Delaware Courts have consistently held that clear, express and unambiguous language that modifies default fiduciary duties is enforceable in the context of Delaware limited partnerships.
In In re El Paso Pipeline Partners, L.P. Derivative Litigation (Del. Apr. 20, 2015) the Delaware Court of Chancery qualified this rule when it held that a conflict of interest transaction can violate contractual standards set forth in a partnership agreement even if default fiduciary duties have been modified or eliminated.
In El Paso, the Court was deciding whether an LP agreement had been violated in a drop-down transaction that occurred involving a Master Limited Partnership (“MLP”). MLPs are primarily used in the energy sector. In this case, El Paso Pipeline Partners, L.P. (“El Paso MLP”) acquired all of the business assets relating to a liquefied natural gas terminal from El Paso Corporation (“Parent”). Parent owned the general partner of El Paso MLP and therefore controlled El Paso MLP. In its partnership agreement, El Paso MLP eliminated default fiduciary duties and replaced them with a contractual standard pursuant to which each individual person required to approve an action on behalf of El Paso MLP had to subjectively believe that the action was in the best interest of the company. After engaging legal and financial advisors and receiving an opinion that the challenged transaction was financially fair to the unaffiliated unitholders, the conflicts committee, composed solely of independent directors, approved the transaction.
The Court found that there were several flaws with the conflicts committee’s valuation analysis and process for approving the transaction. The Court found that the conflicts committee focused extensively on the amount by which cash distributions for common unitholders of El Paso MLP would increase, while failing to take into account the value of the assets being acquired under a traditional valuation analysis. As a result, the Court awarded damages of $171 million, an amount that the Court determined was the difference between what El Paso MLP paid for the assets and the fair value of the assets. Only the general partner entity was held liable for the award because none of the other defendants, including Parent, was a party to the partnership agreement.
El Paso is a reminder that the contractual flexibility afforded to Delaware limited partnerships can fall under intense scrutiny and conflict-of-interest transactions should be subject to a thorough process to avoid the scrutiny of the Court.