Chancellor Strine Declines to Enjoin Kinder Morgan Acquisition of El Paso: Further Discussion | Practical Law

Chancellor Strine Declines to Enjoin Kinder Morgan Acquisition of El Paso: Further Discussion | Practical Law

On February 29, 2012, Chancellor Strine of the Delaware Court of Chancery declined to enjoin the Kinder Morgan takeover of El Paso, despite a conflicted process.

Chancellor Strine Declines to Enjoin Kinder Morgan Acquisition of El Paso: Further Discussion

by PLC Corporate & Securities
Published on 02 Mar 2012 • Delaware
On February 29, 2012, Chancellor Strine of the Delaware Court of Chancery declined to enjoin the Kinder Morgan takeover of El Paso, despite a conflicted process.
On February 29, 2012, Chancellor Strine of the Delaware Court of Chancery refused to enjoin the stockholder vote to approve the merger of El Paso Corporation (El Paso) and Kinder Morgan, Inc., (Kinder Morgan) despite his findings that the plaintiffs have a reasonable likelihood of success in showing the merger process was "tainted by disloyalty." Although the transaction was negotiated for El Paso by a CEO with an undisclosed conflict of interest and the board was advised by a financial advisor with a known conflict, the Chancellor found that the balance of harms did not warrant a preliminary injunction.

Background

On October 16, 2011, El Paso and Kinder Morgan entered into a merger agreement under which Kinder Morgan would acquire El Paso for total consideration valued at $26.87 per share at signing that was comprised of cash, stock and warrants. Before entering into merger negotiations, El Paso had planned to spin off its exploration and production business (E&P business) and retain its pipeline business. Kinder Morgan approached El Paso with hope of acquiring the whole business before the spin-off could drive up the value of the pipeline business. It then planned to sell off the E&P business itself.
On February 9, 2012, the plaintiffs submitted a motion for preliminary injunction in the Delaware Court of Chancery (court) to enjoin the stockholder vote on the merger.

Conflicted Process

The transaction was negotiated entirely by El Paso's CEO (Foshee). Foshee was interested in making a bid, along with other El Paso managers, to buy the E&P business following the sale of El Paso to Kinder Morgan, expressing this interest to Kinder Morgan's CEO during the negotiations. However, Foshee did not disclose this conflict of interest to El Paso's board of directors.
El Paso's long-term financial advisor, Goldman Sachs & Co (Goldman), was also conflicted because it:
  • Owned about 19% of Kinder Morgan stock.
  • Controlled two board seats at Kinder Morgan and had appointed two senior principals to the board.
Goldman disclosed this conflict of interest and the El Paso board engaged a second financial advisor, Morgan Stanley, to advise on the potential merger. However:
  • Goldman was still the exclusive advisor on the spin-off alternative and providing regular financial updates to the board so they could compare the spin-off and the merger.
  • Morgan Stanley only stood to get paid a fee ($35 million) if the transaction with Kinder Morgan was completed.
  • Goldman negotiated a $20 million fee for its work on the merger, despite the fact that it recused itself from advising on the merger.
  • The lead Goldman banker for El Paso personally owned about $340,000 of Kinder Morgan stock and did not disclose this potential conflict to the El Paso board.

Merger Negotiations and Price

Kinder Morgan first approached El Paso in August 2011 with an offer of $25.50 per share in cash and stock. The El Paso board declined this offer, but entered into negotiations with Kinder Morgan less than a month later after Kinder Morgan threatened to launch a hostile takeover bid. Following negotiations with Foshee, the parties reached an agreement of $27.55 in cash and stock. However, Kinder Morgan later retracted that price and reduced their offer to $26.87 with a mix of cash, stock and warrants (with a high strike price and limited dividend protection). The reduced price, however, was at a premium to market and the board accepted the deal on the advice of Morgan Stanley. During the negotiations, the board did not conduct any market check.

Deal Protections

The deal protections in the merger agreement included:
  • A no-shop with a fiduciary out for a superior proposal for more than 50% of El Paso's equity or assets. Because the E&P business made up less than 50% of El Paso's assets, this precluded El Paso from entertaining offers for the separate divisions.
  • A $650 million termination fee that would make it expensive for a third party to purchase the pipeline business on its own.
The court found these deal protections troubling because the only viable alternative to the proposed transactions with Kinder Morgan was to sell the business units separately, rather than a sale of El Paso as a whole.

Key Litigated Issues and Outcome

The key litigated issue was whether the court should enjoin the transaction. In deciding this, the court looked at:
  • Whether the plaintiffs had a reasonable likelihood of success in proving the merger was tainted by disloyalty and whether they were likely to suffer an irreparable harm without an injunction.
  • Whether the balance of equities favored an injunction.
Although the court found that the plaintiffs did have a reasonable likelihood of success in proving a breach of the duty of loyalty, it held that the balance of equities did not favor an injunction. The court ultimately decided not to deprive the stockholders of their ability to vote in the merger.

Practical Implications

As the court found that the plaintiffs had a reasonable likelihood of success on the merits, this case will likely continue and either end with a settlement or go on to trial. Key factors that influenced the court's support of the plaintiff's case, included:
  • Foshee's undisclosed conflict and control of the negotiations.
  • Goldman's continued involvement in the process despite the disclosure of the conflicts.
  • The fee structure for the advisory work of Goldman and Morgan Stanley.
  • The undisclosed personal conflict of the Goldman banker.
Although the court found many decisions of the board questionable (such as the decision to move forward with Kinder Morgan to avoid a public takeover bid, the acceptance of the lowered price and agreed on deal protections), with a proper process, these decisions may have been respected under the business judgment of the board (see Practice Note, Fiduciary Duties of the Board of Directors.
This decision highlights the court's scrutiny of both insider and investment banker conflicts. Without full disclosure of all conflicts and without truly functional (rather than simply form) safeguards to protect the merger process from being tainted by those conflicts, the court will not, by default, defer to the board's decisions.
Court documents: