In Re: Encore Energy Partners LP Unitholder Litigation, Cons., C.A. No. 6347-VCP (Del. Ch. Aug. 31, 2012).
Issue Presented: Whether the terms of an LP Agreement protected the general partner from claims regarding what would otherwise be a self-interested transaction, without breaching any duty owed to its limited partners?
Short Answer: Yes.
The Court began its decision by referring to several other relatively recent cases which dealt with the issue of whether the terms of a limited partnership protected the general partners from claims for breaches of fiduciary duty in connection with what would otherwise be self-interested transactions. See, e.g., In Re K-Sea Transp. P’rs L.P. Unitholders Litig., 2012 WL 1142351 (Del. Ch. Apr. 4, 2012); Gerber v. Enter. Prods. Hldgs., LLC, 2012 WL 34442 (Del. Ch. Jan. 6, 2012); Lonergan v. EPE Hldgs., LLC, 5 A.3d 1008 (Del. Ch. 2010); Brinckerhoff v. Tex. A. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010).
This case involved a merger that created a potential conflict of interest. The general partner sought and received “Special Approval” from its conflicts committee before approving a merger that involved an affiliated transaction and submitting it for unitholder approval. If the “Special Approval” is valid, the Limited Partnership Agreement (LPA) immunizes the merger from judicial challenge and protects the general partner from claims that would otherwise subject it to liability if the economic terms of the merger were shown to be unfair.
The Court began with the truism that the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) permits a Limited Partnership Agreement to eliminate all duties, other than the implied contractual covenant of good faith and fair dealing, that a person may owe to a limited partnership and its limited partners.” The LPA in this case at Section 7.9(e) provided that all duties, including fiduciary duties, would be waived except as expressly set forth in the agreement. The agreement provided for an express contractual duty of good faith and further provided a “Special Approval” procedure which referred to an approval by a majority of the members of the Conflicts Committee acting in good faith. Section 7.9(b) defined good faith for purposes of the agreement.
The Court noted that Vice Chancellor Noble recently “interpreted identical language contained within an LLC Agreement” in the case of In Re: Atlas Energy Resources, LLC, 2010 WL 4273122, at *12 (Del. Ch. Oct. 28, 2010). In that case, Vice Chancellor Noble concluded based on that agreement that “an act is in good faith if the actor subjectively believes that it is in the best interest of the company, and that to state a claim for breach of the contractually defined fiduciary duty, defendants must have acted in a manner they subjectively believed was not in the best interests of the company and its unitholders. In other words, the relevant contractual language required a showing that the special committee believed it was acting against the company’s interests.” See footnotes 53 to 55.
The Court in this case also referred to a recent Delaware Supreme Court decision in RAA Mgmt., LLC v. Savage Sports Holdgs., Inc., of this year, in which the Court emphasized the importance of the uniform interpretation and application of the same language and contracts. Thus, the Court in this case interpreted the “identical language of the LPA (that was in the Atlas case), as requiring plaintiffs to allege facts from which one reasonably can infer that the defendants subjectively believed that they were acting against Encore’s interests.”
The Court reasoned that the plaintiffs did not allege sufficient facts from which one could reasonably infer that the Conflicts Committee members subjectively believed they were acting contrary to the interests of the partnership by giving special approval to the merger.
The Court explained that: “In the final analysis, the relevant inquiry dictated by the LPA was whether the Conflicts Committee approved the merger with the subjective belief that it was in the best interest of the partnership. Whether their determination was objectively reasonable is not relevant to that contractually prescribed standard.” See footnote 71.
Specifically, the Court explained that the plaintiffs did not allege facts from which one could infer the Conflicts Committee made its decision in bad faith: “i.e., with the subjective belief that their approval was contrary to the partnership’s best interest.”
The Implied Covenant of Good Faith and Fair Dealing
The Court further illuminated its decision by addressing the implied covenant of good faith and fair dealing. The Court referred to the very recent Chancery decision in ASB Allegiance which dealt with a contract that conferred discretionary rights on a party. The implied covenant requires such a party to exercise its discretion reasonably. See also DV Realty Advisors LLC, another recent case at footnote 78, involving the common law definition of good faith, and highlighted on these pages here.
The Court underscored the following reasoning: “To use the implied covenant to replicate fiduciary review would vitiate the limited reach of the concept of the implied duty of good faith and fair dealing. Rather, to state a claim under the implied covenant, plaintiffs must identify how the Conflicts Committee’s allegedly feckless negotiations frustrated the fruits of the bargain that the parties reasonably expected.” See footnotes 83 and 84.
The Court also concluded that: “The elimination of fiduciary duties implies an agreement that losses should remain where they fall.” The Court observed that the “near absence under the LPA of any duties whatsoever to Encore’s public equity holders presumably would discourage risk adverse investors that are willing to take a leap of faith from investing their money in an enterprise controlled by the general partner and its affiliates.” But, the “right to enter into good and bad contracts” makes the implied covenant an ersatz substitute for the warning “caveat emptor.” The Court advised that:
“Investors apprehensive about the risks inherent in waiving the fiduciary duties of those with whom they entrust their investments may be well advised to avoid master limited partnerships like Encore. Having decided to take a leap of faith in the reach for the kind of returns the master limited partnership investment might yield, however, plaintiff cannot reintroduce fiduciary review to the back door of the implied covenant.” See footnotes 96 through 99.
In closing, the Court referred to the recent Gerber and the recent In Re K-Sea cases to support the conclusion that: “A plaintiff cannot 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 footnote 108.