Williams Companies, Inc. v. Energy Transfer Equity, L.P., et al., No. 330, 2016 (Del. Mar. 23, 2017) – The Delaware Supreme Court affirmed the judgment entered by the Court of Chancery in favor of the defendant concerning the defendant’s termination of a merger agreement. The Court held that although there was evidence from which the trial court could have found that the defendant breached certain covenants, the breach did not materially contribute to the termination of the agreement, and thus, judgment in favor of the defendant was appropriate. Chief Justice Strine dissented, finding fault with the “lenses” through which the Court of Chancery viewed the evidence.

This appeal concerned a failed merger between The Williams Companies, Inc. and Energy Transfer Equity, LP. The merger was structured into two parts. First, The Williams Companies, Inc. would merge into a new entity called Energy Transfer Corp. LP, and Energy Transfer Equity, LP would transfer $6.05 billion to Energy Transfer Corp. LP in exchange for 19% of the newly formed limited partnership’s stock. Second, Energy Transfer Corp. LP would transfer the assets of The Williams Companies, Inc. to Energy Transfer Equity, LP in exchange for newly issued Class E partnership units with Energy Transfer Equity, LP. The merger would cause The Williams Companies, Inc. to receive $6.05 billion and 81% ownership interest in Energy Transfer Corp. LP, while Energy Transfer Equity, LP would own the assets of The Williams Companies, Inc. and a 19% stake in Energy Transfer Corp. LP.

The merger was conditioned on the issuance of an opinion from Energy Transfer Equity, LP’s tax attorney that the second step of the transaction would qualify as a tax-free exchange under Section 721 of the Internal Revenue Code. The agreement included a provision which required the parties to use “commercially reasonable efforts” to obtain the tax opinion. The agreement also required the parties to use “reasonable best efforts to take … all things necessary, proper or advisable to consummate and make effective, in the most expeditious manner practicable” the merger.

After the parties executed the merger agreement, the energy market suffered an economic downturn which resulted in a significant decline in the value of the assets transacted between the parties. Energy Transfer Equity, LP’s shares, in fact, were worth only $2 billion. This decrease in value caused Energy Transfer Equity, LP to question whether the second step of the transaction would qualify under Section 721 of the Internal Revenue Code. Energy Transfer Equity, LP notified its tax attorney of its concerns. Prior to this communication, the tax attorney was prepared to issue the necessary opinion in furtherance of the deal. However, after speaking with Energy Transfer Equity, LP, the tax attorney concluded that it was no longer able to issue the opinion. Tax counsel for The Williams Companies, Inc. disagreed with this conclusion and offered two proposals to resolve the issue. The tax attorney for Energy Transfer Equity, LP determined that neither proposal would allow it to issue the tax opinion. Accordingly, Energy Transfer Equity, LP terminated the agreement.

Plaintiff The Williams Companies, Inc. filed suit, alleging that Defendant Energy Transfer Equity, LP breached the agreement by failing to use “commercially reasonable efforts” to obtain the tax opinion and “reasonable best efforts” to complete the deal. The Court of Chancery entered judgment in favor of the defendant. The plaintiff appealed.

The Delaware Supreme Court held that the Court of Chancery erred in finding that Energy Transfer did not breach its contractual duties to exercise “commercially reasonable efforts” to obtain the tax opinion or make “reasonable best efforts” to consummate the transaction. The relevant contractual provisions imposed “an affirmative duty to help ensure performance[,]” as opposed to “a negative duty not to thwart or obstruct performance.” The Court of Chancery erred in viewing these contractual provisions through a negative lens and focusing on the absence of evidence to show that Energy Transfer did not breach its covenants.

Despite this error, the Delaware Supreme Court held that the Court of Chancery applied the correct burden of proof in concluding that Energy Transfer did not prevent the consummation of the deal. The rule is that “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of the transaction. The plaintiff has no obligation to show what steps the breaching party could have taken to consummate the transaction.” Although the Court of Chancery found that Energy Transfer did not breach any covenants in the first phase of the analysis, the trial court nevertheless addressed the second phase in a footnote which the Court viewed as sufficient for purposes of determining whether Energy Transfer materially contributed to the failed transaction. The trial court found that there was no evidence linking Energy Transfer’s action or inaction to the failed transaction, and the Court held that such finding was not clearly erroneous.

Williams also claimed that the Court of Chancery erred in finding that Energy Transfer was not equitably estopped from terminating the transaction. “The doctrine of equitable estoppel may be invoked when a party by his conduct intentionally or unintentionally leads another, in reliance upon that conduct, to change position to this detriment.” The Court rejected this argument, holding that the tax attorney, and not Energy Transfer itself, changed its position. The Court held that Energy Transfer was unaware of the potential tax liability and, at all times, sought to consummate the deal. Accordingly, the Court affirmed the entry of judgment.

Chief Justice Strine, in his dissent, found fault with the lens through which the majority and the Court of Chancery viewed the evidence. The covenants to exercise “commercially reasonable efforts” and “reasonable best efforts” imposed an affirmative obligation to support the closing of the deal, yet the trial court focused on what actions Energy Transfer did not take to block the tax opinion. “[B]oth parties [must] work together to resolve [their] problems in good faith. If one party does not, and that party also committed to a particular level of effort to fulfill such conditions, that may constitute a covenant breach.” Chief Justice Strine held that there was sufficient evidence in the record to conclude that Energy Transfer breached its covenants and such breach materially contributed to the failure of the transaction. He noted that “it was rather obvious that [Energy Transfer] did not wish to go through with the deal” and “it was difficult to imagine that [it] was not putting implicit, but undeniably extant, pressure on [its tax attorney] to have doubts about whether he could give the opinion.” The dissent concluded that Energy Transfer looked for ways to get out of the deal despite its contractual duty to exercise “commercially reasonable efforts” and “reasonable best efforts,” respectively, and where “you breach your obligation to help a condition come about, you do not get credit for rigging the game.”

The Delaware Supreme Court’s holding is noteworthy concerning its interpretation of the covenants to exercise “commercially reasonable efforts” and “reasonable best efforts” as imposing an affirmative obligation on the parties. Where a contract includes such affirmative covenants, no party may sit idle, watch the deal shrivel on the vine and subsequently deny liability because of its inaction. While the Court failed to shed considerable light on what conduct constitutes “commercially reasonable efforts” or “reasonable best efforts,” such covenants require action, including, but not limited to working with a counterparty to address issues in a collaborative fashion and facilitating cooperation between the parties and their professionals.