Alternative entities, such as limited partnerships and limited liability companies, have an advantage over corporations because of the greater flexibility to define the terms of the arrangement by contract. Foremost among this flexibility is the ability to tailor the governance of the entity, including defining the duties of managers and controllers. Thus, it is typical in a well-crafted governing document of a non-corporate entity to eliminate or limit fiduciary duties and to establish procedures for approval of conflict-of-interest transactions. When this is done, the more demanding entire fairness standard for review of these transactions applied by the Delaware courts to corporations will not be applicable. Instead, the transaction will be assessed under the standards established in the governing document. A standard commonly used for approval of conflict-of-interest transactions, and the one at issue in the recent decision of the Delaware Chancery Court in El Paso Pipeline Partners L.P. Derivative Litig., C.A. No. 7141-VCL (Del. Ch. April 20, 2015), is to require approval by an independent committee whose members “believe in good faith that the transaction is in the best interests” of the entity. This standard was applied in a challenge to a dropdown of natural gas terminal and pipeline assets by El Paso Corporation, an energy provider, to a master limited partnership that it controlled.
The decision in El Paso Pipeline, awarding $171 million in damages against the general partner in favor of the limited partners, reminds us that, even under a contractual standard like the one in common use, a conflict-of-interest transaction will be subject to intense scrutiny by the courts and needs to be approached, justified and documented in a rigorous way similar to a corporate conflict-of-interest transaction that is subject to entire fairness review.
The El Paso Pipeline decision also has lessons regarding how to deal with and evaluate conflict-of-interest transactions and once again demonstrates the skepticism with which Delaware courts approach investment banker fairness opinions. Some of these lessons are:
- Real independence and healthy skepticism go a long way in giving credibility to a special committee.
- The importance of a comprehensive contemporary record cannot be underestimated and that record should not be inconsistent with extrinsic communications, such as emails.
- A financial advisor must be entirely independent and act that way, and the committee must insist that the financial advisor’s work be comprehensive, complete and objective.
- The committee must fully inform itself and treat the financial advisor’s work as that of an adviser, to be factored in as the committee makes its own determinations based upon the information before it as the same may evolve and change.
- The relevant metrics are important in assessing fairness and one metric alone, such as accretion in value, may not be sufficient for determining fairness and what is in the best interests of the entity.
Because of its detailed analysis, the El Paso Pipeline decision is well worth reading. Its most important lesson though is the need to approach conflict-of-interest transactions involving alternative entities with the same care and attention paid to similar corporate transactions even though the entity’s governing document establishes its own standard for approval that is less demanding than entire fairness.