United States: In Re El Paso Pipeline Partners, L.P. Derivative Litigation: A Cautionary Tale For MLPs And Yieldcos

The Delaware Court of Chancery, in In re: El Paso Pipeline Partners, L.P. Derivative Litigation , C.A. No. 7141–VCL, 2015 WL 1815846 (Del. Ch. Apr. 20, 2015), found that a master limited partnership ("MLP") overpaid its parent corporation by $171 million for certain "dropdown" assets because the Conflicts Committee of its general partner failed to form a subjective belief that the dropdown was in the best interests of the MLP.

This decision could bolster the power of activist investors and should serve as a cautionary tale for MLPs and Yieldcos alike.

The Transactions at Issue

El Paso Corp. ("Parent") formed El Paso Pipeline Partners, L.P. ("El Paso MLP") to maximize the amount of capital it could raise and to lower the cost of that capital by transferring to El Paso MLP assets generating stable cash flows. Parent controlled El Paso MLP through its ownership of El Paso Pipeline GP Company, L.L.C. ("General Partner"), a subsidiary of Parent that served as El Paso MLP's sole general partner.

In March 2010, Parent dropped down to El Paso MLP a 51 percent interest in Southern LNG Company, L.L.C. and Elba Express, L.L.C. (together, "Elba") for $963 million (the "Spring Dropdown"). Several months later, Parent dropped down its remaining 49 percent interest in Elba and a 15 percent interest in Southern Natural Gas, L.L.C. ("Southern") for $1.412 billion (the "Fall Dropdown"). An El Paso MLP limited partner brought a derivative suit claiming that El Paso MLP had been harmed by the overvaluation of these assets. The court granted summary judgment to the defendants as to the Spring Dropdown. However, it found the General Partner liable for breach of El Paso MLP's Limited Partnership Agreement ("LP Agreement") in the Fall Dropdown, in no small part because it determined, based on a comparison of the terms and negotiations of the Fall Dropdown with those of the Spring Dropdown, that the Conflicts Committee had affirmatively ignored certain lessons learned and acknowledged in the earlier transaction. In doing so, according to the court, the Committee had caved in to pressure from Parent regarding the price of the Fall Dropdown assets.

The LP Agreement permissibly waived the common law fiduciary duties that the General Partner would have otherwise owed El Paso MLP's limited partners under Delaware law and replaced them with contractual standards relating to the governance of El Paso MLP. In relevant part, the LP Agreement permitted approval of related-party transactions such as those between Parent and El Paso MLP, despite the inherent conflict of interest, as long as one of several conditions was met. Among these was "Special Approval," i.e., "approval by a majority of the members of the Conflicts Committee [of the General Partner's board of directors] acting in good faith." For the Conflicts Committee to act in good faith, the LP Agreement required only that its members subjectively "believe that the determinations or other action is in the best interests of the Partnership."

Deficiencies of the Fall Dropdown

The court identified a variety of problems with the Conflicts Committee's consideration of the Fall Dropdown. Ultimately, the decision paints a picture of the Conflicts Committee as one that simply "went through the motions" and whose judgment was subordinated to the twin goals of increasing distributions to common unitholders and raising inexpensive capital for its Parent. The court noted that while it expected the Committee and its financial advisor(the "FA") to "provide a credible account" of how they evaluated and negotiated the Fall Dropdown and determined that it was in the best interests of the MLP, it instead concluded that they lacked explanation of such details. Whether because they did not learn the relevant information, disregarded information they did learn, or were overruled by Parent, the court found that the Committee "did not subjectively believe that approving the Fall Dropdown was in the best interests of [El Paso MLP]." In reaching this determination, the court considered the Conflicts Committee's disregard for lessons learned in the Spring Dropdown, its preoccupation with "accretion" over value add, and the failing of the FA.

The Conflicts Committee's Conscious Disregard of Lessons Learned. In both the Spring and Fall Dropdowns, El Paso MLP acquired a share of Parent's Elba assets. During the several months between the two transactions, the Conflicts Committee members appear to have decided that it would not be "in the best interests of [El Paso MLP] to have too much of its assets tied up in the LNG trade" because of a negative outlook and limited growth prospects for LNG generally. Moreover, the Conflicts Committee members became convinced that El Paso MLP had paid too much in the Spring Dropdown because the markets reacted negatively and because an unrelated LNG facility transaction closed at a comparatively lower valuation. For these reasons, the Conflicts Committee resolved to negotiate harder with Parent for the next dropdown.

Despite these intentions expressed by the Conflicts Committee in contemporaneous email communications among its members, the court outlined the ways in which the Conflicts Committee did not act in accordance with its actual views and "consciously disregarded" the lessons it learned in the Spring Dropdown. As an initial matter, the court found that the Conflicts Committee "accommodated" Parent by agreeing to acquire its remaining interest in Elba. With respect to valuation for the Fall Dropdown, the court found that the Committee "did more than simply negotiate poorly." According to the court, they allowed the Spring Dropdown price to anchor the Fall Dropdown negotiations, ignored what evidence they had regarding a fair value for the Elba assets, and did not use Parent's Spring Dropdown valuation arguments to push back against its proposed Fall Dropdown valuation. Although the Conflicts Committee successfully argued for the inclusion of the Southern assets in the Fall Dropdown in exchange for agreeing to acquire the remaining Elba assets, the court found that they did not stand firm on their own stated interest in separate valuations for the two. This allowed Parent to increase the price El Paso MLP paid for the Elba assets above the agreed-upon valuation without the Committee realizing it.

The Preoccupation with Accretion. The court also found that rather than determining that the Fall Dropdown was in the best interests of El Paso MLP, the Conflicts Committee appears to have, by focusing on whether the transaction would be accretive to the holders of El Paso common units, failed to acknowledge or understand that "accretion" is not a part of valuation. The court found that the Committee "fixated myopically on accretion" despite the fact that accretion would not add value—the fundamental feature of a sound acquisition according to the court.

The Failings of the Financial Advisor. The court's decision portrays the Conflicts Committee's FA as ineffective at best, and misleading or manipulative at worst. The court implies that the FA acted as if Parent, rather than the Conflicts Committee, was its client, noting that each dropdown began with a diligence session performed with Parent and that Parent "back channeled" throughout the Fall Dropdown with the FA. With respect to the Fall Dropdown, the court found that the FA viewed it as an "update" on its work on the Spring Dropdown and noted that the FA failed to perform any new analyses notwithstanding that it was specifically requested to do so by the Conflicts Committee. Furthermore, the court noted that the FA's valuation methodology changed between the Spring and Fall Dropdowns, but that the FA failed to explain these changes to the Conflicts Committee.

In fact, the court pointed out that the FA, the Conflicts Committee, and Parent all produced a number of inconsistent justifications for the valuation work that was performed for the Fall Dropdown. The court also noted specifically that the FA worked on a contingent fee basis and would not get paid until and unless the deal closed, concluding that the FA specialized in producing "visually pleasing presentation[s] designed to make the dropdown look as attractive as possible," but was not aggressive about seeking out information that would help it produce a fair valuation. The court concluded that to ensure that the deal would go through, the FA was not entirely truthful with Conflicts Committee members and manipulated its valuation analyses (e.g., shifting the meaning and purported value of majority and minority stakes, carefully selecting precedent transactions to show that the Fall Dropdown valuation had a comparably favorable EBITDA multiple, and using misleading or erroneous inputs (cost of capital, discount rate, terminal value) for its discounted cash flow analysis). The court also rejected the FA's fall-back argument—that the FA had exercised its "judgment"—on the grounds that the FA's "judgment" routinely benefitted Parent instead of El Paso MLP. In short, the court concluded that the FA "failed to perform the real work of an advisor to a committee" and "[r]ather than helping the Committee bolster its claim to have acted in good faith, [the FA] undercut it."

Ultimately, the court found that El Paso MLP overpaid for the Fall Dropdown assets by $171 million and imposed damages against the general partner in that amount. In so finding, the court emphasized that ritualistic, nonsubstantive dropdowns to MLPs (and, by analogy, to Yieldcos) can pose a danger if not handled carefully. Indeed, the court's extensive opinion may provide a road map to activists intent on derivative litigation second-guessing business decisions and demonstrates that the elimination of board fiduciary duties in constituent documents is not sufficient to shield against such suits. MLPs, Yieldcos, and financial advisory firms should take note and handle such intercompany dropdown transactions with due care.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions