Practitioners do not need to throw out the carefully crafted partnership agreements used by master limited partnerships because of the recent decision by Vice Chancellor Laster in In re: El Paso Pipeline Partners, L.P. Derivative Litigation, C.A. No. 7141-VCL, 2015 WL 1815846 (Del. Ch. Apr. 20, 2015). In El Paso, Vice Chancellor Laster concluded that the general partner of the relevant master limited partnership breached its limited partnership agreement by authorizing and causing the master limited partnership to enter into a transaction with the general partner’s affiliate. The opinion is driven by a unique set of facts and therefore does not require practitioners to make drastic changes to master limited partnership agreements. The decision, however, does offer practical lessons for those advising master limited partnerships, or other alternative entities and their sponsors. This article will first describe the El Paso opinion and then provide three practical lessons to take away from the decision.
Facts
The Transaction
El Paso Pipelines Partners, L.P. (MLP) was a publicly owned master limited partnership that owned interests in companies that operate natural gas pipelines, liquid natural gas terminals, and storage facilities throughout the United States. The plaintiffs were limited partners in MLP. In El Paso, the plaintiffs challenged MLP’s acquisition of interests in two subsidiaries of El Paso Corporation, Inc. (Parent). At the time that the challenged transaction was consummated, Parent controlled both MLP and El Paso Pipeline GP Company, L.L.C. (the General Partner), the sole general partner of MLP.
The challenged transaction in El Paso was one of three transactions consummated by MLP with Parent in 2010. In March 2010, MLP acquired a 51 percent interest in each of Southern LNG Company, LLC and Elba Express, LLC (collectively referred to as “Elba”) for approximately $963 million (the Spring Dropdown). In November 2010, MLP acquired the remaining 49 percent interest in Elba and a 15 percent interest in another subsidiary of Parent, Southern Natural Gas, L.L.C. (Southern) for approximately $1,412 million (the Fall Dropdown). The plaintiffs challenged both the Spring Dropdown and the Fall Dropdown. In a previous opinion, the court granted defendant’s motion for summary judgment regarding the Spring Dropdown but denied the motion for summary judgment regarding the Fall Dropdown. El Paso is the court’s decision regarding the Fall Dropdown.
Contractual Framework
In order to understand the court’s decision, it is necessary to understand the contractual framework that governed decision-making under the MLP partnership agreement. The MLP partnership agreement eliminated all fiduciary duties and permitted interested transactions between MLP and Parent or its affiliates so long as such transaction was approved by one of four permissible methods under the MLP partnership agreement. One permissible approval method was “Special Approval,” which was defined as approval by a majority of an ad hoc committee made up of independent members of the board of directors of the General Partner (the Committee). The only contractual requirement for “Special Approval” was that the Committee members believe in good faith that the transaction was in the best interests of MLP. The Delaware Supreme Court has interpreted similar language as setting forth a “subjective belief” standard. See Allen v. Encore Energy P’rs LP, 72 A.3d 93, 104 (Del. 2013). Thus, under MLP’s contractual framework, in order to challenge the Fall Dropdown successfully the plaintiffs were required to prove, by a preponderance of the evidence, that the Committee did not subjectively believe the Fall Dropdown was in the best interests of MLP. The court reasoned that a plaintiff could meet this burden by providing “persuasive evidence that the [Committee] members intentionally fail[ed] to act in the face of a known duty, demonstrating a conscious disregard for [their] duties.”
The Committee’s Work
The court reviewed the Committee’s work based on the contractual framework of the MLP partnership agreement described above. In order to assess the Committee’s work on the Fall Dropdown, the court also reviewed the Committee’s work on the Spring Dropdown and a transaction consummated in the summer of 2010. The court also noted that for each transaction, the Committee was made up of the same members, and the Committee engaged the same financial advisor and law firm.
Spring dropdown. With respect to the Spring Dropdown, Parent initially suggested that MLP acquire 51 percent of Elba for total consideration of $1,053 million. Subsequently, Parent revised the proposal to suggest that MLP acquire a 49 percent interest of Elba for $865 million after the Committee objected to acquiring a majority stake in Elba. Ultimately, Parent’s proposal was revised back to an acquisition of 51 percent of Elba. In assessing the Committee’s work, the court noted that in spite of the back and forth on the proposals, the pricing did not change significantly based on the acquisition of a control or a non-control position in Elba.
Further, the court found that the Committee was not aware of a key factor related to Elba until trial. The cash flow provided by Elba’s long-term contracts, its principal assets, was not 100 percent guaranteed by credit-worthy guarantors but rather the credit-worthy guarantors guaranteed less than 20 percent of the total. The Committee members did not realize that the credit-worthy guarantors guaranteed less than 100 percent of the cash flow until trial. Also, the court observed that the Committee did not do a good job in negotiating the Spring Dropdown with Parent. For example, the Committee internally agreed that a price in the $780 million range was fair, but then in actual negotiations the Committee initially countered with a price range of $860–$870 million and then ultimately agreed to $963 million. Following the announcement of the Spring Dropdown, the market reacted negatively causing MLP’s shares to trade down 3.6 percent on the news, which caused a Committee member to remark, “[t]he next time we will have to negotiate harder.” The court reasoned that the Committee’s work on the Spring Dropdown did not support an inference of bad faith, but the court viewed it as an expensive lesson on negotiating such deals.
The court also discussed a summer dropdown transaction in which MLP acquired a 16 percent interest in Southern. Following the summer dropdown transaction, two of the three Committee members indicated that they did not want MLP to acquire additional interests in Elba.
Fall dropdown. In October 2010, Parent proposed the Fall Dropdown. Despite the Committee’s opposition to acquiring additional interests in Elba, Parent proposed that MLP acquire the rest of the interests in Elba and offered MLP an option to acquire an additional 15 percent interest in Southern. Members of the Committee did not like having MLP acquire the balance of Elba and thought the price was too high. But members of the Committee thought the negatives in Parent’s “informal” proposal could be mitigated by reducing the price to $900 million and removing any conditionality regarding the Southern interest. Subsequently, Parent revised the proposal accordingly. The Committee ultimately approved the revised proposal at an acquisition price of $1,412 million.
In assessing the Committee’s work on the Fall Dropdown, the court also described the financial advisor’s work. According to the court, the financial advisor regarded its work on the Fall Dropdown as little more than an update of its work on the Spring Dropdown. The court identified a number of differences between the Fall Dropdown presentations and the Spring Dropdown presentations that the financial advisor made, in the court’s view, to make Parent’s asking price look better. The court believed that the financial advisor viewed its client as the “deal” and was focused on getting the deal done in order to collect its contingent fee.
In terms of the Committee’s work, the court noted that the Committee did not use the lessons learned from the Spring Dropdown to guide the pricing for the Fall Dropdown, nor did the chief negotiator make the types of arguments that a motivated bargainer would make. Thus, although the Committee may have overpaid for its controlling interest in Elba in the Spring Dropdown, the Committee used that price as the guide to price the Fall Dropdown. Further, although the Committee asked the financial advisor to value Elba and Southern separately, the Committee never learned the price MLP paid for each asset. Consequently, the Committee members did not know how the Fall Dropdown prices of Elba and Southern compared with the prices paid by MLP in the spring and summer transactions.
Decision
In finding for the plaintiffs, the court noted that it was persuaded by the accretion of points and standing in isolation, any single error or group of errors could be excused or explained, but at some point the story was no longer credible. According to the court, one of the troubling factors was that the Committee members’ e-mails expressed their “actual views,” which were not consistent with testimony provided at trial. The Committee members’ e‑mails generally expressed a belief that it was not in the best interests of MLP to acquire additional interests in Elba.
In addition, the court found the Committee’s myopic focus on accretion to the holders of common units to be misguided. According to the court, the Committee viewed its job as confirming that a transaction would be accretive to the holders of common units. The court found the Committee’s focus to be misguided for two reasons.
First, under the contractual framework set forth in MLP’s partnership agreement, a determination that a transaction is good for the holders of common units is not sufficient to determine whether it is in the best interests of MLP. According to the court, the contractual fiduciary duties in MLP’s partnership agreement set forth a standard that was drastically different from traditional fiduciary duties. A prior decision involving MLP described the differences between traditional fiduciary duties and the duties set forth in MLP’s partnership agreement. See Allen v. El Paso Pipeline GP Co., L.L.C., 113 A.3d 167, 179–181 (Del. Ch. 2014). In that prior decision, the court described the traditional fiduciary duties as follows: “A board of directors owes fiduciary duties to the corporation for the ultimate benefit of its residual risk bearers, viz. the class of claimants represented by undifferentiated equity. . . . When making decisions that have divergent implications for different aspects of the capital structure a board’s fiduciary duties call for the directors to prefer the interests of the common stock.” In contrast to traditional fiduciary duties, Vice Chancellor Laster described the standard in the MLP partnership agreement as follows: “Rather than requiring the Conflicts Committee to reach a subjective belief that the Drop-Down was in the best interests of [MLP] and its limited partners, [the MLP partnership agreement] requires only that the Conflicts Committee believe subjectively that the Drop-Down was in the best interests of [MLP] . . . [w]hen considering an issue, the Conflicts Committee has discretion to consider the full range of entity constituencies, including but not limited to employees, creditors, suppliers, customers, the general partner, the IDR holders, and of course the limited partners.” In light of the contractual modification of fiduciary duties, the court seemed to conclude that the Committee could not consider solely how the transaction would affect the holders of common units but rather it must consider how it affected MLP and its full range of entity constituencies.
Secondly, the court found the Committee’s focus misguided because of its preoccupation with accretion. In the court’s view, an accretion analysis fails to determine value or whether a buyer is paying a fair price, and therefore it fails to show whether a transaction is in the best interests of MLP. Consequently, because the accretion analysis does not indicate whether a transaction is in the best interest of MLP, the Committee’s focus on accretion was incorrect.
Furthermore, the court reasoned that the Committee not only negotiated badly but also disregarded the “expensive lessons” learned from the Spring Dropdown. According to the court, although the Committee overpaid for a majority interest in Elba and the market Elba operated in deteriorated following the Spring Dropdown, MLP still paid on a percentage basis, roughly the same price for the minority interest in Elba in the Fall Dropdown.
Finally, the court found that the financial advisor’s work undermined any confidence the court could have in the Committee’s work. The court concluded that the financial advisor was more concerned with justifying Parent’s asking price and collecting its fee than providing good advice.
Based on the multiple problems with the approval process, the court concluded that the members of the Committee did not subjectively believe the Fall Dropdown was in the best interests of MLP. According to the court, the Committee viewed MLP as a controlled company and it knew the Fall Dropdown was something that Parent wanted and the Committee deemed it sufficient that the transaction was accretive. The court determined that the Committee members “disregarded a known duty” to determine that the Fall Dropdown was in the best interests of MLP. Consequently, the court found that the General Partner breached the MLP partnership agreement and awarded damages to the plaintiffs.
Practical Lessons
The El Paso decision was highly fact-driven, but the decision offers lessons for those drafting master limited partnership agreements and other alternative entity agreements.
Contractual Fiduciary Duties
The Delaware Revised Uniform Limited Partnership Act (DRULPA) and other Delaware alternative entity acts provide practitioners with the ability to modify and even eliminate fiduciary duties. But the elimination of fiduciary duties should be considered carefully. If fiduciary duties will be modified, drafters should carefully assess the resulting contractual fiduciary duties of a board or similar governing body to determine whether the modified fiduciary duties actually meet the objectives of the sponsor. In El Paso, the MLP partnership agreement eliminated the traditional fiduciary duties of the general partner and instead replaced them with a contractual fiduciary duty standard that governed interested transactions. The applicable standard in MLP’s partnership agreement required that the Committee conclude that an interested transaction was in the best interests of MLP. As noted above, Vice Chancellor Laster believed that the Committee members incorrectly focused primarily on what was in the best interests of the holders of common units as opposed to focusing on what was in the best interests of MLP. If traditional fiduciary duties applied, then the Committee’s focus on the holders of common units probably would have been correct.
Vice Chancellor Laster has described the contractual standard in the MLP partnership agreement as providing the Committee with discretion to “consider the full range of entity constituencies, including but not limited to employees, creditors, suppliers, customers, the general partner, and the limited partners.” Vice Chancellor Laster described such a standard as conferring contractual discretion on the Committee to balance the competing interests of MLP’s various entity constituencies when determining what is in the best interest of MLP. Based on the El Paso decision, the discretion provided in the MLP partnership agreement as written was not broad enough to permit the Committee to prefer the interests of certain constituencies.
Consequently, one lesson from El Paso is that the contractual fiduciary duties provided in alternative entity agreements perhaps should be drafted to state clearly what interests may be considered or preferred by a governing board. If, in making decisions, the sponsors of an entity intend for the governing board to focus on the effect such decision will have on a specific entity constituency, then the sponsors should draft the agreement accordingly. For example, the sponsors might draft the agreement to state that such governing board has a duty to determine what is in the best interests of a specific entity constituency, such as the residual equity holders, instead of the entity itself. However, if language similar to MLP’s partnership agreement is used that requires a determination of what is in the best interests of the entity, then language should be added to the agreement that confers upon the governing board the discretion to “prefer” a certain class of entity constituencies in making decisions. Thus, following El Paso, practitioners should consider whether an alternative entity agreement should allow a governing board to focus on, and possibly prefer, a specific entity constituency.
Tailor Agreements
It has been said that master limited partnerships are guided by one simple principle in making acquisitions: it must be accretive to available to cash flow. See John Goodgame, Master Limited Partnership Governance, 60 Bus. Law 471, n. 468 (2005) (quoting UBS Warburg, MLP Bible 24 (Apr. 2003)). The El Paso decision, however, criticized the Committee for focusing on accretion. The DRULPA, like other Delaware alternative entity acts, provides parties with the ability to draft and tailor the parameters, duties, and standards for the governance of a limited partnership. The flexibility inherent in the DRULPA may be used to permit a governing body to focus on principles that might be important in a specific industry. For example, a master limited partnership’s agreement could be drafted to provide a conflicts committee with the discretion to consider, and place great weight on, whether an interested transaction will be accretive in determining whether an acquisition is in the best interests of the partnership. Thus, another lesson from El Paso is that practitioners should consider using the contractual flexibility in the DRULPA to tailor a governance standard, and how compliance will be measured, based upon the specific industry of the alternative entity and the investors’ objectives.
Documenting the Approval Process
Vice Chancellor Laster stated that he expected that, at trial, he would hear a credible account from the Committee members as to how they evaluated the Fall Dropdown, negotiated the final price and how they ultimately concluded the Fall Dropdown was in the best interests of MLP. However, because of the significant number of dropdowns consummated by MLP and the length of time between the approval of the Fall Dropdown and trial, it is not surprising that the Committee members were unable to provide detailed explanations for why decisions were made or not made. Consequently, some explanations tended to focus less on what actually happened in the Fall Dropdown process, but rather focused on what the Committee has typically done. Because it might be difficult to recall specific details of a fast-moving approval process for one of many deals years later, it is helpful to have a well-documented approval process with properly drafted minutes.
Reasonable advisors might disagree on the benefits of short-form minutes versus long-form minutes; however, clear and concise long-form minutes can be incredibly useful in a fiduciary duty breach case. The minutes do not need to recite verbatim a discussion at the committee’s meeting, but the minutes should set forth a specific decision point and recount the general discussion and the decision made or not made. Furthermore, the minutes should include the rationale for such decision or non-decision and any advice provided by advisors. Well-drafted long-form minutes may prove invaluable to committee members years later as they prepare for a deposition. Such minutes would be particularly helpful for an entity that enters into and consummates many transactions. Thus, another lesson from El Paso is to draft minutes in a manner that truly captures the committee’s deliberations and any advice provided by its advisors, such that the minutes may help committee members recall key facts regarding the approval process years later.
Conclusion
As stated above, although the El Paso decision generated much discussion at the time it was issued, its applicability should not be widespread. The decision, however, offers lessons for drafting modifications to fiduciary duties for governing boards, tailoring agreements for a specific industry and provides considerations for how to document an approval process.