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In re K-Sea Transportation Partners L.P. Unitholders Litigation, C.A.No. 6301-VCP (Del. Ch. June 10, 2011) (Parsons, V.C.)

June 10, 2011

In this opinion, the Delaware Court of Chancery denied the motion of the plaintiffs, common unitholders in K-Sea Transportation Partners L.P. (the “Plaintiffs”), to expedite their challenge of a proposed merger between K-Sea Transportation Partners L.P., a Delaware limited partnership (“K-Sea”), and Kirby Corporation (“Kirby”). The Court found that, although the Plaintiffs established a colorable claim that the proposed merger was not fair and reasonable, the Plaintiffs failed to show a sufficient possibility of irreparable injury to justify expedited relief.

In the proposed merger, Kirby offered to purchase K-Sea’s equity interests for $329 million, with $18 million specifically allocated to pay for the units and incentive distribution rights (“IDRs”) held by K-Sea’s general partner. The K-Sea Board of Directors (the “Board”) recognized that the $18 million allocation to the general partner created a potential conflict of interest and followed the procedures governing conflict of interest transactions in the K-Sea Limited Partnership Agreement (the “LPA”). The LPA permits the consummation of transactions presenting a possible conflict of interest in several ways. One such way, through which such a transaction is conclusively deemed to be fair and reasonable to K-Sea, is if the transaction is approved (a “Special Approval”) by a conflicts committee of the Board (the “Committee”).  The Committee – consisting of three independent, non-employee Board directors – unanimously found that the proposed merger was fair and reasonable to K-Sea and its limited partners and issued a Special Approval of the proposed transaction. The full K-Sea Board accepted the Committee’s approval and recommended that unitholders vote to adopt the merger agreement and approve the merger with Kirby.

The Plaintiffs alleged that the proposed merger transaction was not fair and reasonable to K-Sea’s limited partners for three reasons. First, they argued that the Committee had a duty to consider separately the fairness of the $18 million payment in exchange for the general partner’s units and IDRs, and that the Committee failed to satisfy that duty by evaluating only the fairness of the proposed transaction as a whole. The Court rejected this allegation, finding that the language of the LPA did not support the Plaintiffs’ arguments that the Committee had a duty to consider the $18 million allocation in isolation. The Court emphasized that the LPA governs the affairs of K-Sea and held that the Committee satisfied its duty to determine that the proposed merger transaction was fair and reasonable to K-Sea by complying with the requirements of the LPA.

The Court likewise rejected the Plaintiffs’ second allegation that the Board’s and the general partner’s disclosures regarding the proposed merger were materially misleading, finding that the Board and the general partner satisfied their disclosure duties by complying with the provisions of the LPA addressing what information and notices must be provided to limited partners in the event of a proposed merger.The Court rejected the Plaintiffs’ contention that default fiduciary duties imposing more stringent disclosure applied, emphasizing that the Delaware Revised Uniform Limited Partnership Act gives “maximum effect to the principle of freedom of contract,” and affords parties the discretion to draft their partnership agreements to limit traditional fiduciary duties. The Court held that courts should consider default fiduciary duties only when the partnership agreement is silent on the issue. While the LPA provided that default fiduciary duties could apply to the extent not otherwise provided in the LPA, the Court stated that any such default fiduciary duties that might otherwise be applicable with regard to the merger disclosure had in fact been overridden by the LPA, in large part by the merger provisions of the LPA. Because the LPA indicated what information the Board and the general partner were required to disclose to the limited partners in the event of a proposed merger, and the Board and the general partner complied with those requirements, the Court held that the Board and the general partner satisfied their disclosure duties.

The Court accepted the Plaintiffs’ third argument that the independence of the members of the Committee could have been compromised, and in such event, the LPA might not authorize the Committee to grant Special Approval of the merger transaction. Here the Plaintiffs pointed to each of the Committee members’ receipt of 15,000 phantom common units in December 2010, immediately before merger negotiations with Kirby began. The phantom unit awards were scheduled to fully vest over five years in equal installments or immediately upon a change of control. Therefore, the Plaintiffs argued, the Committee members had a decided financial interest in approving the proposed merger, which would result in the accelerated vesting of the phantom units. The Court noted that the phantom units granted to the Committee members constituted a significant portion of their total holdings in K-Sea and acknowledged that the prospect of immediate vesting of the phantom units may have biased the Committee members’ judgment in favor of the merger. The Court also noted that the closely correlated timing between the grant of the phantom units and the merger negotiations supported an inference that it might have been made with an intent to influence the Committee members’ consideration of the merger. Because the Committee’s independence may have been impermissibly tainted by the receipt of the phantom units so that their authority to provide a Special Approval of the merger was void, the Court found that the Plaintiffs had articulated a colorable claim that the proposed merger was not fair and reasonable.

The Court nonetheless denied the Plaintiffs’ motion to expedite because the Plaintiffs failed to demonstrate a sufficient possibility of a threatened irreparable injury that would justify an expedited preliminary injunction proceeding. The Plaintiffs argued that they would suffer irreparable harm if the Court did not grant expedited relief because they might not be able to collect on any judgment they obtained in the litigation. The Plaintiffs alleged that collection would be difficult, if not impossible, because 90% of the economic interest in K-Sea is owned by pass-through entities that would likely be judgment proof by the time the Plaintiffs sought to collect on any judgment. The Court recognized that a plaintiff may show irreparable injury if he demonstrates that he will be unable to collect on a judgment, or if there is a substantial likelihood that he will be unable to do so, but the Court found that the Plaintiffs did not meet this burden. The Plaintiffs offered only “speculation” that collection might be difficult or impossible, instead of facts sufficient to show that collection is likely to be difficult or impossible. Accordingly, the Court held that Plaintiffs did not establish the required showing of irreparable harm and denied plaintiffs’ motion to expedite.

The full opinion is available here