July 2015 | Issue 81
Vice Chancellor Laster of the Delaware Court of Chancery was underwhelmed, to say the least, by the quality of the fairness analysis put forward by the Conflicts Committee and its Financial Advisor in connection with the approval of the pricing of a major financial transaction between two related public companies.
El Paso Corporation (“Parent”) was a New York Stock Exchange listed company focused on the production and transmission of natural gas. Parent, through a General Partner, controlled a Delaware Limited Partnership called El Paso MLP, which was also traded on the NYSE.
Parent had created El Paso MLP (“MLP”) as a vehicle to raise capital based on the cash flow of Parent assets. MLP was a pass-through entity for tax purposes. Because of this, MLP could distribute cash to investors in a tax-efficient manner. This meant that investors valued the cash flows more highly at the MLP level than at the Parent level. Parent took advantage of this valuation difference by periodically selling batches of its assets to MLP for cash. These transactions are referred to as dropdowns.
Dropdowns are transactions between related parties. The limited partnership agreement governing MLP permitted Parent to engage in a transaction involving a conflict of interest (such as a dropdown) if the transaction received approval from a Conflicts Committee made up of qualified members from the board of the General Partner. The only contractual requirement for approval of a transaction was that the Committee members believe in good faith that the transaction is in the best interests of MLP. The Conflicts Committee in the El Paso transactions was advised by an outside law firm and a Financial Advisor.
The Fall Dropdown
Parent carried out three dropdowns in 2010. Two of these, referred to as the “Spring Dropdown,” and the “Fall Dropdown” gave rise to a derivative lawsuit in Delaware Chancery Court asserting that the prices paid in the dropdowns by MLP were too high. In re: El Paso Pipeline Partners, L. P. Derivative Litigation, 2015 Del. Ch. LEXIS 116 (April 20, 2015).
The court turned away plaintiff’s challenge of the Spring Dropdown, granting defendant’s motion for summary judgement. It decided, however, to take a closer look at the Fall Dropdown.
This transaction involved the sale of part of Southern LNG Company, LLC, which owned a liquefied natural gas terminal on Elba Island, GA. and Elba Express, which owned a natural gas pipeline. The two companies were treated as a single unit, referred to as “Elba.” The fall transaction consisted of a 49% interest in Elba, plus a 15% interest in another natural gas pipeline called Southern Natural Gas LLC.
The Court is Disappointed
The court was very disappointed by what it learned at trial. It said “I expected that at trial, the Committee members and their financial advisor would provide a credible account of how they evaluated the Fall Dropdown, negotiated with Parent, and ultimately determined that the transaction was in the best interests of El Paso MLP. It turned out that in most instances, the Committee members and their financial advisor had no explanation for what they did. The few explanations they had were conclusory or contradicted by contemporaneous documents….The evidence at trial ultimately convinced me that when approving the Fall Dropdown, the committee members went against their better judgement and did what Parent wanted, assisted by a financial advisor that presented each dropdown 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 court then went on to describe in particular what it saw as shortcomings in the Financial Advisor’s analysis. These included improper selection of comparable transactions, misleading data exhibits, artful selection of discount rates and inconsistencies with its approach in previous valuations.
The court finished as follows, “The Financial Advisor failed to perform the real work of an advisor to a committee. Instead of helping the Committee develop alternatives, identify arguments, and negotiate with [Parent], Financial Advisor sought to make the price that Parent proposed look fair. Financial Advisor’s real client was the deal, and the firm did what it could to justify the Fall Dropdown, get to closing, and collect its contingent fee. Rather than helping the Committee bolster its claim to have acted in good faith, the Financial Advisor undercut it.”
The Court’s Conclusion
The General Partner was found to be liable for breach of contract in connection with the Fall Dropdown. The amount of damages was found to be $171 million.