IN RE: EL PASO PIPELINE PARTNERS, L.P. DERIVATIVE LITIGATION
Submitted: April 16, 2014
Jessica Zeldin, ROSENTHAL, MONHAIT & GODDESS, P.A., Wilmington, Delaware; Jeffrey H. Squire, Lawrence P. Eagel, Raymond A. Bragar, BRAGAR EAGEL & SQUIRE, PC, New York, New York; Attorneys for Plaintiffs.
Peter J. Walsh, Jr., Brian C. Ralston, Matthew F. Davis, Samuel L. Closic, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Attorneys for Defendants El Paso Pipeline GP Company, L.L.C., El Paso Corporation, Douglas L. Foshee, John R. Sult, Ronald L. Kuehn, Jr., D. Mark Leland, Arthur C. Reichstetter, William A. Smith, and James C. Yardley.
Lewis H. Lazarus, Thomas E. Hanson, Jr., Courtney R. Hamilton, MORRIS JAMES LLP, Wilmington, Delaware; Attorneys for Nominal Defendant El Paso Pipeline Partners, L.P.
LASTER, Vice Chancellor.
In March 2010, El Paso Corporation sold to El Paso Pipeline Partners, L.P. (the "Partnership" or "El Paso MLP") a 51% interest in Southern LNG Company, L.L.C. ("Southern LNG") and a 51% interest in El Paso Elba Express Company, L.L.C. ("Elba Express"). In this lawsuit, the plaintiffs challenge both the March 2010 transaction and a subsequent November 2010 transaction in which El Paso MLP acquired the remaining 49% interests in Southern LNG and Elba Express. After discovery, the defendants moved for summary judgment in their favor, and the plaintiffs cross moved for summary judgment as to liability. This decision grants the defendants' motion for summary judgment as to the March 2010 transaction. The plaintiffs' cross motion as to the March 2010 transaction is consequently denied. This opinion does not address the November 2010 transaction.
I. FACTUAL BACKGROUND
The facts are drawn from the materials presented in support of the cross motions for summary judgment. When considering the defendants' motion, conflicts in the evidence must be resolved in favor of the plaintiffs and all reasonable inferences drawn in their favor. At this stage of the case, the court cannot weigh the evidence, decide among competing inferences, or make factual findings.
A. The Partnership Structure
El Paso MLP is a Delaware limited partnership headquartered in Houston, Texas. El Paso MLP operates as a master limited partnership ("MLP"), a term that refers to a publicly traded limited partnership that is treated as a pass-through entity for federal income tax purposes. El Paso MLP owns interests in companies that operate natural gas pipelines, liquid natural gas ("LNG") terminals, and storage facilities throughout the United States. Its common units trade on the New York Stock Exchange under the symbol "EPB."
MLPs that focus on transporting and storing oil and natural gas, like El Paso MLP, are commonly referred to as midstream MLPs. Midstream MLPs are typically "sponsored" by a corporation with MLP-qualifying assets that generate stable cash flows. The sponsor seeks to maximize the market value of those assets by selling them to an MLP that can issue publicly traded securities on the strength of the cash flows and distribute the cash periodically to investors in a tax-efficient manner. In the typical structure, the sponsor owns 100% of the general partner of the MLP, giving the sponsor control over the MLP. The sponsor initially contributes a block of assets to the MLP and, over time, sells additional assets to the MLP. Because the assets move from the sponsor level down to the MLP level, the sales are referred to colloquially as "drop-downs."
In August 2007, El Paso Corporation ("El Paso Parent") formed El Paso MLP and contributed to El Paso MLP an initial set of MLP-qualifying assets. On November 15, El Paso MLP announced an initial public offering of 25, 000, 000 common units. The IPO prospectus cautioned that El Paso Parent would have no obligation to drop down additional assets into El Paso MLP. Despite this disclosure, El Paso Parent was plainly creating a sponsored MLP, implying that El Paso MLP over time would acquire assets from El Paso Parent.
Consistent with the typical MLP structure, El Paso Parent indirectly owns 100% of defendant El Paso Pipeline GP Company, L.L.C., a Delaware limited liability company and the general partner of El Paso MLP (the "General Partner"). The General Partner in turn owns a 2% general partner interest in El Paso MLP. By virtue of the general partner interest, El Paso Parent has a 2% economic interest in El Paso MLP and, more importantly, exercises control over El Paso MLP. At the time of the transaction in question, El Paso Parent also owned, either through the General Partner or its affiliates, approximately 61.4% of El Paso MLP's outstanding common units plus all of its incentive distribution rights. As is customary with sponsored MLPs, El Paso MLP has no employees of its own. Employees of El Paso Parent manage and operate El Paso MLP's business.
At the time of the March 2010 transaction, defendants Douglas L. Foshee, James C. Yardley, John R. Sult, D. Mark Leland, Ronald L. Kuehn, William A. Smith, and Arthur C. Reichstetter (together, the "Individual Defendants") constituted the board of directors of the General Partner (the "GP Board"). Four of the Individual Defendants held management positions with El Paso Parent or the General Partner. Foshee was the President and CEO of El Paso Parent. Yardley served as an Executive Vice President of El Paso Parent and as President and CEO of the General Partner. Sult served as CFO of El Paso Parent and the General Partner. Leland served as an Executive Vice President of El Paso Parent and President of El Paso Midstream Group, Inc., having previously served as the CFO of El Paso Parent and the General Partner. Each of the management directors beneficially owned equity stakes in El Paso Parent that dwarfed their equity stakes in El Paso MLP.
The other three members of the GP Board were outside directors, although two had past ties to El Paso Parent. Kuehn was Interim CEO of El Paso Parent in 2003 and served as Chairman of the Board of El Paso Parent from 2003 until 2009, one year before the challenged transaction occurred. Smith was an Executive Vice President of El Paso Parent and Chairman of El Paso Merchant Energy's Global Gas Group until 2002. Reichstetter was the only director without past ties to El Paso Parent.
At the time of the challenged transaction, El Paso Parent was itself a publicly traded Delaware corporation headquartered in Houston, Texas. In May 2012, El Paso Parent was acquired and became a wholly owned subsidiary of Kinder Morgan, Inc.
B. The Drop-Down Proposal
On February 9, 2010, El Paso Parent offered to sell to El Paso MLP 49% interests Southern LNG and Elba Express. El Paso Parent proposed that El Paso MLP would pay $865 million and assume $147 million of debt, for total value of $1.012 billion. On February 15, El Paso Parent altered its proposal to offer 51% of Southern LNG and Elba Express for $900 million plus the assumption of $153 million in debt, for total value of $1.053 billion. This decision refers to El Paso MLP's eventual purchase of 51% of Southern LNG and Elba Express as the "Drop-Down."
Southern LNG owned an LNG terminal on Elba Island, a private 840-acre island off the coast of Georgia. Elba Express owned a 190-mile natural gas pipeline that connected the Elba Island terminal to four major interstate natural gas pipelines. The Elba Island terminal was built in the 1970s to receive LNG shipped from overseas, store it, and vaporize it for distribution in the United States. Shortly after it was built, market developments made importing LNG unattractive, and the terminal was mothballed for nearly 20 years. It resumed operations in 2001 after market developments made importing LNG attractive again.
In 2006, when the market for imported LNG was strong, El Paso Parent sought approval from the Federal Energy Regulatory Commission ("FERC") for a two-phase expansion of the Elba Island facility, referenced respectively as Phase III-A and Phase III-B. Royal Dutch Shell, plc ("Shell") reserved the output from Phase III-A, and BG Group plc ("British Gas") secured an option to reserve the output from Phase III-B.
By 2010, when El Paso Parent proposed the Drop-Down, domestic discoveries of shale gas and improved techniques for its extraction had led to higher levels of domestic production and lower gas prices. As a result, the market for imported LNG had weakened. Demand at the Elba Island facility fell to less than 10% of capacity, and El Paso Parent assumed that British Gas would not exercise its option for Phase III-B. At the time, the principal sources of revenue for Southern LNG and Elba Express were existing contracts with subsidiaries of Shell and British Gas (the "Service Agreements"). Under the Service Agreements, the subsidiaries had reserved 100% of the firm capacity of the Elba Island terminal and the Elba Express pipeline, guaranteeing that Shell and British Gas would have the capacity to transport or store gas at any time for a set charge. Because the Service Agreements were firm contracts, Southern LNG and Elba Express would charge fees to Shell and British Gas regardless of whether they actually stored or transported gas. The Service Agreements had terms of 25 to 30 years.
Despite their lengthy terms and firm pricing, the Service Agreements were not sure things. The Shell and British Gas counterparties were special purpose entities with no assets of their own. If the Service Agreements became sufficiently unprofitable, then Shell and British Gas could walk away from their subsidiaries, leaving Southern LNG and Elba Express to collect from judgment-proof shells. Although other subsidiaries of Shell and British Gas had guaranteed the counterparties' performance, those guarantees only covered approximately 20% of the revenue that the Service Agreements otherwise might generate.
The plaintiffs believe that because of the weakened domestic market for imported LNG, El Paso Parent faced a significant risk that Shell and British Gas would choose to breach the Service Agreements, leaving Southern LNG and Elba Express with less than 20% of their anticipated revenue. The plaintiffs argue that through the Drop-Down, El Paso Parent sought to off-load these now-risky assets onto El Paso MLP at an inflated price.
C. The Conflicts Committee
Because El Paso Parent controlled El Paso MLP through the General Partner, and because El Paso Parent owned the assets that El Paso MLP would be acquiring, the DropDown created a conflict of interest for the General Partner. El Paso MLP's limited partnership agreement (the "LP Agreement" or "LPA") contemplated that El Paso MLP could proceed with a transaction that presented a conflict of interest for the General Partner if El Paso MLP followed one of four contractual paths set out in Section 7.9(a) of the LP Agreement. One of the contractual paths authorized El Paso MLP to proceed if the conflict-of-interest transaction received "Special Approval." The LP Agreement defined this form of approval as "approval by a majority of the members of the Conflicts Committee acting in good faith." LPA § 1.1. The LP Agreement in turn defined the Conflicts Committee as
a committee of the Board of Directors of the General Partner composed of two or more directors, each of whom (a) is not a security holder, officer or employee of the General Partner, (b) is not an officer, director or employee of any Affiliate of the General Partner, (c) is not a holder of any ownership interest in the Partnership Group other than Common Units and awards that may be granted to such director under the Long Term Incentive Plan and (d) meets the independence standards required of directors who serve on an audit committee of a board of directors established by the Securities Exchange Act and the rules and regulations of the Commission thereunder and by the National Securities Exchange on which the Common Units are listed or admitted to trading.
At El Paso MLP, the Conflicts Committee was not a standing committee of the GP Board, but rather a committee constituted on an ad hoc basis to consider specific conflict-of-interest transactions. On February 12, 2010, the GP Board resolved to seek Special Approval for the Drop-Down. The resolution established a limited-duration iteration of the Conflicts Committee for that purpose, specifying that this incarnation of the Conflicts Committee would
automatically dissolve upon the earlier to occur of the time at which (i) either such Conflicts Committee or the [GP] Board determines that there are no terms which appear to be acceptable to both sides and which would be within parameters that would allow the Conflicts Committee to grant Special Approval regarding the [Drop-Down] or (ii) the [Drop-Down] is consummated.
Transmittal Affidavit of Samuel L. Closic dated Oct. 30, 2013 (the "Closic Aff.") Ex. 5 at EPP0002.
The resolution granted the Conflicts Committee, for the period of existence, the power and authority
to evaluate and assess whether the [Drop-Down] is fair and reasonable to the Partnership and, if the Conflicts Committee so determines, (a) to approve the [Drop-Down] as provided by Section 7.9(a) of the Limited Partnership Agreement and (b) to make a recommendation to the [GP] Board whether or not to approve such terms and conditions of the [DropDown].
Id. at EPP0003. The resolution provided that when acting for these purposes, the Conflicts Committee would "assume and exercise all lawfully delegable powers and authority of the [GP] Board in taking any of the aforesaid actions and in making any and all decisions relating to the [Drop-Down]." Id. The resolution also provided that "the officers, agents and employees of [El Paso MLP] are hereby authorized to assist the Conflicts Committee and to provide it with all information and documents that it requests with respect to the [Drop-Down]." Id. at EPP0003-04.
The resolution named Reichstetter, Kuehn, and Smith as the members of the committee. At its first meeting on February 19, 2010, the Conflicts Committee appointed Reichstetter to serve as Chair. At some point, the committee retained Akin Gump Strauss Hauer & Feld LLP ("Akin Gump") as its legal advisor and Tudor, Pickering, Holt & Co. ("Tudor") as its financial advisor. The engagements appear to have happened as a matter of course before the Conflicts Committee ever formally met.
As suggested by the ready hiring of Akin Gump and Tudor, the record reflects that El Paso Parent, the GP Board, and the individuals who served on the Conflicts Committee have developed a level of comfort with the Special Approval process:
• Between 2008 and 2012, El Paso Parent and El Paso MLP engaged in eight drop-down transactions. Although El Paso MLP's initial public offering prospectus stated that El Paso MLP could obtain assets from third parties, the eight drop-down deals were the exclusive means by which El Paso MLP acquired assets.
• El Paso Parent initiated each transaction. El Paso MLP never initiated a transaction.
• On each occasion, the General Partner opted to proceed by Special Approval and formed a Conflicts Committee.
• On each occasion, the members of the Conflicts Committee were Kuehn, Smith, and Reichstetter.
• On each occasion, Reichstetter served as Chair of the Conflicts Committee and did the bargaining for the Conflicts Committee.
• On each occasion, the committee hired Tudor as its financial advisor.
• On each occasion, the Conflicts Committee obtained some marginal improvement in the terms of El Paso Parent's original proposal.
• On each occasion, Tudor opined that the resulting deal was fair and collected a $500, 000 fee plus expenses.
The Special Approval process for the Drop-Down fit this pattern.
D. Special Approval Is Granted.
Over the course of the next month and a half, the Conflicts Committee met five times to review El Paso Parent's proposal. On February 19, 2010, Tudor held its first due diligence session with El Paso Parent management, including representatives of Southern LNG and Elba Express. El Paso Parent management gave Tudor a fifty-four page presentation that provided an overview of the proposed transaction and Southern LNG's and Elba Express's assets, including a summary of the Service Agreements. The summary described the Service Agreements as long-term, fixed-fee contracts, but noted that the contractual counterparties were subsidiaries of Shell and British Gas rather than Shell and British Gas themselves. The summary also noted that the counterparties' obligations were covered by multi-year guarantees from other subsidiaries of Shell and British Gas that had Aa2/AA and A2/A credit ratings, respectively. The presentation included a chart that set forth the total demand revenue that Southern LNG and Elba Express would receive over the life of the Service Agreements and the total amount of the demand revenue that was guaranteed by the Shell and British Gas subsidiaries.
Later in the day on February 19, 2010, the Conflicts Committee held its initial meeting. The committee formally elected Reichstetter as Chair and discussed due diligence issues with Tudor. According to the minutes of the meeting, Tudor explained that El Paso Parent management had
spoken at length about the high quality of the assets, operations and cash flows of [Southern LNG and Elba Express] that made them attractive investments, including (i) the long term, demand-charge contracts backed by substantial guarantees from Shell and British Gas, (ii) the stable, long-term cash flows, (iii) minimal maintenance capital requirements, (iv) dual docks, (v) the absence of commodity price exposure and (vi) significant natural gas take-away capacity with access to numerous substantial pipelines.
Closic Aff. Ex. 5 at EPP0012. The minutes recite that the Conflicts Committee discussed "how the valuation of the [interests] could be affected by the projected growth [of less than 1%] and the stability of the cash flows, which were impacted by the firm, long-term, demand charge contracts, as well as the related credit analysis, including the substantial sponsor support from Shell and British Gas." Id. The plaintiffs argue that by stressing the "long-term" nature of the Service Agreements and the "substantial" guarantees and support from Shell and British Gas, the El Paso Parent representatives and Tudor misled the Conflicts Committee about the value of those agreements.
The Conflicts Committee next met on February 24, 2010, when Tudor presented its preliminary financial analysis. Tudor's analysis addressed (i) the cash flow accretion of the proposed transaction, (ii) factors affecting the value/yield of El Paso MLP units, (iii) a summary of the current state of the public capital markets, (iv) recent midstream drop-down transactions comparable to the proposed transaction, (v) Tudor's preliminary valuation analysis, and (vi) the pro forma impact of the proposed transaction on El Paso MLP. Tudor's preliminary valuation analysis included a discounted cash flow analysis, a transaction comparables analysis, and a publicly traded company comparables analysis. The Conflicts Committee focused primarily on the discounted cash flow analysis. According to the minutes, the Conflicts Committee discussed that "due to the nature and quality of the assets . . ., the [Drop-Down] likely could have a positive affect [sic] on the Partnership's credit rating." Id. at EPP0017. The plaintiffs assert that the continued emphasis on the quality of the Southern LNG and Elba Express assets demonstrates that the Conflicts Committee did not fully understand how easily Shell and British Gas could walk away from the Services Agreement and the limited coverage provided by the guarantees.
The Conflicts Committee met again on March 2, 2010. Tudor had updated its financial analysis to address questions previously raised by the Conflicts Committee. In discussing the Drop-Down's probable impact on El Paso MLP's credit rating, Tudor explained that members of El Paso MLP had met with the Fitch, Moody's, and S&P ratings agencies, and the ratings agencies were "cautiously optimistic about the possibility of receiving in the near future a ratings upgrade to an 'investment grade' rating." Closic Aff. Ex. 5 at EPP0023. In addition, the Conflicts Committee asked, hypothetically, whether Tudor would be a buyer at the 10.8x EBITDA multiple implied by the Drop-Down. According to the minutes, Tudor advised that "a 10.8x EBITDA multiple tended to be higher than the average multiples applicable to more recent M&A transactions in [the] midstream sector" but that "such a multiple was consistent with the lower risk profile of [Southern LNG and Elba Express]." Id. Given their assessment of the Services Agreements, the plaintiffs disagree that the Southern LNG and Elba Express assets had a "lower risk profile."
After the meeting on March 2, 2010, Reichstetter met with representatives of El Paso Parent to negotiate the transaction price. After some limited back and forth, they agreed upon consideration of $963 million, consisting of $661 million in cash, common units of El Paso MLP worth $149 million, and the assumption by El Paso MLP of a 51% share of the $300 million of outstanding debt owed by Southern LNG and Elba Express. The parties later agreed to value the common units at $27.87 per unit, representing the highest of the average of the volume-weighted average prices of the common units for the 5-, 10-, and 20-day trading periods ending on March 23, 2010. Dividing the agreed-upon figure of $149 million by the price of $27.87 resulted in the issuance of 5, 346, 251 common units to El Paso Parent.
On March 17, 2010, the Conflicts Committee met and received an updated valuation analysis from Tudor. The materials addressed the implied return on El Paso MLP's potential investment and suggested that it would exceed the implied return that might typically be associated with a long-term firm contract with either Shell or British Gas. The materials also addressed counterparty credit risk associated with the Southern LNG and Elba Express contracts. Akin Gump provided a presentation ...