Two opinions affirm a powerful defense against certain typical MLP unitholder claims against the general partner, its affiliates, and individual directors.
On May 28, 2013, the Delaware Supreme Court issued two opinions addressing the conclusive presumption of good faith that can arise under a limited partnership agreement (LPA), which has been a topic of frequent debate in master limited partnership (MLP) litigation.
The Delaware Revised Uniform Limited Partnership Act (DRULPA) gives “maximum effect to the principle of freedom of contract.”1 DRULPA expressly allows parties to an LPA to restrict or eliminate traditional fiduciary duties, other than the implied contractual covenant of good faith and fair dealing.2 LPAs often expressly modify or replace traditional fiduciary duties with contractual standards applicable to different types of decisions by the general partner, and exculpate the general partner and its directors from monetary liability so long as they acted in “good faith” as defined in the LPA. Many LPAs provide a conclusive presumption that the general partner acts in good faith when it relies upon the advice of an expert advisor in making its decision.
In Norton v. K-Sea Transportation Partners, L.P. (K-Sea),3 the Supreme Court held that the LPA at issue imposed a “good faith” requirement upon the general partner in deciding whether to approve a merger, and that under the LPA “good faith” required only that the general partner reasonably believe that its actions were not inconsistent with the partnership’s best interests. The LPA also provided a conclusive presumption that the general partner acted in good faith, because it relied upon the opinion of a qualified financial advisor. Accordingly, the claims against the general partner as well as the individual director defendants were properly dismissed.
In Brinckerhoff v. Enbridge Energy Co., Inc. (“Enbridge”),4 the Supreme Court held that the general partner was entitled to a conclusive presumption of good faith because it relied on the opinion of a qualified financial advisor, despite the opinion containing language different from that of a typical fairness opinion. The Supreme Court also held that the plaintiff had not, in any case, adequately pleaded facts alleging bad faith against the general partner or the other defendants. Therefore, the claims against all defendants were properly dismissed.
The cases are discussed below in more detail.
Norton v. K-Sea Transportation Partners, L.P.
In 2011, K-Sea Transportation Partners L.P. (K-Sea) entered into a merger agreement with Kirby Corporation (Kirby). In addition to the per-share consideration accorded to common unitholders, the merger agreement called for a separate payment to K-Sea’s general partner (K-Sea GP), for its incentive distribution rights (IDRs).5 The merger received Special Approval from K-Sea’s Conflicts Committee, which consisted of independent members of the Board of Directors of K-Sea GP’s own general partner (KSGP), after the Conflicts Committee obtained an opinion from financial advisors Stifel Nicolaus & Co. (Stifel) that the consideration was fair from a financial perspective to the common unitholders. Thereafter, Plaintiffs, unitholders of K-Sea, filed suit against K-Sea, its directors, K-Sea GP, and related entities in the Delaware Court of Chancery. Plaintiffs alleged, among other things, breaches of contractual and fiduciary duties for approving the merger agreement without considering the fairness of the payment that was made to K-Sea GP for the IDRs. Plaintiffs also claimed that the grant of Special Approval was not effective.
Defendants filed a motion to dismiss, which the Court of Chancery granted in full. The Court of Chancery found that the LPA required two things for approval of a merger: (1) K-Sea GP’s consent and (2) approval by the holders of a majority of the common units.6 The Court of Chancery noted that under the LPA, K-Sea GP has sole discretion in granting consent, and may consider any interests or factors it chooses, but is not obligated to consider any specific interests or factors.7 The Court of Chancery found that the exercise of this discretion was constrained only by the LPA’s exculpation provision, which waived traditional fiduciary duties and substituted a narrower duty to act in good faith, contractually defined as “in a manner not inconsistent with the best interests of the Partnership as a whole.”8
The Court of Chancery described the LPA’s provision addressing potential conflicts of interest, which includes the Special Approval process, as a permissive “safe harbor”: a transaction that received Special Approval would be deemed fair and reasonable and therefore not a breach of the LPA, but failure to qualify for the safe harbor would not automatically result in a breach.9 Unlike in Enbridge (discussed below), in which the LPA specifically required the interested transactions at issue to be fair and reasonable to the partnership, the K-Sea LPA did not expressly state that all mergers must satisfy such a standard.10 The Court of Chancery found that K-Sea GP’s approval would only be a breach if it failed to meet the LPA’s controlling duty of good faith.11 The Court of Chancery then found that under the LPA’s conclusive presumption provision, K-Sea GP was deemed conclusively to have acted in good faith because it relied on Stifel’s opinion.12 The Court of Chancery also found the conclusive presumption of good faith satisfied the implied covenant of good faith and fair dealing.13
Plaintiffs appealed, arguing that the “fair and reasonable” standard applied to all transactions raising a potential conflict, and was not merely an optional safe harbor as the Court of Chancery found. Plaintiffs also argued that the Special Approval process was inadequate because the Conflicts Committee and the fairness opinion did not separately consider the IDR payment to K-Sea GP. Plaintiffs further argued that it was the Conflicts Committee, not K-Sea GP, that relied upon the fairness opinion, and that only K-Sea GP was entitled to the conclusive presumption of good faith in the LPA. Defendants countered that the Court of Chancery correctly interpreted the LPA and that Special Approval is a safe harbor and not mandatory.
The Delaware Supreme Court unanimously affirmed the trial court’s decision.14 The Supreme Court affirmed that the LPA grants K-Sea GP sole discretion to consent to a merger, without the need to consider any particular factors or interests.15 The Supreme Court found that K-Sea GP’s exercise of that discretion was subject only to the contractual duty to act in, or at least not inconsistent with, the best interests of K-Sea, which under the LPA replaced all other fiduciary duties that might otherwise exist.16
The Supreme Court noted that the LPA limited defendants’ monetary liability for damages to actions that were not taken in good faith, but it did not explicitly define “good faith” in that context.17 Construing the contract as a whole, the Supreme Court found that it could not “discern a rational distinction” between “good faith” in that provision and the contractually defined duty to act in, or at least not inconsistent with, the best interests of K-Sea.18
The Supreme Court further affirmed that the conflict-of-interest provision in the LPA, which includes the Special Approval process, is permissive and not mandatory.19 The Supreme Court noted that while the provision provides that if K-Sea GP’s resolution of a conflict of interest is fair and reasonable then it is not a breach of the LPA, it does not follow that the LPA has been breached if the resolution is not fair and reasonable.20 The Supreme Court cited other provisions in the LPA that supported this conclusion. In particular, one provision created an affirmative obligation not to engage in certain interested transactions unless they were fair and reasonable to K-Sea, and another provided that whenever the resolution of a conflict of interest is required to be fair and reasonable, the determination should be made in the context of similar or related transactions.21 The Supreme Court reasoned that the LPA’s drafters knew how to create an affirmative obligation when they intended to do so, and that not all resolutions of conflicts of interest were required to be fair and reasonable.22
Turning to whether K-Sea GP fulfilled its contractual duty to approve the merger in good faith, the Supreme Court stated that it could infer that K-Sea GP acted in bad faith from Plaintiffs’ allegation that it used its position to extract excessive IDR payments.23 However, the Supreme Court ultimately found that Plaintiffs failed to plead a cognizable claim that K-Sea GP did not act in good faith, because K-Sea GP relied on Stifel’s opinion in approving the merger and was thus conclusively deemed to have acted in good faith.24 The Supreme Court found it irrelevant that Stifel did not address the fairness of the IDR payment, because the LPA stated that K-Sea GP was not required to consider the interest of any person other than the partnership when approving a merger.25 The Supreme Court also noted defendants’ argument that the fairness opinion exceeded the requirements of the LPA by stating the consideration was fair to the limited partners, as opposed to the partnership as a whole, but declined to weigh in on whether an opinion addressing fairness to the partnership as a whole would fulfill a general partner’s duties on these facts.26
Finally, the Supreme Court rejected Plaintiffs’ argument that K-Sea GP was not entitled to the conclusive presumption because the Conflicts Committee, not K-Sea GP, relied on Stifel’s opinion. The Supreme Court found it unreasonable to infer that the entire KGSP Board of Directors did not rely on an opinion obtained by one of its committees, or that K-Sea GP—a “pass-through” entity controlled by KSGP—did not rely on the opinion.27 The Supreme Court did not address whether Plaintiffs would have a claim based on the implied covenant of good faith and fair dealing, because Plaintiffs had not raised that issue on appeal.28
The Supreme Court also held that although only K-Sea GP was entitled to the conclusive presumption of good faith, Plaintiffs nonetheless had no valid claim against the other defendants; Plaintiffs could not “state a cognizable claim for relief against the other defendants for causing K-Sea GP to take an action that did not breach K-Sea GP’s duties under the LPA.”29
Brinckerhoff v. Enbridge Energy Co., Inc.
In 2009, Enbridge Energy Partners, L.P. (EEP) entered into a joint venture agreement (JVA) with Enbridge, Inc. (Enbridge) to construct the Alberta Clipper Project (ACP).30 The Board of Directors of EEP’s general partner (EEP GP) formed a Special Committee and approved the transaction after obtaining an opinion from financial advisors Tudor Pickering Holt & Co. (Tudor) that the price was “representative of an arm’s length transaction.” Thereafter, Plaintiff, a unitholder of EEP, brought suit against EEP, EEP GP and various related entities, alleging breach of fiduciary duties and breach of the implied covenant of good faith and fair dealing, on the grounds that the JVA failed to take into account certain of EEP’s pre-existing contributions to the ACP.
Defendants filed a motion to dismiss, which the Court of Chancery granted in its entirety. The Court of Chancery noted that because this was an interested transaction, EEP’s LPA required that the transaction be fair and reasonable, a standard that was satisfied if the terms of the transaction were “no less favorable to [EEP] than those being generally available from or provided to unrelated third parties.”31 The Court of Chancery found that the exculpation provision of the LPA limited defendants’ monetary liability to only those acts that were not taken in good faith.32 The Court of Chancery further held that, under the LPA’s conclusive presumption provision, EEP GP was entitled to a conclusive presumption that it acted in good faith because it relied on Tudor’s opinion.33
Although none of the other defendants was entitled to the conclusive presumption of good faith, the Court of Chancery found that Plaintiff had not adequately pleaded allegations that they had acted in bad faith.34 The Court of Chancery also dismissed the breach of the implied covenant claim because the LPA expressly contemplated the conduct at issue.35 The Court of Chancery questioned whether a plaintiff could ever state a claim for breach of the implied covenant when the defendant was entitled to a conclusive presumption of good faith, but declined to rule on the issue because plaintiff had not adequately pleaded allegations of bad faith.36
Plaintiff appealed, arguing that he adequately pleaded bad faith, and that the exculpatory provision only barred monetary damages and not equitable remedies such as reformation. The Supreme Court remanded for consideration of plaintiff’s claims for reformation, but the Court of Chancery found that plaintiff had waived the claim by not raising it earlier. Plaintiff appealed again, asserting that the reformation claim was not waived, reasserting that the terms of the transaction were unfair, and arguing that Tudor’s opinion was not a fairness opinion because it did not use the typical “fair from a financial perspective” language or the language from the LPA that the terms were no less favorable than those available to third parties. Defendants responded that the Court of Chancery correctly found that the reformation claim had been waived and that the language in Tudor’s opinion was the equivalent of the customary fairness opinion language.
The Supreme Court adopted the Court of Chancery’s reasoning and affirmed its decision in all respects.37 The Supreme Court agreed that the LPA limited defendants’ monetary liability to acts that were not taken in good faith, and that only EEP GP was entitled to a conclusive presumption of good faith for relying on an expert’s opinion.38 Without addressing plaintiff’s argument regarding the language used in Tudor’s opinion, the Supreme Court affirmed that EEP GP was entitled to the conclusive presumption based on its reliance on that opinion.39 The Supreme Court affirmed that plaintiff failed to adequately plead facts alleging bad faith against the remaining defendants, noting that to do so would require that the decision to enter the JVA be “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”40 The Supreme Court also affirmed the dismissal of the implied covenant and reformation claims for the reasons expressed by the trial court.41
The Supreme Court noted, however, that this case is not the case to address the effect of a conclusive presumption on the availability of judicial review, because the trial court based its decision on both EEP GP’s conclusive presumption of good faith and Plaintiff’s failure to adequately allege bad faith.42
The K-Sea and Enbridge decisions demonstrate that conclusive presumptions arising under LPAs are valid and enforceable by their terms, and that where those terms have been satisfied they can provide a powerful defense against certain typical MLP unitholder claims against the general partner, its affiliates and individual directors. The decisions also make clear that the Delaware Supreme Court will read each LPA as a whole, and in a manner that gives meaning to all of its terms where possible. Each case will therefore turn on the specific language of the relevant LPA as applied to the transaction in question. Many issues remain to be addressed by the Supreme Court, including the interplay between the conclusive presumption of good faith and the non-waivable, implied contractual duty of good faith and fair dealing. In both K-Sea and Enbridge the Supreme Court noted that the plaintiffs had not properly raised those issues on appeal.43 The Supreme Court may address those issues in other cases that are currently pending before it.