In April, the judge found that El Paso Corp. owed $171 million to the El Paso Pipeline Partners unitholders because the partnership's three-member special committee did not meet its contractual duties in approving a deal where El Paso Corp. sold assets to its controlled subsidiary El Paso Pipeline Partners. But because El Paso Corp. owned 41.4% of El Paso Pipeline Partners, Laster held that KMI is only liable for 58.6% of the $171 million. Kinder Morgan said it would appeal the decision to the Delaware Supreme Court.
Kinder Morgan bought El Paso Corp. in 2012 and last year the combined company bought Pipeline Partners. Kinder Morgan argued that Laster should therefore dismiss the case, a claim the judge rejected yesterday in a 110-page opinion.
The decision turns on a fine point of Delaware law. El Paso Pipeline's public unitholders styled their suit as a derivative action, one technically brought on behalf of the company itself. El Paso Corp. -- still the nominal defendant in the case -- argued that the derivative claim was extinguished by Kinder Morgan's 2014 purchase of El Paso Pipeline Partners.
Laster disagreed. Dismissing the case, he wrote, "would generate a windfall" for El Paso Corp. "at the expense of the unaffiliated limited partners for whose indirect benefit the suit originally was brought."
The judge's initial decision in the matter shocked the limited partnership world. The deal at issue in the case was a so-called "drop-down" transaction, a structure common in the energy industry in which a parent company sells assets to a subsidiary. Laster's decision was remarkable both because of the size of the damages and because he imposed the liability in the context of a partnership, a form of business organization that generally gives directors far greater leeway than the corporation does.
The outcome in El Paso recalls Laster's 2012 ruling in shareholder litigation arising from the sale of Del Monte Foods and his 2014 decision in a similar case involving the sale of Rural/Metro Corp., where he found that investment bankers had aided and abetted directors in violating their fiduciary duties. Del Monte resulted in an $89 million settlement to shareholders, and Laster awarded $76 million to Rural/Metro shareholders in a decision that the Delaware Supreme Court upheld earlier this week.
But Del Monte and Rural/Metro were both corporations, while El Paso Pipeline Partners was a partnership whose documents provided that its directors did not owe fiduciary duties to unitholders, a common feature of alternative business entities organized under Delaware law. Rather than corporate law, El Paso involves contract law. To pass muster, El Paso Partners' three-member special committee had only to "believe in good faith" that the deal at issue in the case "was in the best interests of El Paso MLP," the judge wrote, a far more lenient standard than would have applied in the corporate context.
Laster found on April 20 that the directors failed to meet even that lower standard. His ruling was apparently the first from Delaware in which a judge has imposed liability in an MLP drop-down transaction blessed by a conflicts committee. The 60-page opinion in the case left lawyers wondering if the outcome signaled a new, more searching approach to MLP drop-down deals or was the product of an unusual fact pattern that will have little future impact. There has been no significant development on that point since the April opinion came down.
The El Paso case involves two drop-down transactions. In 2010, El Paso Corp. sold two related subsidiaries, which Laster lumps together as Elba, to El Paso Pipeline Partners, which was also a subsidiary of El Paso Corp. and which Laster calls for the sake of clarity El Paso MLP. Parent, as Laster styles El Paso Corp., sold El Paso MLP a 51% interest in Elba in March 2010 and the remaining 49% plus a 15% stake in another Parent subsidiary, Southern Natural Gas LLC in November 2010. The fall transaction was the one at issue in the case, though Laster evaluates it in light of the spring transaction.
El Paso MLP shareholders challenged both deals. In 2014, Laster dismissed the claims relating to the spring drop-down but allowed the derivative claims relating to the fall drop-down to proceed to a three-day trial. The evidence at trial, Laster wrote, "ultimately convinced me that when approving the fall drop-down, the committee members went against their better judgment and did what the Parent wanted, assisted by a financial adviser that presented each drop-down in the best possible light, regardless of whether the depictions conflicted with the advisor's work on similar transactions or made sense as a matter of valuation theory."
The judge found that Parent, who was the general partner in El Paso MLP, breached the partnership agreement "by causing El Paso MLP to engage in the fall drop-down." He did not impose liability on either El Paso MLP's directors or its investment bank, Tudor, Pickering, Holt & Co. LLC, which along with Akin, Gump, Straus, Hauer & Feld LLP advised the El Paso MLP on the Parent drop-downs as a matter of course.
On March 24, 2010, the El Paso MLP special committee agreed to buy 51% of the Elba assets for $963 million. El Paso MLP's units dropped 3.6% on the news. El Paso MLP special committee member Ronald Kuehn wrote to fellow special committee member Arthur Reichstetter, "It is really not in the best interests of El Paso MLP to have too much of its assets tied up in the LNG trade." Reichstetter replied, "It's as though you read my mind."
But the two men and colleague William Smith shortly thereafter approved a deal in which Parent sold El Paso MLP the rest of Elba. Their bankers at Tudor, Pickering, "viewed the fall drop-down as little more than an update of their work on the spring drop-down," Laster wrote. The bank chose the code name "Encore" for the fall deal; one of the bankers, unnamed in the opinion, wrote in an email that the name was "more tactful than 'Again?' "
The sense that El Paso MLP was repeating a bad transaction helped Laster reach his conclusion. He wrote: "The committee members consciously disregarded the learning they supposedly gained from engaging in the spring drop-down, which involved the same core asset -- approximately half of Elba."
El Paso MLP ended up paying $1.1 billion for both the Elba assets and a 15% stake in Southern Natural Gas LLC, but the inclusion of the latter in the fall drop-down only made the judge more skeptical. The El Paso MLP special committee did not price the two stakes separately, the judge found, which made it that much easier for them to approve a bad deal. He also criticized Tudor, Pickering's advice on the deal. "Tudor's actions demonstrated that the firm sought to justify Parent's asking price and collect its fee" of $500,000 for rendering a fairness opinion, Laster wrote. "Tudor's approach made it all the more likely that the committee practiced appeasement as well."
The defendants argued that the fall drop-down was accretive to earnings, but "accretion is not a part of valuation," Laster wrote. He perhaps viewed the accretion argument as a post hoc justification of a transaction that the El Paso MLP special committee knew was a bad one. Instead, he found, El Paso MLP overpaid for the Elba assets by $171 million. Despite the dramatic result and Laster's evident displeasure with the special committee and its investment bank, he was not quite as harsh on the defendants as he was in Del Monte and Rural/Metro, and he did not single out individual bankers by name, a small but telling difference. Because the El Paso case allowed the judge to compare two deals for a percentage of the same asset struck in the same year, it will be easy for future defendants to distinguish.
Laster may have been trying to limit the El Paso holding when he wrote that none of the "numerous problems with the fall drop-down standing alone would have supported a finding that the committee members did not act in subjective good faith. Even a combination of problems would not have been sufficient to overcome the presumption of good faith and the testimony of the committee members. Indeed, the fall drop-down could have suffered from many flaws as long as the committee members reached a rational decision for comprehensible reasons."
But that did not place the El Paso deal beyond judicial scrutiny, and at the very least the opinion is a reminder that judges will find a way to censure MLP conduct they find dubious even as they acknowledge the differences between partnership law and corporate law.
As Wachtell, Lipton, Rosen & Katz wrote in an April memorandum to clients, the first El Paso decision "continues the recent trend of Delaware's intense scrutiny of financial advisers and reaffirms the special need for careful process in controller transactions, even in the context of transactions involving MLPs."
The El Paso Pipeline Partners unitholders used Jessica Zeldin of Rosenthal, Monhait & Goddess PA in Wilmington and Jeffrey Squire and Lawrence Eagel of Bragar Eagel & Squire PC on the case decided yesterday. El Paso Pipeline Partners tapped Lewis Lazarus, Thomas Hanson, Jr., Courtney Hamilton and Brett McCartney of Wilmington's Morris James LLP. El Paso Corp and its directors turned to Peter Walsh, Brian Ralston, Berton Ashman, Jr. and Matthew Davis of Potter Anderson & Corroon LLP in Wilmington.