Williams Cos., Inc. v. Energy Transfer Equity, L.P., C.A. Nos. 12168-VCG & 12337-VCG (Del. Ch. June 24, 2016) (Glasscock, V.C.)
In this post-trial decision, the Court of Chancery permitted Energy Transfer Equity, L.P. (“ETE”) to terminate its agreement to acquire The Williams Companies, Inc. (“Williams”) after a decline in the energy market rendered the acquisition unpalatable to the buyer. Noting that “even a desperate man can be an honest winner of the lottery,” the Court held that, notwithstanding ETE’s commercially reasonable efforts, its tax counsel, Latham & Watkins LLP (“Latham”), determined in good faith that it could not provide an opinion that tax authorities should treat a component of the merger as a tax-free exchange under Section 721(a) of the Internal Revenue Code, which caused the failure of a condition precedent to the merger.
The dispute arose from a September 28, 2015 Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which ETE was to acquire Williams for a mixture of cash and stock. To minimize tax exposure, the Merger Agreement provided for ETE to create Energy Transfer Corp LP (“ETC”), a limited partnership taxable as a corporation, into which Williams would merge. The Williams stockholders were to receive 81 percent of ETC’s stock and $6.05 billion in cash.
The tax-focused merger structure had two main components. First, ETE would transfer the cash consideration to ETC for distribution to the Williams stockholders in return for 19 percent of ETC’s stock (the “Cash Transaction”). Second, ETC would transfer the assets of Williams to ETE in exchange for newly issued Class E units of ETE (the “Contribution Transaction”). As a condition precedent to the merger, Latham was to deliver an opinion that tax authorities should treat the Contribution Transaction as a tax-free partnership contribution under Section 721(a) of the Internal Revenue Code, which exempts contributions of property to a partnership in exchange for interest in the partnership (the “Section 721 Opinion”). The Merger Agreement required ETE to use commercially reasonable efforts to obtain the Section 721 Opinion from Latham and contained a standard covenant for ETE to conduct business in the ordinary course while the merger was pending.
Following execution of the Merger Agreement, conditions in the energy market deteriorated, leading ETE to seek to withdraw from the transaction. In addition, ETE grew concerned regarding its ability to finance the cash component of the merger consideration and determined to privately place a new class of units that would require their holders to forgo certain cash distributions to ensure that ETE had sufficient cash to manage its bridge financing (the “Special Issuance”).
Thereafter, the head of ETE’s tax department discovered that, as a result of the unforeseen decline in ETE’s unit price (the ETC shares were intended to be similar in value to ETE’s partnership units), the IRS might attribute the difference between the cash consideration and the value of ETC’s shares to the Contribution Transaction, which would jeopardize the status of the Contribution Transaction as a tax-free partnership contribution. ETE informed Latham of the issue, and upon reevaluation, Latham determined that it expected to be unable to issue the Section 721 Opinion at the closing date. In response, Williams proposed alternative transaction structures, but Latham determined that the modifications would not alter its conclusion.
Williams initiated two actions in the Court of Chancery. In the first action, Williams sought rescission of the Special Issuance, alleging that ETE breached the Merger Agreement’s covenant to conduct business in the ordinary course by effecting it. In the second action, Williams alleged that ETE failed to use commercially reasonable efforts to obtain the Section 721 Opinion, and as a result, ETE should not be permitted to terminate the merger on that basis. The Court held a joint trial on both actions and, in this post-trial opinion, ruled in favor of ETE.
The Court first determined that Latham’s inability to issue the Section 721 Opinion permitted ETE to terminate the merger. The Court found that Latham acted in good faith and exercised its independent legal judgment to determine that it could not issue the Section 721 Opinion and did not alter its determination as a result of its client’s newfound desire to withdraw from the merger. The Court noted that Latham had undergone extensive analysis and devoted over 1,000 hours of attorney time to evaluate the risk of the IRS treating the transactions as a taxable disguised sale of assets, finding legitimate the concern regarding the potential to reallocate the overpayment for the ETC stock in the Cash Transaction as a result of the price drop of ETE units. In addition, the Court rejected the suggestion by Williams that Latham’s refusal to alter its opinion based on proposed alternative transaction structures suggested any bad faith, explaining that Williams’ own expert testified that tax authorities would ignore the modifications and evaluate the merger as originally structured to determine whether the Contribution Transaction qualified as a taxable event.
Next, the Court found that ETE did not materially breach its duty to use commercially reasonable efforts to secure the Section 721 Opinion from Latham, explaining that Williams failed to identify or provide evidence of any actions that ETE could have taken to cause Latham to issue the Section 721 Opinion in good faith. The Court rejected the contention that ETE’s identification to Latham of the issue resulting from the overpayment for ETC stock constituted a breach, explaining that Latham remained free to determine that the issue did not affect its conclusion, and that Latham, as a law firm of international renown, was unlikely to risk its reputation based solely on the desire of one particular client. The Court also found significant that ETE did not instruct Latham to refuse to issue the Section 721 Opinion and did not obstruct Latham’s evaluation, which distinguished ETE’s conduct from previous precedent.
Finally, the Court declined to order rescission of the Special Issuance, noting that any harm that could befall the Williams stockholders would occur only if the merger were consummated. In light of the “near certainty” that ETE would terminate the merger as a result of the Court’s ruling on the Section 721 Opinion issue, the Court rejected the application by Williams for injunctive relief.