On April 20, 2015, the Delaware Chancery Court ruled in the case of In Re: El Paso Pipeline Partners L.P. that El Paso Pipeline GP Co. LLC, the general partner of El Paso Pipeline Partners LP, was liable for causing the MLP to overpay by $171 million for midstream assets purchased from its parent and sponsor, El Paso Corp. The crux of the opinion was a finding that the conflicts committee of the general partner’s board could not have concluded, in good faith, that the proposed transaction was in the MLP’s best interests, which is the standard found in many MLP partnership agreements. The opinion is noteworthy for the lessons it offers as to how to satisfy that standard when faced with a conflict of interest transaction between an MLP and its affiliated sponsor.

Be transparent and avoid sidebars—The court found that the sponsor’s management failed to communicate to the conflicts committee all of the key commercial terms related to the assets purchased by the MLP. The court also found that the conflicts committee’s financial advisor had private conversations with sponsor’s management, without the conflicts committee’s knowledge, which influenced the advisor’s presentation to the conflicts committee. Sponsors should ensure that all of the material commercial terms related to a transaction are shared with a conflicts committee and that private conversations with a committee’s advisors, which might hinder the objective flow of information, are minimized.

Keep detailed minutes and minimize emails—The conflicts committee’s members could not provide detailed testimony at trial regarding their review of the proposed transaction and spoke only in generalities. Furthermore, the committee members’ trial testimony was contradicted by contemporaneous emails that showed they did not believe the proposed transaction was in the MLP’s best interests but were willing to set aside their concerns to appease the sponsor. Committees should talk less among themselves, ask their counsel to take detailed notes during their meetings and memorialize at least some background and evidence of the items discussed in formal minutes. Committee members should carefully consider the content of email communications that could be taken as favoring the sponsor to an MLP’s detriment.

Avoid valuation missteps—The court found that the conflicts committee committed three key valuation missteps. First, it adopted a valuation methodology based on a previous transaction despite having market and third party information indicating the methodology would lead to an overpayment. Committees should be sensitive to market signals regarding valuation and use that information to inform their negotiations. Second, the court found that the conflicts committee’s main focus was whether the transaction would be accretive to distributions from the MLP. Accretion should be one factor, rather than the main focus, in determining whether a transaction is in an MLP’s best interests. Third, the court found that the conflicts committee’s financial advisor manipulated its financial analysis to show the transaction in a more favorable light and did not adequately communicate the basis of its analyses to the committee. A conflicts committee should require its advisors to present valuation information on an objective basis and to thoroughly explain the rationale for, and any revisions to, that analysis over time.

Stress independence of members and advisors—Even though the conflicts committee satisfied stock exchange independence standards, the court found that the sponsor exercised de facto control over the committee. Two of the three committee members had significant equity holdings in, and had previously served in executive positions with, the sponsor. The transaction also unfolded on the exact timeline set by the sponsor, with minimal deviation by the conflicts committee for negotiations. These factors helped the court conclude that the conflicts committee leaned toward appeasing the sponsor rather than safeguarding the MLP. Conflicts committees should consider whether their independence criteria should be more stringent than stock exchange independence standards. In addition, conflicts committees should be assertive in their roles and sponsors should foster a culture where conflicts committee input is encouraged and accepted. More mature MLPs may consider retaining a separate legal advisor for the MLP itself (in addition to counsel for sponsor and counsel for the conflicts committee) and bifurcating their business teams between the sponsor and the MLP to get as close as possible to an arm’s length process in the negotiations.

Hire unbiased advisors—The court found that the conflicts committee hired the same legal and financial advisors on each transaction as a matter of course and that the financial advisor’s fee was entirely contingent upon delivery of an opinion concluding that the transaction was financially fair to the MLP’s unaffiliated unitholders. The court indicated that the promise of repeat business, combined with the financial terms, incentivized the financial advisor to deliver such an opinion, regardless of its accuracy. Committees may consider a bidding process for their advisor engagements from time to time. If a committee desires to consistently hire the same advisors, there should be a conversation captured in the record as to why that advisor is well-placed to handle the representation each time they are retained. Finally, the financial advisor’s fee should not be contingent on the delivery of its fairness opinion, but rather the advisor should be paid when it has completed its work, regardless of the answer.

The El Paso ruling has waved a red flag at the figurative bull that is the plaintiffs’ bar. We have already seen plaintiffs’ firms filing suits to challenge recent transactions where the complaints have been patterned almost verbatim from the ruling. Process improvements will not entirely deter challenges, but carefully following the recommendations above will go a long way to preparing a strong defense.

David Ronn and Barbara de Marigny are partners, and Ryan Giggs is an associate, in the Houston office of McGuireWoods LLP where their practice focuses on advising MLPs, their sponsors and their conflicts committees.