On March 23, 2017, the Supreme Court of Delaware affirmed the Court of Chancery’s denial of an injunction sought by plaintiff The Williams Companies, Inc. to prevent defendant Energy Transfer Equity, L.P. from terminating a merger of the two energy companies. The Williams Companies., Inc. v. Energy Transfer Equity, L.P., C.A. Nos. 12168 & 12337 (Del. Mar. 23, 2017). The 4-1 decision authored by Justice James T. Vaughn, Jr. determined that the Chancery Court erred by “adopt[ing] an unduly narrow view of the obligations imposed” by defendant’s covenants in the merger agreement to use “reasonable best efforts” to consummate the deal and “commercially reasonable efforts” to secure an opinion from its outside tax counsel—a condition precedent to the merger—that the transaction qualified for tax-free treatment. According to the Delaware Supreme Court, those provisions “placed an affirmative obligation on the parties to take all reasonable steps to obtain the [tax-free] opinion and otherwise complete the transaction.” Nevertheless, the Supreme Court affirmed the denial of the injunction because the Chancery Court found that defendant’s conduct (or lack thereof) did not “materially contribute” to outside tax counsel’s decision not to issue the tax-free opinion.

The parties entered into a merger agreement in September 2015. Significantly, “[t]he merger was conditioned upon the issuance of an opinion by [defendant’s] tax counsel . . . that the second step of the transaction, the transfer of [plaintiff’s] assets to [defendant] in exchange for . . . partnership units, ‘should’ be a tax-free exchange of a partnership interest for assets under Section 721(a) of the Internal Revenue Code.” The merger agreement also contained provisions that required the parties to use “commercially reasonable efforts” to obtain the tax-free opinion and to use “reasonable best efforts” to consummate the transaction.

According to the Court, the decline of the energy market after signing made the deal “financially undesirable” to defendant, which then “rais[ed] an issue” with its tax counsel as to whether the IRS might view a portion of the transaction taxable, and “[t]he issue ultimately led to [tax counsel] being unable to issue the [tax-free] opinion.” As the opinion was a condition of the transaction, defendant “indicated that it would not proceed with the merger.” Plaintiff sued to enjoin the termination of the merger, alleging that defendant had breached its obligations under the merger agreement to use “commercially reasonable efforts” to obtain the tax-free opinion and “reasonable best efforts” to complete the deal. The Chancery Court denied the injunction after an expedited trial, relying principally on the ground that defendant’s tax counsel had acted in good faith and that defendant did not obstruct the issuance of the opinion.

The Delaware Supreme Court found that the Chancery Court took too narrow a view of defendant’s duties to use “commercially reasonable efforts” and “reasonable best efforts.” Instead of “imposing only a negative duty not to thwart or obstruct performance,” the Court explained that “covenants like the ones involved here impose obligations to take all reasonable steps to solve problems and consummate the transaction.” Notably, the Supreme Court did not clearly distinguish between these two covenants. Turning to the facts, the Court found that “[t]here was evidence . . . from which it could have concluded that defendant did breach its covenants,” including by not “engag[ing] earlier or more fully” with plaintiff to resolve the issue and by publicly disclosing that its tax counsel had declined to issue the opinion. The Court nonetheless determined—based on a footnote in the Chancery Court’s decision—that defendant’s “action or inaction” did not “materially contribute to the failure of the [tax-free opinion] condition” because it was a “good faith determination made by [tax counsel] independent of any conduct by [defendant].” Therefore, the Supreme Court affirmed the Chancery Court’s denial of the injunction.

Dissenting, Chief Justice Leo E. Strine, Jr. explained that because the Chancery Court did not analyze the issue with the proper “lens,” he would have remanded the case for a new trial “at which [defendant] would be required to prove that its breach did not materially contribute to the failure of [tax counsel] to deliver the [tax free] opinion.”

Click here to view the judgement.