Corporate Governance: Transactions with Controlling Shareholders

Two recent events around the world bear eerie resemblances with India’s own corporate governance scandal that came to light in Satyam Computers nearly three years ago.

Readers may recall that the Satyam episode was triggered by the company’s proposed acquisition of two related entities, Maytas Properties and Maytas Infra, which was approved by the board of Satyam, but vehemently rejected by its shareholders. One of our readers points to us a decision of the Delaware Chancery Court that considered a similar set of circumstances involving an NYSE-listed company. A summary and discussion of that decision is available here.

In that case, Southern Peru Copper Corporation, the company in question, acquired 99.15% shares of Minera Mexico, which stake was held by Grupo Mexico (the controlling shareholder of Southern Peru). Although Southern Peru formed a special committee of disinterested directors to consider and approve the transaction, the Delaware Chancery Court found a breach of the directors’ duty of loyalty and ordered damages of more than $1.2 billion. In effect, Southern Peru had overpaid for the acquisition in what was clearly a related-party transaction. The court found that the acquisition did not meet the “entire fairness” standard required of transactions between companies and their controlling shareholders, and that the special committee of directors was operating under a “controlled mindset” by seeking to rationalize the transaction rather than independently evaluate it.

Although the Satyam-Maytas transaction was shelved before it was effected, there are similarities in the manner in which Satyam’s board and Southern Peru’s special committee of directors acted to “rationalize” the respective deals. While Delaware law does impose high standards of loyalty on directors in such related-party transactions, it is unlikely that a similar outcome would emerge from an Indian court. Firstly, duties of directors are not as developed and crystallized in the Indian context, and there is very little precedent of directors being found to breach their duties. Secondly, duties of directors in Indian companies are owed only to the company, and not directly to the shareholders (whether minority or otherwise). Thirdly, controlling shareholders themselves do not owe any duty as they are not considered fiduciaries in a manner directors are. All of these impose difficulties in making similar claims under Indian law when controlling shareholders extract value out of a company by causing it to enter into acquisition of related entities owned by the controlling shareholders.

The second aspect of the Satyam episode relates to the confession by its chairman to having falsified its books of account to the extent of over $1 billion through the existence of fictitious assets. The similarity here is with the recent scandal that has erupted involving Olympus, the Japanese company, where losses were masked for several years before they were recently discovered and made public. Of course, it is still early stages in that episode, with efforts being made to save the company, much the same way the Indian government salvaged Satyam as a corporate entity.