Cleaning Up a Dirty Energy DealIn re El Paso Corporation Shareholder Litigation
Obtained a $110 million settlement in this shareholder action
When El Paso Corporation and Kinder Morgan, Inc. announced their proposed $21.1 billion merger, it raised eyebrows at Labaton Sucharow.
The proposed merger was being touted to El Paso's investors as creating the nation's biggest empire of oil and gas pipelines. We found it more remarkable that El Paso had hired Goldman Sachs to advise its board of directors as to the financial fairness of the merger despite the fact that Goldman had a 19.1 percent ownership stake in the acquiror Kinder Morgan, and thus would directly benefit if Kinder Morgan bought El Paso on the cheap. On top of that, two of Goldman's managing directors were sitting on Kinder Morgan's board. Labaton Sucharow's client, who was an El Paso shareholder, shared our concern, so we promptly drafted and filed suit on their behalf. The suit sought to hold the directors of El Paso accountable for breaching their fiduciary duties to El Paso's shareholders, and asserted claims against Kinder Morgan and Goldman Sachs for aiding and abetting the board's dereliction of duty.
The shareholder vote on the merger was just a few months away. As we and our co-counsel reviewed thousands of documents produced by the defendants and third parties and deposed El Paso and Kinder Morgan's executives, directors and advisors, it became clear that the conflicts ran even deeper than originally suspected. For example, it turned out that the investment banker who led the Goldman Sachs team advising El Paso's board owned a substantial amount of stock of Kinder Morgan, giving him a personal incentive to steer the board toward accepting a lowball offer. It also emerged that Morgan Stanley, which El Paso had brought in to cleanse the appearance of Goldman's conflict in the transaction, was itself conflicted. Namely, Morgan Stanley would only be paid for its advice if the proposed merger closed—whereas it would receive nothing if El Paso instead pursued another business strategy. In short, Morgan Stanley, like Goldman Sachs, had a powerful financial incentive to tell the Board that Kinder Morgan's offer was fair to El Paso's shareholders, even if, in reality, it shortchanged them.
Lastly, we learned that El Paso's CEO had a hidden agenda that put his personal interests in conflict with those of El Paso's shareholders. The CEO was acting as El Paso's chief negotiator in the merger. In that role, he had a duty to bargain hard with the acquiror and secure the best possible value for El Paso's shareholders. Instead, he was secretly plotting to buy half of El Paso back from Kinder Morgan the minute that the merger closed. As a result, El Paso's CEO had no incentive to extract the last nickel from Kinder Morgan, since it might hurt his chances to later convince Kinder Morgan to sell half of El Paso back to him at a bargain rate.
Following a marathon six-hour hearing in February 2011, Delaware Chancellor Leo Strine issued an opinion in which he "reluctantly" declined to enjoin the shareholder vote on the transaction but was nevertheless highly critical of "the disturbing nature of some of the behavior leading to [the merger's] terms." Chancellor Strine also observed that "plaintiffs have a reasonable likelihood of success in proving that the Merger was tainted by disloyalty." Armed with that guidance, Labaton Sucharow and our co-counsel, with client approval, decided to press forward with the case. The goal was to recover money damages from the defendants and compensate El Paso's investors for the losses they suffered when El Paso's board of directors, aided and abetted by Goldman Sachs and Kinder Morgan, sold the company for less than its full value.
In September 2012, after an additional six months of hard-fought litigation, Labaton Sucharow and its co-counsel negotiated a settlement whereby the defendants would pay $110 million to resolve the shareholder class' claims. Also, as part of the settlement, Goldman Sachs would not be allowed to receive its $20 million advisory fee. Goldman Sachs acknowledged that the lawsuit was a contributory cause to it agreeing to waive its advisory fee. The Court approved the settlement terms as fair and reasonable in December 2012. In the settlement hearing, Chancellor Strine remarked that, "I think it's a very substantial achievement for the class…there is clearly a sizeable and tangible benefit that was produced only because of the litigation."
The achievement obtained in this litigation went beyond the size of the settlement amount, which, while constituting a small percentage of the overall transaction, was, as the Chancellor noted, substantial in absolute terms, and was the largest recovered for shareholders in any Delaware merger transaction suit not involving a management-led buy-out. Of more long-lasting significance, Chancellor Strine's rebuke was heard across the financial and legal industries due to his scathing criticism of the motives and conduct of Goldman Sachs and El Paso's CEO. As such, banks who advise the boards of target companies in merger acquisitions, including Goldman Sachs, Barclays Capital, Bank of America, and Citigroup, are all considering reforms to their conflict policies, such as disclosing the personal shareholdings of their advisory teams before working with clients. This result, which is directly attributable to the litigation, promises to change the landscape of merger transactions for the better.