But a shareholder suit challenging the sale of El Paso Corp. to Kinder Morgan Inc. offered such a chance, and Strine seized it. Furthermore, the Delaware courts' increased willingness to make large damages awards means Strine's attitude may translate into significant costs for private equity buyers in the future.
The judge's 33-page opinion in the El Paso case has garnered significant attention for its harsh treatment of Goldman, Sachs & Co., which provided the company with banking advice even though it owns a 19% stake in Kinder Morgan and has two seats on its board. But Strine also went after El Paso CEO Doug Foshee, whose board charged him "with handling all negotiations with Kinder Morgan without any presence or close supervision by an independent director or legal advisor," the judge wrote.
Many boards give their CEOs such leeway when negotiating an arm's-length deal, but Foshee had his eye on El Paso's oil-and-gas exploration and production unit. El Paso had announced in May that it planned to spin out the unit, which Kinder Morgan planned to sell. Foshee discussed a potential management buyout of the E&P unit with Brent Smolik, who heads the division, at the same time as Foshee was negotiating the sale of the entire company with Richard Kinder, CEO of Kinder Morgan, Strine found.
Most damning, the judge wrote, "Foshee kept this information to himself and even told Smolik he wanted to discuss the management buyout as late in the process as possible." After the merger agreement was signed, Foshee twice asked Richard Kinder to allow El Paso's management to bid on the E&P division. Kinder rejected those overtures and instead struck a deal to sell the division to a consortium led by Apollo Global Management LLC for $7.15 billion.
The conflict was obvious, Strine wrote, since "Foshee was interested in being a buyer of a key part of El Paso at the same time as he was charged with getting the highest possible price as a seller of that same asset." That led Strine to look skeptically on several of Foshee's decisions, most notably allowing Kinder to back off of an agreement to buy El Paso for $27.55 per share in cash and stock, subject to due diligence. Instead, El Paso got a consideration worth $26.87 a share when the deal was signed on Oct. 16.
Strine wrote that Foshee should have rejected Kinder Morgan's lowered bid and forced it to make a hostile offer for El Paso that would have generated the highest possible price for the company. The difference of 68 cents a share between Kinder Morgan's first offer and the final price amounts to more than $500 million in total deal value. Strine suggested that the damages could be that high.
The judge waved away the fact that the deal came at a 37% premium to El Paso's closing price before announcement, and the stock has continued to rise in value along with Kinder Morgan's. Instead, he wrote, "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."
Similarly, he continued, in 2006 and 2007, "the early actions of poorly policed, conflicted CEOs in baking up deals with their favorite private equity sponsors before any market check (or often even board knowledge) likely dampened the competition among private equity firms that could have generated the highest price if proper conduct had occurred and the right process had been used."
Strine acknowledged that shareholders are loath to vote down a high-premium deal and refused to enjoin the El Paso shareholder vote for that reason. The company's shareholders voted overwhelmingly to approve the company's sale to Kinder Morgan on March 9, despite questions raised by some shareholders and a judge's harsh criticism of how the deal between the two oil-and-gas pipeline operators was negotiated. The deal, originally worth $21.1 billion
when struck last October and one of 2011's largest deals, passed with 95% of El Paso voters supporting the merger, the company said. About 79% of the outstanding shares voted at the special meeting.
Delaware has become far more willing to award large damages to shareholder plaintiffs, as Strine did in December when he awarded $285 million to plaintiffs' lawyers in the Southern Peru Copper Corp. case. Kinder Morgan will likely have to write a significant check to settle the El Paso suit. It may be the first of many where target managers have acted badly in trying to craft a buyout.
David Marcus covers legal matters for The Deal magazine.