A recent Delaware Court of Chancery decision in In re El Paso Pipeline Partners, L.P. discusses the process surrounding related party transactions in a publicly-traded limited partnership. The Court’s opinion provides notable comments on the scope of the contractual duties of general partners, including the meaning of good faith. The opinion also emphasizes the need for special committee to follow a rigorous process when dealing related party transactions. In this respect, the opinion critically examines the role of financial advisers in conflict of interest transactions.
In Canada, related party transactions in publicly-traded entities are regulated by Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions (MI 61-101) which set forth a series of procedural requirements to address the conflicts of interest raised by such transactions, including, in certain circumstances, a formal valuation and approval by minority shareholders. Although the regulatory regime is different in Canada, investment advisors and independent directors involved in a transaction subject to MI 61-101 should find the Court’s observations in El Paso relevant.
El Paso Corporation (EPC) is a natural gas and energy provider that has been a wholly owned subsidiary of Kinder Morgan since 2012. EPC controlled El Paso Pipeline Partners, L.P. (El Paso MLP) through the ownership of all of El Paso MLP’s general partner interest, representing 2% economic interest. EPC also owned about 52% of El Paso’s common units, which traded on the New York Stock Exchange until 2014.
El Paso MLP was created to maximize the market value of EPC’s mid-stream assets and the amount of capital it could raise based on that valuation. In a nutshell, the purpose of El Paso MLP was to purchase EPC assets over time in the course of “dropdown” transactions. When it was created, El Paso MLP bought an initial set of mid-stream assets for EPC. El Paso MLP never acquired assets from third parties.
At issue in this case are dropdown transactions realized in 2010. In March 2010 (Spring Dropdown), EPC sold El Paso MLP a 51% interest in Elba, one of its subsidiaries, for a consideration of $963 million in cash. In November 2010 (Fall Dropdown), EPC sold the remaining 49% in Elba to El Paso MLP along with a 15% interest in another of its subsidiaries for a total consideration of $1.412 billion.
The dropdown transactions were governed by the limited partnership agreement that provided contractual requirements for such transactions in lieu of common law duties, as authorized by the Delaware Limited Partnership Act. Specifically, the dropdown transactions were subject to the approval of the “conflicts committee” whose members had to believe in good faith that the transactions were in the best interest of the partnership. The two dropdown transactions were approved by the conflicts committee composed of independent directors and advised by Tudor, Pickering, Holt & Co. (Tudor). The investment bankers formally opined that the proposed transactions were fair from a financial point of view.
Unitholders in El Paso MLP challenged the dropdown transactions. They argued that, by allowing these transactions to take place, the General Partner and the conflicts committee members breached their express contractual obligations as well as unwritten obligations created by the implied covenant of good faith and fair dealing. Although summary judgment was granted with respect to the Spring Dropdown, the case did proceed for the Fall Dropdown.
The Court of Chancery ruled that the conflicts committee members did not have a subjective belief that the Fall Dropdown was in the best interests of the partnership. The Court found that the members “viewed El Paso MLP as a controlled company that existed to benefit Parent by providing a tax-advantaged source of inexpensive capital”. Among the deficiencies noted, the Court remarked that the committee disregarded market evidence with respect to the Spring Dropdown that showed that El Paso MLP had paid too much for these assets. Further, the committee did not use information about recent arm’s length acquisitions of similar assets to negotiate a better price. Having regard to this context, the Court found the committee members “consciously disregarded their own independent and well-considered views about value” and that their “actions evidenced conscious indifference to their responsibilities to El Paso MLP”.
In addition, the Court stressed that the investment banker’s “work product further undermined any possible confidence in the Committee”. Emphasizing several methodological flaws, the Court observed that the investment bankers failed to perform the real work of an advisor to a committee: “Instead of helping the Committee develop alternatives, identify arguments, and negotiate with the controller, Tudor sought to make the price that Parent proposed look fair”.
Consequently, the Court held that the General Partner breached the partnership agreement by engaging in the Fall Dropdown. The Court awarded damages of $171 million in favor of plaintiffs.
For a PDF version of this post, see Legal Trends Spring 2015