Allen v. El Paso Pipeline Partners, L.P., C.A. No. 7520-VCL (Del. Ch. June 20, 2014) (Laster, V.C.)
In this memorandum opinion granting defendants’ motion for summary judgment, the Court of Chancery dismissed claims for breach of contract and the implied covenant of good faith and fair dealing in connection with the approval of a sale of assets to a master limited partnership by its parent corporation. In so ruling, the Court held that where the governing partnership agreement required only that the committee approving the transaction subjectively believe in good faith that the transaction was in the best interests of the partnership, the Court would not impose an additional duty to determine it was also in the best interests of the limited partners. The committee could instead “consider the full range of entity constituencies, including but not limited to … the limited partners."
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. 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 and instead established contractual standards of conduct. In particular, the LPA articulated methods by which El Paso MLP could cleanse conflicted transactions. One such method—“Special Approval”—permitted formation of a conflicts committee; under the terms of the LPA, if upon review of the transaction the conflicts committee believed in good faith that the transaction was in the best interests of the partnership, it could grant Special Approval. Once the committee granted Special Approval, the transaction could not constitute a breach of the LPA or of any duty, express or implied, owed to the limited partners, and anybody challenging the transaction bore the burden of overcoming the presumption that the Committee granted Special Approval in good faith.
As is typical, the LPA also granted the General Partner all of El Paso MLP’s incentive distribution rights (“IDRs”). The IDRs entitle the General Partner to a percentage claim over the cash flows generated by El Paso MLP that increases as the quarterly distributions per common unit increase. At their maximum level, commonly known as the “high splits,” the IDRs entitle the General Partner to 48% of all cash distributed in excess of a certain amount. IDRs are intended to incentivize the General Partner to manage El Paso MLP in a manner that would maximize cash flow to the limited partners, or common unit-holders, through increased distributions. However, as the General Partner’s percentage-take of distributions grows pursuant to the IDRs, the IDRs also necessarily reduce the percentage of cash distributed to the limited partners’ common units. Distributions for El Paso MLP’s IDRs crossed into the “high splits” for the first time upon its February 2011 distribution.
In February 2011, El Paso Parent offered to “drop down” to El Paso MLP a 25% interest in Southern Natural Gas Co. (“Southern”), a natural gas pipeline and storage company and subsidiary of El Paso Parent. El Paso MLP already owned 60% of Southern as a result of prior drop-down transactions. To finance the purchase, El Paso MLP was to issue up to 13.8 million common units.
Pursuant to the terms of the LPA, the General Partner chose to follow the “Special Approval” procedure in connection with the proposed drop down. In accordance with that procedure, the General Partner formed a Conflicts Committee (the “Committee”) comprised of three outside directors of the General Partner’s board of directors (the “GP Board”) to oversee the sales process. After retaining independent legal and financial advisors and meeting on six occasions to discuss and evaluate the drop-down, the Committee granted Special Approval. The drop-down closed in March 2011.
In May 2012, plaintiff brought suit against the General Partner and members of the GP Board for breach of contract and breach of the implied covenant of good faith and fair dealing. Plaintiff asserted additional claims against the members of the GP Board for aiding and abetting the General Partner’s alleged breach of contract. Central to plaintiff’s claims was the allegation that the General Partner’s IDRs, then in the “high splits,” significantly reduced any economic benefit that the drop-down might bring to the limited partners that were unaffiliated with the General Partner, making the drop-down dilutive rather than accretive to the limited partners. Plaintiff argued that because the Committee could not have believed in good faith, in light of the IDRs, that the drop-down was in the best interests of El Paso MLP, its Special Approval was void. Plaintiff further alleged that the Committee’s financial advisor excluded from its fairness opinion any consideration of the dilutive effect of the transaction on the limited partners, thereby suggesting that the Committee could have relied on the opinion only in bad faith. Defendants initially moved to dismiss the complaint, but the Court denied the motion, finding it reasonably conceivable based on the allegations in the complaint that the Committee disregarded the effect of the IDRs and, in bad faith, approved a transaction that was not accretive. At the same time, the Court rejected plaintiff’s allegations that the Committee was not duly independent.
After completing fact and expert discovery, defendants moved for summary judgment. 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 and therefore could not be held personally liable for breach of contract. The Court then turned to the claims against the General Partner, which it split into two parts—breach of the LPA’s express provisions requiring “good faith” and consideration of El Paso MLP’s “best interests,” and breach of the implied covenant of good faith and fair dealing.
The Court held that the requirement that the Committee believe in “good faith” that the transaction was in the “best interests of El Paso MLP” obligated it to consider the best interests of El Paso MLP as a whole, as opposed to the best interests of the limited partners as a class, and that it could consider constituencies aside from the limited partners in making that determination.
The Court found that there was no issue of material fact regarding whether the members of the Committee believed subjectively, in good faith, that the drop-down was in the best interests of El Paso MLP. The Committee met frequently, obtained experienced advisors, and asked questions about the IDRs’ effect on the value of the transaction. 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 found plaintiff’s claim that the General Partner had breached the implied covenant of good faith and fair dealing similarly deficient. According to plaintiff, the Committee’s financial advisor, in rendering its fairness opinion, improperly excluded the dilution that would result from the issuance of new common units to finance the transaction. Relying on the Delaware Supreme Court’s recent holding in Gerber v. Enterprise Products Holdings, LLC, 67 A.3d 400 (Del. 2013), plaintiff argued that the financial advisor’s exclusion of this factor, when it easily could have been determined that the transaction was far more beneficial to the General Partner and El Paso Parent than to the limited partners as a result of the IDRs, supported a claim for breach of the implied covenant as, according to plaintiff, the Committee’s reliance on the fairness opinion could only have been in knowing bad faith.
The Court rejected this argument, explaining that Gerber involved the application of a specific contract provision that granted the general partner a conclusive presumption of good faith if it relied upon the opinion of an expert, such as a financial advisor’s fairness opinion. The plaintiff in Gerber alleged that the fairness opinion was fatally flawed, omitting critical information that cast doubt on its reliability. Although the partnership agreement did not specify the analyses necessary for any fairness opinion relied upon by the general partner, the Supreme Court determined that the plaintiff had alleged a viable implied covenant claim that could potentially overcome the conclusive presumption of good faith. Here, such a provision was not at issue. The Court noted that, although the implied covenant is a mandatory aspect of every Delaware contract, it is narrowly applied only to fill gaps in the express provisions of a contract. Unlike in Gerber, there was no gap in the LPA that needed to be filled by the implied covenant in order to assess the validity of the Committee’s Special Approval. The LPA did not require the Committee to rely upon a financial advisor’s opinion, or therefore require an opinion that specifically took into account the dilutive effect the IDRs might have on the limited partners’ distributions, in order to grant Special Approval. The Court noted that if Gerber held that the implied covenant was breached whenever a fairness opinion failed to consider all elements of consideration from the perspective of the limited partners, then it would have to deny summary judgment given plaintiff’s factual claims. But Gerber, it determined, could not be read so broadly, and because Gerber required interpretation of a contractual provision that was not presently in dispute, it did not control the instant case.
The Court explained that even if the LPA contained a gap regarding whether the drop-down must be in the best interests of the limited partners as a class, the Court’s interpretive gap-filling would produce the same outcome. First, the prospectus provided during El Paso MLP’s initial public offering clearly disclosed that El Paso MLP’s various transactions would give rise to conflicts of interest and that asset purchases, issuances of additions units, and other transactions might affect the amount of cash distributed to unit-holders. Second, one of the purposes of the LPA’s Special Approval provision appeared to be avoidance of litigation, suggesting that the LPA’s drafters would not have wanted the Committee to have to meet some type of objective standard when determining whether a transaction was in the best interests of El Paso MLP. Third, the general tendency of the LPA was to expand the General Partner’s freedom and limit the protections existing under common law. These observations all supported the conclusion that the LPA’s drafters would not have required the Committee to obtain a fairness opinion considering the dilution suffered by the limited partners, had they left a gap in the agreement on the subject. Accordingly, the Court also granted summary judgment to defendants as to plaintiff’s breach of implied covenant claims.
Finally, the Court disposed of plaintiff’s aiding and abetting claims. Although the Delaware Supreme Court has confirmed that parties can aid and abet the breach of “contractual fiduciary duties” under certain circumstances, the LPA completely eliminated all fiduciary duties and supplanted them with a purely contractual standard. Because Delaware law generally does not recognize a claim for aiding and abetting a breach of contract, the Court granted defendants’ motion for summary judgment as to aiding and abetting.