What are MLP conflicts committees and how do they work?
As our MLP 201 explains, MLPs generally have two classes of owners, the general partner and limited partners. At times, potential conflicts of interest may arise between the two classes and independent evaluation is necessary. This is where conflicts committees enter the picture.
According to Latham & Watkins, “The General Partner’s Conflicts Committee is composed entirely of two or more independent directors (typically the same directors serving on the audit committee).” The 2014 10-K for Rose Rock Midstream (RRMS) explains that the committee “has the authority to review specific matters that may present a conflict of interest in order to determine if the resolution of such conflict is ‘fair and reasonable.’” The conflicts committee has permission to engage advisors when needed.
MLPs have frequently received criticism because MLP partnership agreements state that in certain situations
Example 2: Our general partner is allowed to take into account the interests of parties other than us, such as El Paso, in resolving conflicts of interest.">no fiduciary duty is owed to unitholders. While the GP/LP structure is supposed to align the interests of all parties, conflicts committees serve as an additional layer of protection for unitholders as it is their responsibility to make sure all transactions occur in good faith.
Although a stamp of approval from the conflicts committee is not required for decision making, the GP normally seeks the committee’s endorsement of material transactions to protect itself against legal liability. However, on April 20, 2015, the Delaware Court of Chancery released a decision that proves conflicts committee approval does not necessarily equal freedom from adverse litigation outcomes.
The case involved El Paso Pipeline Partners (EPB) which is now a piece of the Kinder Morgan (KMI) pie. As the Memorandum Opinion explains in impressively understandable language, a trial was held to understand the “state of mind of the members of the Conflicts Committee” in relation to two drop-down transactions from El Paso Corporation (the parent company) to EPB in 2010. EPB unitholders alleged that the then-MLP was pressured into overpaying by its parent, and the judge agreed. He didn’t mince words when he said, “in most instances, the [Conflicts] Committee members and their financial advisor had no explanation for what they did.” The judge further expressed that “the Committee members went against their better judgment and did what Parent wanted . . . .” The judgment was for the plaintiff in the amount of $171 million. Interestingly, since this was a derivative lawsuit, the unitholders that initiated the suit won’t see a dime. And now that KMI owns the whole shootin’ match, it’s a little unclear what impact the judgment will actually have on the energy giant. In theory, it seems like a few internal journal entries could end the fiasco.
Some believe this was a situation where the conflicts committee failed to fulfill its purpose. According to Baker Botts, “a conflicts committee must believe that a dropdown, on the best terms that can be negotiated, is in the best interests of the MLP.” Further, “members of the conflicts committee must realize they have a duty to say no to a proposal if they cannot make this determination.” In a recent Reuters article, Tom Hals commented that this judicial decision may mean “investors in publicly traded MLPs gain more protection akin to shareholders in corporations.” This could result in a fresh focus on the role of conflicts committees throughout the MLP space, causing increased attention to member independence and more calculated decision making on behalf of the MLP.