Chancellor Strine in In Re El Paso Corporation Shareholder Litigation, Consol. C. A. No. 6949-CS (Del. Ch. Feb. 29, 2012), denied the stockholder plaintiffs request for a preliminary injunction to enjoin a merger between El Paso Corporation and Kinder Morgan, Inc. While the Court in a 33-page opinion, severely criticized the actions of a number of the players, in the end the Chancellor decided to give the shareholders of El Paso the opportunity to decide for themselves if they liked the price being offered to them.
This decision received widespread coverage in the media. See, e.g., here and here. The Court’s opinion in this matter marks the second time in the span of only a few months that the Delaware Court of Chancery has strongly criticized Goldman Sachs for conflict of interest issues in multi-billion dollar transactions. The most recent high-profile criticism was in the Court of Chancery’s 100-plus page decision in the Southern Peru Copper case highlighted on these pages here.
LexisNexis interviewed Francis Pileggi and Kevin Brady about this decision in a videocast available here.
The plaintiff stockholders of El Paso sought to enjoin a vote on a proposed Merger with Kinder Morgan that offered El Paso a combination of cash, stock, and warrants valued at $30.37 per share, or a 47.8% premium over El Paso’s stock price. The merger resulted from a non-public overture that Kinder Morgan made in the wake of El Paso’s public announcement that it would spin off its exploration and production (“E&P”) business. After the spin-off announcement, Kinder Morgan expressed its interest in acquiring El Paso by offering $25.50 per share in cash and stock but that offer was rejected by the El Paso Board. Kinder Morgan then threatened to go public with its interest in buying El Paso so the El Paso Board entered into negotiations with Kinder Morgan. The El Paso Board, which had as its financial advisors Goldman Sachs and Morgan Stanley, asked Kinder Morgan for a bid of $28 per share in cash and stock, using the company’s CEO, Doug Foshee, as its sole negotiator. Foshee, who was the only non-independent director in El Paso’s 12–member Board, reached an agreement in principle on a deal at $27.55 per share in cash and stock. However, within a few days Kinder Morgan backed out. The parties eventually negotiated a package that was valued at $26.87, comprised of $25.91 in cash and stock, and a warrant with a strike price of $40. The Board approved the merger and entered into the merger agreement which contained a commitment from El Paso to assist Kinder Morgan in the sale of the E&P business, a “no-shop” provision with a fiduciary out, and a $650 million termination fee.
Shareholders Identify “Questionable” Decisions
The El Paso shareholders filed suit challenging the independence of a number of board decisions including:
• The failure of the Board to shop El Paso as a whole or its two key divisions separately to any other bidder after Kinder Morgan made its initial overture, despite knowing that Kinder Morgan was hoping to preempt competition by bidding for the whole company, and despite knowing that although there would be a number of bidders for the company’s two key divisions if marketed separately, there was unlikely to be any rival to Kinder Morgan willing to purchase El Paso as a whole;
• The failure of the board to reject Kinder Morgan’s initial overtures and force it to go public and face the market pressure to raise its offer to a level where it could prevail in a hostile takeover bid;
• Charging Foshee with handling all negotiations with Kinder Morgan without any presence or close supervision by an independent director or legal advisor;
• Allowing Kinder Morgan to renege on the original agreement in principle;
• Agreeing to deal protection measures that would effectively preclude a post-signing market check for bids for the separate divisions because of the limited fiduciary out; and
• Agreeing to a deal that only provided El Paso stockholders with cash and stock equal to $25.91 in value (excluding the warrant), far less than the $27.55 previously agreed to by Kinder Morgan.
Revlon Requires Reasonable Steps
Because directors are required to make reasonable decisions, not perfect decisions, the Court explained that:
…[a] reasonable mind might debate the tactical choices made by the El Paso Board, these choices would provide little basis for enjoining a third-party merger approved by a board overwhelmingly comprised of independent directors, many of whom have substantial industry experience. The Revlon doctrine, after all, does not exist as a license for courts to second-guess reasonable, but arguable, questions of business judgment in the change of control context, but to ensure that the directors take reasonable steps to obtain the highest value reasonably attainable and that their actions are not compromised by impermissible considerations, such as self-interest. By contrast, when there is a reason to conclude that debatable tactical decisions were motivated not by a principled evaluation of the risks and benefits to the company’sstockholders, but by a fiduciary’s consideration of his own financial or other personal self-interests, then the core animating principle of Revlon is implicated.
Goldman Sachs — Conflicts and Questionable Aspects of Valuation
The Court identified the following as “potential conflicts”associated with Goldman Sachs: (1) it owned approximately 19%, or $4 billion worth, of Kinder Morgan stock; (2) it controlled two of Kinder Morgan’s board seats; (3) it had placed two senior Goldman principals on the Kinder Morgan board who thus owed Kinder Morgan fiduciary duties; and (4) the lead Goldman banker working for El Paso personally owned approximately $340,000 of Kinder Morgan stock. While the defendants argued that the conflicts were addressed because “Goldman was walled off from giving strategic advice about the Kinder Morgan bid early in the process and another top-tier bank, Morgan Stanley, came in and gave unconflicted advice” the Court noted that the preliminary record developed in expedited discovery did not support their position. As the Court pointed out:
The fact that Goldman continued to have its hands in the dough of the spin-off is important, because the Board was assessing the attractiveness of the Merger relative to the attractiveness of the spin-off. That was critical because the Board, at the recommendation of Foshee, Goldman, and Morgan Stanley, decided not to risk Kinder Morgan going hostile and not to do any test of the market with other possible buyers of El Paso as a whole, or of either or both of its two key business segments separately. Thus, the Board was down to two strategic options: the spin-off or a sale to Kinder Morgan. Therefore, because Goldmanstayed involved as the lead advisor on the spin- off, it was in a position to continue to exert influence over the Merger. The record suggests that there were questionable aspects to Goldman’s valuation of the spin-off and its continued revision downward that could be seen as suspicious in light of Goldman’s huge financial interest in Kinder Morgan…. Even worse, Goldman tainted the cleansing effect of Morgan Stanley. Goldman clung to its previously obtained contract to make it the exclusive advisor on the spin-off and which promised Goldman $20 million in fees if the spin-off was completed. Despite the reality that Morgan Stanley was retained to address Goldman’s bias toward a suboptimally priced deal with Kinder Morgan and thus Morgan Stanley’s work in evaluating whether the spin-off was a more valuable option was critical to its integrity – enforcing role, Goldman refused to concede that Morgan Stanley should bepaid anything if the spin-off, rather than the Merger, was consummated….Then, despite saying that it did not advise on the Merger – a claim that the record does not bear out in large measure – Goldman asked for a $20 million fee for its work on the Merger.
Court Concludes Plaintiffs Have Shown Probability that Process was Tainted
In reaching its decision that the plaintiff shareholders had shown that “more faithful, unconflicted parties could have secured a better price from Kinder Morgan,” the Court identified the following reasons: “[t]he concealed motives of Foshee, the concealed financial interest of Goldman’s lead banker in Kinder Morgan, Goldman’s continued influence over the Board’s assessment of the spin-off, and the distortion of Morgan Stanley’s incentives that arose as a result of El Paso management’s acquiescence to its Goldman friends’ demands.” The Court also noted that “the failure to use the emergence of Kinder Morgan as a bidder to do a soft test of the market for El Paso’s attractive business unit … compounded by a deal protection package that (1) precluded termination of the Merger Agreement if a favorable bid for the E&P business emerged; and (2) made it very expensive for a bidder for the pipeline business to make an offer because of the $650 million termination fee and Kinder Morgan’s matching rights. The Court went on to note:
At this stage, I cannot readily accept the notion that Goldman would not seek to maximize the value of its multi-billion dollar investment in Kinder Morgan at the expense of El Paso, but, at the same time, be so keen on obtaining an investment banking fee in the tens of millions. Likewise, Daniel and Foshee each had an incentive to secure an undervalued bid for El Paso, and rather than disclose these incentives, each chose to conceal them. Daniel knew about Goldman’s conflict and he knew that his client El Paso knew about it. He also knew that he personally owned Kinder Morgan stock, but he did not disclose that fact. Foshee knew that he was discussing and considering an MBO of the E&P business when he was negotiating price terms with Kinder Morgan, but he did not disclose thatfact. He did not even disclose his discussions with Kinder about an MBO after the deal was baked to the Board. This kind of furtive behavior engenders legitimate concern and distrust.
Court Rejects Plaintiffs’ Request for Relief
Because the Court found that “there are numerous debatable tactical choices that now seem to have been made in large measure based on Foshee’s advice and with important influence from Goldman,” the Court then faced the question what to do about it. The Court noted that “El Paso stockholders arguably have much to gain by seeing this Merger proceed…the price being offered by Kinder Morgan is one that reasonable El Paso stockholders might find very attractive. But it nags, of course, that it is not all that it might have been had things been done the way they should have been.” Does the threat of irreparable injury justify an injunction in light of the risks that an injunction itself would present to the stockholders of El Paso? In deciding this issue, the Court focused on the plaintiffs’ specific request for an injunction which the Court characterized as “oddly telling” because the plaintiffs were not seeking “a preliminary injunction against the Merger Agreement in its traditional form, which is one that lasts until it is overturned on appeal.” Instead the plaintiffs were asking the Court to enter an injunction which would “affirmatively permit El Paso to shop itself in parts or in whole during the period between now and June 30, 2012, in contravention of the no-shop provision of the Merger Agreement, and allow El Paso to terminate the Merger Agreement on grounds not permitted by the Merger Agreement and without paying the termination fee set forth in the Merger Agreement, but then to lift the injunction and then force Kinder Morgan to consummate the Merger ‘if no superior transactions emerge’. That is not a traditional negative injunction that can be done without an evidentiary hearing or undisputed facts. Furthermore, that sort of injunction would pose serious inequity to Kinder Morgan, which did not agree to be bound by such a bargain.”
In the end, the Court concluded that the El Paso Shareholders should have the opportunity to decide whether or not they like the price being offered. The Court went on to state that “[a]lthough an after-the-fact monetary damages claim against the defendants is not a perfect tool, it has some value as a remedial instrument, and the likely prospect of a damages trial is no doubt unpleasant to Foshee, other El Paso managers who might be added as defendants, and to Goldman.”