Brinckerhoff v. Texas Eastern Products Pipeline Co., LLC, C.A. Nos. 2427-VCL, 4548-VCL (Del. Ch. Jan. 15, 2010), read opinion here.
In a consolidated matter, the Court of Chancery approved a settlement and reduced the request from plaintiffs’ counsel for fees and expenses from $19.5 million to $10 million for two actions related to a transaction and subsequent merger, which had as its primary goal extinguishing the plaintiffs’ standing to bring a derivative action. Brinckerhoff v. Texas Eastern Products Pipeline Co., LLC, C.A. Nos. 2427-VCL, 4548-VCL (Del. Ch. Jan. 15, 2010). The Court analyzed the settlement with “significant scrutiny” involving two hearings because the parties asked the Court to approve a Cox Communications settlement (referring to In re Cox Communications, Inc., 879 A.2d 604 (Del. Ch. 2005)) that would resolve not only the litigation related to the merger but also the derivative action.
The Court spent a great deal of time identifying the parties and key players in the challenged transactions. For brevity purposes, the parties are described and defined at the end of this summary.
First Settlement Hearing Unsuccessful
At the first hearing, the Court determined that the record was inadequate so the parties successfully supplemented the record for the second settlement hearing. In discussing the situation created by the two actions, Vice Chancellor Laster used the phrase pas de trois quoting Vice Chancellor Strine’s reference from In re Cox Communications. Vice Chancellor Laster then identified his concerns:
[T]he record established that the special committee focused repeatedly on the Derivative Action, embraced the premise that the claims had significant value, but then approved a deal in reliance on a fairness analysis that afforded no value whatsoever to those very same claims. These and other factors left me to wonder about the good faith of the special committee and brought to mind Chancellor Allen’s admonition, offered in a different context, that “due regard for the protective nature of the stockholders’ class action [and to which I would add derivative actions as well], requires the court, in these cases, to be suspicious, to exercise such powers as it may possess to look imaginatively beneath the surface of events, which, in most instances, will itself be well-crafted and unobjectionable.” It did not require much suspicion or imagination to think that extrinsic factors might have colored the judgment of the special committee and plaintiffs’ counsel when agreeing to a Cox Communications settlement. The lure of a premium transaction, the self-evident benefits of settlement to the controller and other defendants, and the prospect of an easy end to the litigation – coupled with a large fee – create powerful pressures. No one need cross the line of collusion or conscious shirking for these forces to have an effect. “[H]uman nature may incline even one acting in subjective good faith to rationalize as right that which is merely personally beneficial.” (citations omitted).
The Challenged 2006 Transactions: The Sale and the Joint Venture
In 2006, Enterprise LP (1) acquired the Pioneer Plant and all of Teppco Partner’s gas processing rights for $38 million, and (2) along with Teppco, agreed to form a joint venture (the “JV”) to own Jonah Gas Gathering Company (“Jonah”). While Merrill Lynch, which was hired by the Teppco Audit Committee to provide a fairness opinion on the Pioneer Sale, opined that the $38 million purchase price was fair, Merrill Lynch did not consider Teppco’s rights under the processing contract after the Jonah acquisition. Simmons & Co., which was hired by Enterprise to provide a fairness opinion, valued the deal at $780 million by taking into consideration Teppco’s plans to expand Jonah’s gathering and processing systems. On March 31, 2006, the Pioneer sale closed with Enterprise paying only $38 million.
At the same time as the Pioneer sale, the JV proceeded with EPCO employees who were under the control of Daniel Duncan (who controlled both Teppco and Enterprise) negotiating the terms of the JV. In addition to Teppco contributing Jonah to the JV, both Teppco and Enterprise committed to provide half of the funding. In an important deal point, Jonah’s value was “based on Teppco’s historic cost of investment, not Jonah’s value as a going concern.” Using that valuation, Teppco was credited with a capital contribution of approximately $800 million for the purchase price of Jonah, $250 million in prior investments, and an additional amount for Teppco’s portion of the future financing. In the aggregate, this amounted to Teppco owning 80% of the JV. Enterprise was credited with $208 million, or roughly 20% of the financing. Had Jonah been valued as a going concern, plaintiffs alleged that the post- expansion JV was worth about $2.2 billion. For Enterprise to remain a 20% owner, it would have had to more than double its $208 million capital contribution. The plaintiffs did not discount the value for lack of control because Teppco and Enterprise agreed that Enterprise would manage the daily operations.
Teppco expected Goldman Sachs, which had been hired by Teppco to explore financing alternatives, to render a fairness opinion for this transaction but Goldman Sachs declined. After Duncan convinced that directors of Teppco and Enterprise that his motives were not biased and that a fairness opinion was unnecessary, the Teppco Audit Committee approved the deal. Simmons, however, did provide a fairness opinion for Enterprise.
The Derivative Action
Plaintiffs brought the Derivative Action alleging: (1) breach of fiduciary duty against Teppco directors related to the JV and Pioneer Sale; (2) aiding and abetting of breaches of fiduciary against Enterprise; and (3) disclosure violations related to Teppco’s LP and an exchange transaction.
From late 2006 to early 2009, the parties engaged in motion practice (with count three being dismissed), extensive discovery, and mediation. Just before agreeing to mediate, Duncan and members of Enterprise management decided to pursue a merger with Teppco. Enterprise made its initial offer in March of 2009 wherein each Teppco LP unit would be converted into 1.043 Enterprise LP units plus $1 for total consideration at Enterprise’s then-current market value of $21.89 per LP unit. This offer was rejected by the Teppco Audit Committee as “unacceptably low because, among other things, it inadequately valued Teppco’s business and did not take into account the potential value of the [Derivative Action].”
The Merger and Resulting Litigation
In April 2009, defendants’ counsel informed plaintiffs’ counsel of the potential merger. The parties agreed to adjourn the mediation for sixty days and allow the parties to negotiate a deal. On April 29, 2009, Teppco announced publicly that Enterprise had made a merger proposal, plaintiffs filed the Merger Action. Instead of taking any action to expedite or enjoin the action, plaintiffs entered into what Vice Chancellor Laster described as “the Cox Communications minuet,” by which he was referring to a situation:
in which real litigation activity ceases and a special committee engages in coordinated two-track negotiations, one with the controller over the deal and the second with plaintiffs’ counsel over the litigation. If the special committee and the controller close in on a transaction, then the plaintiffs’ counsel gets a heads up so that the three sides can agree simultaneously on terms. The plaintiffs’ claimed causal role in generating the transactional benefits – which the defendants concede to ensure consideration for a global release – in turn supports a fee award for plaintiffs’ counsel.
Negotiations quickly brought the parties to a deal on an exchange ratio of 1:24. Thereafter, counsel for the defendants and the plaintiffs entered into a memorandum of understanding to settle all pending litigation in consideration for the closing of the merger. Importantly, the converse was not true – the closing of the merger was not contingent upon the settlement of the litigation.
Credit Suisse opined that value was fair to the unaffiliated Teppco unitholders – but this analysis did not consider the value of the Derivative Action. The Teppco Special Committee, Teppco Audit Committee, and Teppco GP board all approved and ultimately recommended it to the Teppco LP unitholders. On August 6, 2009, the parties submitted a formal settlement stipulation.
Resolution of the Actions
As an initial matter, the Court discussed the direct and derivative nature of the actions noting that “as a result of the Merger, the distinctions between a derivative action on behalf of Teppco for the indirect benefit of its LP unitholders and a class action on behalf of those same Teppco LP unitholders have blurred. Regardless, “Delaware law recognizes an exception to the continuous ownership requirement when ‘a principal purpose of the merger was the termination of the then pending derivative claims.’” Despite the Court recognizing that after the merger the Derivative Litigation could have continued “as a de facto class action on behalf of holders of Teppco LP units as of the effective time,” the Court recognized that “eliminating the Derivative Action was a principal purpose for the Merger” and that settlement was a practical decision.
Fairness of the Settlement
In considering the fairness of the settlement, the Court noted that “[a] transactional settlement that follows the Cox Communications paradigm requires particular scrutiny because of the nigh-on formulaic nature of the process . . . .” In such a situation, the litigation brought by plaintiffs’ counsel will likely drive the deal price upward and plaintiffs’ counsel is incentivized to agree to the escalated deal price. Defendants’ counsel are also encouraged to reach an agreement as they generally obtain a broad release. As a result, counsel for both parties tend to have their interests align very early and accordingly both recognize the need to develop a “favorable record of settlement negotiations.” The real issue then becomes: how much did the plaintiffs’ lawyers add to transactional negotiations and how much should they get in return for their claims?
The problems of aligned interests are exacerbated where the transactional settlement will resolve both the transaction and a litigation. The Court noted that this case represented an example of that scenario:
The defendants knew they faced a real claim that had survived a motion to dismiss. They were in the midst of discovery and looking towards a trial and potentially adverse result. They thus had even greater incentives to use a transaction to resolve the litigation. Meanwhile, absent an exception to the traditional doctrine of claim extinction by merger, the closing of a transaction could leave the plaintiffs’ lawyers high and dry. The plaintiffs here did not raise a peep about continuing the Derivative Action but rather accepted the ready-made settlement opportunity. Everyone had ample reason to “settle” otherwise viable claims in exchange for the “benefits” provided by the proposed deal.
Accordingly, Vice Chancellor Laster stated that “the Court must give significant scrutiny to Cox Communications settlements, and particularly those that simultaneously resolve pending derivative claims.”
The record developed in the Derivate Action led the Court to believe that the claims were very strong. As for the Merger Action, the claims were not as strong as they were controlled by terms in the LP agreement that were very favorable to defendants. A term of the LP agreement essentially allowed the defendants to rebuke any challenge to the merger so long as it was approved by a majority of the Teppco Audit Committee members. Nonetheless, even though the Court found that the claims in the Merger Action were not as strong as the claims in the Derivative Action, they still represented a “meaningful litigation threat.”
Plaintiffs alleged damages as high as $2 billion. After review of a detailed record, the Court concluded that the Derivative Action could be worth approximately $100 million. In analyzing the consideration provided in the merger, the Court was troubled that the financial advisors failed to address whether the merger price was fair in light of the Derivative Action. The Court said: “[a]lthough I am persuaded that the Merger benefited the Teppco LP unitholders, it is not possible to determine the degree to which the terms of the Merger compensated them for the Derivative Action. Put bluntly, the Merger could well have been the deal that the Special Committee would have negotiated anyway.” Despite some misgivings, the Court considered the fact that the special committee was comprised of “independent, outside directors with no ties to the controller [who] appear to have acted in good faith to negotiate the terms of a premium transaction.” In addition, prior to the Cox Communications mode, the plaintiffs had pursued the Derivative Action with vigor, thereby creating a valuable litigation asset that may have prompted the merger.
Taking into consideration all of these facts, the Court concluded that, in a close call, “the Teppco Special Committee used the Derivative Action as an effective negotiation tool to increase the Merger consideration and obtain a fair result.” Accordingly, the Court approved the settlement.
Even though the defendants agreed not to oppose plaintiffs’ counsel’s request for $19.5 million in fees and $1.5 million in expenses, the Court was required to make its own independent analysis. In analyzing the Sugarland factors and in particular the level of contingency risk the plaintiffs took, the Court noted that in pursuing the Derivative Action the plaintiffs’ counsel undertook real contingency risk, engaged in significant discovery including document review and depositions. However, the Court stated that when the parties shifted into Cox Communications mode, the plaintiffs’ risk was substantially mitigated. In the end, the Court found the $19.5 million figure to be excessive.
The Court awarded plaintiffs’ counsel $10 million – which represents 10% of the benefits conferred by the Derivative Action, stating that ten percent “reflects the plaintiffs’ substantial litigation effort while recognizing that the bulk of the litigation remained. . . . Like Vice Chancellor Strine, I believe that higher percentages are warranted when cases progress further or go to the distance to a post-trial adjudication.”
This summary was prepared by Kevin F. Brady and Ryan P. Newell.
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