The Chancery Court held that a general partner of a master limited partnership breached the entity’s limited partnership agreement by failing to act in the best interests of the entity and instead acting in a manner that benefited the parent of its general partner and increased distributions to the entity’s common unitholders. The Chancery Court focused on the general partner’s failure to consider lessons learned from a similar past transaction and the inadequacy of the financial advisor’s fairness opinion.
In In re: El Paso Pipeline Partners, L.P. Derivative Litigation, plaintiff challenged two transactions in which El Paso Corporation (“Parent”) sold to El Paso Pipeline Partners, L.P., a master limited partnership (“El Paso MLP”), its interest in two subsidiaries of Parent, Southern LNG Company, L.L.C. and Elba Express, L.L.C. (collectively, “Elba”). Both subsidiaries were engaged in the liquefied natural gas (“LNG”) business. Parent is the parent company of El Paso MLP’s general partner, El Paso Pipeline GP Company, L.L.C. (the “General Partner”); and thus, Parent exercised control over El Paso MLP through the General Partner. In the first transaction, in March 2010, Parent dropped-down a 51% interest in Elba to El Paso MLP for total consideration of $963 million (the “Spring Dropdown”). In the second transaction, in November 2010, Parent dropped-down to El Paso MLP the remaining 49% interest in Elba for at least $931 million and 15% of another Parent subsidiary, for total consideration of $1.412 billion (the “Fall Dropdown”).
Plaintiff challenged both the Spring Dropdown and Fall Dropdown under El Paso MLP’s limited partnership agreement (the “LP Agreement”), alleging that the members of the Conflicts Committee of the General Partner’s board (the “Committee”) did not believe in good faith that the transaction was in the best interests of El Paso MLP, as required by a special approval process for conflict of interest transactions pursuant to the terms of the LP Agreement. Under this standard, the Chancery Court granted the defendants’ motion for summary judgment regarding the Spring Dropdown, but found a question of fact regarding the approval of the Fall Dropdown. In this post-trial decision, the Chancery Court ruled on plaintiff’s breach of contract claim with respect to the Fall Dropdown.
Parent engaged in five dropdown transactions in which it sold assets to El Paso MLP. These dropdown transactions enabled Parent to obtain capital at a lower cost due to the higher value that investors place on cash flows at the MLP level and to have the tax benefit of distributing cash to investors via a pass through entity. The Committee approved the Spring Dropdown based on the opinion of its financial advisor that the transaction was fair to the common unitholders other than the General Partner and its affiliates. The market responded negatively to the closing of the Spring Dropdown, which resulted in El Paso MLP’s common units trading down 3.6%. However, despite a weakening market for LNG, Parent offered the Fall Dropdown to El Paso MLP. The same financial advisor then prepared a deficient valuation summary in which Parent’s asking price was made to look more attractive and the Committee ultimately approved the Fall Dropdown at a price similar to the price of the Spring Dropdown.
The Chancery Court began its legal analysis by explaining that the LP Agreement “required that the Committee members believe subjectively that the Fall Dropdown was in the best interests of El Paso MLP. The contractual standard did not require that the Committee make a determination about the best interests of the common unitholders as a class or prioritize their interests over other constituencies.” In order to establish a breach of the LP Agreement, plaintiff was required to prove by a preponderance of the evidence that the Committee members did not believe that the Fall Dropdown was in the best interests of El Paso MLP. Plaintiff could prove such a breach by showing that the Committee members disregarded their known duty to form a subjective belief that the Fall Dropdown was in the best interests of El Paso MLP. The court then explained that the Committee members did not have that subjective belief because they instead believed that the Fall Dropdown would enable El Paso LP to increase distributions to common unitholders and enable Parent to continue to raise capital at lower costs.
In addition, the Chancery Court explained that the Committee disregarded evidence that El Paso MLP paid too much in the Spring Dropdown and allowed that price to guide the price of the Fall Dropdown. The Chancery Court stated that the financial advisor’s “work product further undermined any possible confidence in the Committee.” The Committee’s financial advisor “made a minimal effort in connection with the Fall Dropdown” and “manipulated the deal process through malfeasance” by making the Fall Dropdown appear more attractive.
According to the Chancery Court, the Committee “viewed El Paso MLP as a controlled company that existed to benefit Parent by providing a tax-advantaged source of inexpensive capital.” The Committee considered it adequate that Parent desired to complete the Fall Dropdown and that it benefited El Paso MLP’s common unitholders; and thus, the Chancery Court held that the Committee members disregarded their known duty to have a subjective belief that the Fall Dropdown was in the best interests of El Paso MLP. The Chancery Court then calculated the damages from the Fall Dropdown to be $171 million based on a valuation from plaintiff’s expert.