In a recent decision, the Delaware Court of Chancery provided additional guidance on the meaning of the "commercially reasonable efforts" required of parties to an acquisition agreement to ensure that the closing conditions are satisfied. The case arose from the proposed acquisition of Williams Cos by Energy Transfer Equity LP (ETE) – both publicly traded energy companies – for approximately $38 billion, based on the valuation at signing. The transaction involved a heavily negotiated and highly complex tax structure, stemming from Williams' desire for its stockholders to remain holders of publicly traded common stock (as opposed to partnership units) and to receive a significant cash payment. Because there were many potentially negative tax ramifications to the merger, the parties included:
- a condition to closing that ETE's tax attorneys, Latham & Watkins LLP, issue an opinion that the transaction "should" be treated by the tax authorities as a tax-free exchange under Section 721(a) of the Internal Revenue Code; and
- a covenant that required ETE to use "commercially reasonable efforts" to cause its tax attorneys to issue the 721 tax opinion.
However, following the execution of the merger agreement in September 2015, the energy markets deteriorated and the value of the parties' assets suffered a sharp decline that threatened ETE's ability to finance the $6 billion cash portion of the merger. As a result, ETE was left with what Vice Chancellor Glasscock described as "a bitter case of buyer's remorse"(1) and preferred to terminate, rather than restructure, the agreement. During this period, ETE's tax director reassessed several aspects of the merger structure and raised concerns that the Internal Revenue Service might not consider the transaction a tax-free exchange. After sharing those concerns, ETE's tax counsel at Latham reviewed the transaction and concluded that because of the decline in value of partnership units, the firm would be unable to deliver the necessary opinion before the merger closing, frustrating a closing condition and allowing ETE to terminate the agreement without penalty. While Williams' attorneys proposed two potential restructuring solutions, Latham concluded that neither proposal would enable it to deliver the opinion.
Williams brought suit against ETE, claiming that it had failed to use "commercially reasonable efforts" to obtain the tax opinion and should be enjoined from terminating the merger agreement. Following a two-day expedited trial, the chancery court held that ETE could terminate the merger agreement, even after assessing its non-tax related motivation with a "skeptical eye". The court found no evidence that ETE's tax attorneys had been unduly pressured into changing their analysis or had otherwise acted in bad faith, and reasoned that the reputational damage Latham was likely to incur far outweighed any benefits of "unethical deferring" to the interests of this particular client.
The court then analysed the meaning of the term 'commercially reasonable efforts', which was undefined in the merger agreement. Based on a 2008 decision of the Delaware Supreme Court,(2) the chancery court determined that "commercially reasonable efforts" required ETE "to do those things objectively reasonable to produce the desired 721 opinion, in the context of the agreement between the parties". Because Williams was unable to provide any commercially reasonable efforts that ETE could have taken for Latham to issue the opinion, the court could not conclude that ETE had breached the agreement.
This decision illustrates that parties may not have a meeting of minds on what various clauses entail, particularly covenants and agreements that require some efforts standard, underscoring the risk of reliance on undefined terms that tie to important closing conditions.
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Gala Ades-Laurent also contributed to this update.