Norton v. K-Sea Trans. Partners L.P., No. 238, 2012 (Del. May 28, 2013)
In this en banc decision, the Delaware Supreme Court affirmed the Court of Chancery’s dismissal of a complaint challenging a merger between K-Sea Transportation Partners L.P. (“K-Sea”) and third-party Kirby Corporation (“Kirby”). Among other allegations, plaintiffs had alleged that the general partner of K-Sea was conflicted in approving the merger because it obtained in the merger excessive consideration for incentive distribution rights (“IDRs”) that it held. The primary issue addressed by the Court was the appropriate standard under K-Sea’s limited partnership agreement (the “LPA”) to apply to the general partner’s approval of the merger. After analyzing provisions in the LPA that addressed conflicts of interest and imposed contractual fiduciary duties, the Court concluded that the controlling standard under the LPA was whether the general partner exercised its discretion to approve the merger in good faith (i.e., with a reasonable belief that its actions were in, or not inconsistent with, the best interests of K-Sea). In reaching this result, the Court found that the LPA provision that specifically addressed conflict of interest transactions created a permissive safe harbor that did not impose any additional affirmative duties on the general partner with respect to its approval of the merger. Applying another provision of the LPA, the Court concluded that the general partner was entitled to a conclusive presumption that it acted in good faith when it approved the merger because in doing so it relied on a fairness opinion of a financial advisor acting within its expert competence.
The appeal arose out of an action brought by plaintiffs on behalf of common unit holders of K-Sea. K-Sea General Partner GP LLC (“KSGP”) is the general partner of K-Sea General Partner L.P. (“K-Sea GP”). K-Sea GP is the general partner of K-Sea and held a 0.3% interest in K-Sea and indirectly held the IDRs. The IDRs entitled K-Sea GP to receive increasing percentages of K-Sea’s distributions once payments to limited partners exceeded certain levels. Plaintiffs alleged that the IDRs were worth as little as $100,000. In early 2011, Kirby’s CEO reached out to K-Sea to discuss a potential transaction between Kirby and K-Sea. Negotiations ensued, and Kirby eventually offered $329 million for K-Sea, which included an $18 million payment for the IDRs. Because the payment for the IDRs created a possible conflict of interest, the KSGP board referred the proposed merger to a conflicts committee for a recommendation. Under the LPA, the conflicts committee’s approval of the merger would constitute “Special Approval,” which purportedly would limit the unit holders’ ability to challenge the transaction. The conflicts committee engaged an independent financial advisor, which opined that the consideration K-Sea’s unaffiliated common unit holders received was fair from a financial viewpoint. The conflicts committee then unanimously recommended the merger to KSGP’s board, which approved it. A majority of K-Sea’s unit holders voted in favor of the transaction, and it closed on July 1, 2011.
In their class action complaint, plaintiffs alleged the conflicts committee breached its fiduciary duties by recommending the transaction without evaluating the fairness of the $18 million payment for the IDRs. Plaintiffs also alleged that K-Sea GP and KSGP’s board breached the LPA by approving an unfair transaction and by relying on the conflicts committee’s purportedly inadequate Special Approval.
After reciting the well-known canons of contract construction used by Delaware courts and recognizing that the Delaware Revised Uniform Limited Partnership Act gives “maximum effect to the principle of freedom of contract,” the Supreme Court analyzed the contractual fiduciary duties imposed by the LPA to determine what standard applied to the merger. The Court started with general duties imposed by the LPA. Section 14.2 of the LPA established that K-Sea GP must approve any proposed merger and that it could consent to a merger “in the exercise of its discretion.” The Court found that the “discretion” granted by Section 14.2 was limited, as a practical matter, by the limited partners’ right to a majority vote on the merger. The “discretion” was also subject to a contractual fiduciary duty imposed by another provision of the LPA, which required the general partner to “reasonably believe that its action is in the best interest of, or not inconsistent with, the best interests of [K-Sea]” (i.e., a “good faith” standard).
After parsing the LPA’s provisions to arrive at this “good faith” standard, the Court considered whether any other provision of the LPA supplanted that standard. The Court turned to Section 7.9(a) of the LPA, which addressed conflict of interest transactions and established procedures for curing conflicts. The Court began its analysis with the threshold question of whether Section 7.9(a) imposed an affirmative duty on K-Sea GP to establish that the merger was fair and reasonable, or whether Section 7.9(a) only created a safe harbor on which K-Sea GP could rely in conflict transactions. The Court looked to other provisions of the LPA and determined that not all resolutions of conflict transactions needed to meet a “fair and reasonable” standard. The Court then concluded that Section 14.2’s “discretion” standard applied to mergers generally, and that Section 7.9(a) provided a safe harbor on which K-Sea GP could – but was not required – to rely to resolve any conflict of interest relating to the merger. Accordingly, if K-Sea chose to use Section 7.9(a) to cleanse a conflict but failed to meet its requirements, it could still rely on the “discretion” standard imposed by Section 14.2 and its related “good faith” requirement.
Because Section 7.9(a) did not impose an affirmative duty on K-Sea GP, the Court focused its analysis on whether K-Sea GP exercised in good faith its discretion to approve the merger. The Court then looked to Section 7.10(b) of the LPA, which created a conclusive presumption of good faith if the act taken was done in reliance on the opinion of financial advisors reasonably believed to be acting within their professional or expert competence. The conflicts committee had obtained a fairness opinion in connection with its analysis of the merger. Plaintiffs did not allege that the analyses underlying the fairness opinion obtained by the conflicts committee were flawed. Their primary complaint was that the fairness opinion did not address the fairness of the $18 million payment for the IDRs. Noting that the LPA provided that K-Sea GP had no obligation to consider the relative interests of any party in a conflict transaction or to consider the interests of any person other than K-Sea, the Court held that plaintiffs “had no reasonable contractual expectation that K-Sea GP or the Conflict Committee’s retained investment banker would specifically consider the IDR Payment’s fairness.” The Court thus found that the fairness opinion satisfied the LPA’s requirements. The Court then concluded that, though the conflicts committee had obtained the fairness opinion from its financial advisor, it was unreasonable to infer that the entire KSGP board did not rely on the opinion obtained by a subcommittee of the board. Furthermore, because K-Sea GP was a pass-through entity ultimately controlled by KSGP, it was only reasonable to infer that K-Sea GP relied on the fairness opinion.
Finally, the Court recognized that plaintiffs’ only claim against the other defendants was that they caused K-Sea GP to enter into the merger. The Court concluded that plaintiffs could not state a claim for relief against the other defendants for causing K-Sea GP to take an action that it was permitted to take under the LPA. Accordingly, the Court affirmed the Court of Chancery’s dismissal of plaintiffs’ claims against all the other defendants.