The path from the signing of a merger agreement to the closing of the transaction can be long and labor-intensive, potentially requiring the parties to secure a range of stockholder approvals, antitrust and other regulatory approvals, debt and equity financing arrangements, and third party consents. In framing these pre-closing requirements, M&A practitioners often distinguish between those actions that are wholly within the parties’ control, which can be addressed by unqualified commitments to achieve the desired results, and those that are not, which can be addressed instead only by the parties’ undertakings to seek the desired results.
The extent to which the parties are then obligated to seek to achieve such results can be subject to extensive wordsmithing -- must they use their “best efforts”, “reasonable efforts”, “good faith efforts”, “reasonable good faith efforts”, “commercially reasonable efforts”, “commercially reasonable best efforts” or some other formulation along those lines? While one may assume a hierarchy of meaning among these terms (such that, for example, “best efforts” may be considered a more stringent standard than “reasonable efforts”), courts have generally provided limited guidance to their underlying meaning.
In Williams Cos. v. Energy Transfer Equity, LP, decided on June 23, 2016, the Delaware Court of Chancery considered whether a buyer’s pre-closing conduct constituted “commercially reasonable efforts” under Delaware law, revisiting its 2008 decision in Hexion Specialty Chemicals, Inc. v. Huntsman Corp. While the Williams opinion does not clarify whether “commercially reasonable efforts” has a meaning that is different than, for example, “best efforts,” it does provide greater clarity as to how these undertakings will be interpreted in context.
The Merger Agreement
The Williams case arises out of the proposed merger between The Williams Companies, Inc. and Energy Transfer Equity, L.P., both major gas pipeline companies, in a heavily negotiated transaction involving a complex, tax-driven structure. Following the execution of the merger agreement in September 2015, however, the energy markets plummeted. This resulted in a steep decline in the value of the parties’ pipeline assets and accordingly threatened Energy Transfer’s ability to secure the debt financing required to pay the $6 billion cash portion of the merger consideration. At this point, the financial rationale for the transaction evidently became less compelling to Energy Transfer and, according to court testimony, it was believed that Energy Transfer would have preferred simply to terminate the transaction rather than restructure its terms and conditions.
A critical element of the multi-step transaction structure was to ensure the tax-free treatment of the transaction. To that end, the closing of the transaction was conditioned upon Energy Transfer’s outside tax counsel delivering an opinion to the effect that the transaction should qualify as a tax-free exchange under the applicable Internal Revenue Code provision. During the pre-closing period, however, Energy Transfer’s tax director reassessed certain aspects of the transaction structure and raised concerns that the IRS might not in fact view the transaction as tax-free. Taking into account these concerns, Energy Transfer’s outside tax counsel ultimately concluded that they would be unable to deliver their tax opinion at the closing of the merger -- thus frustrating one of the closing conditions to the transaction and enabling Energy Transfer ultimately to terminate the merger agreement. In response, Williams proposed two potential restructuring solutions intended to address these the tax issues, but Energy Transfer’s outside tax counsel concluded that neither such proposal would enable it to provide the required opinion. Williams then brought suit in the Delaware Chancery Court, alleging, among other things, that Energy Transfer materially breached its obligations under the merger agreement to use “commercially reasonable efforts” to obtain the tax opinion at closing and, accordingly, to enjoin Energy Transfer from terminating the merger agreement.
The Court’s Decision
Williams argued that this was a classic case of buyer’s remorse, making the “veiled suggestion” that Energy Transfer, now eager to extricate itself from the transaction, had pressured its outside tax counsel into accepting its view as to a “bogus” tax issue that would preclude it from rendering its opinion at closing, and that Energy Transfer had thus failed to use commercially reasonable efforts to obtain the required opinion in order to complete the transaction.
Vice Chancellor Glasscock states in his opinion that, while it is not a defined term in the merger agreement, “commercially reasonable efforts” should be understood as an “objective standard” under Delaware law, requiring the party so obligated to “do those things objectively reasonable to produce the desired [tax opinion] in the context of the agreement reached by the parties.” On that basis, even assuming that Williams was correct as to Energy Transfer’s motives, and even assuming that outside counsel may be predisposed to taking positions favored by their clients, Vice Chancellor Glasscock ruled in favor of Energy Transfer, concluding that Williams had failed to identify any specific actions that Energy Transfer could reasonably have taken that would have caused its outside counsel, acting in good faith, to deliver the required opinion.
Comparison to Hexion
Williams relied heavily in its argument on the Chancery Court’s earlier decision in Hexion. As Vice Chancellor Glasscock notes in Williams, the facts of that case are very similar to Hexion on a superficial level: both involve a buyer seeking to terminate a merger agreement due to changed circumstances and a target company alleging that, in doing so, the buyer had failed to use its commercially reasonable (or reasonable best) efforts to close the transaction as required by the merger agreement.
In Hexion, the buyer asserted that it could not close the transaction because of a failure to obtain its required debt financing against the backdrop of underperformance in Huntsman’s business following the signing of the merger agreement and the broader impact of the looming financial crisis of 2008. Vice Chancellor Lamb held that Hexion had not used “reasonable best efforts” to consummate the debt financing required to close its merger with Huntsman. This conclusion was based, among other things, on the fact that Hexion had, without first consulting with Huntsman and based on allegedly skewed financial information, obtained a third party opinion that the combined company would be insolvent, and then made the insolvency opinion publicly available -- thereby scuttling its required debt financing for all practical purposes.
Vice Chancellor Lamb essentially conflated the buyer’s failure to use its reasonable best efforts to close the merger with a lack of good faith, finding that Hexion had knowingly and intentionally breached its obligations under the merger agreement -- or, as Vice Chancellor Glasscock put it in Williams, that Hexion had “actively and affirmatively torpedoed its ability to finance.”
By contrast, while Energy Transfer may have been equally eager to avoid its deal, Vice Chancellor Glasscock found no evidence in Williams that its outside tax counsel had been unduly pressured into changing its analysis or had otherwise conducted itself in bad faith -- rather, although Energy Transfer may not have exhausted every possible option to restructure its deal, it did not act affirmatively to frustrate its closing conditions, and there were apparently no commercially reasonable alternatives that would have changed the outcome.
It is the latter point that makes Williams an instructive case for M&A practitioners. While it may be facile to conclude that “commercially reasonable efforts” must mean something other than “actively and affirmatively torpedo[ing]” a transaction, the Hexion decision included broader language suggesting that a buyer must also determine whether there are any “viable options… to allow it to perform without disastrous financial consequences” [emphasis added]. This language appeared somewhat at odds, for example, with the leading New York law case on this topic, Bloor v. Falstaff Brewing Corp., which held that the ostensibly more stringent “best efforts” standard “does not prevent the party from giving reasonable consideration to its own interests.”
The Williams decision takes a slightly more nuanced approach, however, excusing Energy Transfer’s failure to entertain Williams’ restructuring proposals on the basis that the proposals evidently would not have changed its outside tax counsel’s analysis -- and thus would not have achieved the desired result. Indeed, while Energy Transfer did solicit a second opinion from another outside tax counsel (which also concluded that it could not deliver the required tax opinion, albeit based on a completely different analysis), it otherwise appeared not to have sought out any other “viable options” to complete its transaction.
While the Williams decision states that “commercially reasonable efforts” should be understood as an objective standard, it is clear by comparison to Hexion that the subjective facts of the parties’ underlying conduct may inevitably have a bearing on the manner in which compliance with such a standard is interpreted. Likewise, the decision does not address whether the outcome would have been different if Energy Transfer had been obligated to use its “best efforts” to obtain the tax opinion, and may thus not avoid future lawyerly debates over the appropriate “efforts” standard for pre-closing covenants in M&A agreements.
Whether or not it is borne out in the case law, however, M&A practitioners often default to distinguishing between “best” and “commercially reasonable” efforts solely on the basis of whether a particular course of action would be costly to the parties. Although the case law regarding “efforts” may still be somewhat muddled on the whole, Williams does makes more clear that “reasonableness” should be viewed in relation to the intended results, and whether a course of action will be viewed as “commercially reasonable” will be based not only on whether it is financially burdensome to the parties, but also on whether it can reasonably be expected to achieve the desired outcome.