During 2013, the Delaware Supreme Court has addressed challenges to transactions involving publicly traded limited partnerships in four cases: (1) Brinckerhoff v. Enbridge Energy Co., Inc., et al.1; (2) Norton v. K-Sea Transportation Partners L.P., et al.2; (3) Gerber v. Enterprise Products Holdings, L.L.C., et al.3; and (4) Allen v. Encore Energy Partners, L.P., et al.4
On the heels of its decisions in Enbridge and K-Sea Transportation, and immediately prior to its decision in Encore, each of which enforced partnership agreements exculpating directors and officers from claims for breaches of fiduciary duties, the Delaware Supreme Court in Gerber injected a cautionary note and reinvigorated the concept of the “implied duty of good faith and fair dealing.”
The Gerber case involved Enterprise GP Holdings, LP (“EPE”) and Enterprise Products Partners LP (“Enterprise Products LP”), which were part of a two-tiered Delaware master limited partnership structure. At issue were two transactions: (i) EPE’s 2009 sale of the general partner of a pipeline company, Texas Eastern Products Pipeline Company LLC (“TEPPCO GP”), by merger to Enterprise Products LP (the “2009 Sale”), and (ii) EPE’s 2010 decision to merge with Enterprise Products LP (the “2010 Merger”). Plaintiff Gerber, an EPE unitholder, challenged the approval of these transactions by EPE’s Audit, Conflict and Governance Committee (the “Committee”).
The 2009 Sale. EPE originally acquired the asset involved in the 2009 Sale—TEPPCO GP—for approximately $1.1 billion in 2007. The 2009 Sale was structured for tax purposes as two concurrent, cross-conditional mergers of Teppco Partners, L.P. (“Teppco L.P.”) and of its general partner, TEPPCO GP, in another agreement. For purposes of the motion to dismiss, and based solely on the untested allegations in the pleadings, the Delaware Supreme Court assumed that these concurrent transactions were “separately negotiated” and that EPE received consideration of approximately $100 million for TEPPCO GP. The Committee approved the 2009 Sale based in part upon a fairness opinion rendered by Morgan Stanley. Morgan Stanley opined that the total consideration paid for (i) the 2009 Sale and (ii) EPE’s sale of Teppco L.P. was fair from a financial point of view in the aggregate. Morgan Stanley expressly disclaimed any opinion as to the fairness of any particular component of the consideration, including the amount paid in the 2009 Sale alone.
The 2010 Merger. The 2010 Merger involved a conversion of each outstanding EPE limited partnership unit into 1.5 common units representing limited partner interests of Enterprise Products LP. In approving the 2010 Merger, the Committee again relied on an opinion by Morgan Stanley as to the fairness of the unit exchange ratio. The Delaware Chancery Court found for purposes of the motion to dismiss, again based solely on the plaintiff’s pleadings, that “a primary purpose” of the 2010 Merger was to eliminate derivative claims relating to EPE’s previous purchase of TEPPCO GP in 2007 and the sale of TEPPCO GP in 2009. Morgan Stanley’s opinion did not independently value those claims.
Section 17–1101(d) of the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) provides that a general partner’s duties, including fiduciary duties, “may be expanded or restricted or eliminated by provisions in the partnership agreement; provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”
EPE’s governing partnership agreement provided multiple protections to its general partner to insulate its decisions from judicial review. The agreement disclaimed fiduciary duties and provided that the general partner need only act in “good faith,” which the agreement defined as acting with a belief that a determination or other action “is in the best interests of the Partnership.” Likewise, the agreement provided a safe harbor for any transaction undertaken with “Special Approval” by the Committee. The agreement also created a “conclusive presumption” that the general partner acts in “good faith” where the “General Partner consult[s] with . . . [experts or] investment bankers . . . .” The Delaware Chancery Court held these provisions sufficient to insulate the defendants from liability and dismissed the case. The Delaware Supreme Court disagreed, finding that the Chancery Court “improperly conflates” the contractual obligation to act in good faith and the implied covenant of good faith and fair dealing.
The Supreme Court explained that a breach of the implied covenant occurs if the general partner acts “arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that [the affected class] reasonably expected.” Thus, claims for breach of the implied covenant turn on whether it is clear from the terms of the agreement that the parties would have prohibited the alleged conduct if they had thought to address it at the time of contracting. By contrast, the “good faith” obligation imposed by a partnership agreement focuses on the duties owed at the time of the alleged wrongdoing and the extent to which those duties have been breached.
Emphasizing the temporal distinction between the implied covenant and the contractual obligation, the Supreme Court found that the partnership agreement’s “conclusive presumption of good faith” could not retroactively alter Gerber’s expectations at the time of contracting. Thus, the agreement’s presumption did not bar Gerber’s claim for breach of the implied covenant. Turning to whether Gerber pled sufficient facts, the Supreme Court emphasized that in each of the fairness opinions relied on by the Committee, the consideration critical to the transaction (i.e., the fairness of the 2009 Sale price and the value of the legal claims extinguished by the 2010 Merger) had not been specifically addressed. The Supreme Court found that “Gerber has pled that [EPE] engaged in a manifestly unfair transaction, and then relied on an unresponsive fairness opinion, to ensure that its contractual fiduciary duty would be conclusively presumed to have been discharged.” The Supreme Court determined that Gerber could not have reasonably expected at the time of contracting that the Committee would rely on fairness opinions of this nature. For that reason, the Supreme Court held Gerber’s claim for breach of the implied covenant survived the defendants’ motion to dismiss.
It is important to keep in mind the context in which the decision in Gerber was rendered: the appeal of a dismissal on the pleadings, without the benefit of a developed evidentiary record, and in which the court must assume the facts pled by the plaintiff are true.
It is clear from the Delaware Supreme Court’s opinion that a partnership agreement may limit the fiduciary duty of good faith. But an agreement may not modify the “implied duty of good faith and fair dealing” contained in every contract, nor insulate the general partner from a violation of that implied duty, which occurs whenever the general partner acts arbitrarily or unreasonably to frustrate the unitholder’s bargain. One may expect that in future Delaware cases an alleged breach of the implied duty will be pleaded routinely. However, the Supreme Court set the bar high, requiring facts showing arbitrary and/or unreasonable conduct on the part of the general partner. Thus, while the Delaware Supreme Court has reinvigorated the implied duty in Gerber, only limited circumstances should give facts sufficient energy to hurdle that bar.