In re El Paso Pipeline Partners, L.P. Derivative Litig., C.A. No. 7141-VCL (Del. Ch. Jun. 12, 2014) (Laster, V.C.)
In this memorandum opinion resolving cross-motions for summary judgment, the Court of Chancery dismissed in part claims challenging a drop-down sale governed by a limited partnership agreement that supplanted fiduciary duties with contractual obligations. The Court reasoned that, among other things, where an alternative entity agreement replaces fiduciary duties with a detailed contractual governance scheme, Delaware courts should hesitate to use the implied covenant to re-impose fiduciary duties upon the parties to the agreement.
In 2007, defendant El Paso Corporation (“El Paso Parent”) formed defendant El Paso Pipeline Partners, L.P. (“El Paso MLP”), a publicly traded Delaware master limited partnership, as a tax-friendly way to hold cash-generating oil and gas assets. El Paso Parent controlled El Paso MLP through its ownership of El Paso MLP’s general partner, defendant El Paso Pipeline GP Company, L.L.C. (the “General Partner”). El Paso MLP’s limited partnership agreement (the “LPA”) eliminated all common law fiduciary duties owed by the General Partner. Instead, the LPA established contractual standards for three categories of actions that the General Partner might take in its capacity as General Partner. Non-conflicted transactions required acting in subjective good faith, unspecified but otherwise conflicted transactions required proceeding in one of four identified ways, and certain enumerated conflicted transactions (not at issue in this case) required more targeted action.
In February 2010, El Paso Parent offered to sell a 51% interest in two of its subsidiaries, Southern LNG Company, L.L.C. (“Southern”) and El Paso Elba Express Company, L.L.C. (“Elba”), to El Paso MLP in a drop-down transaction. Southern owned a liquefied natural gas terminal on Elba Island, Georgia, and Elba owned the 190-mile pipeline that connected Southern’s terminal to four major interstate pipelines. In 2006, two subsidiaries of Shell and British Gas entered service agreements to purchase 100% of the firm capacity of the Elba Island terminal for terms of 25 to 30 years, respectively. Shell and British Gas issued guarantees for 17% of the projected revenue of the service agreements.
El Paso Parent’s position on both sides of the drop-down sale created a conflict of interest for the General Partner, thus requiring completion of one of four procedures outlined in the LPA to cleanse the transaction. As it had in past drop-downs, the General Partner chose the “Special Approval” procedure, forming an ad hoc Conflicts Committee (the “Committee”) to oversee the sales process. The Committee was comprised of three outside directors of the General Partner’s board of directors (the “GP Board”). Pursuant to the LPA, the Committee was to grant Special Approval of the drop-down if it believed in good faith that the purchase was in the best interests of the partnership. After hiring independent legal and financial advisors to perform due diligence and meeting on five occasions to discuss and evaluate the drop-down, the Committee granted Special Approval. The drop-down closed in March 2010.
In response to the announcement of the transaction, plaintiff, an El Paso MLP common unitholder, brought suit against the General Partner and members of the GP Board derivatively for breach of contract and breach of the implied covenant of good faith and fair dealing. Plaintiff brought secondary claims for aiding and abetting breach of contract and tortious interference against the members of the GP Board, and asserted a claim against El Paso Parent for unjust enrichment. In an earlier transcript ruling, the Court partially granted the defendants’ motion to dismiss, finding no basis for a claim of unjust enrichment and ruling that the directors constituting the Committee were all duly independent. After completing fact and expert discovery, the defendants moved for summary judgment and the plaintiff cross-moved for summary judgment as to liability.
According to plaintiff, the Committee members ignored the risk that Shell and British Gas, Southern and Elba’s largest customers, would be incentivized to walk away from their service agreements with Southern’s import facilities and Elba’s pipeline due to the weakness of the domestic natural gas market. Plaintiff also alleged that the Committee ignored the fact that El Paso Parent chose not to exercise its right to purchase an interest in Gulf LNG, a natural gas import terminal then under construction, at the same time that it was selling Southern and Elba to El Paso MLP for a much higher price. Plaintiff argued that these facts demonstrated that Special Approval was not properly obtained, contending that representatives of both El Paso Parent and El Paso MLP’s financial advisor misled the Committee regarding the value of Southern and Elba and that the Committee acted in bad faith when it recommended approval of the sale.
The Court began its summary judgment analysis with the breach of contract claim. As a threshold matter, the Court granted summary judgment for the individual defendant members of the GP Board because they were not parties to the LPA. The Court then turned to the claims against the General Partner, which it split into two parts—breach of the LPA’s express provisions, and breach of the implied covenant of good faith and fair dealing.
The Court analyzed the claim for breach of the LPA’s express provisions first. After finding that the GP Board’s use of the Special Approval process was a proper course of action under the LPA, the Court looked to the LPA’s Special Approval requirements to determine what facts were necessary to adjudicate a breach of contract claim. The LPA defined Special Approval as approval by a majority of the Committee acting in “good faith.” Under Delaware law, the standard for the LPA’s definition of good faith requires a subjective belief that the sale was in the best interest of El Paso MLP. The Court determined that, contrary to plaintiff’s claims, the Committee acted in good faith because it understood the state of the natural gas industry and did not consciously disregard the risk that Shell and British Gas might breach their service agreements. Moreover, that the General Partner did not inform the Committee of its decision to forgo purchasing a stake in another liquid natural gas terminal for a substantially lower price had no bearing on the Committee’s subjective good faith. Although a price differential could imply bad faith in some circumstances, the Committee members would have to know about such pricing issues in order for a factual dispute regarding good faith to be raised. Accordingly, the Court granted summary judgment for the General Partner as to the claim that the drop-down violated the express provisions of the LPA.
The Court then addressed plaintiff’s claim that the General Partner had breached the implied covenant of good faith and fair dealing. The Court noted that although the implied covenant is a mandatory aspect of every Delaware contract, it should be used sparingly and applied narrowly where there are gaps in the express provisions of the contract that need to be filled. According to the Court, determining whether to use the implied covenant requires three steps: (1) determining whether a gap exists in the contract; (2) determining whether the gap needs to be filled; and (3) determining, based on the parties’ past acts and current intentions, how to fill the gap. Applying these steps to the LPA, the Court determined that two gaps existed—one regarding the General Partner’s potential obligation to volunteer information that could be material to the Committee’s decision to grant Special Approval, and another regarding the General Partner’s prohibition from intentionally misrepresenting facts.
The Court determined that it could not use the implied covenant to fill the first gap. The Court identified several actions taken by the parties to the LPA indicating that the parties would not have imposed an obligation to disclose material information on the General Partner had they considered such a provision. First, the drafters had adopted a general approach of expanding the General Partner’s freedom of action and limiting the protections supplied by fiduciary duties. Second, the drafters had fully eliminated fiduciary duties rather than limiting their reach; these duties included the duty to disclose all material information. Third, the LPA included another common law requirement, but excluded the common law duty to disclose. Finally, the overall structure and terms of the LPA indicated that had the parties intended to include a disclosure obligation, they would have done so in specific terms. Accordingly, the Court could not use the implied covenant in this instance to “replicate fiduciary review.” As stated by the Court, “[w]hen an alternative entity agreement eliminates fiduciary duties as part of a detailed contractual governance scheme, Delaware courts should hesitate to use the implied covenant to reconstruct the outcome that fiduciary duty analysis would have generated.”
Turning to plaintiff’s contentions that certain defendants provided the committee with false information, the Court held that although the implied covenant did prohibit the General Partner from providing false information to the Committee, there was no factual basis to infer that the General Partner had actually been supplying misinformation. The Court therefore granted summary judgment for the defendants as to the implied covenant aspect of plaintiff’s claim for breach of contract. Because there was no underlying breach of contract, the Court likewise granted summary judgment on the claims for secondary liability under aiding and abetting and tortious interference. Finally, the Court denied plaintiff’s cross motion for summary judgment as to liability.