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Allen v. El Paso Pipeline GP Co., L.L.C.

Court of Chancery of Delaware

June 20, 2014

WILLIAM ALLEN, Plaintiff,
v.
EL PASO PIPELINE GP COMPANY, L.L.C., RONALD L. KUEHN, JR., JAMES C. YARDLEY, JOHN R. SULT, DOUGLAS L. FOSHEE, D. MARK LELAND, ARTHUR C. REICHSTETTER, WILLIAM A. SMITH, and EL PASO PIPELINE PARTNERS, L.P., Defendants, and EL PASO PIPELINE PARTNERS, L.P., Nominal Defendant

Submitted: March 28, 2014.

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[Copyrighted Material Omitted]

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[Copyrighted Material Omitted]

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Jessica Zeldin, ROSENTHAL, MONHAIT & GODDESS, P.A., Wilmington, Delaware; Samuel H. Rudman, Mark S. Reich, Michael G. Capeci, ROBBINS GELLER RUDMAN & DOWD LLP, Melville, New York; Randall J. Baron, ROBBINS GELLER RUDMAN & DOWD LLP, San Diego, California; Ethan D. Wohl, WOHL & FRUCHTER LLP, New York, New York; Attorneys for the Named Plaintiff and the Class.

Peter J. Walsh, Jr., Brian C. Ralston, Berton W. Ashman, Jr., Gerard M. Clodomir, Matthew R. Dreyfuss, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Attorneys for Defendants El Paso Pipeline GP Company, L.L.C. Douglas L. Foshee, Ronald L. Kuehn, Jr., D. Mark Leland, Arthur C. Reichstetter, William A. Smith, John R. Sult, and James C. Yardley.

Lewis H. Lazarus, Thomas E. Hanson, Jr., MORRIS JAMES LLP, Wilmington, Delaware; Attorneys for Defendant and Nominal Defendant El Paso Pipeline Partners, L.P.

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MEMORANDUM OPINION

LASTER, Vice Chancellor.

On March 4, 2011, El Paso Pipeline Partners, L.P. (the " Partnership" or " El Paso MLP" ) bought a 25% interest in Southern Natural Gas Co. (" Southern" ). The seller was El Paso Corporation (" El Paso Parent" ), the parent company of the Partnership's general partner, El Paso Pipeline GP Company, L.L.C. (the " General Partner" ). The plaintiffs have challenged the transaction, claiming that the defendants violated their express contractual obligations and the implied covenant of good faith and fair dealing or, alternatively, aided and abetted those wrongful acts. After the close of fact and expert discovery, the defendants moved for summary judgment. This decision grants their motion.

I. FACTUAL BACKGROUND

The facts are drawn from the materials submitted in connection with the motion 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

El Paso MLP is a Delaware limited partnership that operates as a publicly traded master limited partnership

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(" MLP" ). Headquartered in Houston, Texas, El Paso MLP owns interests in companies that operate natural gas pipelines and storage facilities throughout the United States.

El Paso Parent indirectly owns 100% of the General Partner, which in turn owns a 2% general partner interest in El Paso MLP. The general partner interest provides the General Partner with a 2% economic interest in El Paso MLP and, more importantly, gives the General Partner control over El Paso MLP. The General Partner also owns all of El Paso MLP's incentive distribution rights (" IDRs" ), which are a class of non-voting units authorized by the Partnership's First Amended and Restated Agreement of Limited Partnership (the " LP Agreement" or " LPA" ). The IDRs are a form of interest in El Paso MLP distinct from the general partner interest, which is owned by the General Partner, and the limited partner interest, which is represented by the common units.

The IDRs give the General Partner a preferential claim to cash flows generated by El Paso MLP.

IDRs incentivize a general partner, whose economic general partner interest in the MLP is otherwise fixed and relatively small, to manage the MLP to maximize cash flow for the LP units. The IDRs are a form of pay for performance, with performance measured in distributable cash. In MLP lingo, as the operating partnership performs better, the general partner " rides up the splits" and receives a greater share of the incremental cash generated by its efforts. . . .
While helpful as a means of incentivizing general partner performance and aligning interests, IDRs have downsides. Most obviously, the overhang of the IDR claim on cash flows limits the distributions available to the LP units. This reduces the attractiveness of LP units, resulting in a lower trading price and making them less attractive as a source of new money or as an acquisition currency. Equally important, as the operating partnership performs better, the increasing IDR claim drives up its cost of equity capital, which limits its ability to undertake new projects.

Lonergan v. EPE Hldgs., LLC, 5 A.3d 1008, 1012-13 (Del. Ch. 2010) (footnote omitted).

The LP Agreement establishes the terms of the IDRs, including the right to preferential cash flows. Under Article VI of the LP Agreement, El Paso MLP must distribute all " Available Cash" from the Partnership's operating and capital surplus within forty-five days of the end of each fiscal quarter. Section 6.4 of the LP Agreement allocates the percentage share of the Available Cash among the General Partner, the limited partners, and the IDRs. The percentage allocated to the IDRs escalates depending on the level of quarterly distributions received by the limited partners on their common units. The following table illustrates the allocation:

Quarterly Distribution Per

Allocations of Incremental Available Cash

Common Unit

General Partner

IDRs

Limited Partners

From Zero up to and including the

2%

0%

98%

Minimum Quarterly Distribution

($0.28750)

From the Minimum Quarterly

2%

0%

98%

Distribution up to and including the

First Target Distribution ($0.33063)

From the First Target Distribution up

2%

13%

85%

to and including the Second Target

Distribution ($0.35938)

From the Second Target Distribution

2%

23%

75%

up to and including the Third Target

Distribution ($0.43125)

Above the Third Target Distribution

2%

48%

50%

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In the jargon of the MLP trade, the level at which 48% of each incremental dollar flows to the IDRs is known as the " high splits." Once at that level, because the General Partner owns both the 2% general partner interest and all of the IDRs, the General Partner receives 50% of each incremental dollar of available cash. When the General Partner also owns common units, the take is even higher because the General Partner also receives its pro rata share of the amounts distributed to the limited partner interests.

At the time of the transaction challenged in this litigation, El Paso Parent owned, either through the General Partner or its affiliates, approximately 48.9% of El Paso MLP's outstanding common units. This meant that when El Paso MLP reached the high splits, El Paso Parent would receive 74.45% of each incremental dollar of Available Cash, broken down as follows: (i) 2.00% from the General Partner interest; (ii) 48.00% from the IDRs, and (iii) 24.45% from its common units.

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 Southern Transaction

On February 8, 2011, El Paso Parent proposed to sell to El Paso MLP a 22% general partner interest in Southern for a purchase price of $587 million, excluding debt. This decision refers to the transaction as the " Drop-Down."

Southern is a natural gas pipeline and storage company with a network of approximately 8,000 miles of pipelines extending across the southeastern United States. At the time of the proposal, El Paso MLP already owned a 60% general partner interest in Southern that it had acquired from El Paso Parent through earlier drop-down transactions, including 10% transferred to El Paso MLP upon its formation, 15% acquired in September 2008, 20% acquired in June 2010, and 15% acquired in November 2010.

El Paso Parent's proposal contemplated that El Paso MLP would finance the Drop-Down with proceeds from the public issuance of up to 12 million common units, a draw on the Partnership's revolving credit facility, and a cash contribution from El Paso Parent to maintain the General Partner's 2% general partner interest in El Paso MLP. El Paso MLP had used the same financing structure for previous drop-down transactions. The proposal gave El Paso MLP the option to purchase an additional 3% interest in Southern on the same terms, depending on the success of El Paso MLP's unit issuance. If El Paso MLP exercised the option, it would acquire in total an additional 25% general partner interest in Southern, for aggregate ownership of 85%.

C. The Contractual Approval Framework

Because El Paso Parent controlled El Paso MLP through its ownership of the General Partner and also owned the interest in Southern that El Paso MLP would acquire, the Drop-Down created a conflict

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of interest for the General Partner. The LP Agreement establishes contractual requirements for such a transaction.

As authorized by the Delaware Limited Partnership Act, the LP Agreement eliminates all common law duties, including fiduciary duties, that the General Partner, El Paso Parent, or the directors might otherwise owe to El Paso MLP and its limited partners. LPA § 7.9(e). In place of common law duties, the LP Agreement substitutes contractual commitments. When the General Partner takes action in its capacity as the General Partner, and when the decision involves a conflict of interest for the General Partner, Section 7.9(a) of the LP Agreement establishes the governing standard. Section 7.9(a) provides that the action will be " permitted and deemed approved by all Partners" and " not constitute a breach" of the LP Agreement or " any duty stated or implied by law or equity" as long as the General Partner proceeds in one of four contractually specified ways. Id. § 7.9(a). The relevant contractual language states:

Unless otherwise expressly provided in this Agreement . .., whenever a potential conflict of interest exists or arises between the General Partner . .., on the one hand, and the Partnership . .., any Partner or any Assignee, on the other, any resolution or course of action by the General Partner . . . in respect of such conflict of interest shall be permitted and deemed approved by all Partners, and shall not constitute a breach of this Agreement, . . . or of any duty stated or implied by law or equity, if the resolution or course of action in respect of such conflict of interest is (i) approved by Special Approval, (ii) approved by the vote of a majority of the Outstanding Common Units (excluding Common Units owned by the General Partner and its Affiliates), (iii) on terms no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or (iv) fair and reasonable to the Partnership, taking into account the totality of the relationships between the parties involved (including other transactions that may be particularly favorable or advantageous to the Partnership).

Id.

For the Drop-Down, the General Partner elected to proceed by way of 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." Id. § 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.

Id. 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.

In February 2011, when El Paso Parent proposed the Drop-Down, the members of the board of directors of the General Partner

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(the " GP Board" ) were defendants Douglas L. Foshee, James C. Yardley, John R. Sult, D. Mark Leland, Ronald L. Kuehn, Jr., William A. Smith, and Arthur C. Reichstetter. Foshee, Yardley, Sult, and Leland 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 these members of the GP Board 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, two years before the challenged transaction took place. 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.

To evaluate the Drop-Down, the GP Board established a Conflicts Committee consisting of Kuehn, Reichstetter, and Smith. Reichstetter served as Chair. The committee retained Tudor, Pickering, Holt & Co. (" Tudor" ) as its financial advisor and Akin Gump Strauss Hauer & Feld LLP (" Akin Gump" ) as its legal advisor.

D. The Special Approval Process

On February 9, 2011, the Conflicts Committee held its first formal meeting. After the meeting, Tudor and Akin Gump began conducting due diligence.

The Conflicts Committee met for the second time on February 15, 2011. Tudor summarized its initial due diligence, noting (i) the status of various developmental and expansion projects involving Southern, (ii) adjustments made to El Paso MLP's financial projections since the prior acquisition of an interest in Southern, and (iii) El Paso MLP's strong financial performance since the earlier transaction. After the meeting, Reichstetter asked Tudor to explore whether MLPs paid lower multiples when acquiring assets from their sponsors if the sponsors were receiving higher splits under the IDRs. Reichstetter also asked Tudor to research which sponsors of the fifteen largest MLPs had agreed to reduce their share of the IDR cash flows.

The Conflicts Committee met again on February 24, 2011. Tudor made a presentation that included (i) a financial overview of El Paso MLP and its market performance, capital structure, and projected capital expenditures, (ii) a financial overview of Southern and its projected EBITDA, distributable cash flows, and projected capital expenditures, (iii) a comparison of El Paso Parent's prior financial projections for Southern with its most recent projections, and (iv) a comparison of El Paso MLP's debt levels with those of its competitors. Tudor advised that the transaction was expected to be more accretive on a per-unit basis to El Paso MLP's common unitholders than previous drop-down transactions. After the meeting, Reichstetter asked Tudor to analyze the growth rates for El Paso MLP's component businesses, for EL Paso MLP as a whole, and on a pro forma basis assuming the Drop-Down took place.

The Conflicts Committee next met on February 28, 2011. The members and

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their advisors discussed the anticipated timing of the transaction and the ...


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