Thibaut Lesure
This decision comes as a reminder that even though a limited partnership agreement may eliminate, expand or limit its partners’ fiduciary duties through express and unambiguous language, the duty of good faith and fair dealing remains. Indeed, under Delaware law, fiduciary duties in limited partnerships can be modified and even eliminated, but particular care must be taken to ensure the prudent drafting of these new provisions and to ensure the strict compliance of the directors regarding the remaining duties.
In El Paso, the transaction at issue was the second of a series of dropdown transactions. These transactions are frequent in the energy sector and entail the acquisition of assets by a corporation, followed by a contribution of those assets to a partnership. This allows the corporation to obtain tax benefits and low cost capital via the cash paid by the controlled entity for the asset. The El Paso Corporation (“EPC”), which is today owned by Kinder Morgan, is the parent corporation of El Paso Pipeline Partners, L.P. (“El Paso Partners”) via its sole general partner (the “General Partner”). Since March 2010, the parent company engaged in the so-called dropdown transactions. First, it sold a 51% interest in one of its subsidiaries (“Elba”) to El Paso Partners, another subsidiary for approximately $963 million in cash (the “Spring Dropdown”). In November 2010, the so-called “Fall Dropdown” included the sale of the remaining 49% interest, and additionally a 15% interest i n another EPC subsidiary (“Southern”) for $1.412 billion to El Paso Partners. This sale was a two-step “dropdown” —the “Spring Dropdown” and the “Fall Dropdown.” However, the court had only ruled on the Fall Dropdown, having granted summary judgment in the defendants’ favor on the Spring Dropdown.
Following the procedures of the limited partnership, the transactions were reviewed and approved by a committee of three directors of the General Partner’s board (the “Committee”). This Committee was advised for each of the transactions by outside counsel and a financial adviser, Tudor, Pickering, Holt & Co. (“Tudor”).
After the completion of both transactions, limited partners sued the General Partner in 2011. The claim was based on the alleged breach by the General Partner of the obligation under the limited partnership agreement that the Committee members have the “subjective belief” that the dropdowns were in the “best interests” of El Paso Partners.
The Court mentioned several failures regarding the committee’s task and valuation analysis. According to Vice Chancellor Laster, it seemed that the committee members’ actions “evidenced conscious indifference to their responsibilities” to shareholders. The Court based its analysis on the exchange of emails between members where doubts regarding the transaction were expressed. Despite these doubts, committee members agreed on the price proposed, in all likelihood with the intent to please EPC management.
Moreover, the Committee did not seem to be concerned about past mistakes. Following the completion of the Spring Dropdown, the market responded negatively—common units of El Paso Partners traded down 3.6% on the news. The court pointed out that the Committee did not negotiate harder, failing in its duty to compare to similar transactions, in a deteriorated market. To the court, the Committee members had “consciously disregarded their own independent and well-considered views.”
The Committee members seemed to have been only concerned by the “accretion” of the transaction —that is, the increase of earnings per share. The Court noted the irrelevant character of this element, regarding the analysis of the fair price, since the consideration used has been changed. This shortsighted analysis, forgetting the creation of value in the long term, cannot be considered being in the best interests of the MLP.
Forgetting their essential duties, the Committee’s task had not been facilitated by its financial adviser, Tudor. With strong words, the Court found that Tudor’s work was biased and prevented any possible confidence in the Committee. He voluntarily miscalculated the risk associated with the deal in using irrelevant numbers in his Discounted Cash Flow analysis, he used a deceptive discount rate. And ultimately, making any analysis impossible, contrary to the first dropdown, he did not divide into separate minority-acquisition and majority-acquisition groups; therefore, he “manipulated the deal process through malfeasance.” The Committee members, who already did not seem very inclined to deepen and broaden their investigations, were duped by a financial adviser trying to make the transaction appear as attractive as possible. In the context of the transaction at issue, the members committee seemed to have consciously disregarded what they were supposed to have learned from the previous transactions and their judgments in the official transaction documents “stood in tension with their privately expressed views.” They were not convinced that this transaction was in the best interests of the Partnership and they caved in to the General partner to achieve “Parent’s goal of raising inexpensive capital.”
On the basis of the analysis of the amount overpaid by the partnership for the transaction, the court came to the conclusion that the General Partner should compensate the partnership $171 million. The lawsuit had been conducted through a derivative claim. Thus, the money will end up in the coffers of the limited partnership.
This decision is of particular significance because partnerships are often used by parent companies as investment vehicles in order to obtain tax benefits and freely deal with the affairs of the general partners. It confirms the idea that there is still a possibility to “scrutinize compliance with contractual standards.” The large freedom afforded by the laws of Delaware regarding the limitation of the possibilities of conflict of interests and involvement in the business through the general partner should not obscure the need to comply the general partner’s contractual obligations. It would be a mistake to see the use of these conflicts committees as a mere formality, serving to give carte blanche to the parent company. This decision adds to the already exhaustive list of cases dealing with conflict of interests.
Thibaut Lesure is a French LLM student studying corporate law and finance at Widener University Delaware Law School. He has a Master’s in International and European business law and will study in a French business school next year before taking the French bar exam
Suggested Citation: Thibaut Lesure, In El Paso the Court of Chancery Found that the Modification of Fiduciary Duties Does Not Grant carte blanche, Del. J. Corp. L. (July 6, 2015), www.djcl.org/blog.