A Delaware business court judge on Wednesday said he won’t stop El Paso Corp. shareholders from voting next week on a proposed takeover by Kinder Morgan Inc. (KMI), but he admonished El Paso Corp. CEO Doug Foshee and Goldman Sachs Group Inc. for “disturbing” behavior that led to the transaction. Shareholders still have a chance to weigh in on whether they believe the sale to KMI was “tainted by disloyalty,” wrote Delaware Chancellor Leo Stine.

Houston-based KMI last October agreed to buy cross-town rival El Paso in a $21.1 billion transaction in 2011, which when completed will create the biggest natural gas pipeline franchise in North America (see Daily GPI, Oct. 18, 2011).

El Paso shareholders subsequently sued in the Court of Chancery of the State of Delaware, alleging that the merger agreement was rife with conflicts of interest (No. 6949-CS) (see Daily GPI, Feb. 23). At the time of the merger deal Goldman — a 19% stakeholder in KMI — also was advising El Paso about a proposed spin-off of the company’s exploration and production (E&P) business (see Daily GPI, May 25, 2011). The lawsuit also claimed that Foshee had been negotiating privately with KMI, which compromised his ability to negotiate.

Stine said he would not issue a temporary injunction but said the merger agreement was “disturbing” and open to lawsuits by shareholders. In his 34-page opinion, the judge scathingly criticized Goldman and Foshee.

Among other things, Stine said lead Goldman adviser Steve Daniel didn’t disclose that he personally owned close to $340,000 of KMI stock. Foshee didn’t disclose to the El Paso board that he secretly was working on a bid with KMI to buy the E&P unit.

“He kept that motive secret, negotiated the merger, and then approached Kinder Morgan’s CEO on two occasions to try to interest him in the idea,” wrote the judge. “In other words, when El Paso’s CEO was supposed to be getting the maximum price from Kinder Morgan, he actually had an interest in not doing that.”

Morgan Stanley was brought in by El Paso to address Goldman’s economic incentive for a deal, but Goldman “tainted the cleaning effect” because it “continued to intervene…and was able to achieve a remarkable feat: giving the new investment bank an incentive to favor the merger by making sure that this bank [Morgan Stanley] only got paid if El Paso adopted the strategic option of selling to Kinder Morgan…”

The record, said Stine, “is filled with debatable negotiating and tactical choices by El Paso fiduciaries and advisers,” in particular by Foshee “who made the most of the important tactical choices, and he never surfaced his own conflict of interest.”

According to court records, KMI first expressed an interest in acquiring El Paso in late August, but the initial $25.50/share offer was turned down by the board. On Sept. 9 KMI “threatened to go public with its interest,” and instead of forcing KMI “into an expensive public struggle, the board entered into negotiations…” Foshee was deployed as the “sole negotiator,” and he reached an agreement with KMI on Sept. 18 for $27.55/share in cash and stock.

“Soon thereafter, on Sept. 23, [CEO Rich] Kinder said, ‘oops, we made a mistake,'” wrote Stine. “‘We relied on a bullish set of analyst projections in order to make our bid. Our bad. Although we were tough enough to threaten to go hostile, we just can’t stand by our bid.'” In the days after KMI lowered its offer by about $534 million for “arguably ludicrous” reasons. Foshee didn’t try to renegotiate and El Paso “ended up taking a package that was valued at $26.87…

“Worst of all was that the supposedly well motivated and expert CEO [Foshee] entrusted with all the key price negotiations kept from the board his interest in pursuing a managed buyout (MBO) of the company’s E&P business.” Foshee apparently spoke with E&P chief Brent Smolik “about approaching KMI with a management bid for the E&P assets.” An email exchange between Smolik and El Paso CFO John Sult “suggests that Smolik and Foshee were discussing the MBO opportunity while Foshee was negotiating the merger terms with Rich Kinder.”

At a time when it was Foshee’s and his board’s duty to “squeeze the last drop of the lemon out for El Paso’s shareholders, Foshee had a motive to keep juice in the lemon that he could use to make a financial Collins for himself and his fellow managers interested in pursuing an MBO of the E&P business,” Stine said.

After the opinion was published, plaintiff attorney Mark Lebovitch said, “Our clients are pleased to see that Delaware law will not tolerate the type of callous indifference to real and material conflicts of interests that the parties to this deal have shown.”

An El Paso spokesman said the court “made the right decision by allowing the shareholders of El Paso to decide for themselves whether they wish the merger to go forward. El Paso respectfully disagrees, however, with certain of the preliminary findings contained in the court’s opinion and expects to have the opportunity to more fully respond to those findings in future proceedings.”

Goldman Sachs said it also respected Stine’s opinion but it wanted “to be clear that we stood by our client through this process, encouraging them to get independent views from another adviser. We were also transparent with El Paso about our relationship with Kinder Morgan and the related issues.”

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