The nation’s leading forum for business and shareholder disputes recently confirmed that alternative entities such as limited liability companies (LLCs), limited partnerships (LPs) and master limited partnerships (MLPs) can limit their managers’ fiduciary duties, or waive them altogether, by contract.
In Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc. (TCP), the Delaware Supreme Court affirmed the dismissal of a unitholder’s claims challenging the fairness of a transaction in which the general partner (GP) of a TransCanada MLP had a conflict of interest—a parent of the GP had sold a pipeline asset to the MLP. In its governing LP agreement, however, the MLP had carefully circumscribed the GP’s fiduciary duties under such conflict scenarios, and the GP satisfied its obligations under the LP agreement.
Consequently, the trial court held that the GP’s compliance with the applicable procedures set forth in the LP agreement precluded judicial review of the unitholder’s unfairness claims. The trial court explained: “[w]here equity holders in such entities have provided for such a custom menu of rights and duties by unambiguous contract language, that language must control judicial review of entity transactions, subject only to the cautious application of the implied covenant of good faith and fair dealing.” That is, managers of an alternative entity, unlike directors of a traditional corporation, can have their fiduciary duties limited or completely eliminated, with the exception of the implied contractual duty of good faith and fair dealing.
In TCP, the unitholder-plaintiff claimed that the sale of a pipeline asset by an affiliate of the GP was unfair to the partnership and that the GP orchestrated the transaction in bad faith. Under the LP agreement, the GP’s contractual obligation was to ensure that such conflicted transactions were “fair and reasonable” to the partnership. In addition, the LP agreement contained a safe harbor provision by which special approval of a conflicted transaction by a conflicts committee created a conclusive presumption that the transaction is “fair and reasonable.” The trial court held that because the GP obtained special approval of the transaction by a duly constituted and informed conflicts committee, the transaction was conclusively “fair and reasonable,” thus precluding judicial review of the fairness of the transaction.
The Delaware Supreme Court recently affirmed the trial court’s dismissal, holding that the plaintiff “cannot escape the conclusive effect given to Conflicts Committee approval solely by attacking the fairness of the underlying transaction.”
In short, the GP’s compliance with its contractual obligations in the LP agreement left no room for judicial scrutiny of the conflicted transaction.
The Supreme Court also upheld the dismissal of the plaintiff’s good faith and fair dealing claim. Delaware’s Revised Uniform Limited Partnership Act provides that although a managing partner’s “duties may be expanded or restricted or eliminated by provisions in the partnership agreement[,] . . . the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”
The trial court dismissed the plaintiff’s claim for breach of the implied covenant of good faith and fair dealing, reasoning that courts must “apply the implied covenant of good faith and fair dealing cautiously to infer contractual terms or gaps to address situations that the contracting parties did not anticipate.” Since the LP agreement explicitly supplied the standard for special approval of a conflicted transaction by a conflicts committee, there were no “gaps” to be filled by the implied covenant. The Supreme Court agreed, holding that “the implied covenant is narrowly applied . . . . [P]laintiffs may not invoke the covenant solely by contending that a transaction is unfair to the limited partnership and that the Conflicts Committee therefore must have acted in bad faith.”
TCP is an important affirmation of the principle that a carefully drafted LLC or LP agreement can reduce managers’ exposure to litigation by equity holders.