In a memorandum opinion, Chancellor Bouchard of the Delaware Chancery Court recently dismissed a class action challenging the merger of a Delaware master limited partnership (MLP) with an affiliated entity for, among other alleged reasons, breaching the contractual requirement in the MLP’s partnership agreement that the MLP’s general partner act in good faith.1 The provisions of the MLP’s partnership agreement expressly eliminated all fiduciary duties and replaced them with contractual standards governing conflicted transactions, which Chancellor Bouchard considered “critical to th[e] case.”
Consistent with past Delaware precedent, this opinion serves as a reminder to MLPs, their general partners and MLP investors that Delaware courts will honor an MLP’s decision to contractually eliminate state law fiduciary duties in the partnership agreement, including the duty of disclosure, and replace them with alternative contractual standards governing conflicted transactions. Moreover, the decision emphasizes that where the alternative contractual “safe harbor” process in an MLP’s partnership agreement is satisfied, a conflicted transaction is immune to judicial review in Delaware. As a result, strict compliance with the partnership agreement’s safe harbor process is key to shielding a conflicted transaction from judicial scrutiny.
MLPs can contractually eliminate state law fiduciary duties. MLPs, like other Delaware limited partnerships, are governed by their partnership agreements and by the Delaware Revised Uniform Limited Partnership Act (DRULPA). DRULPA has an explicit policy “to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements.”2 Thus, when an MLP eliminates fiduciary duties in its partnership agreement, Delaware courts will refrain from providing the judicial review typically applied in the corporate context, although partnership agreements cannot eliminate the implied covenant of good faith and fair dealing.
Like most MLP partnership agreements, the partnership agreement at issue eliminated all fiduciary duties and replaced them with a series of safe harbors intended to address potentially conflicted transactions. Under the partnership agreement’s terms, only one of the safe harbors must be satisfied to cause a potentially conflicted transaction to be deemed approved by all limited partners and not to constitute a breach of the partnership agreement or of any express or implied duty in law or equity. Defendants argued the merger was shielded from judicial review because two of the safe harbors were satisfied:
- the merger was approved by “Special Approval” (that is, a majority of the members of the conflicts committee of the board of the MLP’s general partner); and
- the merger was approved by a majority of the unaffiliated common units (that is, the units not held by the MLP’s general partner or its affiliates).
Chancellor Bouchard only addressed the unaffiliated unitholder approval safe harbor because it was undisputed that the merger was approved by the holders of a majority of the unaffiliated common units.
An MLP’s contractual elimination of fiduciary duties also eliminates the duty of disclosure under Delaware law. Plaintiff argued that the unaffiliated unitholder approval safe harbor could not be relied upon because unitholders were not fully informed about the merger due to alleged omissions from the merger proxy statement. Under Delaware common law, a general partner owes a duty to fully disclose all material information when seeking unitholder action, which duty is derived from the duties of care and loyalty.
Chancellor Bouchard found that by expressly eliminating all fiduciary duties, the MLP’s partnership agreement also eliminated Delaware’s common law duty of disclosure and replaced it with the partnership agreement’s sole disclosure requirement to provide unitholders a copy or summary of the merger agreement with the notice of special meeting to approve the merger. As a result, no other disclosure obligations existed under the express terms of the partnership agreement. Moreover, Chancellor Bouchard found that the implied covenant of good faith and fair dealing would not create additional disclosure obligations under the partnership agreement where, as here, the partnership agreement expressly extinguished the duty of disclosure and replaced it with “an explicitly delineated alternate system.”
As a result, Chancellor Bouchard found that the plaintiff failed to state a claim for relief because the unaffiliated unitholder approval safe harbor applied, meaning that the merger was immune to challenge for contractual breach.3
Partnership agreements cannot eliminate disclosure obligations under the federal securities laws. Despite the elimination of state law fiduciary duties, Chancellor Bouchard noted that MLP investors could still seek recourse under the federal securities laws if they took issue with the information received prior to voting on the merger. As a result, MLPs should always consider all of their obligations under the federal securities laws when preparing public disclosures regardless of what disclosure obligations exist in their partnership agreements.
Investors are responsible for understanding any limitations on their rights imposed by MLP partnership agreements. Despite acknowledging the potential harshness of shielding a conflicted transaction from judicial review under Delaware law without requiring the disclosure of all material information as part of the unitholder vote, Chancellor Bouchard reminded those who invest in alternative entity structures, like MLPs, of Delaware’s “express policy…to give maximum effect to the principle of freedom of contract,” which policy “affords commercial parties the advantage of great flexibility to privately order their affairs…[which] flexibility can come at a cost.” He further noted that this case serves as a reminder that investors “must be careful to read those agreements and to understand the limitations on their rights.”