Chancery Court Decisions Offer Practice Tips for MLP Conflict Transactions
The master limited partnership (“MLP”) structure is designed to accommodate transactions involving putative conflicts of interest, but two recent decisions by the Delaware Court of Chancery highlight the potential risks and uncertainties in unitholder litigation concerning MLP conflict transactions. In Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP,  which involved the general partner’s exercise of a call right in its individual capacity, the Court applied a contractual equivalent of entire fairness review to the partnership’s disclosure of the potential exercise, allegedly issued to cause the trading price of the partnership’s units to drop and reduce the call price, and found at the pleading stage that the disclosure may have been so unfair to unitholders as to make it not fair and reasonable to the partnership. In Dieckman v. Regency GP LP,  which involved the acquisition of the partnership by an affiliate of its general partner effected ostensibly pursuant to conflicts committee approval and unaffiliated unitholder approval, the Court granted partial summary judgment in favor of the plaintiff that neither safe harbor applied because the committee was not validly constituted and the proxy statement for the transaction was materially false and misleading, and denied summary judgment in favor of the defendants that a conclusive presumption of good faith applied because there existed a genuine issue of material fact whether the general partner actually relied on the fairness opinion provided by a financial advisor.
Below, we discuss these decisions and provide practice tips for MLP counsel.
In Boardwalk, former unitholders of Boardwalk Pipeline Partners, LP (the “Partnership” or “Boardwalk”) challenged the exercise by Boardwalk’s general partner (the “General Partner”) of an option to purchase all of Boardwalk’s publicly traded common units (the “Call Right”) that the General Partner or its affiliates did not already own. Under Boardwalk’s limited partnership agreement (the “Partnership Agreement”), the General Partner could exercise the Call Right if, among other conditions, it received a legal opinion that Boardwalk’s pass-through tax status was likely to have “a material adverse effect on the maximum applicable rate that can be charged to customers.” The call price was specified as the 180-day average of daily closing prices for the common units prior to the General Partner’s mailing of notice to unitholders of the exercise.
After the Federal Energy Regulatory Commission (“FERC”) announced a change to its rate-setting policies for MLP pipelines, Boardwalk publicly stated that it did not expect FERC’s proposed changes to have a material impact on revenues. A few weeks later, though, Boardwalk announced that the General Partner was “seriously considering” exercising the Call Right (the “Potential-Exercise Disclosure”). Following that disclosure, the trading price of Boardwalk’s common units fell.
Unitholders promptly filed suit in the Court of Chancery seeking to prevent the General Partner from exercising the Call Right using a 180-day measurement period that included trading days affected by the Potential-Exercise Disclosure, claiming that the disclosure artificially lowered the unit trading price and undermined the contractual call price methodology. The parties soon reached a settlement and Boardwalk announced that the General Partner would exercise the Call Right. Just hours after that announcement, FERC announced a final rule that, rather than have an adverse impact, could have a favorable impact on MLP pipeline rates. Subsequently, the General Partner exercised the Call Right and Boardwalk became its wholly owned subsidiary. Following the Court’s rejection of the settlement, new plaintiffs took over the litigation.
On a defense motion, the Court declined to dismiss most of the plaintiffs’ claims. In pertinent part, the Court held that the plaintiffs did not adequately plead that the General Partner breached Section 7.9 of the Partnership Agreement by exercising the Call Right because “Section 7.9(c) relieved the General Partner of any duties” when acting in its individual capacity. In contrast, the Court found that the plaintiffs adequately pled that the General Partner breached Section 7.9 by making the Potential-Exercise Disclosure, concluding at the pleading stage that the General Partner had to comply with one of the four conflict resolution standards in Section 7.9(a) because it was acting in its official capacity and a potential conflict existed in that the disclosure “was highly likely to … harm the limited partners by reducing” the call price. Finding the first three standards (i.e., conflicts committee approval, disinterested unitholder approval, or a resolution on arm’s-length terms) to not have been pursued or otherwise not available, the Court determined that the fourth standard conceivably was not satisfied because the Potential-Exercise Disclosure could be viewed as “so highly unfair to the limited partners as to make it not fair and reasonable to the Partnership.”
The Court next held that the plaintiffs adequately pled that the General Partner violated Section 15.1 by exercising the Call Right without obtaining a contractually compliant tax opinion. The Court found that the term “maximum applicable rate” was subject to multiple reasonable interpretations and, therefore, the tax opinion may not have satisfied Section 15.1 because it addressed the rates approved by FERC and not the rates actually charged by Boardwalk. The Court also found that the plaintiffs’ allegations suggested that the firm that issued the tax opinion may have “skewed its analysis … to reach the outcome that its client wanted,” because it failed to address a “major issue” that “was obvious to all of the industry players” and that Boardwalk addressed in its comments to FERC. The Court found that the plaintiffs’ other criticisms of the tax opinion concerned matters that were not required by Section 15.1 or were mere disagreements with the firm’s methodology.
The Court also held that the plaintiffs adequately pled that the General Partner breached the implied covenant of good faith and fair dealing. The Court noted that the call price methodology was “deliberately retrospective” so that it “would not be affected by the General Partner’s decision to exercise.” In the Court’s view, “the Potential-Exercise Disclosure represented a marked and unexplained shift from the defendants’ initial assessment” of FERC’s proposed policy changes and, therefore, it was reasonably conceivable that the Potential-Exercise Disclosure was meant to “drive down the price of the common units” and lower the call price.
In addition, the Court determined that the plaintiffs adequately pled a claim against the General Partner’s affiliates for tortious interference with contractual relations, finding that it was reasonably conceivable that those defendants, without justification, “interfered with the Partnership Agreement maliciously or in bad faith by causing the Partnership to make the Potential-Exercise Disclosure to drive down the price of the common units and by causing the General Partner to exercise the Call Right opportunistically.”
In Regency, a former unitholder of Regency Energy Partners LP (“Regency”) brought a purported class action challenging the merger of Regency with an entity affiliated with its general partner (the “Acquiror”). After the conclusion of discovery, the parties filed cross-motions for summary judgment seeking rulings on the application of certain provisions in Regency’s limited partnership agreement (the “LPA”). The LPA provisions at issue involved: (i) the conclusive presumption of good faith provided by the general partner’s reasonable reliance on a fairness opinion by an investment bank (“Fairness Opinion”); (ii) the safe harbor applicable to conflict transactions approved by an independent conflicts committee (“Special Approval”); and (iii) the safe harbor applicable to conflict transactions approved by a vote of the majority of common units not held by the general partner and its affiliates (“Unitholder Approval”).
The Court first analyzed the Fairness Opinion provision, which stated, in relevant part, that an action “‘taken in reasonable reliance on an investment banker’s opinion ‘shall be conclusively presumed to have been done ... in good faith.”’ The Fairness Opinion provision, unlike the Special Approval and Unitholder Approval provisions, was not contained in the section of the LPA dealing with the resolution of potential conflicts of interest and did not explicitly state that it applied to conflict transactions. Plaintiff disputed the applicability of the provision on two grounds, arguing that the provision was not applicable to conflict transactions at all and that the conflicts committee formed to evaluate the merger did not actually rely on the Fairness Opinion provided by its financial advisor.
The Court found a genuine issue of material fact regarding whether the conflicts committee relied on the financial advisor’s Fairness Opinion. In reaching this conclusion, the Court primarily relied on two pieces of evidence. First, several days before its approval, the conflicts committee determined the transaction was fair to the public unitholders on less favorable terms than those addressed by the financial advisor in its Fairness Opinion. Second, weeks after the financial advisor provided its Fairness Opinion, the parties amended the terms of the merger to replace a cash component of the consideration with additional Acquiror units, but the financial advisor did not update its Fairness Opinion to account for this change.
Because the factual dispute found by the Court precluded it from finding that the Fairness Opinion provision had been satisfied, the Court did not have to rule on whether the conclusive presumption of good faith arising from reasonable reliance on the financial advisor’s Fairness Opinion applied in the context of conflict transactions. The Court did, however, indicate that it found the decision in Morris v. Spectra Energy Partners (DE) GP, LP to be persuasive on the issue. In Spectra, the Court ruled that the general conclusive presumption of good faith where there was a fairness opinion did not apply to conflict transactions, which were specifically addressed in a separate provision of the partnership agreement that provided for a rebuttable presumption of good faith. The Regency Court noted that any analysis would require a nuanced review of the contract language and deferred ruling on the issue.
The Court next examined the Special Approval provision. Plaintiff moved for summary judgment arguing that Special Approval was not obtained because the conflicts committee was not validly constituted. The LPA provided that no person could serve as a member of the conflicts committee and simultaneously serve on the board of an affiliate of the general partner. One of the members of the conflicts committee, however, simultaneously served on the board of an affiliate of the general partner and on the conflicts committee for at least five days. Defendants argued that a subsequent resolution, signed after the committee member’s resignation from the affiliate board, showed that the first resolution was an error. The Court rejected this argument, finding the facts distinguishable from cases where a later resolution was found to revoke prior inconsistent action. Unlike those cases, the only difference between the two resolutions was that the first resolution added a third person to the conflicts committee. Because the second resolution did not contain language revoking the committee member’s prior appointment and the record otherwise lacked any evidence indicating an intent to revoke the prior appointment, the Court granted plaintiff’s motion for summary judgment that the Special Approval safe harbor was not satisfied.
The Court then granted plaintiff’s motion for summary judgment that the Unitholder Approval safe harbor was not satisfied on the ground that the proxy soliciting unitholder approval of the merger was materially false and misleading in two respects. In the Court’s view, the proxy falsely stated that the Regency conflicts committee consisted of “two independent directors,” even though one of the committee members did not satisfy the criteria set forth in the LPA in order to serve on the committee. In addition, according to the Court, the proxy falsely stated that the conflicts committee’s approval of the merger “constituted ‘Special Approval’ as defined in the [LPA],” again even though the committee had not been validly constituted. The Court found both misstatements to be material because whether the conflicts committee was independent under the terms of the LPA and whether a “form of protection” for unitholders provided in the LPA was followed were important to a reasonable unitholder when deciding how to vote on the merger.
Takeaways and Practice Points
Some of the key takeaways and practice points for MLP counsel to consider in light of the Boardwalk and Regency decisions include:
- Conflict Resolution Safe Harbors: Still Optional? Many MLP partnership agreements contain provisions regarding resolution of conflicts of interest or “safe harbors” that, if employed, will enable a conflict transaction to better withstand judicial review. The Delaware courts generally have interpreted these safe harbor provisions as optional. The Boardwalk decision, however, appears to treat satisfaction of one of the safe harbors as mandatory in that case where the general partner faced a potential conflict of interest, stating that the general partner was required to “show that it complied with one of four enumerated paths for its action ‘not [to] constitute a breach of this Agreement.’” Depending on the pertinent facts, deal planners should therefore consider utilizing a conflicts committee to obtain “Special Approval” in circumstances involving a potential conflict. MLP agreement drafters may want to consider additional language addressing the optional nature of safe harbors even where there is a conflict.
- What is a Conflict of Interest? In light of the Court’s decision in Boardwalk to employ entire fairness-like review by operation of the “fair and reasonable” conflict resolution provision, and not the subjective “good faith” standard generally applicable to official actions by the general partner, the defendants had a more difficult burden to prevail on a motion to dismiss. MLP counsel, however, should also note the Court’s application of the conflict resolution standard rather than the general “good faith” standard to what appeared to be a truthful disclosure by the partnership (arguably required by securities laws) of the general partner’s consideration of a contractual right it could exercise in its individual capacity. In the context of a potential transaction, MLP counsel should therefore carefully evaluate what may possibly implicate the conflict resolution provisions in the partnership agreement.
- A “Stakeholder” Theory for MLP Unitholder Claims? The “fair and reasonable” standard commonly found in MLP partnership agreements is in view of “the Partnership.” Delaware courts on prior occasions have interpreted such a standard (or a similar standard) as a contractual duty owed to the partnership, not the limited partners, and a claim for breach thereof as derivative in nature (which gives rise to additional requirements a plaintiff must satisfy). The Boardwalk decision appears to suggest that, while a contractual duty may only be owed to the partnership, depending on the particular facts of the case, a court may consider the impact on unitholders as one of the partnership’s constituencies and allow a claim to survive a motion to dismiss even where there is no apparent impact on the partnership or its employees, creditors, suppliers, or customers.
- Fairness and Legal Opinions: The Regency decision highlights the importance of creating a record that a board or committee actually relied on the opinion of its financial advisor. MLP counsel therefore should make sure that the board or committee does not make a determination regarding a transaction until after receipt of the fairness opinion. And, if the consideration exchanged in a transaction changes, the board or committee should request that the financial advisor update the fairness opinion to address the revised terms. In addition, meeting minutes should reflect that the board or committee received and relied on the fairness opinion when making a determination with respect to a transaction. The Boardwalk decision shows that a legal opinion should meet the substance of any contractual requirements and address the key issues, but that a plaintiff’s criticisms of counsel’s good-faith analysis will be rejected by a court.
- Freedom of Contract and Precise Drafting: A number of MLP agreements provide that a general partner’s compliance with a conflict resolution safe harbor will result in the transaction being “conclusively” deemed fair and reasonable to the partnership. After Spectra and now Regency, MLP counsel should consider adding such language to the conflict resolution provision of the partnership agreement if not already present. MLP counsel also may want to consider adding language to clearly state that a conclusive presumption of good faith arising from reliance on a financial advisor’s fairness opinion applies in the context of a conflict transaction. As the Court observed in Spectra and Regency, “when sophisticated parties intend to provide a conclusive presumption in a conflicts situation, they know how to draft such a provision.”
- Unaffiliated Unitholder Approval Safe Harbor: Even where an MLP agreement eliminates the fiduciary duty of disclosure and replaces it with a minimal disclosure obligation, if a general partner goes beyond that limited contractual requirement and issues a proxy statement to induce unitholders to approve a transaction to satisfy an unaffiliated unitholder approval safe harbor, there may arise an implied obligation not to mislead unitholders. MLP counsel should be aware that, as was the case in Regency, plaintiffs’ counsel will try to identify misleading disclosures relating to the general partner’s satisfaction of another safe harbor (such as special approval by a conflicts committee) as a way to challenge the general partner’s satisfaction of the unitholder approval safe harbor. MLP counsel should therefore carefully consider the disclosures surrounding any other safe harbor in solicitation materials with respect to a conflict transaction.
In light of the Boardwalk and Regency decisions, MLP agreement drafters should take full advantage of the substantial flexibility afforded by Delaware law to privately order the affairs of the partnership and may want to consider language changes that could more ably accommodate conflict transactions. And, when executing a potential conflict transaction, it is important to closely follow one or more conflict resolution procedures (if available) to best position the transaction to withstand (or be immunized from) judicial scrutiny.
 2019 WL 4927053 (Del. Ch. Oct. 7, 2019).
 2019 WL 5576886 (Del. Ch. Oct. 29, 2019).
 2019 WL 4927053.
 Id. at *1.
 Id. at *1-2.
 Id. at *2.
 Id. at *3.
 Id. at *4-5.
 Id. at *5.
 Id. at *5-6.
 Id. at *6.
 Id. at *29.
 Id. at *12-13.
 Id. at *9-12.
 Id. at *13-14.
 Id. at *14-16.
 Id. at *8-21.
 Id. at *18-19.
 Id. at *19-20.
 Id. at *17, 20.
 Id. at *22.
 Id. at *23.
 Id. at *23-24.
 Id. at *27-29.
 2019 WL 5576886.
 Id. at *1.
 Id. at *3.
 Id. at *5.
 Id. at *6-7.
 Id. at *7.
 Id. at *7-8.
 Id. at *6.
 2017 WL 2774559 (Del. Ch. June 27, 2017).
 Regency, 2019 WL 5576886, at *6.
 Id. at *6 & n.39.
 Id. at *8.
 Id. at *9.
 Id. at *10.
 Id. at *11.
 Id. at *12.
 Id. at *12-13.
 Norton v. K-Sea Transp. Partners L.P., 67 A.3d 354, 365 (Del. 2013); Allen v. Encore Energy Partners, L.P., 72 A.3d 93, 102 (Del. 2013); El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1258 n.41 (Del. 2016).
 See El Paso, 152 A.3d at 1259-65; Mesirov v. Enbridge Energy Co., Inc., 2018 WL 4182204, at *9 (Del. Ch. Aug. 29, 2018).
 Regency, 2019 WL 5576886, at *6 (quoting Spectra, 2017 WL 2774559, at *12).
 Id. at *12 (quoting Dieckman v. Regency GP LP, 155 A.3d 358, 368 (Del. 2017)).
This article was originally published by Law360 on January 6, 2020.