In a decision that would have sent shivers down the spines of thousands of investment banks across Australia and sent lawyers scrambling for engagement letters, NSW Supreme Court judge David Hammerschlag declared that JP Morgan’s $50.8 million bill to mine Consolidated Minerals would be reduced to only $20 million.

The case stems back to the 2006 takeover of ConsMin by Ukrainian billionaire Gennadiy Bogolyubov. ConsMin was earlier run by colourful mining identify Michael Kiernan, who had departed the company the prior year after institutional shareholders refused to provide him an exceedingly generous options package.

In October 2006, ConsMin, which was then being managed by South African Rodney Baxter, received a $2.08 per share takeover approach by Pallinghurst Resources, an investment group run by former BHP Billiton chief Brian Gilbertson. The offer, which consisted of cash and shares in a special purpose vehicle that would own ConsMin, was increased in February 2007 to about $2.23 per share.

It is important to note that the Pallinghurst offer was to be undertaken by Scheme of Arrangement. That means it was a very friendly deal in which ConsMin effectively managed the transaction, convened meetings of shareholders and prepared an explanatory memorandum supporting the deal for shareholders. As financial advisers, JP Morgan would have presumably advised the board to accept the offer.

Shortly before ConsMin shareholders were set to vote on the deal, a surprise bid emerged from Territory Resources, a company run by former chief Kiernan. The Territory bid valued ConsMin at about $3.72 (made up of $2 cash and the remainder in Territory shares). Previously, an “expert’s” report prepared by PwC for ConsMin valued the company at $2.33 — this valuation conveniently fitted with the ConsMin’s board’s decision to embrace Pallinghurst’s offer. As this Crikey story noted, the expert’s report was flawed, using incorrect values for ConsMin’s equity investments and below-market assumptions for metals prices.

Despite Territory’s bid being substantially higher than Pallinghurst’s offer, ConsMin’s rejected it (again, at the time being advised by JP Morgan). This columnist claimed at the time that:

“The ConsMin board’s decision to dismiss what appears to be a materially higher offer, regardless of their belief of Territory’s intrinsic value, does not seem to be in the best interests of shareholders. At the very least, ConsMin should enter into negotiations with Territory to perhaps increase the cash amount offered if they are concerned about the underlying value of Territory shares.”

Michael Kiernan held similar views, noting that “we consider the board has been a total irrelevance for some time [and that] we’ve pitched our proposal quite squarely to the shareholders of ConsMin”.

But the story certainly didn’t end there.

On  July 20, 2007, Pallinghurst increased its offer to $3.30 per share cash — this was still less than Territory’s bid, but its cash basis made it more certain. The offer was shortly after increased to $3.60.

Meanwhile, Palmary, the company owned by Bogolyubov had quietly been building a stake in ConsMin. On August 31, Palmary then made a bid for ConsMin, for $3.95 — all in cash.

It should be remembered that these subsequent bids had not been endorsed by the ConsMin board and its financial adviser JP Morgan — in fact, they had presumably advised to sell Pallinghurst for about $2.08 per share.

A week after Palmary’s initial bid, Pallinghurst came back with an offer of $4.10 per share, which was soon after topped again by Palmary with a bid of $4.50 (by this time, Territory had bowed out of the race). After another round of bidding Palmary eventually “won” the battle with a knock-out bid of $5.

The rapid increase in the final sale price of ConsMin came about through two factors — first, the surprise bid from Territory, which stopped the company from conducting the scheme meeting to approve the Pallinghurst bid for $2.23 per share. Had it not been for the timely Territory bid, ConsMin (thanks to its advisers JP Morgan and a flawed “expert” report) would have convinced shareholders to accept a bid that grossly undervalued the company. Second, during the takeover fight, the price of manganese (the major metal mined by ConsMin) increased sharply. Neither of these factors were due to JP Morgan — in fact, the first factor was despite  it.

This much was noted by the judge, who observed that:

“It can hardly be said that the defendant was defending itself against Pallinghurst, when all that occurred was that a bidding war ensued, ensuring that the price being offered continued to burgeon. As the two main protagonists progressively increased their offers, the directors adjusted their recommendations accordingly.”

Soon after the transaction completed, JP Morgan sent ConsMin a bill for its “services”. Initially, JP Morgan indicated that the bill would be about $32 million, however, that was soon increased to $51 million, largely consisting of about $40 million in “incentive fees” (this amount was based on the initial amount offered by Pallinghurst of $2.08 and the final price paid by Palmary of $5). ConsMin disputed this figure, offering $20 million (which reflected an incentive fee based on Palmary’s initial and final offers).

After considering the various legal arguments, specifically, how to calculate the “incentive fee”, Justice Hammerschlag found that JP Morgan’s claim for $50 million “would result in an outcome that would be capricious, unreasonable and unjust”. Instead, the court held that the incentive fee was $9 million, and should have been based on the difference in Palmary’s first and final bids.

This columnist has long taken issue with how investment bankers are remunerated — not merely the quantum (leading investment bankers at firms such as Macquarie and Goldman Sachs JBWere often receive higher remuneration than most CEOs) but more specifically, that their pay and bonuses often have minimal link to their actual performance. This problem works both ways — for example, bankers are not paid if a deal falls through, so they can spend hundreds of hours of time for no reward.

The prospect of the ultimate acquirer having to pay tens of millions in takeover defence fees to an adviser who literally did less than nothing to achieve the sale is extraordinary. The strange sight of JP Morgan, a recipient of billions of dollars of taxpayer monies in the United States, taking legal action to recover a fee that was in no way commensurate to the services it provided is somewhat bizarre. If anything, the advice of JP Morgan may, had it not been for the Territory bid, have actually cost ConsMin shareholders more than $700 million in forgone sales proceeds.

(To draw an analogy, this is much like a real estate agent advising a vendor to accept an offer $500,000, but the vendor rejecting the advice and eventually selling the property for $1,300,000 after a heated auction — only to receive a bill from the agent based on the full $1,300,000 price.)

A JP Morgan spokesperson confirmed that the bank “believe there are strong grounds for appeal and … are currently assessing our response in that regard.”

Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed — become a fan on Facebook.