In a recent Delaware Chancery Court decision, Vice Chancellor Laster considered yet another challenge to the approval by a “conflicts committee” of a master limited partnership (“MLP”) in the energy sector of a transaction with the MLP’s parent company. Although the Vice Chancellor noted criticism of the process undertaken by the conflicts committee as portrayed in the complaint by holders of the publicly-traded  units of the MLP, the Court nonetheless dismissed the complaint due to the limited ability to challenge the transaction under the partnership agreement (which was typical for MLPs).

Earlier this year, V.C. Laster, in the El Paso MLP case, concluded that a subsidiary MLP’s conflicts committee had failed to satisfy even a subjective good faith standard when approving “drop-downs” (i.e., the sale of assets by the parent to the subsidiary MLP, a common transaction in the energy sector where parents often engage in the development of the assets, while publicly traded subsidiaries engage in the operation of the assets once development is complete).  The defendants there were unable to establish that the conflicts committee members had a subjective belief that the drop-down was in the best interests of the MLP, in part because of a misplaced focus on the accretive impact on near-term distributions, as opposed to the long-term value of the drop-down assets.

The recent Kinder Morgan case involves a different type of related-party transaction.  The parent was acquiring two of its publicly-traded subsidiaries, the MLP and another entity and proposed paying the same per unit price for each subsidiary.  Insiders were invested more heavily in the non-MLP subsidiary. The complaint portrays the same committee of independent directors (and advisors) negotiating against the parent on behalf of both subsidiaries and agreeing to transactions where there was at least a reasonable inference that the limited partners of the MLP received an inferior deal relative to the owners of the other entity (where the insiders were more heavily invested) and otherwise did not receive adequate consideration.  V.C. Laster observed that the facts alleged in the complaint created at least a reasonable inference that the committee failed to act in the best interests of the MLP unit holders based on the committee’s “pattern of concessions, a blind-eye toward contradictory market evidence, [and] the transfer of significant value in the form of tax benefits to the controller”.  If the MLP were a corporation engaged in a merger with its controlling stockholder, this complaint would never have been dismissed.  But the rules of the road are different for MLPs.

As in the El Paso MLP decision, the Court noted that the MLP’s partnership agreement provided that neither the controller nor the members of the conflicts committee were subject to fiduciary duties to the MLP’s limited partners.  Instead, the transaction was evaluated under a contractual standard (set forth in the MLP’s partnership agreement) as to whether the committee members believed (i) subjectively that the transaction was “fair and reasonable” to the MLP and (ii) subjectively and reasonably that the transaction was “in the best interests of, or not inconsistent with, the best interests of” the MLP.

Each of the tests focuses on the impact of the transaction on the MLP, not the limited partners. And the Court emphasized that, even based on the facts alleged in the complaint, the merger of the troubled MLP (which faced a “looming crisis”) into its healthier parent was in the best interests of the MLP. Any unfairness of the consideration to the public limited partners was simply not relevant to the question of fairness to the MLP itself.  (This is, of course, a puzzling distinction for those familiar with the analyses of duties of directors in the context of related party merger transactions where fiduciary duties to equity holders are applicable.)

Based on this analysis, the Court granted the motion to dismiss the complaint notwithstanding the facts alleged in the complaint indicating that the conflicts committee may not have acted in the interests of the MLP’s limited partners. The obvious take-away from this case is that so long as the defendants in challenged MLP transactions are able to establish a record supporting the conclusion that the conflicts committee members believed the transaction to be in the best interest of the MLP, even well-pled claims that a transaction was not fair to the limited partners are unlikely to succeed.  (In the El Paso case, the defendants were not able to meet even this limited burden.)

We would caution, however, that going forward plaintiffs may well seek to reframe their challenges to conflicts committee processes so as to survive motions to dismiss.  Indeed, Vice Chancellor Laster seemed to leave the door open to future challenges based on allegations of breach of implied covenants.  In particular, the plaintiffs in the Kinder Morgan case alleged the partnership agreement contained an implied covenant that the conflicts committee members would include only non-conflicted directors.  The Vice Chancellor appeared to accept that the partnership agreement may have contained such an implied covenant, but dismissed that allegation in part on the basis that the complaint failed to plead specific facts supporting the allegation that committee members had a material conflict.  We expect that plaintiffs in future transactions of this type will seek to creatively plead allegations of breach of implied covenants with the goal of surviving motions to dismiss.