In re Encore Energy Partners LP Unitholder Litig., Cons. C.A. No. 6347-VCP (Del. Ch. Aug. 31, 2012) (Parsons, V.C.)
In this memorandum opinion, the Delaware Court of Chancery dismissed claims for breach of duty and breach of the implied contractual covenant of good faith and fair dealing brought by former unaffiliated unitholders of a Delaware master limited partnership against the limited partnership’s general partner and its directors and parent in connection with an interested merger.
The master limited partnership at issue was Encore Energy Partners LP, a Delaware limited partnership (the “Partnership”). Vanguard Natural Resources, LLC (“Vanguard”) acquired all of the outstanding common units of the Partnership in a unit-for-unit exchange (the “Merger”). Vanguard’s indirect subsidiary, however, was the Partnership’s general partner (the “General Partner”). Because the then prospective Merger posed a potential conflict of interest, the General Partner sought and received “Special Approval” from its “Conflicts Committee” (comprised of three independent directors on its board), as prescribed in the Partnership’s limited partnership agreement (the “Partnership Agreement”), before approving the Merger. The plaintiffs, representing a class of the Partnership’s former unaffiliated common unitholders (the “Plaintiffs”), argued that the Conflicts Committee’s Special Approval was defective under the terms of the Partnership Agreement and that the Merger reflected an unfair exchange. The Plaintiffs’ complaint averred that the General Partner, its Board of Directors, and Vanguard (collectively, the “Defendants”) breached their contractual duties to the Plaintiffs, and the implied contractual covenant of good faith and fair dealing, by proposing, approving and consummating the Merger, which was not fair or reasonable and was made in bad faith. Subsequently, the Defendants brought a motion to dismiss for failing to state a claim upon which relief could be granted.
First, the Court looked to the Partnership Agreement to determine what duties the Defendants owed to the Plaintiffs. The Partnership Agreement stated that “[e]xcept as expressly set forth in [the Partnership] Agreement, neither the General Partner nor any other [Defendant] shall have any duties or liabilities, including fiduciary duties, to the Partnership or any Limited Partner.” As such, the Court held that the Defendants owed the Plaintiffs only those duties expressly set forth in the Partnership Agreement and whatever non-waivable default obligations the implied contractual covenant of good faith and fair dealing imposed.
According to the Court, the only duty expressly set forth in the Partnership Agreement was a contractual duty of good faith. The Partnership Agreement provided that “[w]henever the General Partner makes a determination or takes or declines to take any other action, or any of its Affiliates causes it to do so, in its capacity as the general partner of the Partnership . . . then the General Partner, or such Affiliates causing it to do so, shall make such determination or take or decline to take such other action in good faith.”
Notwithstanding the general nature of this provision, Section 7.9(a) of the Partnership Agreement (the “Special Approval Provision”) provided a specific mechanism for resolution of conflicts of interest. The Special Approval Provision provided that whenever a potential conflict of interest arose between the General Partner or any of its affiliates, on the one hand, and the Partnership, on the other, any course of action taken by the General Partner or any of its affiliates would not constitute a breach of the Partnership Agreement or of any duty if the course of action was approved by a majority of the members of the Conflicts Committee acting in good faith.
To act in “good faith,” as defined in the Partnership Agreement, a person “must believe that the determination or other action is in the best interests of the Partnership.” The Court interpreted this language as requiring only a subjective belief and, therefore, stated that the Plaintiffs needed to allege facts from which one reasonably could infer that the Defendants subjectively believed that they were acting against the Partnership’s interests.
Under this standard, the Court found that the Plaintiffs failed to allege such facts. Although the Plaintiffs alleged in their complaint that the Defendants were ineffectual negotiators and conducted a shoddy negotiation process, these allegations were insufficient to find that the Defendants acted in bad faith. However bad the Conflicts Committee’s decision may have appeared from the complaint, the Plaintiffs failed to allege facts from which one could infer that the Conflicts Committee made its decision with the subjective belief that their approval of the Merger was contrary to the Partnership’s best interests. Absent such allegations, the Conflicts Committee’s approval of the Merger satisfied the contractual definition of good faith and, in turn, the Special Approval Provision. The Court, therefore, held that the Defendants satisfied their express duties under the Partnership Agreement.
The Court then found, based on the facts alleged in the complaint, that the Defendants could not have breached the implied contractual covenant of good faith and fair dealing. The Plaintiffs argued that the manner in which the Conflicts Committee negotiated the Merger frustrated their reasonable expectation that the Special Approval be conditioned upon achieving an objectively fair and reasonable value for the Plaintiffs. The implied contractual covenant, the Plaintiffs argued, required the Defendants to meet this reasonable expectation. Based on the terms of the Partnership Agreement, however, the Court disagreed. Among other things, the Partnership Agreement: (1) limited the Conflicts Committee members’ duties to a subjective good faith standard; (2) neither required nor prohibited the consideration of particular factors by the Conflicts Committee in granting Special Approval; and (3) exculpated the Defendants from any monetary liability unless they acted in bad faith or engaged in fraud, willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was criminal. This contractual framework, according to the Court, was “inimical to requiring that a transaction receiving Special Approval be objectively fair and reasonable.” In its reasoning, the Court affirmed the principle that the implied contractual covenant of good faith and fair dealing is not a free-floating duty but rather a limited gap-filling tool to infer contractual terms to which parties to an agreement would have agreed had they anticipated a situation they failed to address in the agreement.
Although the Court concluded that the Defendants’ actions could not have frustrated the Plaintiffs’ reasonable expectations, it also found that the Partnership Agreement provided an alternative and independent reason why the Defendants did not breach the implied contractual covenant. The Partnership Agreement provided that the General Partner would be conclusively presumed to have acted in good faith if it acted in reliance upon the advice or opinion of investment bankers. Because the Conflicts Committee relied on such advice when giving the Special Approval, the Court found that the General Partner’s Board of Directors and the General Partner also relied on such advice. The Court held that the Plaintiffs could not plead that the General Partner breached the implied contractual covenant when the General Partner was conclusively presumed, by the terms of the Partnership Agreement, to have acted in good faith. The Court also held that the implied contractual covenant only applies to the actual parties to an agreement. As such, the General Partner was the only Defendant against whom a claim of a breach of the implied contractual covenant could be asserted.