Notwithstanding Questionable Board decisions and significant management and financial adviser conflicts of interest, court allows stockholders to decide whether to approve merger
The Delaware Chancery Court denied an application for
preliminary injunction to stop a stockholder vote on a merger, in
In re El Paso Corporation Shareholder Litigation,
Consolidated CA No. 6949-CS.
El Paso, which has both a natural gas pipeline and a gas and oil
exploration and production (E&P) business, announced its
intention to spin off the E&P business. The announcement
prompted Kinder Morgan, Inc., to make a nonpublic offer to El Paso
to acquire El Paso in its entirety. El Paso understood that Kinder
Morgan intended to keep only the pipeline business, but wanted to
acquire El Paso before the spin-off, to discourage other bidders
for the pipeline business.
After El Paso's board declined Kinder Morgan's initial
$25.50 per share bid, Kinder Morgan threatened to go public with a
hostile takeover. El Paso's exclusive financial adviser with
respect to the spin-off recommended against tempting Kinder Morgan
to commence a hostile bid. Rather than open the field to
competitive bidding, the El Paso board authorized the company's
CEO alone (without "supervision" from any independent
director or legal counsel) to continue private negotiations with
Kinder Morgan.
The CEO hadn't disclosed to the board, however, that he wanted
to acquire the E&P business from Kinder Morgan, which hoped to
dispose of the E&P business before the merger was consummated.
Although he withheld his personal overture to Kinder Morgan until
after principal merger terms were agreed upon, the CEO would have
had a number of reasons to refrain from negotiating the best
possible deal for stockholders.
El Paso's financial adviser also owned 19 percent of Kinder
Morgan and, as a member of Kinder Morgan's control group, was
entitled to designate two of its board members. Due to this obvious
conflict of interest, El Paso engaged a second financial adviser to
advise the company regarding Kinder Morgan's bid, but the
conflict was not entirely ameliorated. The original financial
adviser continued to advise El Paso in comparing the value to
stockholders of the spin-off relative to the Kinder Morgan bid.
Given its interest in seeing the merger completed (although on
terms most favorable to Kinder Morgan), the first firm had
incentive to undervalue the spinoff. The second financial adviser
would receive a $35 million fee upon completion of the merger, but
nothing from the $25 million fee if the spin-off was consummated.
The second firm was faced with the choice of recommending either
the merger and getting paid, or recommending the spin-off and
receiving no fee. To ensure that its first firm would receive a fee
even if a transaction with Kinder Morgan precluded the spin-off, El
Paso's board agreed to pay the firm $20 million upon
consummation of the merger, notwithstanding the firm's claim
that it was not giving El Paso merger advice. (The firm also sought
credit as a financial adviser to El Paso when the merger agreement
was announced.) In addition, the firm's lead adviser to El Paso
did not inform El Paso that he personally owned $340,000 of Kinder
Morgan stock.
In the negotiations, Kinder Morgan increased its offer to $27.55,
in cash and stock, per El Paso share. A few days later, claiming it
had made a mistake, Kinder Morgan replaced the bid with an offer of
$25.91, in cash and stock, and a Kinder Morgan stock purchase
warrant, for total consideration of $26.87 per El Paso share, which
El Paso accepted. The merger agreement contained a no-shop clause
that precluded El Paso from separately selling the E&P business
and a termination fee likely to foreclose bids on the pipeline
business.
Notwithstanding the 37 percent premium to market that the merger
consideration represented, plaintiff stockholders contended that
the conflicts of interest prevented stockholders from receiving
more and cited a number of questionable decisions made by the board
to support their view. Agreeing that "more faithful,
unconflicted parties [probably] could have secured a better price
from Kinder Morgan," the court nonetheless declined the
stockholders' application for injunctive relief.
Although stockholders might not be made whole by money damages, the
court reasoned that the value of the merger consideration was
sufficiently attractive that reasonable stockholders might
want—and therefore should be allowed—to accept
it. No other bidder had emerged, and enjoining the merger might
result in its termination. The court believed that the unusual
mandatory relief plaintiffs requested reflected this quandary.
Acknowledging that "[t]he kind of troubling behavior
exemplified here can result in substantial wealth shifts from
stockholders to insiders," the court concluded that more
injury probably would result from granting plaintiffs' motion
than denying it. The court ventured, however, that for the
financial adviser, El Paso's CEO, and perhaps other El Paso
managers, "the likely prospect of a damages trial is no doubt
unpleasant."
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