The energy sector has long been known for big and flashy deals, and in 2011 Kinder Morgan, Inc.’s unsolicited acquisition of El Paso Corporation was the biggest and flashiest of them all. In fact, at $37.4 billion including assumed debt, it was the world’s largest M&A deal of any kind (not counting AT&T Inc.’s failed acquisition of T-Mo­bile USA Inc.). The New York Times described the Kinder–El Paso tie-up as the crowning achievement in the career of Kinder Morgan CEO Richard Kinder, with the combined company owning or operating 67,000 miles of pipeline.

Indeed, as the global M&A market continues to rebound, energy deals have played a starring role. In 2011 energy, mining, and utilities accounted for $564 billion worth of global M&A deals, or about 25 percent of overall M&A activity, according to merger­market. Rising oil prices and advances in drilling technology that promise to unlock the value of shale oil and gas deposits in the United States spurred much of the dealmaking, whether it was spin-offs aimed at creating pure natural gas pipeline plays or international mining companies seeking to buy shale assets in the U.S.

“The energy landscape has changed dramatically, from the U.S. being written off as a country with dwindling resources to suddenly finding ourselves chockablock with shale gas and oil,” says Sullivan & Cromwell partner James Morphy, who helped represent BHP Billiton Limited in its acquisition of Petrohawk Energy Corporation for $12.1 billion. (Petrohawk was represented by Simpson Thacher & Bartlett.)

Other big energy deals of 2011 included the $26 billion merger of Duke Energy Corporation and Progress Energy, Inc., into the nation’s largest utility (pending regulatory approval); Energy Transfer Equity, L.P.’s $5.9 billion acquisition of Southern Union Company; and Marathon Oil Corporation’s spin-off of its refinery business into a $14 billion public company.

But the Kinder Morgan-El Paso deal—which was approved by shareholders on March 9 and is currently the subject of a shareholder suit alleging conflict of interest by El Paso financial adviser Goldman Sachs & Co.—stood out from the rest. Kinder Morgan, which was cofounded in 1996 by former Enron Corporation president Richard Kinder, had made a bid for El Paso in 2010, but it was rejected. In May 2011 El Paso announced a plan to separate into two public companies. One—a spin-off—would focus on gas exploration and production. The other would be centered around the pipeline business. The transaction would be tax-free and give investors a choice between a straight-ahead E&P (exploration and production) investment and a pure pipeline play. The plan was code-named “Project Zygosity.”

Meanwhile, Kinder Morgan had raised $2.2 billion in an IPO in February, putting it in a stronger position to make a big acquisition, and it again set its sights on El Paso. On August 30, after El Paso had filed its spin-off registration statement for the E&P business with the Securities and Exchange Commission, Kinder Morgan made an unsolicited offer of $25.50 per share—60 percent cash and 40 percent stock—a 35 percent premium over El Paso’s stock price. That offer led to a series of complex negotiations, as El Paso continued moving forward with its spin-off plan and Kinder Morgan came back with sweetened (and unsweetened) offers while threatening to go hostile.

For Kinder Morgan and its legal team, led by Weil, Gotshal & Manges partner Thomas Roberts, El Paso’s potential spin-off put them in a race against an unknown deadline. “We didn’t know how soon [the spin-off] was going to happen,” Roberts says, though he assumed that it could be completed in a few weeks. (Bracewell & Giuliani was cocounsel to Kinder Morgan in the acquisition, and Simpson Thacher did debt financing work.)

El Paso took the offer seriously but did not pull its plans for the spin-off. Wachtell, Lipton, Rosen & Katz partner David Katz, who represented El Paso, says keeping it on track was key to the deal because El Paso always had an attractive alternative in its back pocket if acquisition talks failed. “We were fortunate in that we’d already filed with the SEC, and things were well down the pike,” Katz says. “We thought the spin would make a lot of sense and could be delivered in relatively short order.”

El Paso continued to hedge its bets. Indeed, according to Kinder Morgan’s securities filings, the day after the company CEOs agreed on $27.55 per share as “the basis for further negotiations,” El Paso filed an amended registration statement for its spin-off. Katz says the timing was coincidental, but “while it wasn’t planned to be part of the negotiation, we obviously used it in the negotiation. We were fortunate to have SEC comments to respond to, and by making that filing, it helped us show how serious” El Paso was about the spin-off.

“Deliberate or not, it makes a statement that they’re moving forward,” says Weil’s Roberts. “I don’t know that it helped their negotiation, but it didn’t hurt them.”

There was much left to negotiate. El Paso wanted Kinder Morgan to sign a standstill agreement, which it balked at initially because it wanted to keep the hostile bid option. (Such an agreement limits the number of shares that a bidder can purchase in a target firm during negotiations.) “We did not want to sign a standstill agreement unless we had a pretty good idea that we were close to the deal,” Roberts says.

“We came up with a middle ground of limited due diligence,” Katz says. “I think that was a creative solution to bridge a gap. I’ve seen plenty of negotiations break down over that exact point.”

With the limited confidentiality agreement in place, Kinder Morgan agreed to forgo financing contingencies and assume the risk of any government-mandated divestitures, also known as a “hell or high water” provision. Kinder Morgan also wanted to sell El Paso’s E&P unit before the deal closed to help with financing, and El Paso agreed to cooperate with the sale.

But there was one more major wrinkle. After entering into a full swap of confidential data, “Kinder Morgan became concerned that assumptions underlying its model were too aggressive,” according to its securities filing, and withdrew its $27.55 offer. Instead it offered cash and stock worth $25.50 per share and warrants to buy Kinder Morgan stock at $40 a share for a period of five years. Kinder Morgan claimed that that kept the cost of the deal at $27.55 a share.

“We pushed back, and things came to a halt for a period of time,” Katz recalls. “We continued to work on the spin, and they knew that, which made it that much closer to getting done.”

As commodity prices were starting to collapse and U.S. and European governments wrangled over debt issues, Kinder Morgan and El Paso agreed on October 16 on cash and stock of $25.91 per share, a slightly sweetened warrant component and limited dividend protection, for a 37 percent premium to El Paso’s most recent closing share price. At last, El Paso could put Project Zygosity—its planning for the spin-off—to rest.

Deal In Brief

Kinder Morgan–El Paso

Value  $38 billion

Weil’s Role  Acquiror’s Counsel

Wachtell’s Role  Target’s Counsel