On September 20, 2018, the Delaware Supreme Court affirmed the dismissal of claims for breach of the implied covenant of good faith and fair dealing brought against the controlling unitholder and its affiliates on the board of a company that provides services to children with disabilities in connection with the sale of that company. Miller v. HCP Trumpet Investments, LLC, No. 107, 2018 (Del. Sept. 20, 2018). Pursuant to a waterfall set forth in the company’s operating agreement (the “OA”), the controlling investor was entitled to nearly all of the first $30 million in proceeds in the event of a sale. The OA, which included an explicit waiver of fiduciary duties, provided that the board could approve a sale of the company to an independent third party and “determine in its sole discretion the manner in which [such sale] shall occur, whether as a sale of assets, merger, transfer of [m]embership [i]nterests or otherwise.” After the company was sold for $43 million, minority members sued for breach of the implied covenant of good faith and fair dealing, arguing that it imposed an obligation to conduct an “open-market” sale process to ensure maximum value for all members. Although the Delaware Supreme Court disagreed with the Delaware Court of Chancery’s holding that the implied covenant did not apply to the sale, the Court affirmed the dismissal on the basis that the implied covenant did not imply Revlon-type sale requirements.
Plaintiffs alleged that defendants engineered a quick sale of the company at a below-market price reflecting defendants’ “perverse incentive” to sell the company without concern for maximizing value because the controlling investor was entitled to the bulk of the first $30 million but nearly nothing of the proceeds above that. The Delaware Court of Chancery found that the OA afforded the controller-dominated board “sole discretion” as to the manner in which to “market the company,” subject to the limitation that the sale is to an unaffiliated third-party buyer. According to the Court of Chancery, the OA thus explicitly addressed how the company should be sold and, therefore, “leaves no room for the implied covenant to operate.” As an alternative holding, the Court found that, even if the implied covenant did operate to regulate the manner of a sale, plaintiffs failed to demonstrate that the parties would have proscribed a sale through a private negotiation rather than an open-market process if the issue had arisen at the time of contracting.
The Delaware Supreme Court affirmed the dismissal of the implied covenant claims, concurring with the Court of Chancery’s “essential holding” that the “clear elimination of fiduciary duties is inconsistent with the plaintiff[s’] argument that the agreement’s implied covenant subsumes the affirmative duties imposed upon corporate boards in the change of control context by Revlon.” But the Supreme Court disagreed with the Court of Chancery’s determination that the “sole discretion” provision applied to the marketing of the company. Instead, the Court found that it afforded the board “sole discretion” as to the manner in which the sale would be structured after it otherwise agreed to sell the company. Moreover, the Court emphasized that, even if the language applied to the way the company was sold, the board was still “obligat[ed] to use that discretion consistently” with the implied covenant. The Court added that the inclusion of specific provisions regarding conflict-of-interest transactions is relevant to the application of the implied covenant, “but does not vitiate its application.”