Delaware Courts and the Weakening of the Duty of Loyalty: In re El Paso Corp. Securities Litigation (The Broader Significance of the Decision)(Part 6)
There are many things to like about this case.
Plaintiffs alleged conflicts of interest. Defendants provided a rational for a finding that, at the pleading stage, these allegations did not raise any real concerns about the merger process. The interest of the CEO of El Paso in buying the E&P business from Kinder Morgan could have been viewed as insignificant, a passing fancy. The Chinese wall designed to keep Goldman from influencing the merger could have been viewed as adequate. Had the court agreed with these views, the case would have been addressed under the duty of care and quickly dismissed. The court, however, applied a mix of legal analysis and common sense to acknowledge that the allegations brought by plaintiffs in fact raised real concerns.
The court also used a mix of legal analysis and common sense to conclude that an action for damages would not be sufficient. Claims against directors would, at a minimum, flounder on the waiver of liability provision. Claims against the CEO may have had a stronger legal foundation, but the court, in a common sense fashion, recognized that such an action would not provide an adequate amount of recovery even if plaintiffs were able to succeed.
The court also recognized that, despite the payment of an adequate price for El Paso, shareholders may nonetheless have been harmed by this type of conflict.
The kind of troubling behavior exemplified here can result in substantial wealth shifts from stockholders to insiders that are hard for the litigation system to police if stockholders continue to display a reluctance to ever turn down a premium-generating deal when that is presented. The negotiation process and deal dance present ample opportunities for insiders to forge deals that, while “good” for stockholders, are not “as good” as they could have been, and then to put the stockholders to a Hobson’s choice.
There are also some lessons from the case that in fact may improve the integrity of the process, providing greater assurance that the outcome will in fact be in the best interests of shareholders. Certainly this case and others have sent a message to financial advisors that the Delaware courts will take a close look at their role in any merger, particularly those involving the possibility of a conflict of interest. At a minimum, they will need to provide greater certainty that potential conflicts of interest play no role in the merger process.
But in the end, there were no consequences for the potential problems identified by plaintiffs. In other words, alleged conflicts of interest could be identified and harm shown but the courts would do nothing about them.
What about the argument that the injunction would have been harmful to shareholders? There is, of course, the possibility that an injunction would have benefited shareholders by allowing the company to be sold at a higher price. Likewise, the injunction could have caused Kinder Morgan to walk and take with it the highest possible price available to shareholders.
The opinion, however, hinted at interest by both Kinder Morgan and other companies in acquiring the pipeline business. Moreover, while the court was correct that there was no competing offer, El Paso was considering an alternative: spinning off the E&P business and allowing the pipeline to become a free standing business that was apparently of considerable interest to other companies. It is possible that shareholders would have benefited from the alternative.
All of this is, of course, speculation. The truth is that any injunction would have posed the risk that shareholders would have lost out on the highest possible price. Even if true, however, such an injunction would have produced benefits that went beyond the specific deal. An injunction would have sent a warning in future mergers that the process mattered.
Instead, the effect of this decision is to conclude that sometimes process matters and sometimes it does not, hardly a basis for shareholders placing their faith in process as a means of protecting their interest.
Primary materials in this case, including the opinion, can be found at the DU Corporate Governance web site.