Register to receive a printed copy(For Lexis Practice Advisor® Subscribers Only)
Lexis Practice Advisor®Free Trial
Learn More AboutLexis Practice Advisor®
By: Joshua Davidson, Baker Botts LLP
If you are internal counsel to a publicly traded corporation that has decided to form a master limited partnership (MLP) and would like to become better educated about MLPs before starting the IPO process, below are 10 practice tips for you.
MLPs have a special tax status. Unlike corporations, they are not taxed at the entity level and unitholders are taxed on their allocated share of income, not on their distributions. This is only the case, however, if the MLP satisfies certain complex qualifying income rules. Ninety percent of the MLP’s income must be from certain activities related to natural resources or other qualifying sources. If the MLP fails that test in any one year, it will become taxable as a corporation. Although specialist tax counsel handles the qualifying income analysis, you should be aware of the following:
Unlike a corporation, a Delaware limited partnership is a creation of contract and a court will look to the words of the partnership agreement to determine the rights of the parties. MLP agreements generally contain very similar provisions. The key provisions deal with:
The agreement runs close to 100 pages, which demonstrates how many aspects of the MLP are governed by contract.
When the general partner or its officers and directors are acting on behalf of the partnership, they must act in good faith, meaning that they must subjectively believe that their decision is in, or not opposed to, the best interest of the MLP (or in some cases, simply not adverse to the MLP). In any case, the actor is presumed to have acted with the requisite standard and a plaintiff will have the difficult burden of showing otherwise. When the general partner or the parent acts in its own capacity, it owes no fiduciary duty to the MLP.
An MLP is governed by its general partner, which will be a subsidiary of the parent corporation. The board sits at the general partner level and therefore its directors (who manage the MLP) are appointed by the parent corporation (as the sole shareholder of the general partner) and are not elected by the public unitholders of the MLP. An MLP board is not required to have a majority of independent directors, and typically a majority of directors are officers of the parent. MLPs are also not required to have a governance or compensation committee but are required to have a standard audit committee of three independent directors
The general partner will have officers, who are frequently also officers of the parent corporation. Key issues to consider are:
The MLP’s principal source of acquisitions is likely to be the parent corporation. When an MLP buys assets from its parent in exchange for cash or units, it is called a dropdown. Because the parent controls the MLP and therefore sits on both sides of the transaction, a conflicts committee of at least two independent directors is usually empowered to evaluate and negotiate the dropdown with the parent. Approval by an appropriately constituted conflicts committee doing its job properly will cleanse any conflict of interest and place a high bar for a plaintiff seeking to challenge the dropdown. Key points to keep in mind:
One of the key selling points in the marketing of MLPs is that they generally distribute all of their available cash except for reserves necessary in the business. Acquisitions and capital projects are very often funded with external capital. The typical MLP has three types of limited partner interests at IPO, each with its own cash distribution priorities: common units, subordinated units, and incentive distribution rights. You should become familiar with concepts such as subordination period, high splits, distribution coverage ratio, operating surplus, and adjusted operating surplus.
MLPs are subject to all federal securities laws, except that there are no annual proxy statements for the election of directors since the directors are appointed by the owner of the general partner. Proxy statements are required to the same extent as corporations for actions requiring unitholder votes, such as the approval of new stock incentive plans or material corporate transactions. Furthermore, limited partnerships are ineligible issuers for anything other than firm commitment underwritings, which means that an MLP that is a well-known seasoned issuer (WKSI) cannot use a WKSI shelf registration statement for at-the-market programs or resale shelves that contemplate a plan of distribution other than a firm commitment underwriting.
Three principal differences to be aware of are:
MLPs follow generally accepted accounting principles (GAAP) and Regulation S-X (17 C.F.R. § 210.1-01 - § 210.12-29), but there are a few noteworthy differences. First of all, because dropdowns are transactions between entities under common control, MLPs will often be required to recast their quarterly and annual historical financial results to reflect the acquisition as if made at the beginning of the period. Secondly, MLPs very often use a non-GAAP measure called cash available for distribution. As MLPs are cash distribution vehicles, a great deal of attention is paid to this metric by investors. Getting the SEC comfortable with your non-GAAP presentations can require some work. Third, because MLPs are so acquisitive, and because they often acquire partial interests in entities, you will be required to become familiar with the nuances of acquisition and joint venture accounting (Regulations S-X 3-05 (17 C.F.R. § 210.3-05) and 3-09 (17 C.F.R. § 210.3-09)).
Joshua Davidson is a partner in Baker Botts’ Houston office and handles a wide range of corporate and securities work. He is nationally recognized for his experience in transactions involving MLPs, YieldCos, and royalty trusts. Mr. Davidson is head of the firm’s Capital Markets and MLP/YieldCo Practice and has concentrated on MLPs for almost 25 years. He has participated in hundreds of equity and debt public offerings and private placements of MLPs and other alternative entities, including more than 60 initial public offerings. Mr. Davidson works with companies in the pipeline, midstream, oil and gas, renewable energy, shipping, refining, coal, propane, and heating oil industries.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Capital Markets & Corporate Governance > IPOs > Practice Notes
For information on the taxation of master limited partnerships, see
> TAXATION OF PUBLICLY TRADED PARTNERSHIPS
RESEARCH PATH: Capital Markets & Corporate Governance > Beneficial Ownership: Reporting, Compliance and Tax Matters > Tax Consequences > Practice Notes
For an overview on the disclosure requirements for master limited partnerships in the oil and gas industry, see
> OIL AND GAS INDUSTRY PRACTICE GUIDE
RESEARCH PATH: Capital Markets & Corporate Governance > Industry Practice Guides > Oil & Gas > Practice Notes