Delaware Court of Chancery Again Addresses MLP Call Rights
A number of master limited partnership (“MLP”) agreements contain a call right in favor of the general partner to purchase all of the MLP’s publicly traded units that the general partner or its affiliates do not already own, if certain contractually specified conditions are met. Despite that the call right would be exercised by the general partner in its individual capacity, free of any fiduciary or contractual duties, other conduct by the general partner or its affiliates around the exercise of the call right may give rise to allegations by unitholders of putative conflicts of interest and purported breaches of the MLP agreement. As well, because the implied covenant of good faith and fair dealing may not be eliminated, though it is a narrow gap-filler that is rarely invoked successfully, the covenant can, in certain circumstances, lead to potential risks and uncertainties in unitholder litigation challenging an MLP transaction.
In a prior article, we discussed the Court of Chancery’s October 2019 decision in Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, which involved a general partner’s exercise of a call right in an MLP agreement. There, 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 before the actual exercise and in turn reduce the call price derived from the units’ trailing market prices. The Court largely denied a defense motion to dismiss, finding at the pleading stage that the potential exercise disclosure may have been so unfair to unitholders as to make it conceivably not fair and reasonable to the partnership.
In January 2020, in In re CVR Refining, LP Unitholder Litigation, the Court of Chancery addressed another unitholder challenge to a call right exercise, which allegedly followed the “Boardwalk playbook” that, according to the plaintiffs, set out “how the controller of an MLP could weaponize a call right with a trailing-market-price-based buyout price by artificially manipulating the stock price.” Again, the Court largely denied a pleading-stage defense motion to dismiss. Below, we discuss the CVR decision and provide practice tips for MLP counsel.
The CVR Decision
In CVR, former unitholders of CVR Refining, L.P. (the “Partnership”), a Delaware master limited partnership, challenged the exercise by the indirect parent (“Parent”) of the Partnership’s general partner (the “General Partner”) of a call right (“Call Right”) in the Partnership’s limited partnership agreement (the “Partnership Agreement”) to purchase all of the Partnership’s common units held by the public unitholders.
Under the Partnership Agreement, the General Partner or its assignee could exercise the Call Right if, among other things, the General Partner and its affiliates increase their holdings from “less than 70% of the total Limited Partner Interests” to “more than 80% of the total Limited Partner Interests.” The Call Right had two price-setting provisions: a “90-day Provision” prevented public unitholders from having their units called at a price below what the General Partner or its Affiliates paid to purchase any units in the 90 days preceding the exercise; and a “20-day Provision” specified the call price as the average daily closing price for the 20 trading days prior to the exercise.
In May 2018, Parent commenced a partial exchange offer at $27.63 per common unit (“Exchange Offer”), which represented a 25% premium to the previous trading price, that would position the General Partner or its assignee to exercise the Call Right. The board of directors (the “Board”) of the General Partner, comprising persons affiliated with Parent’s controller (“Controller”), determined that it would not make a recommendation for or against the Exchange Offer, and stated in the Schedule 14D-9 that it was “expressing no opinion” on the Exchange Offer. After the Exchange Offer closed, Controller and its affiliates went from owning less than 70% of the Partnership’s units to owning 84.5% of the units, thereby positioning the General Partner or its assignee to exercise the Call Right.
In public filings issued contemporaneously with the commencement of the Exchange Offer, Controller and Parent “disclaimed any intention to exercise the Call Right.” Despite this statement, many analysts speculated that Controller and Parent would exercise the Call Right, and the trading price of the Partnership’s common units fell over the course of the following weeks. On November 14, 2018, a vice president at Parent and the General Partner (the “Vice President”), or a trust associated with her, purchased Partnership units at a price of $16.72 per unit.
On November 29, 2018, four months after the closing of the Exchange Offer, Parent announced it was “now contemplating” exercising the Call Right. At that time, the Partnership’s units were trading at approximately $17.16 per unit, and that price “fell precipitously thereafter.”
Nearly two months after that announcement, on January 17, 2019, Parent, who had been assigned the Call Right by the General Partner, exercised the Call Right at the price of $10.50 per unit as determined by the 20-Day Provision (“Exercise Price”). Had Parent exercised the Call Right at the Exchange Offer price, it would have paid an additional $393 million.
Following Parent’s exercise of the Call Right, multiple lawsuits were filed by former unitholders in the Court of Chancery. Plaintiffs asserted claims for breach of the Partnership Agreement against the Partnership, the General Partner, and Parent (among others); for breach of the implied covenant of good faith and fair dealing against the Partnership, the General Partner, and Parent (among others); and for tortious interference against Parent, Controller, and the Board. Plaintiffs alleged that Defendants, following the “Boardwalk playbook,” engaged in a “multi-step scheme” to devalue the Partnership’s units so that Parent could exercise the Call Right at an artificially lower price.
On a defense motion, the Court largely declined to dismiss Plaintiffs’ claims. The Court first held that, at the pleading stage, Plaintiffs had adequately alleged that the General Partner and the Partnership breached the Partnership Agreement in connection with the Exchange Offer, and against the General Partner and Parent in connection with the Exercise Price. With respect to the Exchange Offer, the Court found that Plaintiffs had alleged sufficient facts to suggest that the General Partner may have breached Section 7.9(a) of the Partnership Agreement by causing the Partnership to issue the non-recommendation as to the Exchange Offer, finding at the pleading stage that it was “reasonably conceivable that the Board believed that the Exchange Offer was adverse to the interests of the [public unitholders] with no offsetting benefits, and, thus, adverse to the Partnership as a whole.” Rejecting Defendants’ argument that the Exchange Offer was a voluntary unitholder-level transaction that required no involvement from, and the Partnership Agreement imposed no relevant obligation on, the General Partner, the Court found that Plaintiffs’ allegations suggested that the General Partner acted in its official capacity when the Board deliberated, made, and publicly issued the non-recommendation determination in the Schedule 14D-9, an official document, and that it was reasonably conceivable based on Plaintiffs’ allegations that the General Partner may have done so in “Bad Faith” insofar as the Board conceivably acted with the subjective belief that the action was adverse to the Partnership.
With regard to the Exercise Price, the Court found it reasonably conceivable based on Plaintiffs’ allegations that the Vice President was an “Affiliate” of the General Partner and that the General Partner and Parent (who by the time of the exercise had been assigned the General Partner’s Call Right) may have breached Section 15.1 of the Partnership Agreement insofar as the Exercise Price was below that paid by the Vice President when she purchased Partnership units within the prior 90-day period. The Court found it “reasonably conceivable that [the Vice President’s] role … at [Parent] and the General Partner affords her the power to direct management and policies at these entities,” and noted that the Vice President was allegedly held out as an “executive officer” on Parent’s website, and in its press releases and SEC filings. Further, Controller was alleged to have included the Vice President’s units in its calculation of the total holdings of the “General Partner and its affiliates.” The Court did not address Defendants’ argument that the Vice President did not buy the units but rather that a trust did, finding it a factual issue that could not be decided at the pleading stage.
The Court next found that Plaintiffs stated a claim for breach of the implied covenant against the General Partner and Partnership. Rejecting Defendants’ attempts to distinguish the case from Boardwalk and Dieckman v. Regency GP LP, the Court found it “reasonably conceivable that implied in the language of the Call Right provision is a requirement that the defendants not act to undermine the protections afforded to unitholders by the price-protection mechanisms.” The Court rejected Defendants’ argument that, because Parent made the allegedly manipulative disclosure and was not a party to the Partnership Agreement at the time, there was no breach of the implied covenant, finding at the pleading stage that it was “reasonably conceivable that the General Partner worked with [Parent] to frustrate the Call Right’s price-protection mechanisms,” noting each Board member’s allegedly “strong ties” to Controller and Parent, “their knowledge of the events at Boardwalk,” and the “temporal proximity of the relevant events.” The Court also rejected Defendants’ argument that Parent “may well have been legally required” to make the disclosure, because from that argument “it is reasonable to infer the defendants may not have been legally required to issue the disclosure, and that the disclosure’s sole purpose was to drive down the trading price of the common units in advance of exercising the Call Right.”
Lastly, the Court found that Plaintiffs stated a claim for tortious interference against Parent, Controller, and the former Chairman of the General Partner and Parent who resigned from the Board in July 2018. Following the Court’s analysis in Boardwalk, the Court rejected the “stranger rule” as an absolute defense to tortious interference claims against affiliates and instead opted for the nuanced “limited privilege” approach endorsed by the Delaware Supreme Court. With regard to the Board, against whom Plaintiffs also asserted the claim, the Court explained that directors and officers of a contracting entity cannot be held liable for tortious interference unless they exceeded the scope of their agency in doing so. Because Plaintiffs did not allege that the Board members exceeded the scope of their agency, the Court dismissed the claim against them. Given that the former Chairman resigned before some of the events at issue, but was alleged to have used his control over the Partnership and General Partner after his resignation, the Court denied the motion to dismiss as to him.
Takeaways and Practice Points
Some of the key takeaways and practice points to consider in light of CVR include:
- Limited Contractual Protections May Not Always Be Fatal To Unitholder Claims. MLP agreements provide limited protections to public investors. With fiduciary duties eliminated, unitholders generally can look only to the express terms of the partnership agreement for protection and, in rare cases, to the implied covenant. In addition, many MLP agreements contain safe-harbor procedures that, if employed, will enable a conflict-of-interest transaction to better withstand judicial review or even immunize a deal from unitholder challenge. However, to the extent such safe-harbor procedures are not closely followed or, as was pled in CVR, there are factual allegations suggesting subjective bad faith in breach of the contractual duty of good faith or unanticipated and unreasonable conduct undermining contractual protections for unitholders, the Delaware courts may well allow a complaint to survive a motion to dismiss.
- Contractual Duty Of Good Faith May Apply In Spaces Without Express Obligations. MLP agreements typically contain a general standard of care on the part of the general partner to act in subjective good faith when taking official action as well as specific provisions that may have different express standards for particular situations. Delaware courts usually prefer specific provisions over general ones, but the general standard of care may well be found to operate in the areas of the agreement without express standards. Thus, as seen in CVR, even if there may not be an affirmative contractual obligation specific to the particular situation at issue, such as the exchange offer in that case, the general contractual standard of care could apply and require the general partner to act in subjective good faith when taking official action.
- Subjective Bad Faith May Be Shown Through Objective Facts. As the Court in CVR explained, the subjective good faith standard, which is based on the actual belief of the decisionmaker, is distinct from the objective good faith standard, which is based on a “reasonable person” standard. As such, an alleged breach of the subjective standard can be more difficult for a plaintiff to plead. Nonetheless, as seen in CVR, the objective facts and circumstances in a particular case may raise doubt concerning the actual belief of the decisionmaker. In addition, the personal knowledge and experience of the decisionmaker may be viewed by the Court as relevant in connection with a subjective good faith analysis, such that significant knowledge and experience potentially could result in the inference of an actual belief on the part of the decisionmaker that an allegedly detrimental action would not be in the partnership’s interest. Therefore, it is important to develop a record to show the decisionmaker made the decision or took the action consistent with its contractual duty of subjective good faith.
- A “Holistic” View Of The Partnership? The contractual duty of good faith commonly found in MLP agreements is owed to the partnership. For example, the MLP agreement in the CVR case prohibited the general partner from acting in its official capacity with “the belief that such determination, action or omission was adverse to the interest of the Partnership.” The Delaware Supreme Court has held that a similar contractual duty of good faith—articulated in the converse, i.e., that the general partner had to “believe that [its] determination or other action [was] in the best interest of the Partnership”—was a duty “owed to the Partnership, not the individual limited partners.” The CVR decision, following the analysis in the Boardwalk decision, took a “holistic approach” to the partnership and found, at the pleading stage, that an adverse impact on unitholders, with no offsetting benefits to the partnership, conceivably could mean that the general partner’s action was adverse to the partnership as a whole.
- What Is Adverse To The Partnership? Further to the last point, the CVR Court’s discussion is significant insofar as “Delaware courts have long recognized” that a putative claim arising from the devaluation of stock “is entirely derivative in nature.” A derivative claim, of course, gives rise to additional standing and pleading requirements a plaintiff must satisfy. It also is worth noting that, in CVR, the plaintiffs alleged that the exchange offer was adverse to the partnership as a whole because the subsequent decreased trading price for the common units increased the partnership’s cost of equity. While that allegation may be true as a theoretical matter, a company’s cost of equity, “unlike the interest rate on debt, … is an implicit cost and cannot be directly observed.” Accordingly, while the Court let the plaintiffs’ “cost of equity” theory survive the defense motion to dismiss given the low “conceivability” standard, plaintiffs’ theory may well fail on a more developed record because Delaware courts do not award speculative or conjectural damages.
- The Implied Covenant May Potentially Remedy The Manipulation Of A Call Right. The implied covenant of good faith and fair dealing inheres in every contract governed by Delaware law. It cannot be eliminated. While ever-present, it is a narrow gap-filler. The implied covenant cannot rewrite a contract or save a disappointed party from a bad deal. However, it may potentially be invoked where a party acts unreasonably or arbitrarily in an unanticipated way, frustrating the fruits of the bargain. In addition, the implied covenant potentially may cover aspects of a deal that are “so obvious to the participants that they never think, or see no need, to address.” Hence, the implied covenant claim asserted in Boardwalk and CVR, alleging the forward manipulation of the retrospective call right price, was found to survive a defense motion to dismiss.
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MLP agreement drafters should take full advantage of the substantial flexibility afforded by Delaware law to privately order the affairs of the partnership. As well, in light of the CVR decision, MLP transaction planners should consider the steps to be taken to effectuate a transaction; if they may give rise to unitholder allegations of putative conflicts of interest or purported breaches of the MLP agreement, such as a contractual duty of good faith, it is important to closely follow one or more safe-harbor procedures, such as special approval by a conflicts committee, and/or to develop a record to establish that the decisionmaker satisfied its contractual duty of good faith, in order to best position the transaction to withstand or potentially be immunized from judicial scrutiny.
 2019 WL 4927053 (Del. Ch. Oct. 7, 2019).
 2020 WL 506680 (Del. Ch. Jan. 31, 2020).
 Id. at *4.
 Id. at *18.
 Id. at *1.
 Id. at *4.
 Id. at *5-6.
 Id. at *5.
 Id. at *6.
 Id. at *7.
 Id. at *1.
 Id. at *7.
 Id. at *4-5.
 Id. at *18.
 Id. at *11, *13.
 Id. at *10.
 Id. at *9-10. The Court found that Plaintiffs’ complaint did not state a claim against Parent in this regard because it was not a party to the Partnership Agreement at the time of the Exchange Offer. Id. at *11.
 Id. at *12.
 Id. The Court found that Plaintiffs’ complaint did not state a claim against the Partnership because the Partnership was not alleged to have taken any action in connection with the Call Right. Id. at *13.
 Id. at *13, *16.
 155 A.3d 358 (Del. 2017).
 CVR, 2020 WL 506680, at *15.
 Id. at *16.
 Id. The Court dismissed the claim against Parent because it was not bound by the Partnership Agreement at the time. Id.
 Id. at *3, *17-18.
 Id. at *17-18.
 Id. at *18.
 See Brinckerhoff v. Enbridge Energy Co., Inc., 159 A.3d 242, 254 (Del. 2017).
 CVR, 2020 WL 506680, at *3.
 El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1259 (Del. 2016); see also Mesirov v. Enbridge Energy Co., Inc., 2018 WL 4182204, at *9 (Del. Ch. Aug. 29, 2018).
 Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 353 (Del. 1988).
 Aswath Damodaran, Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, p. 28 (Wiley 2d ed. 2006).
 Dieckman, 155 A.3d at 368.