In Re El Paso Corporation Shareholder Litigation
2012 Del. Ch. LEXIS 46, 2012 WL 653845, 41 A.3d 432 (2012)
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Rule of Law:
When a corporate fiduciary, such as a CEO, and a financial advisor have undisclosed conflicts of interest that are adverse to the stockholders' interests during merger negotiations, the process is tainted by a breach of the duty of loyalty, establishing a reasonable probability of success on the merits for a claim challenging the transaction.
Facts:
- El Paso Corporation announced a plan to spin off its exploration and production (E&P) business.
- Following the announcement, Kinder Morgan, Inc. made an unsolicited offer to acquire all of El Paso, with the intention of keeping El Paso's pipeline business and selling the E&P business.
- The El Paso board of directors designated its CEO, Doug Foshee, as the company's sole negotiator for the merger.
- While negotiating the sale, Foshee developed an interest in leading a management buyout (MBO) of the E&P business from Kinder Morgan after the merger was complete. Foshee did not disclose this interest to the El Paso board.
- El Paso's longtime financial advisor, Goldman Sachs, had a major conflict of interest, owning 19% of Kinder Morgan (a $4 billion investment) and controlling two seats on its board.
- The lead Goldman Sachs banker advising El Paso, Steve Daniel, personally owned approximately $340,000 of Kinder Morgan stock, which he failed to disclose to El Paso.
- To mitigate Goldman's conflict, El Paso hired a second bank, Morgan Stanley, but its fee arrangement was structured so that it would receive a large fee only if the Kinder Morgan merger was consummated, and nothing if another strategic option, like the spin-off, was pursued.
- Foshee ultimately agreed to a lower price from Kinder Morgan than had been agreed upon in principle just weeks earlier and suggested a counter-offer below the floor authorized by the board.
Procedural Posture:
- Stockholders of El Paso Corporation filed a lawsuit against the company's fiduciaries in the Delaware Court of Chancery, which is a trial court.
- The stockholder plaintiffs moved for a preliminary injunction to prevent a stockholder vote on the proposed merger between El Paso and Kinder Morgan, Inc.
- The court granted expedited discovery to the parties.
- The Court of Chancery then considered the plaintiffs' motion for a preliminary injunction.
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Issue:
Is there a reasonable probability of success on the merits for a claim that a merger agreement was tainted by breaches of the duty of loyalty when the selling company's CEO and sole negotiator had an undisclosed interest in buying a key asset from the acquirer post-merger, and the company's primary financial advisor had significant, undisclosed financial interests in the acquirer?
Opinions:
Majority - Chancellor Strine
Yes, the plaintiffs have a reasonable probability of success on a claim that the merger is tainted by breaches of fiduciary duty. The court found compelling evidence that the negotiation process was compromised by the undisclosed self-interests of key fiduciaries. CEO Doug Foshee’s secret desire to pursue a management buyout of the E&P assets created a perverse incentive for him not to extract the highest possible price from Kinder Morgan, as a lower acquisition price for El Paso could lead to a lower sale price for the assets he wished to buy. This conflict tainted his role as the sole negotiator. Furthermore, the conflict of El Paso's financial advisor, Goldman Sachs, was inadequately addressed; the lead Goldman banker concealed his personal holdings in Kinder Morgan, and the supposedly 'cleansing' second advisor, Morgan Stanley, was given a fee structure that incentivized it to favor the very deal it was meant to be independently scrutinizing. These concealed interests make it impossible to view the board's otherwise debatable negotiating choices through the deferential lens of the business judgment rule and instead suggest a breach of the duty of loyalty.
Analysis:
This opinion serves as a powerful modern application of the Revlon duty of loyalty in the M&A context. It emphasizes that procedural formalities, such as hiring a second financial advisor, are insufficient to cleanse a transaction if they do not substantively cure the underlying conflicts. The decision signals to corporate boards, executives, and financial advisors that courts will rigorously scrutinize the motivations of key players and that failure to disclose personal financial interests can fatally taint a deal process, even one that results in a significant premium for stockholders. This case provides a strong precedent for challenging mergers where the process appears compromised by insider self-dealing, making full and transparent disclosure of all potential conflicts critically important.
