long-term copper price of $1.30 in valuing Southern Peru appears to be based entirely on post-hoc speculation. Put simply, there is no credible evidence of the Special Committee, in the heat of battle, believing that the long-term copper price was actually $1.30 per pound but using $0.90 instead to give Southern Peru an advantage in the negotiation process.

The Court of Chancery also noted that Professor Schwartz did not produce a standalone equity value for Minera that justified issuing shares of Southern Peru stock worth $3.1 billion at the time the Merger Agreement was signed.

The record reflects that the Court of Chancery did understand the Defendants' argument and that its rejection of the Defendants' "relative valuation" of Minera was the result of an orderly and logical deductive reasoning process that is supported by the record. The Court of Chancery acknowledged that relative valuation is a valid valuation methodology. It also recognized, however, that since "relative valuation" is a comparison of the DCF values of Minera and Southern Peru, the result is only as reliable as the input data [1248] used for each company. The record reflects that the Court of Chancery carefully explained its factual findings that the data inputs Goldman and Professor Schwartz used for Southern Peru in the Defendants' relative valuation model for Minera were unreliable.

The Court of Chancery weighed the evidence presented at trial and set forth in detail why it was not persuaded that "the Special Committee relied on truly equal inputs for its analyses of the two companies." The Court of Chancery found that "Goldman and the Special Committee went to strenuous lengths to equalize the value of Southern Peru and Minera." In particular, the Court of Chancery found that "when performing the relative valuation analysis, the cash flows for Minera were optimized to make Minera an attractive acquisition target, but no such dressing up was done for Southern Peru."

The Court of Chancery also noted that Goldman never advised the Special Committee that Minera was worth $3.1 billion, or that Minera could be acquired at, or would trade at, a premium to its DCF value if it were a public company. Nevertheless, the Court of Chancery found "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." Accordingly, the Court of Chancery concluded:

The Special Committee's cramped perspective 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 proposed. After this game of controlled mindset twister and the contortions it involved, the Special Committee agreed to give away over $3 billion worth of actual cash value in exchange for something worth demonstrably less, and to do so on terms that by consummation made the value gap even worse, without using any of its contractual leverage to stop the deal or renegotiate its terms. Because the deal was unfair, the defendants breached their fiduciary duty of loyalty.

Entire fairness is a standard by which the Court of Chancery must carefully analyze the factual circumstances, apply a disciplined balancing test to its findings, and articulate the bases upon which it decides the ultimate question of entire fairness.^[54] The record reflects that the Court of Chancery applied a "disciplined balancing test," taking into account all relevant factors.^[55] The Court of Chancery considered the issues of fair dealing and fair price in a comprehensive and complete manner. The Court of Chancery found the process by which the Merger was negotiated and approved constituted unfair dealing and that resulted in the payment of an unfair price.

The Court of Chancery's post-trial determination of entire fairness must be accorded substantial deference on appeal.^[56] The Court of Chancery's factual findings are supported by the record and its conclusions are the product of an orderly and [1249] logical deductive reasoning process.^[57] Accordingly, the Court of Chancery's judgment, that the Merger consideration was not entirely fair, is affirmed.^[58]

DAMAGE AWARD PROPER

In the Court of Chancery, the Plaintiff sought an equitable remedy that cancelled or required the Defendants to return to Southern Peru the shares that Southern Peru issued in excess of Minera's fair value. In the alternative, the Plaintiff asked for rescissory damages in the amount of the then present market value of the excess number of shares that Grupo Mexico held as a result of Southern Peru paying an unfair price in the Merger.

In the Court of Chancery and on appeal, the Defendants argue that no damages are due because the Merger consideration was more than fair. In support of that argument, the Defendants rely on the fact that Southern Peru stockholders should be grateful, because the market value of Southern Peru's stock continued on a generally upward trajectory in the years after the Merger. Alternatively, the Defendants argue that any damage award should be at most a fraction of the amount sought by the Plaintiff, and, in particular, that the Plaintiff has waived the right to seek rescissory damages because of "his lethargic approach to litigating the case."

The Court of Chancery rejected the Defendants' argument that the post-Merger performance of Southern Peru's stock eliminates the need for damages. It noted that the Defendants did not "present a reliable event study about the market's reaction to the Merger, and there is evidence that the market did not view the Merger as fair in spite of material gaps in disclosure about the fairness of the Merger." The trial judge was of the opinion that a "transaction like the Merger can be unfair, in the sense that it is below what a real arms-length deal would have been priced at, while not tanking a strong company with sound fundamentals in a rising market, such as the one in which Southern Peru was a participant. That remains my firm sense here...." The Court of Chancery's decision to award some amount of damages is supported by the record and the product of a logical deductive reasoning process.

Nevertheless, the Court of Chancery did agree with the Defendants' argument that the Plaintiff's delay in litigating the case rendered it inequitable to use a rescission-based approach in awarding damages.^[59] The Court of Chancery reached that determination because "[r]escissory damages are the economic equivalent of rescission and[,] therefore[,] if rescission itself is unwarranted because of the plaintiff's delay, so are rescissory damages."^[60] Instead of entering a rescission-based remedy, the Court of Chancery decided to craft a damage award, as explained below:

[The award] approximates the difference between the price that the Special Committee would have approved had the Merger been entirely fair (i.e., absent a breach of fiduciary duties) and the price that the Special Committee actually agreed to pay. In other words, I will take the difference between this fair price and the market value of 67.2 million [1250] shares of Southern Peru stock as of the Merger date. That difference, divided by the average closing price of Southern Peru stock in the 20 trading days preceding the issuance of this opinion, will determine the number of shares that the defendants must return to Southern Peru. Furthermore, because of the plaintiff's delay, I will only grant simple interest on that amount, calculated at the statutory rate since the date of the Merger.^[61]

After determining the nature of the damage award, the Court of Chancery determined the appropriate valuation for the price that the Special Committee should have paid. To calculate a fair price for remedy purposes, the Court of Chancery balanced three separate values. The first value was a standalone DCF value of Minera. Using defendant-friendly modifications to the Plaintiff's expert's DCF valuation, the Court of Chancery calculated that a standalone equity value for Minera as of October 21, 2004 was $2.452 billion. The second value was the market value of the Special Committee's 52 million share counteroffer made in July 2004, "which was sized based on months of due diligence by Goldman about Minera's standalone value, calculated as of the date on which the Special Committee approved the Merger." Because Grupo Mexico wanted a dollar value of stock, the Court of Chancery fixed the value at what 52 million Southern Peru shares were worth as of October 21, 2004, the date on which the Special Committee approved the Merger, at $2.388 billion, giving Minera credit for the price growth to that date. The third value was the equity value of Minera derived from a comparable companies analysis using the companies identified by Goldman. Using the median premium for merger transactions in 2004, calculated by Mergerstat to be 23.4%, and applying that premium to the value derived from the Court of Chancery's comparable companies analysis yielded a value of $2.45 billion.

The Court of Chancery gave those three separate values equal weight in its damages equation: (($2.452 billion + $2.388 billion + $2.45 billion)/3). The result was a value of $2.43 billion. It then made an adjustment to reflect the fact that Southern Peru bought 99.15%, not 100%, of Minera, which yielded a value of $2.409 billion. The value of 67.2 million Southern Peru shares as of the Merger Date was $3.756 billion.^[62] Therefore, the base damage award by the Court of Chancery amounted to $1.347 billion.^[63] The Court of Chancery then added interest from the Merger Date, at the statutory rate, without compounding and with that interest to run until time of the judgment and until payment.

The Court of Chancery stated that Grupo Mexico could satisfy the judgment by agreeing to return to Southern Peru such number of its shares as are necessary to satisfy this remedy. The Court of Chancery also ruled that any attorneys' fees would be paid out of the award.

The Defendants' first objection to the Court of Chancery's calculation of damages is that its methodology included the Special Committee's counteroffer of July 2004 as a measure of the true value of Minera. The Defendants assert that the counteroffer was "based only on Goldman's preliminary analyses of the companies before the completion of due diligence. And there was no evidence this was anything [1251] other than what it appears to be — a negotiating position."

The Court of Chancery explained its reason for including the counteroffer in its determination of damages, as follows:

In fact, you know, the formula I used, one of the things that I did to be conservative was actually to use a bargaining position of the special committee. And I used it not because I thought it was an aggressive bargaining position of the special committee, but to give the special committee and its advisors some credit for thinking. It was one of the few indications in the record of something that they thought was actually a responsible value.

And so it was actually not put in there in any way to inflate. It was actually to give some credit to the special committee. If I had thought that it was an absurd ask, I would have never used it. I didn't think it was any, really, aggressive bargaining move. I didn't actually see any aggressive bargaining moves by the special committee. I saw some innovative valuation moves, but I didn't see any aggressive bargaining moves.

The record reflects that the value of Minera pursuant to the counteroffer ($2.388 billion) was very close to the other two values used by the Court of Chancery ($2.452 billion and $2.45 billion). The Court of Chancery properly exercised its discretion — for the reasons it stated — by including the Special Committee's counteroffer as one of the component parts in its calculation of damages. Therefore, the Defendants' argument to the contrary is without merit.

The Defendants also argue that the Court of Chancery "essentially became its own expert witness regarding damages by basing its valuation, at least in part, on its own computer models." In support of that argument, the Defendants rely upon the following statement by the trial judge during oral argument on the fee award: "I'm not going to disclose everything that we got on our computer system, but I can tell you that there are very credible remedial approaches in this case that would have resulted in a much higher award." The Defendants submit that "[i]n the absence of proof from [the] Plaintiff, this speculation and outside-the-record financial modeling is impermissible."

In making a decision on damages, or any other matter, the trial court must set forth its reasons. This provides the parties with a record basis to challenge the decision. It also enables a reviewing court to properly discharge its appellate function.

In this case, the Court of Chancery explained the reasons for its calculation of damages with meticulous detail. That complete transparency of its actual deliberative process provided the Defendants with a comprehensive record to use in challenging the Court of Chancery's damage award on appeal and for this Court to review. Accordingly, any remedial approaches that the Court of Chancery may have considered and rejected are irrelevant.

The Court of Chancery has the historic power "to grant such ... relief as the facts of a particular case may dictate."^[64] Both parties agree that an award of damages by the Court of Chancery after trial in an entire fairness proceeding is reviewed on appeal for abuse of discretion.^[65] [1252] It is also undisputed that the Court of Chancery has greater discretion when making an award of damages in an action for breach of duty of loyalty than it would when assessing fair value in an appraisal action.^[66]

In this case, the Court of Chancery awarded damages based on the difference in value between what was paid (the "give") and the value of what was received (the "get"). In addition to an actual award of monetary relief, the Court of Chancery had the authority to grant pre- and post-judgment interest, and to determine the form of that interest.^[67] The record reflects that the Court of Chancery properly exercised its broad historic discretionary powers in fashioning a remedy and making its award of damages. Therefore, the Court of Chancery's judgment awarding damages is affirmed.

ATTORNEYS' FEE AWARD

The Plaintiff petitioned for attorneys' fees and expenses representing 22.5% of the recovery plus post-judgment interest. The Court of Chancery awarded 15% of the $2.031 billion judgment, or $304,742,604.45, plus post-judgment interest until the attorneys' fee and expense award is satisfied ("Fee Award"). The Court of Chancery found that the Fee Award "fairly implements the most important factors our Supreme Court has highlighted under Sugarland,^[68] including the importance of benefits," and "creates a healthy incentive for plaintiff's lawyers to actually seek real achievement for the companies that they represent in derivative actions and the classes that they represent in class actions."

On appeal, the Defendants contend "the Court of Chancery abuse[d] its discretion by granting an unreasonable fee award of over $304 million that pays the Plaintiff's counsel over $35,000 per hour worked and 66 times the value of their time and expenses." Specifically, they argue the Court of Chancery gave the first Sugarland factor, i.e. the benefit achieved, "dispositive weight," and that the remaining factors do not support the Fee Award. The Defendants also argue that the Court of Chancery erred by failing to assess the reasonableness of the Fee Award. They submit that the Court of Chancery did not: correctly apply a declining percentage analysis given the size of the judgment; consider whether the resulting hourly rate was reasonable under the circumstances; and evaluate whether the Fee Award conformed to the Delaware Rules of Professional Conduct.^[69] The Defendants further contend that the Court of Chancery committed reversible error by "[a]llowing Plaintiff's attorneys to collect fees premised upon the nearly $700 million in prejudgment interest ... even in spite of the fact that the delay impeded a full presentation of the evidence."

Common Fund Doctrine

Under the common fund doctrine, "a litigant or a lawyer who recovers a [1253] common fund for the benefit of persons other than himself or his client is entitled to a reasonable attorney's fee from the fund as a whole."^[70] The common fund doctrine is a well-established basis for awarding attorneys' fees in the Court of Chancery.^[71] It is founded on the equitable principle that those who have profited from litigation should share its costs.^[72]

"Typically, successful derivative or class action suits which result in the recovery of money or property wrongfully diverted from the corporation ... are viewed as fund creating actions."^[73] In this case, the record supports the Court of Chancery's finding that Defendants breached their duty of loyalty by exchanging over $3 billion worth of actual cash value for something that was worth much less. The record also supports the Court of Chancery's determination that the $2.031 billion judgment resulted in the creation of a common fund. Accordingly, Plaintiff's counsel, whose efforts resulted in the creation of that common fund, are entitled to receive a reasonable fee and reimbursement for expenses from that fund.^[74]

Calculating Common Fund Attorneys' Fees

In the United States, there are two methods of calculating fee awards in common fund cases: the percentage of the fund method and the lodestar method.^[75] Under a percentage of the fund method, courts calculate fees based on a reasonable percentage of the common fund.^[76] The lodestar method multiplies hours reasonably expended against a reasonable hourly rate to produce a "lodestar," which can then be adjusted through application of a "multiplier," to account for additional factors such as the contingent nature of the case and the quality of an attorney's work.^[77]

Beginning in 1881, fees were calculated and awarded from a common fund based on a percentage of that fund.^[78] Fees continued to be calculated on a percentage approach for almost 100 years. During the 1970s, however, courts began to use the lodestar method to calculate fee awards in common fund cases.^[79]

[1254] In the 1980s, two events led to the reconsideration of the lodestar method. First, in 1984, the United States Supreme Court suggested that an award in a common fund case should be based upon a percentage of the fund.^[80] By that time, "the point that `under the common fund doctrine ... a reasonable fee is based on a percentage of the fund bestowed on the class' was so well settled that no more than a footnote was needed to make it."^[81] Second, in 1985, a Third Circuit Task Force issued a report concluding that all attorney fee awards in common fund cases should be structured as a percentage of the fund.^[82] The report criticized the use of the lodestar method for determining the reasonableness of attorneys' fees in common fund class actions and listed nine deficiencies in the lodestar method.^[83] "Ultimately, the Third Circuit allowed district court judges to exercise discretion in employing the percentage of the fund method, the lodestar method, or some combination of both, but the concerns voiced in the 1985 report, as well as in other publications, were not fully answered."^[84] Today, after several years of experimentation with the lodestar method, "the vast majority of courts of appeals now permit or direct courts to use the percentage method in common-fund cases."^[85]

Delaware's Sugarland Standard

In Sugarland Industries, Inc. v. Thomas, this Court rejected any mechanical approach to determining common fund fee awards.^[86] In particular, we explicitly disapproved the Third Circuit's "lodestar method."^[87] Therefore, Delaware courts are not required to award fees based on hourly rates that may not be commensurate with the value of the common fund created by the attorneys' efforts. Similarly, in Sugarland, we did not adopt an inflexible percentage of the fund approach.

Instead, we held that the Court of Chancery should consider and weigh the following factors in making an equitable award of attorney fees: 1) the results achieved; 2) the time and effort of counsel; 3) the relative complexities of the litigation; 4) any contingency factor; and 5) the standing and ability of counsel involved.^[88] Delaware courts have assigned the greatest weight to the benefit achieved in litigation.^[89]

[1255] Sugarland Factors Applied

The determination of any attorney fee award is a matter within the sound judicial discretion of the Court of Chancery.^[90] In this case, the Court of Chancery considered and applied each of the Sugarland factors. In rendering its decision on the Fee Award, the Court of Chancery began with the following overview:

When the efforts of a plaintiff on behalf of a corporation result in the creation of a common fund, the Court should award reasonable attorneys' fees and expenses incurred by the plaintiff in achieving the benefit. Typically a-percentage-of-the-benefit approach is used if the benefit achieved is quantifiable.... And determining the percentage of the fund to award is a matter within the Court's discretion.

The aptly-named Sugarland factor[s], perhaps never more aptly-named than today, tell us to look at the benefit achieved, the difficulty and complexity of the litigation, the effort expended, the risk-taking, [and] the standing and ability of counsel. But the most important factor, the cases suggest, is the benefit. In this case it's enormous — a common fund of over 1.3 billion plus interest.

The Court of Chancery then addressed each of the Sugarland factors. The result was its decision to award the Plaintiff's counsel attorneys' fees and expenses equal to 15% of the amount of the common fund.

Benefit Achieved

With regard to the first and most important of the Sugarland factors, the benefit achieved, the Court of Chancery found that "[t]he plaintiffs here indisputably prosecuted this action through trial and secured an immense economic benefit for Southern Peru." The Court of Chancery stated that "this isn't small and this isn't monitoring. This isn't a case where it's rounding, where the plaintiffs share credit."^[91] The Court of Chancery concluded that "anything that was achieved ... by this litigation [was] by these plaintiffs." With pre-judgment interest, the benefit achieved through the litigation amounts to more than $2 billion. Post-judgment interest accrues at more than $212,000 per day. The extraordinary benefit that was achieved in this case merits a very substantial award of attorneys' fees.

The Defendants take issue with the fact that the Fee Award was based upon the total damage award, which included pre-judgment interest. They contend that including such interest in the damage award is reversible error because the Plaintiff took too long to litigate this matter. The record reflects that the Court of Chancery considered the slow pace of the litigation in making the Fee Award. In response to the Defendants' [1256] arguments, the trial judge stated: "I'm not going to ... exclude interest altogether. I get that argument.... The interest I awarded is fairly earned by the plaintiffs. It's a lower amount. And, again, I've taken that [pace of litigation] into account by the percentage that I'm awarding." The Court of Chancery's decision to include pre-judgment interest in its determination of the benefit achieved was not arbitrary or capricious, but rather was the product of a logical and deductive reasoning process.

Difficulty and Complexity

The Court of Chancery carefully considered the difficulty and complexity of the case. It noted that the Plaintiff's attorneys had succeeded in presenting complex valuation issues in a persuasive way before a skeptical court:

They advanced a theory of the case that a judge of this court, me, was reluctant to embrace. I denied their motion for summary judgment. I think I gave [Plaintiff's counsel] a good amount of grief that day about the theory. I asked a lot of questions at trial because I was still skeptical of the theory. It faced some of the best lawyers I know and am privileged to have come before me, and they won....

I think when you talk about Sugarland and you talk about the difficulty of the litigation, was this difficult? Yes, it was. Were the defense counsel formidable and among the best that we have in our bar? They were. Did the plaintiffs have to do a lot of good work to get done and have to push back against a judge who was resistant to their approach? They did.

The Plaintiff's attorneys established at trial that Southern Peru had agreed to overpay its controlling shareholder by more than fifty percent ($3.7 billion compared to $2.4 billion). In doing so, the Court of Chancery found that the Plaintiff had to "deal with very complex financial and valuation issues" while being "up against major league, first-rate legal talent." This factor supports a substantial award of attorneys' fees.

Contingent Representation

The Plaintiff's attorneys pursued this case on a contingent fee basis. They invested a significant number of hours and incurred more than one million dollars in expenses. The Defendants litigated vigorously and forced the Plaintiff to go to trial to obtain any monetary recovery. Accordingly, in undertaking this representation, the Plaintiff's counsel incurred all of the classic contingent fee risks, including the ultimate risk — no recovery whatsoever. The Court of Chancery acknowledged that the fee award was "going to be a lot per hour to people who get paid by the hour," but that in this case, the Plaintiff's attorneys' compensation was never based on an hourly rate. Therefore, the Court of Chancery found that an award representing 15% of the common fund was reasonable in light of the absolute risk taken by Plaintiff's counsel in prosecuting the case through trial on a fully contingent fee basis.

Standing and Ability of Counsel

The Court of Chancery acknowledged that it was familiar with Plaintiff's counsel and had respect for their skills and record of success. The Defendants do not contest the skill, ability or reputation of the Plaintiff's counsel. They argue, however, that the Court of Chancery "should have weighed more heavily Plaintiff's counsel's undoubted ability against the causal manner in which this case was litigated." The record does not support that argument.

[1257] First, the Court of Chancery credited the Defendants' arguments that a rescission-based remedy was inappropriate because of the Plaintiff's delay in litigating the case. Second, the Court of Chancery noted that the record could justify a much larger award of attorneys' fees, but it ultimately applied a "conservative metric because of Plaintiff's delay." Accordingly, the record reflects that the Court of Chancery's Fee Award took into account the length of time involved in getting this case to trial.

Time and Effort of Counsel

The effort by the Plaintiff's attorneys was significant. The Plaintiff's attorneys reviewed approximately 282,046 pages in document production and traveled outside the United States to take multiple depositions. They also engaged in vigorously contested pretrial motion practice. They invested their firms' resources by incurring over a million dollars of out-of-pocket expenses. Most significantly, however, the Plaintiff's attorneys took this case to trial and prevailed. We repeat the Court of Chancery's statement: "anything that was achieved ... by this litigation [was] by [the Plaintiff's attorneys]."

The primary focus of the Defendants' challenge to the Court of Chancery's Fee Award is on the hourly rate that it implies, given that Plaintiff's counsel spent 8,597 hours on this case. They argue that the Court of Chancery abused its discretion by failing to consider the hourly rate implied by the Fee Award as a "backstop check" on the reasonableness of the fee. The Court of Chancery recognized the implications of this argument: "I get it. It's approximately — on what I awarded, approximately $35,000 an hour, if you look at it that way." However, the Court of Chancery did not look at it that way.

Sugarland does not require, as the Defendants argue, courts to use the hourly rate implied by a percentage fee award, rather than the benefit conferred, as the benchmark for determining a reasonable fee award. To the contrary, in Sugarland, this Court refused to adopt the Third Circuit's lodestar approach, which primarily focuses on the time spent.^[92] There, we summarized that methodology, as follows:

Under Lindy I, the Court's analysis must begin with a calculation of the number of hours to be credited to the attorney seeking compensation. The total hours multiplied by the approved hourly rate is the "lodestar" in the Third Circuit's formulation. It has, indeed, been said that the time approach is virtually the sole consideration in making a fee ruling under Lindy I.^[93]

In rejecting the lodestar methodology, we held the Court of Chancery judges "should not be obliged to make the kind of elaborate analyses called for by the several opinions in Lindy I and Lindy II."^[94]

Moreover, in Sugarland, this Court rejected an argument that was almost identical to the one the Defendants make in this case. There, the corporation asserted on appeal that in assessing the reasonableness of the fee the Court of Chancery should have given more weight to the plaintiffs' counsel's hours and hourly rate.^[95] This Court expressly rejected the use of time expended as the principal basis for determining fees awarded to plaintiff's counsel.^[96] Instead, we held that the [1258] benefit achieved by the litigation is the "common yardstick by which a plaintiff's counsel is compensated in a successful derivative action."^[97]

In applying that "common yardstick," we affirmed the Court of Chancery's determination that the plaintiffs' attorneys were "entitled to a fair percentage of the benefit inuring to Sugarland and its stockholders...."^[98] We also affirmed the Court of Chancery's determination that 20% of the benefit achieved was a reasonable award.^[99] Our only disagreement with the Court of Chancery in Sugarland was the "benefit" to which the percentage of 20% should be applied.^[100]

In this case, the Court of Chancery properly realized that "[m]ore important than hours is `effort, as in what Plaintiffs' counsel actually did.'"^[101] In applying Sugarland, the Court of Chancery understood that it had to look at the hours and effort expended, but recognized the general principle from Sugarland that the hours that counsel worked is of secondary importance to the benefit achieved.^[102] In this case, the Court of Chancery was aware of the hourly rate that its Fee Award implied and nonetheless properly concluded that, in accordance with Sugarland, the Plaintiff's attorneys were entitled to a fair percentage of the benefit, i.e., common fund. It then found that "an award of 15 percent of the revised judgment, inclusive of expenses... is appropriate."

The Defendants' alternative to their hourly argument is a challenge to the fairness of the percentage awarded by the Court of Chancery. The Defendants contend that the Court of Chancery erred by failing to apply a declining percentage analysis in its fee determination. According to the Defendants, this Court's decision in Goodrich v. E.F. Hutton Group, Inc.^[103] supports the per se use of a declining percentage. We disagree.

In Goodrich, we discussed the declining percentage of the fund concept, noting that the Court of Chancery rightly "acknowledged the merit of the emerging judicial consensus that the percentage of recovery awarded should `decrease as the size of the [common] fund increases.'"^[104] We also emphasized, however, that the multiple factor Sugarland approach to determining attorneys' fee awards remained adequate for purposes of applying the equitable common fund doctrine.^[105] Therefore, the use of a declining percentage, in applying the Sugarland factors in common fund cases, is a matter of discretion and is not required per se.

In this case, the record does not support the Defendants' argument that the Court of Chancery failed to apply a "declining percentage." In exercising its discretion and explaining the basis for the Fee Award, the Court of Chancery reduced the award from the 22.5% requested by the [1259] Plaintiff to 15% based, at least in part, on its consideration of the Defendants' argument that the percentage should be smaller in light of the size of the judgment:

Now, I gave a percentage of only 15 percent rather than 20 percent, 22 1/2 percent, or even 33 percent because the amount that's requested is large. I did take that into account. Maybe I am embracing what is a declining thing. I've tried to take into account all the factors, the delay, what was at stake, and what was reasonable. And I gave defendants credit for their arguments by going down to 15 percent. The only basis for some further reduction is, again, envy or there's just some level of too much, there's some natural existing limit on what lawyers as a class should get when they do a deal.^[106]

Thus, the record reflects that the Court of Chancery did reduce the percentage it awarded due to the large amount of the judgment. The Defendants are really arguing that the Fee Award percentage did not "decline" enough.

Fee Award Percentage Discretionary

In determining the amount of a reasonable fee award, our holding in Sugarland assigns the greatest weight to the benefit achieved in the litigation.^[107] When the benefit is quantifiable, as in this case, by the creation of a common fund, Sugarland calls for an award of attorneys' fees based upon a percentage of the benefit. The Sugarland factor that is given the greatest emphasis is the size of the fund created, because a "common fund is itself the measure of success ... [and] represents the benchmark from which a reasonable fee will be awarded."^[108]

Delaware case law supports a wide range of reasonable percentages for attorneys' fees, but 33% is "the very top of the range of percentages."^[109] The Court of Chancery has a history of awarding lower percentages of the benefit where cases have settled before trial.^[110] When a case settles early, the Court of Chancery tends to award 10-15% of the monetary benefit conferred.^[111] When a case settles after the plaintiffs have engaged in meaningful litigation efforts, typically including [1260] multiple depositions and some level of motion practice, fee awards in the Court of Chancery range from 15-25% of the monetary benefits conferred.^[112] "A study of recent Delaware fee awards finds that the average amount of fees awarded when derivative and class actions settle for both monetary and therapeutic consideration is approximately 23% of the monetary benefit conferred; the median is 25%."^[113] Higher percentages are warranted when cases progress to a post-trial adjudication.^[114]

The reasonableness of the percentage awarded by the Court of Chancery is reviewed for an abuse of discretion.^[115] The question presented in this case is how to properly determine a reasonable percentage for a fee award in a megafund case. A recent study by the economic consulting firm National Economic Research Associates ("NERA") demonstrates that overall as the settlement values increase, the amount of fee percentages and expenses decrease.^[116] The study reports that median attorneys' fees awarded from settlements in securities class actions are generally in the range of 22% to 30% of the recovery until the recovery approaches approximately $500 million.^[117] Once in the vicinity of over $500 million, the median attorneys' fees falls to 11%.^[118]

Appellate courts that have examined a "megafund rule" requiring a fee percentage to be capped at a low figure when the recovery is quite high, have rejected it as a blanket rule. It is now accepted that "[a] mechanical, a per se application of the [1261] `megafund rule' is not necessarily reasonable under the circumstances of a case."^[119] For example, although the Third Circuit recognized that its jurisprudence confirms the use of a sliding scale as "appropriate" for percentage fee awards in large recovery cases, it has held that trial judges are not required to use a declining percentage approach in every case involving a large settlement.^[120] The Third Circuit reasoned that it has "generally cautioned against overly formulaic approaches in assessing and determining the amounts and reasonableness of attorneys' fees," and that "the declining percentage concept does not trump the fact-intensive [In re] Prudential [Ins. Co. Am. Sales Litigation, 148 F.3d 283 (3d Cir.1998)]/Gunter [v. Ridgewood Energy Corp., 223 F.3d 190 (3d Cir.2000)] [factors,]"^[121] which are similar to this Court's Sugarland factors.

Although several courts have recognized the declining percentage principle, none have imposed it as a per se rule.^[122] In Goodrich, we held the Court of Chancery did not abuse its discretion by rejecting a "per se rule that awarded attorney's fees as a percentage in relation to the maximum common fund available, without regard to the benefits actually realized by class members."^[123] We reasoned that "[t]he adoption of a mandatory methodology or particular mathematical model for determining attorney's fees in common fund cases would be the antithesis of the equitable principles from which the concept of such awards originated."^[124] That ratio decidendi equally applies in this case.

Therefore, we decline to impose either a cap or the mandatory use of any particular range of percentages for determining attorneys' fees in megafund cases. As we stated in Goodrich, "[n]ew mechanical guidelines are neither appropriate nor needed for the Court of Chancery."^[125] We reaffirm that our holding in Sugarland sets forth the proper factors for determining attorneys' fee awards in all common fund cases.^[126]

Fee Award Reasonable Percentage

The percentage awarded as attorneys' fees from a common fund is committed to the sound discretion of the Court of Chancery.^[127] In determining the amount of a fee award, the Court of Chancery must consider the unique circumstances of each case. Its reasons for the selection of a given percentage must be stated with particularity.

The Court of Chancery quantified the Fee Award as 15% of the common fund.^[128] [1262] The Court of Chancery addressed the Sugarland factors and how those factors caused it to arrive at that percentage, as follows:

The plaintiffs here indisputably prosecuted this action through trial and secured an immense economic benefit for Southern Peru. I've already said — and I'm going to take into account — I already encouraged the plaintiffs to be conservative in their application because they weren't as rapid in moving this as I would have liked. I don't think, though, that you can sort of ignore them, to say because they didn't invest six years on this case on an entirely contingent basis, deal with very complex financial and valuation issues, and ignore the fact that they were up against major league, first-rate legal talent.

. . . .

"[O]ne of the things ... the defendants got credit for in this case is that the plaintiffs were slow.... I also took that into account in how I approach interest in the case.... [I] also ... have to take that into account in the percentage I award for the plaintiffs[,] ... [a]nd I took that into account. I took some cap factors into account, setting the interest in what I did.... I have to take some away from the plaintiff's ... lawyers on that ... frankly, there were grounds for me to award more to the company. And I didn't. And — and so that is going to impel me to reduce the percentage that I'm awarding....^[129]

We repeat the Court of Chancery's conclusion:

Now, I gave a percentage of only 15 percent rather than 20 percent, 22 1/2 percent, or even 33 percent because the amount that's requested is large. I did take that into account. Maybe I am embracing what is a declining thing. I've tried to take into account all the factors, the delay, what was at stake, and what was reasonable. And I gave defendants credit for their arguments by going down to 15 percent. The only basis for some further reduction is, again, envy or there's just some level of too much, there's some natural existing limit on what lawyers as a class should get when they do a deal.

We review an award of attorneys' fees for an abuse of discretion.^[130] When an act of judicial discretion is under appellate review, this Court may not substitute its notions of what is right for those of the trial judge, if his or her judgment was the product of reason and conscience, as opposed to being either arbitrary or capricious.^[131] As we recently stated, the challenge of quantifying fee awards is entrusted to the trial judge and will not be disturbed on appeal in the absence of capriciousness or factual findings that are clearly wrong.^[132]

In this case, the Court of Chancery carefully weighed and considered all of the Sugarland factors. The record supports its factual findings and its well-reasoned decision that a reasonable attorneys' fee is 15% of the benefit created. Accordingly, we hold that the Fee Award was a proper exercise of the Court of Chancery's broad discretion in applying the Sugarland factors under the circumstances of this case.

Conclusion

The judgment of the Court of Chancery, awarding more than $2 billion in damages [1263] and more than $304 million in attorneys' fees, is affirmed.

BERGER, Justice, concurring and dissenting:

I concur in the majority's decision on the merits, but I would find that the trial court did not properly apply the law when it awarded attorneys' fees, and respectfully dissent on that issue.

The majority finds no abuse of discretion in the trial court's decision to award more than $304 million in attorneys' fees. The majority says that the trial court applied the settled standards set forth in Sugarland Industries, Inc. v. Thomas,^[133] and that this Court may not substitute its notions of what is right for those of the trial court. But the trial court did not apply Sugarland, it applied its own world views on incentives, bankers' compensation, and envy.

To be sure, the trial court recited the Sugarland standards. Its analysis, however, focused on the perceived need to incentivize plaintiffs' lawyers to take cases to trial. The trial court hypothesized that a stockholder plaintiff would be happy with a lawyer who says, "If you get really rich because of me, I want to get rich, too."^[134] Then, the trial court talked about how others get big payouts without comment, but that lawyers are not viewed the same way:

[T]here's an idea that when a lawyer or law firms are going to get a big payment, that there's something somehow wrong about that, just because it's a lawyer. I'm sorry, but investment banks have hit it big.... They've hit it big many times. And to me, envy is not an appropriate motivation to take into account when you set an attorney fee.^[135]

The trial court opined that a declining percentage for "mega" cases would not create a healthy incentive system, and that the trial court would not embrace such an approach. Rather, the trial court repeatedly pointed out that "plenty of market participants make big fees when their clients win," and that if this were a hedge fund manager or an investment bank, the fee would be okay.^[136] In sum, the trial court said that the fundamental test for reasonableness is whether the fee is setting a good incentive, and that the only basis for reducing the fee would be envy.^[137] That is not a decision based on Sugarland.

Reargument Unanimously Denied

The appellants, Americas Mining Corporation ("AMC") and nominal defendant, Southern Copper Corporation, have filed a motion for reargument. The issue raised on reargument is the narrow question of whether the relevant "benefit achieved" for calculating attorneys' fees in a derivative case, against a majority stockholder and other defendants, is properly defined as the entire judgment paid to the corporation, or, in this case, 19% of the entire judgment paid to the corporation, because the majority stockholder defendant owns 81% of the corporation that will receive the judgment.

This Court has carefully considered the motion for reargument filed by the Defendants, and the response filed by the Plaintiff. We have determined that the motion for reargument is procedurally barred under [1264] Delaware law, because the issue raised on reargument was not fully and fairly presented in the Defendants' opening briefs;^[138] and alternatively, because it is substantively without merit, as a matter of Delaware law.^[139]

Waiver Constitutes Procedural Bar

This Court's rules specifically require an appellant to set forth the issues raised on appeal and to fairly present an argument in support of those issues in their opening brief. If an appellant fails to comply with these requirements on a particular issue, the appellant has abandoned that issue on appeal.^[140] Supreme Court Rule 14(b)(vi)(A)(3) states that "[t]he merits of any argument that is not raised in the body of the opening brief shall be deemed waived and will not be considered by the Court on appeal."

Neither of the Defendants' opening briefs properly raised the issue set forth in the limited motion for reargument. AMC's opening brief did not mention the issue at all and Southern Copper Corporation's opening brief only mentioned the issue indirectly in a footnote. Arguments in footnotes do not constitute raising an issue in the "body" of the opening brief.^[141]

Therefore, the issue raised in the limited motion for reargument is procedurally barred, as a matter of Delaware law, because it has been waived. On that basis alone the motion must be denied.^[142]

Argument Without Substantive Merit

Alternatively, and as an independent basis for denying the limited motion for reargument, we conclude that the Court of Chancery properly rejected the "look through" approach to awarding attorneys' fees in a derivative action. The derivative suit has been characterized as "one of the most interesting and ingenious of accountability mechanisms for large formal organizations."^[143] It enables a stockholder to bring suit on behalf of the corporation for harm done to the corporation.^[144]

Because a derivative suit is being brought on behalf of the corporation, any recovery must go to the corporation.^[145] In addition, a stockholder who is directly injured retains the right to bring an individual action for those injuries affecting his or her legal rights as a stockholder.^[146] Such an individual injury is distinct from an injury to the corporation alone. "In such individual suits, the recovery or other relief flows directly to the stockholders, not to the corporation."^[147]

[1265] In Tooley v. Donaldson, Lufkin, & Jenrette, Inc., this Court held that whether a claim is derivative or direct depends solely upon two questions: "(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?"^[148] It is undisputed that this is a derivative proceeding. In this case, the corporation was harmed and the total recovery is awarded to the corporation, Southern Copper Corporation — not "nominally" but actually.

In assessing the "benefit achieved," the Court of Chancery held, and this Court affirmed, that the benefit achieved in a derivative action is the benefit to the corporation. The "look through" approach to awarding attorneys' fees in a derivative case was properly rejected by the Court of Chancery long ago in Wilderman v. Wilderman.^[149] Similarly, in rejecting the Defendants' "look-through" argument in this derivative action, the Court of Chancery stated:

There's also this argument that I should only award — I should basically look at it like it's a class action case and that the benefit is only to the minority stockholders. I don't believe that's our law. And this is a corporate right. And, you know, if you look going back to 1974 ... there was Wilderman versus Wilderman, 328 A.2d 456, which talks about not disregarding the corporate form in a derivative action and looking at the benefit to the corporation, to the more recent Carlton — Carlson case, which is now reported, in 925 A.2d 506 does the same.

No stockholder, including the majority stockholder, has a claim to any particular assets of the corporation.^[150] Accordingly, Delaware law does not analyze the "benefit achieved" for the corporation in a derivative action, against a majority stockholder and others, as if it were a class action recovery for minority stockholders only. Therefore, the limited motion for reargument is substantively without merit. On that alternative basis alone the motion must also be denied.^[151]

Now, therefore, this 21st day of September 2012, it is hereby ordered that the motion for reargument is unanimously denied.

[1] Sitting by designation pursuant to Del. Const. art. IV, § 12 and Supr. Ct. R. 2 and 4.

[2] The facts are taken almost verbatim from the post-trial decision by the Court of Chancery.

[3] On October 11, 2005, Southern Peru changed its name to "Southern Copper Corporation" and is currently traded on the NYSE under the symbol "SCCO."

[4] Grupo Mexico held — and still holds — its interest in Southern Peru through its wholly-owned subsidiary Americas Mining Corporation ("AMC"). Grupo Mexico also held its 99.15% stake in Minera through AMC. AMC, not Grupo Mexico, is a defendant to this action, but I refer to them collectively as Grupo Mexico in this opinion because that more accurately reflects the story as it happened.

[5] The remaining plaintiff in this action is Michael Theriault, as trustee of and for the Theriault Trust.

[6] These individual defendants are Germán Larrea Mota-Velasco, Genaro Larrea Mota-Velasco, Oscar González Rocha, Emilio Carrillo Gamboa, Jaime Fernandez Collazo Gonzalez, Xavier García de Quevedo Topete, Armando Ortega Gómez, and Juan Rebolledo Gout.

[7] At this point in the negotiation process, Grupo Mexico mistakenly believed that it only owned 98.84% of Minera. It later corrects this error, and the final Merger consideration reflected Grupo Mexico's full 99.15% equity ownership stake in Minera.

[8] Tr. at 159 (Handelsman) ("I think the committee was somewhat comforted by the fact that the DCF analysis of Minera [] and the DCF analysis of [Southern Peru] were not as different as the discounted cash flow analysis of Minera [] and the market value of Southern Peru.").

[9] During discovery, two Microsoft Excel worksheets were unearthed that appear to suggest the implied equity values of Minera and Southern Peru that underlie Goldman's October 21 presentation. One worksheet, which contains the Minera model, indicates an implied equity value for Minera of $1.25 billion using a long-term copper price of $0.90/lb and a discount rate of 8.5%. The other worksheet, which contains the Southern Peru model, indicates an implied equity value for Southern Peru of $1.6 billion using a copper price of $0.90 and a discount rate of 9.0%, and assuming a royalty tax of 2%. Both the Plaintiff's expert and the Defendants' expert relied on the projections contained in these worksheets in their reports. The Defendants have also not contested the Plaintiff's expert's contention that these worksheets include Goldman's discounted cash flow estimates as of October 21, 2004.

[10] Barrow v. Abramowicz, 931 A.2d 424, 429 (Del.2007); Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d 519, 528 (Del.2006).

[11] Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d at 528.

[12] Id.

[13] Drejka v. Hitchens Tire Serv., Inc., 15 A.3d 1221, 1223-24 (Del.2010).

[14] Sheehan v. Oblates of St. Francis de Sales, 15 A.3d 1247, 1253 (Del.2011).

[15] Drejka v. Hitchens Tire Serv., Inc., 15 A.3d at 1222-24.

[16] Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d at 528.

[17] Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997); Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del.1983); see also Rosenblatt v. Getty Oil Co., 493 A.2d 929, 937 (Del.1985).

[18] See Emerald Partners v. Berlin, 726 A.2d 1215, 1221 (Del. 1999); Kahn v. Tremont Corp., 694 A.2d at 428-29.

[19] Weinberger v. UOP, Inc., 457 A.2d at 711.

[20] Id.

[21] Id. (citations omitted).

[22] Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110 (Del.1994).

[23] See id. at 1117 (citation omitted).

[24] Id.

[25] Kahn v. Tremont Corp., 694 A.2d at 428 (citation omitted).

[26] Emerald Partners v. Berlin, 787 A.2d 85 (Del.2001).

[27] Id. at 98-99.

[28] See Emerald Partners v. Berlin, 726 A.2d 1215, 1222-23 (Del. 1999) (describing that the special committee must exert "real bargaining power" in order for defendants to obtain a burden shift); see also Beam v. Stewart, 845 A.2d 1040, 1055 n. 45 (Del.2004) (noting that the test articulated in Tremont requires a determination as to whether the committee members "in fact" functioned independently (citing Kahn v. Tremont Corp., 694 A.2d 422, 429-30 (Del. 1997))).

[29] Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997).

[30] Id. at 429 (citation omitted).

[31] Id. (citation omitted).

[32] Id. at 428.

[33] Accord Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d at 1121 ("[U]nless the controlling or dominating shareholder can demonstrate that it has not only formed an independent committee but also replicated a process `as though each of the contending parties had in fact exerted its bargaining power at arm's length,' the burden of proving entire fairness will not shift." (citing Weinberger v. UOP, Inc., 457 A.2d 701, 709-10 n. 7 (Del.1983))).

[34] Cf. In re Cysive, Inc. S'holders Litig., 836 A.2d 531, 549 (Del.Ch.2003).

[35] See William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1303-04 n. 63 (2001) (noting the practical problems litigants face when the burden of proof they are forced to bear is not made clear until after the trial); cf. In re Cysive, Inc. S'holders Litig., 836 A.2d at 549.

[36] Kahn v. Tremont Corp., 694 A.2d at 428 (citing Weinberger v. UOP, Inc., 457 A.2d at 710). See also In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d 604, 617 (Del.Ch. 2005) ("All in all, it is perhaps fairest and more sensible to read Lynch as being premised on a sincere concern that mergers with controlling stockholders involve an extraordinary potential for the exploitation by powerful insiders of their informational advantages and their voting clout.").

[37] William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1303-04 n. 63 (2001).

[38] In re Cysive, Inc. S'holders Litig., 836 A.2d at 549.

[39] Kahn v. Tremont Corp., 694 A.2d at 428-29.

[40] In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d at 617 (emphasis added).

[41] In re Cysive, Inc. S'holders Litig., 836 A.2d at 548.

[42] Kahn v. Tremont Corp., 694 A.2d at 428.

[43] Emerald Partners v. Berlin, 787 A.2d 85, 99 (Del.2001).

[44] See, e.g., In re Cysive, Inc. S'holders Litig., 836 A.2d at 548 ("Because these devices are thought, however, to be useful and to incline transactions towards fairness, the Lynch doctrine encourages them by giving defendants the benefits of a burden shift if either one of the devices is employed.").

[45] See William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1297 (2001) (explaining that standards of review should be functional, in that they should serve as a "useful tool that aids the court in deciding the fiduciary duty issue" rather than merely "signal the result or outcome").

[46] See In re Cysive, Inc. S'holders Litig., 836 A.2d at 549 (noting that it is inefficient for defendants to seek a pretrial ruling on the burden-shift unless the discovery process has generated a sufficient factual record to make such a determination).

[47] See, e.g., Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985); Weinberger v. UOP, Inc., 457 A.2d at 709 n. 7.

[48] Weinberger v. UOP, Inc., 457 A.2d at 709 n. 7.

[49] Id. at 712, 714.

[50] Id. at 711.

[51] Id.

[52] See, e.g., Valeant Pharms. Int'l v. Jerney, 921 A.2d 732, 746 (Del.Ch.2007).

[53] Weinberger v. UOP, Inc., 457 A.2d at 711.

[54] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1179 (Del. 1995); Nixon v. Blackwell, 626 A.2d 1366, 1373, 1378 (Del. 1993); accord Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d at 1120.

[55] See Nixon v. Blackwell, 626 A.2d at 1373.

[56] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d at 1180; Rosenblatt v. Getty Oil Co., 493 A.2d at 937.

[57] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d at 1180.

[58] Id.

[59] Ryan v. Tad's Enters., Inc., 709 A.2d 682, 699 (Del.Ch.1996).

[60] Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 855 A.2d 1059, 1072 (Del.Ch. 2003).

[61] (citations omitted).

[62] $55.89 closing price × 67,200,000 = $3,755,808,000.

[63] $3.756 billion-$2.409 billion = $1.347 billion.

[64] Weinberger v. UOP, Inc., 457 A.2d at 714; see also Glanding v. Industrial Trust Co., 45 A.2d 553, 555 (Del. 1945) ("[T]he Court of Chancery of the State of Delaware inherited its equity jurisdiction from the English Courts."); 1 Victor B. Woolley, Woolley on Delaware Practice § 56 (1906).

[65] Int'l Telecharge, Inc. v. Bomarko, Inc., 766 A.2d 437, 440 (Del.2000).

[66] Id. at 441.

[67] Summa Corp. v. Trans World Airlines, Inc., 540 A.2d 403, 409 (Del. 1988).

[68] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).

[69] This argument is without merit. Rule 1.5(c) of the Rules of Professional Conduct expressly contemplates fees that are based on a percentage. Comment [3] to the Rule provides that the determination of whether a particular contingent fee is reasonable is to be based on the relevant factors and applicable law. In this case, the Court of Chancery made that reasonableness determination based on the relevant factors and applicable law set forth in Sugarland by this Court.

[70] Boeing Co. v. Van Gemert, 444 U.S. 472, 478, 100 S.Ct. 745, 62 L.Ed.2d 676 (1980) (citations omitted). See also Goodrich v. E.F. Hutton Group, Inc., 681 A.2d 1039, 1049 (Del. 1996) ("[T]he condition precedent to invoking the common fund doctrine is a demonstration that a common benefit has been conferred.").

[71] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1044 (citations omitted).

[72] Id. (citing Boeing Co. v. Van Gemert, 444 U.S. at 478, 100 S.Ct. 745; Maurer v. Int'l Re-Insurance Corp., 95 A.2d 827, 830 (Del.1953)).

[73] Tandycrafts, Inc. v. Initio Partners, 562 A.2d 1162, 1164-65 (Del. 1989) (citing CM & M Group, Inc. v. Carroll, 453 A.2d 788, 795 (Del.1982)).

[74] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1045 (citing Weinberger v. UOP, Inc., 517 A.2d 653, 654-55 (Del.Ch.1986); Chrysler Corp. v. Dann, 223 A.2d 384, 386 (Del. 1966)).

[75] See Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47; Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION (FOURTH) § 14.121 at 187 (2004).

[76] See Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046.

[77] Id. (citations omitted).

[78] Cent. R.R. & Banking Co. v. Pettus, 113 U.S. 116, 124-25, 5 S.Ct. 387, 28 L.Ed. 915 (1885); Trustees v. Greenough, 105 U.S. 527, 532-33, 26 L.Ed. 1157 (1881). See also Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47 (discussing history of common fund fee awards).

[79] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47 (citing Lindy Bros. Builders, Inc. of Phila. v. Am. Radiator & Standard Sanitary Corp., 487 F.2d 161, 167-68 (3d Cir. 1973)).

[80] Blum v. Stenson, 465 U.S. 886, 900 n. 16, 104 S.Ct. 1541, 79 L.Ed.2d 891 (1984).

[81] Shaw v. Toshiba Am. Info. Sys., Inc., 91 F.Supp.2d 942, 962-63 (E.D.Tex.2000) (internal quotation marks omitted).

[82] Report of the Third Circuit Task Force, Court Awarded Attorney Fees, 108 F.R.D. 237, 255 (1985).

[83] Id. at 246-50.

[84] Seinfeld v. Coker, 847 A.2d 330, 335 (Del. Ch.2000) (citing In re General Motors Corp. Pick-Up Truck Fuel Tank Products Liability Litig., 55 F.3d 768, 821 (3d Cir.1995)).

[85] Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION (FOURTH) § 14.121 at 187 (2004); Charles W. "Rocky" Rhodes, Attorneys' Fees in Common-Fund Class Actions: A View from the Federal Circuits, 35 The Advocate (Tex.) 56, 57-58 (2006).

[86] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149-50.

[87] Id. at 150

[88] Id. at 149. See also Loral Space & Commc'ns, Inc. v. Highland Crusader Offshore Partners, L.P., 977 A.2d 867, 870 (Del.2009).

[89] See, e.g., Julian v. E. States Const. Serv., Inc., 2009 WL 154432, at *2 (Del.Ch. Jan. 14, 2009) ("In determining the size of an award, courts assign the greatest weight to the benefit achieved in the litigation.") (citing Franklin Balance Sheet Inv. Fund v. Crowley, 2007 WL 2495018, at *8 (Del.Ch. Aug. 30, 2007)); Seinfeld v. Coker, 847 A.2d 330, 336 (Del.Ch.2000) ("Sugarland's first factor is indeed its most important-the results accomplished for the benefit of the shareholders.") (citations omitted); Dickerson v. Castle, 1992 WL 205796, at *1 (Del.Ch. Aug. 21, 1992) ("Typically, the benefit achieved by the action is accorded the greatest weight.") (citations omitted), aff'd 1993 WL 66586 (Del. Mar. 2, 1993); In re Anderson Clayton S'holders Litig., 1988 WL 97480, at *3 (Del.Ch. Sept. 19, 1988) ("This Court has traditionally placed greatest weight upon the benefits achieved by the litigation."); In re Maxxam Group, Inc., 1987 WL 10016, at *11 (Del.Ch. Apr. 16, 1987) ("The benefits achieved by the litigation constitute the factor generally accorded the greatest weight.").

[90] Johnston v. Arbitrium (Cayman Islands) Handels AG, 720 A.2d 542, 547 (Del.1998).

[91] Cf. In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d at 609-12 (awarding a "substantially smaller [attorney] fee" than that requested by plaintiffs for settlement of claims challenging a fully negotiable merger proposal where no appreciable risk was taken and credit was "shared" with special committee).

[92] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 150.

[93] Id.

[94] Id.

[95] Id. at 149-50.

[96] Id. at 150.

[97] Id. at 147. See Irving Morris and Kevin Gross, Attorneys' Fee Applications In Common Fund Cases Under Delaware Law: Benefit Achieved as "The Common Yardstick." 324 PLI/Lit 167 (1987).

[98] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 150 (emphasis added).

[99] Id. at 151.

[100] Id. at 150-51.

[101] In re Del Monte Foods Co. S'holders Litig., 2011 WL 2535256, at *13 (Del.Ch. June 27, 2011) (citation omitted).

[102] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 147.

[103] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d 1039 (Del. 1996).

[104] Id. at 1048 (citations omitted).

[105] Id. at 1050.

[106] Emphasis added.

[107] See Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149-50.

[108] 4 Alba Conte & Herbert B. Newberg, Newberg on Class Actions § 14:6, at 547, 550 (4th ed.2001). See Irving Morris & Kevin Gross, Attorneys' Fee Applications In Common-Fund Cases Under Delaware Law: Benefit Achieved as "The Common Yardstick," 324 PLI/Lit 167, 175 (1987).

[109] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 (Del.Ch. Mar. 28, 2011) (citing Thorpe v. CERBCO, 1997 WL 67833 at *6 (Del.Ch. Feb. 6, 1997)).

[110] Franklin Balance Sheet Inv. Fund v. Crowley, 2007 WL 2495018, at *13 (Del.Ch. Aug. 30, 2007).

[111] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 n. 2 (citing Julian v. E. States Constr. Serv., Inc., 2009 WL 154432 (Del.Ch. Jan. 14, 2009) (awarding total of 8% when little time and effort were invested before settlement); Korn v. New Castle Cty., 2007 WL 2981939 (Del.Ch. Oct. 3, 2007) (awarding 10% when "there was limited discovery, no briefing, and no oral argument...."); Seinfeld v. Coker, 847 A.2d 330 (Del.Ch.2000) (awarding 10% when case settled after limited document discovery and no motion practice); In re The Coleman Co. S'holders Litig., 750 A.2d 1202 (Del.Ch.1999) (awarding 10% where counsel did not take a single deposition or file or defend a pretrial motion); In re Josephson Int'l, Inc., 1988 WL 112909 (Del.Ch. Oct. 19, 1988) (awarding 18% when case settled after ten days of document discovery); Schreiber v. Hadson Petroleum Corp., 1986 WL 12169 (Del.Ch. Oct. 29, 1986) (awarding 16% when case settled "[s]hortly after suit was filed")).

[112] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 & n. 3 (citing In re Cablevision/Rainbow Media Gp. Tracking Stock Litig., 2009 WL 1514925 (Del.Ch. May 22, 2009) (awarding 22.5% where plaintiffs' counsel devoted nearly 5,000 hours to the case); Gelobter v. Bressler, 1991 WL 236226 (Del.Ch. Nov. 6, 1991) (awarding 16.67% where counsel pursued extensive discovery, including seventeen depositions); Stepak v. Ross, 1985 WL 21137 (Del.Ch. Sept. 5, 1985) (awarding 20% where plaintiff took extensive discovery)).

[113] See Richard A. Rosen, David C. McBride & Danielle Gibbs, Settlement Agreements in Commercial Disputes: Negotiating, Drafting and Enforcement, § 27.10, at 27-100 (2010).

[114] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 & n. 4 (citing Berger v. Pubco Corp., 2010 WL 2573881 (Del.Ch. June 23, 2010) (awarding a total fee of 31.5% where "lengthy and thorough litigation by counsel ... resulted in a final judgment and not a quick settlement"); Gatz v. Ponsoldt, 2009 WL 1743760 (Del.Ch. June 12, 2009) (awarding 33% in case litigated extensively, including through an appeal in the Delaware Supreme Court); Ryan v. Gifford, 2009 WL 18143 (Del.Ch. Jan. 2, 2009) (awarding 33% of cash amount where plaintiffs' counsel engaged in "meaningful discovery," survived "significant, hard fought motion practice" and incurred nearly $400,000 in expenses); Tuckman v. Aerosonic Corp., 1983 WL 20291 (Del.Ch. Apr. 21, 1983) (awarding 29% where litigated through trial and two appeals)).

[115] See Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149.

[116] See Dr. Renzo Comolli et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, NERA Econ. Consulting, July 2012, at p. 31. For an example, the study finds fee awards in securities class actions amount to 27% in cases where the settlement is between $25 million and $100 million, 22.4% in cases where the settlement is between $100 million and $500 million, and 11.1% in cases where the settlement is above $500 million. Id. Figure 31. See also Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION § 14.121 at 187 (2004) ("Attorney fees awarded under the percentage method are often between 25% and 30% of the fund.").

[117] Dr. Renzo Comolli et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, NERA Econ. Consulting, July 2012, at p. 31.

[118] Id.

[119] In re Enron Corp. Sec., Deriv. & ERISA Litig., 586 F.Supp.2d 732, 753-54 (S.D.Tex. 2008) (citing cases and concluding that "[a] mechanical, a per se application of the `megafund rule' is not necessarily reasonable under the circumstances of a case.").

[120] In re Rite Aid Corp. Sec. Litig., 396 F.3d 294, 302-03 (3d Cir.2005) ("[T]here is no rule that a district court must apply a declining percentage reduction in every settlement involving a sizable fund.").

[121] Id. at 303.

[122] Id. at 302-03 (3d Cir.2005).

[123] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1049.

[124] Id. at 1050.

[125] Id.

[126] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).

[127] Chrysler Corp. v. Dann, 223 A.2d 384, 386 (Del.1966).

[128] See Shaw v. Toshiba Am. Info. Sys., Inc., 91 F.Supp.2d 942 (E.D.Tex.2000) (awarding 15% fee on a common fund of $1 billion); In re NASDAQ Market-Makers Antitrust Litig., 187 F.R.D. 465 (S.D.N.Y.1998) (awarding 14% fee on common fund of $1 billion).

[129] Emphasis added.

[130] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149.

[131] Chavin v. Cope, 243 A.2d 694, 695 (Del. 1968).

[132] EMAK Worldwide, Inc. v. Kurz, 50 A.3d 429, 432-33, 2012 WL 1319771, at *3 (Del. Ch. Apr. 17, 2012).

[133] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).

[134] Appellant Southern Copper Corporation's Opening Brief, Exhibit A at 74.

[135] Id. at 82.

[136] Id. at 81-83.

[137] Id. at 83-84.

[138] Flamer v. State, 953 A.2d 130, 134 (Del. 2008); Roca v. E.I. du Pont de Nemours & Co., 842 A.2d 1238, 1242 (Del.2004).

[139] Wilderman v. Wilderman, 328 A.2d 456, 458 (Del.Ch. 1974). See Gentile v. Rossette, 906 A.2d 91, 102-03 (Del.2006); Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del.2004).

[140] Roca v. E.I. du Pont de Nemours & Co., 842 A.2d at 1242.

[141] See Supreme Court Rule 14(d) ("Footnotes shall not be used for argument ordinarily included in the body of a brief....").

[142] Michigan v. Long, 463 U.S. 1032, 1044, 103 S.Ct. 3469, 77 L.Ed.2d 1201 (1983).

[143] Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 351 (Del.1988) (quoting R. Clark, Corporate Law 639-40 (1986)).

[144] Kramer v. W. Pac. Indus., Inc., 546 A.2d at 351.

[145] Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d at 1036.

[146] Id.

[147] Id.

[148] Id. at 1033.

[149] Wilderman v. Wilderman, 328 A.2d at 458.

[150] Norte & Co. v. Manor Healthcare Corp., 1985 WL 44684, at *3 (Del.Ch.) ("[T]he corporation is the legal owner of its property and the stockholders do not have any specific interest in the assets of the corporation.").

[151] Michigan v. Long, 463 U.S. at 1044, 103 S.Ct. 3469.

7 Shareholder litigation 7 Shareholder litigation

7.1 Reference Readings 7.1 Reference Readings

7.1.1. Kandell v. Niv (FXCM) [Knowing Breaches of Law]

7.1.2 Graham v. Allis-Chalmers Manufacturing Co. 7.1.2 Graham v. Allis-Chalmers Manufacturing Co.

John P. Graham and Yvonne M. Graham, on behalf of themselves and the other shareholders of Allis-Chalmers Manufacturing Company who may be entitled to intervene herein, Plaintiffs Below, Appellants, vs. Allis-Chalmers Manufacturing Company et al., Defendants Below, Appellees.

7.1.3 In re Caremark International Inc. Derivative Litigation 7.1.3 In re Caremark International Inc. Derivative Litigation

In re CAREMARK INTERNATIONAL INC. DERIVATIVE LITIGATION.

7.1.4 Stone v. Ritter (Del. 2006) 7.1.4 Stone v. Ritter (Del. 2006)

HOLLAND, Justice:

Facts

Demand Futility and Director Independence

Graham and Caremark

Caremark Standard Approved

Chancery Court Decision

Reasonable Reporting System Existed

Complaint Properly Dismissed

Conclusion

7.1.5 UFCWU v. Zuckerberg 7.1.5 UFCWU v. Zuckerberg

Demand Futility Standard

UNITED FOOD AND COMMERCIAL WORKERS UNION AND PARTICIPATING FOOD INDUSTRY EMPLOYERS TRI-STATE PENSION FUNDv.MARK ZUCKERBERG, et al

7.1.6 Zapata v. Maldonado 7.1.6 Zapata v. Maldonado

ZAPATA CORPORATION, Defendant Below, Appellant, v. William MALDONADO, Plaintiff Below, Appellee.

[780] QUILLEN, Justice:

7.1.7 Americas Mining Corp. v. Theriault (Del. 2012) [Attorney's Fees] 7.1.7 Americas Mining Corp. v. Theriault (Del. 2012) [Attorney's Fees]

HOLLAND, Justice, for the majority:

Issues on Appeal

FACTUAL BACKGROUND[2]

The Key Players

Grupo Mexico Proposes That Southern Peru Acquire Minera

Southern Peru Forms A Special Committee

The Special Committee Hires Advisors And Seeks A Definitive Proposal From Grupo Mexico

The May 7 Term Sheet

Goldman Begins To Analyze Grupo Mexico's Proposal

Special Committee Moves Toward Relative Valuation

The Special Committee Makes A Counterproposal Suggests A Fixed-Exchange Ratio

Grupo Mexico Sticks To Its Demand

The Special Committee's Proposed Terms Rejected But The Parties Work Out A Deal

Multi-Faceted Dimensions Of Controlling Power: Large Stockholders Who Want To Get Out Support A Strategic, Long-Term Acquisition As A Prelude To Their Own Exit As Stockholders

[1231] After One Last Price Adjustment, Goldman Makes Its Final Presentation

Special Committee And Board Approve The Merger

Market Reacts To The Merger

Goldman Does Not Update Its Fairness Analysis

Southern Peru's Stockholders Approve The Merger

Cerro Sells Its Shares

Plaintiff Sues Defendants and Special Committee

TRIAL SCHEDULE PROPERLY MAINTAINED

BURDEN SHIFTING ANALYSIS

UNFAIR DEALING PRODUCES UNFAIR PRICE

DAMAGE AWARD PROPER

ATTORNEYS' FEE AWARD

Common Fund Doctrine

Calculating Common Fund Attorneys' Fees

Delaware's Sugarland Standard

[1255] Sugarland Factors Applied

Benefit Achieved

Difficulty and Complexity

Contingent Representation

Standing and Ability of Counsel

Time and Effort of Counsel

Fee Award Percentage Discretionary

Fee Award Reasonable Percentage

Conclusion

BERGER, Justice, concurring and dissenting:

Reargument Unanimously Denied

Waiver Constitutes Procedural Bar

Argument Without Substantive Merit

UNITED FOOD AND COMMERCIAL WORKERS UNION AND PARTICIPATING FOOD INDUSTRY EMPLOYERS TRI-STATE PENSION FUND
v.
MARK ZUCKERBERG, et al

ZAPATA CORPORATION, Defendant Below, Appellant,
v.
William MALDONADO, Plaintiff Below, Appellee.

FACTUAL BACKGROUND^[2]