In Re K-Sea Transportation Partners LP Unitholders Litigation, C.A. No. 6301-VCP (Del. Ch. April 4, 2012). The prior Chancery decision in this case was highlighted on these pages here.
Issues Addressed: The issues addressed by the Court of Chancery in this matter were whether the fiduciary duty claims and the contractual claims were barred by the provisions in the limited partnership agreement that provided a presumption of good faith.
This is a class action brought on behalf of the common unitholders of a publicly-traded Delaware limited partnership. In March 2011, the partnership agreed to be acquired by a non-affiliated third party at a premium to its trading price. The merger agreement also provided for a separate payment to the general partner to acquire certain partnership interests that it held exclusively. The plaintiffs allege that the amount of that payment far exceeded the economic value of those interests. To avoid this potential conflict of interest, the board submitted the transaction to a conflicts committee of independent directors who, relying on an investment bank’s fairness opinion, determined that the overall transaction was fair and reasonable. On that basis, the full board approved the transaction.
The plaintiffs claim that the conflicts committee was improperly constituted and it was provided with incentives to approve the transaction, thus undermining its purportedly disinterested approval. The plaintiffs claimed that the general partner breached fiduciary duties along with the members of the board. The plaintiffs also accuse the members of the board of materially misleading disclosures. For additional background details, refer to the previous opinion by the Court of Chancery in this case in which a motion to expedite was denied. In Re K-Sea Transp. P’rs L.P. Unitholders Litig., 2011 WL 2520209, at *1-4 (Del. Ch. June 10, 2011) [hereinafter “K-Sea I”], highlighted on these pages.
At footnote 6, the Court noted that the plaintiffs waived any request for rescissionary relief because they did not respond to the arguments by the defendants in their brief and at oral argument that the plaintiffs’ only remaining claims were for money damages. Thus, the Court determined that by failing to respond to that argument, the request by the plaintiffs for rescissionary relief was waived.
After reviewing the standard for a motion to dismiss for failure to state a claim under Court of Chancery Rule 12(b)(6), the Court reviewed the contractual terms of the limited partnership agreement for purposes of determining whether there was an express waiver of any fiduciary duties and whether the agreement provided for a contractual standard of review that supplants fiduciary duty analysis. See, K-Sea I, 2011 WL 2520209, at *8.
According to the terms of the limited partnership agreement, even if there were a breach of the agreement or any default fiduciary duty, that breach could only support a claim for money damages if the plaintiffs also alleged that the breach resulted from actions that were not taken in good faith. Section 7.10(b) further defined that restriction so that any liability for money damages for a breach of the agreement or a breach of the fiduciary duty limited by the agreement, would prevail only if the breach “resulted from an act or omission done in bad faith, and there is a conclusive presumption according to the terms of the agreement that the general partner acted in good faith if it relied on an expert it reasonably believed to be competent to render an opinion on the particular matter.” See footnote 16 citing a case to the effect that: “there is no meaningful difference between the lack of good faith and bad faith.” Accordingly, to prove a breach of the implied covenant, plaintiff must demonstrate that defendants acted in bad faith.
Thus, in order to survive a motion to dismiss, plaintiffs are required to plead facts that, if true, show that defendants both: (1) breached the agreement or a fiduciary duty not eliminated by the agreement and (2) in doing so, acted in bad faith.
The agreement allowed the general partner to exercise its discretion in whether or not to approve a merger. The agreement also limited the fiduciary duties that would otherwise apply by providing that a general partner was permitted to make any decision in its discretion “so long as such action is reasonably believed by K-Sea GP to be in, or not inconsistent with, the best interests of the Partnership.” The Court construed this provision in Section 7.10 to waive, restrict or eliminate traditional fiduciary duties. However those fiduciary duties were not entirely waived. Instead, the provisions substituted a different, more narrow duty which was that the discretion of the general partner had to be exercised in a manner that was “not inconsistent” with the best interest of the partnership as a whole.
Thus, for liability to attach, the general partner must be shown to have acted in bad faith (that is, the general partner believed that its actions did not advance the proper partnership purpose). See footnote 20 citing cases that provide that where a contract confers discretion on one party, the implied covenant requires that that discretion be used reasonably and in good faith.
Importantly, Section 7.10(b) entitled the general partner “to a conclusive presumption of good faith whenever it acts in reliance on an expert opinion as to matters it reasonably believes to be with the expert’s professional competence.” Because the general partner relied on an expert’s opinion, the agreement provides the general partner with a conclusive presumption that it acted in good faith in exercising its discretion to approve the merger agreement.
The Court also addressed whether the agreement’s conclusive presumption of good faith also satisfied the implied covenant of good faith and fair dealing.
For this, the Court referred to a recent decision by Vice Chancellor Noble that directly addressed the issue of whether a plaintiff can “plead that a defendant breached the implied covenant when the defendant is conclusively presumed by the terms of a contract to have acted in good faith.” See Gerber v. Enterprise Products Holdings LLC, 2012 WL 34442, at *12 (Del. Ch. Jan. 6, 2012), highlighted on these pages here.
Answering that question in the negative, Vice Chancellor Noble reasoned in the Gerber case that when the agreement protects the general partner from any claims asserting that the action was taken other than in good faith, that provision would also bar good faith claims under the duty of loyalty, the implied covenant, and any other doctrine. The drafters of the agreement provided that no claims asserting a failure to act in good faith could be asserted when the general partner acted in reliance upon the opinion of an expert.
The Court in this case agreed with that reasoning which, in essence, endowed the general partner with unfettered discretion to consent to a merger and incentivized the general partner to obtain the fairness opinion and to rely on it. The only limitation in this case to the discretion of the general partner was that it exercise its discretion in good faith. Because it relied on the fairness opinion of an investment banker, according to the terms of the agreement the general partner is conclusively presumed to have acted in good faith. Therefore, there is no conceivable set of circumstance on which the plaintiff could prove that the defendant breached a duty by approving the merger agreement. Therefore, those counts of the complaint were dismissed. See generally, footnote 21 which slightly distinguished certain nuances in the facts of the Gerber case that did not change the result.
The Court also dismissed the claims for breach of the fiduciary duty of disclosure. After a discussion of the case law regarding disclosure, the Court determined that the agreement reflected a clear intent to preempt fiduciary principles related to disclosure. Nonetheless, the Court still concluded that the allegedly misleading disclosures could not support a disclosure claim under any reasonably conceivable set of circumstances.
Postscript: Phil Milford has an article on the case for BloombergBusinessweek here.