In his recent decision in In Re: El Paso Pipeline Partners, L.P. Derivative Litigation , Vice Chancellor Laster awarded $171 million in damages to the limited partners of a master limited partnership (“MLP”) that had challenged the MLP’s acquisition of assets from a related party. The transaction at issue — a so-called “dropdown” of assets — involved the sale to the MLP by its controller and general partner (El Paso Corporation) of certain LNG-related assets in exchange for approximately $1.41 billion in cash.
One of the important stated benefits of using MLP structures is the ability to “contract away” from normal Delaware fiduciary duty principles and instead provide that related-party transactions will be evaluated under standards specified in the partnership agreement for the MLP. The relevant standard for the El Paso MLP was on its face quite challenging for the plaintiffs. In particular, the partnership agreement simply
“required that the [independent conflicts] Committee members believe subjectively that the [dropdown transaction] 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. The contractual standard also did not contemplate that a court would review the Committee’s decision using an objective test, such as reasonableness.”
The court also noted that the plaintiffs bore the burden of proving by a preponderance of the evidence that the Committee members did not have such a subjective belief. Put another way, the defendant could have defeated the claim by simply establishing that the Committee members believed the transaction was in the best interests of the MLP, even if that belief was unreasonable and not supported by the facts.
The Vice Chancellor nonetheless concluded that the plaintiffs had met their burden and had proved that the Committee members did not in fact believe that the dropdown transaction was in the best interests of the MLP. The facts noted by the Vice Chancellor in support of this conclusion included:
- The focus of the Committee (characterized by the court as a “preoccupation”) on the impact of the transaction on the ability of the MLP to increase cash distributions on its common units (so-called “accretion”), which the court noted bore no relationship under accepted corporate finance theory to the question of whether the price paid by the MLP for the assets was in the best interests of the MLP.
- The inability of the Committee members to specifically recall how they evaluated the transaction, instead noting what they “typically” would have done.
- The failure of the Committee members to negotiate robustly on behalf the MLP and instead “accommodate” the controller’s requests, which conclusion was supported in part by differences in the private communications of the Committee members (which became available via discovery) and the positions actually taken in negotiations with the controller.
- Reliance on the work of a financial advisor that was harshly criticized by the court as seeking to “justify [the controller’s] asking price and collect its fee”.
In terms of lessons learned, there are at least two. The first is that the decision of course reinforces the conventional, but important, principle that independent directors negotiate with the controller in a fully informed and robust manner, even in transactions in which the standard of review will be quite favorable to the directors. The directors must be prepared to “bargain vigorously or actually say no”, but in this case the Vice Chancellor concluded that the Committee and its advisors simply “went through the motions”.
A second, and perhaps more subtle, lesson is that it becomes increasingly difficult for independent directors to act in this way when a type of transaction becomes routine or accepted in a particular industry. For example, the Vice Chancellor noted that (i) the Committee’s financial advisor had built a specific practice in advising on dropdown transactions in the energy industry, having advised on approximately ten dropdowns per year and with a standard fee for such transactions, and (ii) the dropdown at issue was the fifth such transaction for the MLP since its IPO and the third in 2010. The court also commented that the Committee members focus on “accretion”, with less attention paid to other valuation metrics, was reflected in the testimony of one Committee member that “in this industry, . . . cash distributions are the key to everything, increasing cash distributions to the unitholders”.
The court concluded that this familiarity led to a circumstance in which “everyone understood the routine and expected the transaction to go through with a tweak to the asking price”. The decision serves as a reminder of the importance of independent directors (with the support of their advisors) resisting the notion that a practice is accepted because a particular industry is “different” (e.g., stock option backdating in the technology industry) and instead approach each transaction from first principles.
 In Re: El Paso Pipeline Partners, L.P. Derivative Litigation, C.A. No. 7141-VCL (Del. Ch. Apr. 20, 2015)