In re: El Paso Pipeline Partners L.P. Derivative Litigation, C.A. No. 7141-VCL (June 12, 2014)
By Eric Feldman and Porter Sesnon
In In re: El Paso Pipeline Partners L.P. Derivative Litigation, the Delaware Court of Chancery granted summary judgment in favor of the defendants on claims for breach of contract and breach of the implied contractual covenant of good faith and fair dealing in connection with a conflicted transaction.
In March 2010, El Paso Pipeline Partners, L.P., a Delaware limited partnership that operates as a publicly traded master limited partnership (the “MLP”), purchased a 51% interest in two entities that owned certain liquid natural gas (“LNG”) assets (the “Drop-down”) from its parent corporation that “sponsored” the MLP, El Paso Corporation (the “Parent”). Parent also indirectly owned the general partner of the MLP, El Paso Pipeline GP, L.L.C. (the “General Partner”), giving it control over and an economic interest in the MLP. As a result, the proposed Drop-down created a conflict of interest for the General Partner.
In purchasing these LNG assets, the MLP paid Parent $963 million, comprised of $661 million in cash, the issuance of common units of the MLP worth $149 million, and the assumption of 51% of the $150 million in debt owned by the two entities. The principal sources of revenue for the two entities purchased by the MLP were firm capacity contracts with two special purpose subsidiaries of Royal Dutch Shell and British Gas (“Capacity Contracts”). The Capacity Contracts were described by Parent during the sale process as long-term, fixed-fee contracts that would provide consistent cash flow; however, the two special purpose subsidiaries had no assets of their own, and their respective parent companies had only guaranteed approximately 20% of the revenue that the Capacity Contracts might have generated. Therefore, if the Capacity Contracts became untenable, then Shell and British Gas could walk away with no recourse for the MLP.
The MLP’s limited partnership agreement (the “L.P. Agreement”) contained several specified methods f by which a conflict of interest transaction, such as the Drop-down, could be approved, and stated that approval by any such method would not constitute a breach of the L.P. Agreement or any other duty.. One such way was if a majority of the members of an independent Conflicts Committee, acting in good faith, approved the transaction (“Special Approval”), with “good faith” defined in the L.P. Agreement to mean a belief that the action is in the best interests of the MLP. Notably, the L.P. Agreement eliminated all fiduciary duties of the General Partner.
Pursuant to this provision, a Conflicts Committee was formed to evaluate and approve the Drop-down. The Conflicts Committee engaged a financial advisor, from which it received a fairness opinion relating to the Drop-down, met several times, and negotiated with the Parent on the financial terms of the Drop-down. Ultimately, the Conflicts Committee gave Special Approval for the Drop-down and recommended that the General Partner approve the Drop-down on behalf of the MLP.
Unbeknownst to the Conflicts Committee at the time of the Special Approval of the Drop-down, the Parent had declined to exercise its right of first refusal to purchase additional interests in another entity it owned that held similar LNG assets (the “Similar Transaction”), the price of which was substantially lower than the price the Parent was selling the LNG assets to the MLP. This information could have been relevant to the Conflicts Committee in negotiating and determining whether or not to approve the Drop-down.
The plaintiffs sued derivatively alleging that the Parent sought to off-load risky assets and debt onto the MLP at an inflated price, and in so doing the defendants breached their contractual obligations under the L.P. Agreement as well as the implied contractual covenant of good faith and fair dealing. As to certain defendants, the plaintiffs also alleged aiding and abetting a breach of contract as well as tortious interference with contract. It is worth noting that in an earlier decision in the same litigation, the Court of Chancery had granted a motion to dismiss with respect to allegations that the Conflicts Committee did not meet the independence requirements of the L.P. Agreement such that they could not have given Special Approval, and that such decision had not been further challenged by the plaintiffs.
After completing discovery, the parties each filed motions for summary judgment. The Court of Chancery quickly granted summary judgment on the breach of contract and the breach of the implied contractual covenant claims with respect to all defendants other than the General Partner (the only defendant that was party to the L.P. Agreement), finding that only the actual parties to a contract can be held liable for breach of contract or breach of the implied contractual covenant of good faith and fair dealing, which is itself a breach of contract claim.
In granting summary judgment for the General Partner with respect to the breach of contract claims, the Court of Chancery examined whether the Drop-down was approved as required under the L.P. Agreement, In applying the contractual good faith standard under the L.P. Agreement, the Court of Chancery confirmed that the applicable standard under Delaware law was whether the Conflicts Committee subjectively believed that the Drop-down was in the best interests of the MLP. The Court of Chancery examined the process used by the Conflicts Committee in evaluating the Drop-down, including the use of a financial advisor and receipt of a fairness opinion, and also found relevant that the members of the Conflicts Committee were experts in the industry. In addition, the Court found that even though the guarantees provided by Shell and British Gas were only 20% of the revenue from the Capacity Contracts, rather than 100% as the Conflicts Committee seemed to think, the Conflicts Committee nonetheless believed in good faith they were meaningful protections to the MLP. Further, the Court of Chancery found that it could not use the failure by the Conflicts Committee to consider the Similar Transaction against it since the evidence was undisputed that the Conflicts Committee had no knowledge of the Similar Transaction. Ultimately, the Court of Chancery held that while “[r]easonable minds could disagree about the judgment made by the Conflicts Committee,” it did not evidence bad faith and therefore the subjective good faith standard required by the L.P. Agreement was satisfied.
The Court of Chancery next considered the plaintiffs’ claim that the General Partner breached the implied contractual covenant of good faith and fair dealing by withholding from the Conflicts Committee the existence of, and information concerning, the Similar Transaction, which information could have impacted both the Conflicts Committee’s determination and the fairness opinion. Before determining whether the implied contractual covenant of good faith and fair dealing was breached, the Court of Chancery first needed to determine whether the there was a gap in the L.P. Agreement that needed to be filled, such that the implied contractual covenant was applicable to the situation at issue. In this regard, the Court of Chancery rejected the defendants’ argument that satisfying the L.P. Agreement’s definition of “good faith” necessarily meant that the implied contractual covenant was also satisfied. In so doing, the Court of Chancery confirmed existing precedent that contractual “good faith” and the implied contractual covenant are two different concepts, with the former looking at conduct at the time of acting, and the latter focused on the intent of the parties at the time of contracting.
While the Court of Chancery found that a potential gap existed in the L.P. Agreement related to the volunteering of information, and such a duty of disclosure would otherwise have existed if traditional fiduciary duties applied, it held that the implied contractual covenant did not create an implied duty on the General Partner under the L.P. Agreement to volunteer information to the Conflicts Committee because “[w]hen an alternative entity agreement eliminates fiduciary duties as part of a detailed contractual governance scheme, Delaware courts should hesitate to use the implied covenant to reconstruct the outcome that fiduciary duty analysis would have generated.” According to the Court of Chancery, since the drafters of the L.P. Agreement (1) expanded the General Partner’s freedom to act and reduced the protections that otherwise would have existed, (2) eliminated all fiduciary duties, which in turn eliminated the fiduciary duty of disclosure to limited partners, (3) eliminated the corporate opportunity doctrine, including disclosure obligations otherwise contemplated thereby, and (4) could have easily included such disclosure obligations in the L.P. Agreement if it were meant to apply, as had been done in other Delaware master limited partnership agreements, it would not read such disclosure requirement into the L.P. Agreement. As a result, the Court of Chancery granted summary judgment in favor of the General Partner.
It is worth noting that, in reaching its decision on the implied contractual covenant, the Court of Chancery addressed certain dicta in the Delaware Supreme Court’s opinion in Gerber v. Enter. Prods. Hldgs., LLC, 67 A.3d 400 (Del. 2013), in which the Supreme Court identified potential Special Approval scenarios which could give rise to a breach of the implied contractual covenant. One such hypothetical was where the general partner intentionally concealed material information from a financial advisor that, if disclosed, could cause such financial advisor to change its opinion about a transaction being fair to an opinion that such transaction was not fair. While this scenario is similar to the facts at issue in the current case, the Court of Chancery found that it did not impact its decision for a few reasons. First, the Supreme Court did not say that such facts necessarily would constitute a breach of the implied contractual covenant, only that compliance with contractual good faith might not preclude such claims. Second, such statements were non-binding dicta. Third, unlike in Gerber where the Conflicts Committee based its Special Approval solely on a (flawed) fairness opinion and a provision of the relevant limited partnership agreement stating that reliance on a fairness opinion was conclusively deemed to be acting in good faith under such agreement, in this case, while a fairness opinion was received, it was only one of the factors considered by the Conflicts Committee in making its determination.
Having granted summary judgment with respect to the breach of contract and implied contractual covenant claims, the Court of Chancery also dismissed the aiding and abetting a breach of contract and tortious interference with contract claims as those claims seek to impose secondary liability and there was no longer any underlying, primary wrong to support them.