Supreme Court Upholds Waiver of Claims in LP Agreement Based on Presumption of Good Faith

Norton v. K-Sea Transportation Partners, L.P., Del. Supr., No. 238, 2012 (May 28, 2013). This Delaware Supreme Court decision is the second in consecutive business days that addresses the concept of good faith in the contractual context. See SIGA Technologies, Inc. v. PharmAthene, Inc., highlighted on these pages. (Photo: Supreme Court Building in Dover.)

Photo of the Supreme Court Courthouse in DoverIssue Addressed: Did provision of LP agreement that provided for the presumption of good faith, bar claims based on an alleged conflict of interest? Short Answer: Yes.

Brief Background

The Court of Chancery’s opinion in this case was highlighted on these pages and provides more background details. This opinion is a relatively short and pithy 28 pages in the slip opinion format and readers interested in this topic should read the whole thing. At this time I will simply provide a bare bones overview. In essence, the context was a merger of K-Sea Transportation Partners L.P. and Kirby Corporation. The LP’s general partner (GP) held incentive distribution rights (IDR) which had value separate from the interests of the common unitholders. With affiliates, the GP controlled the LP.

The plaintiff, Norton, claimed that the GP had a conflict of interest when deciding to approve the merger due to compensation payable to the GP, for the IDR, that was not payable to the other unitholders. A Conflicts Committee hired independent financial and legal advisors, and unanimously recommended the merger to the full board, which also approved it.

Bullet Points from Court’s Legal Analysis

  • The high court recited fundamental Delaware contract interpretation principles, such as the following gem: “A meaning inferred from a particular provision cannot control the agreement if that inference conflicts with the agreement’s overall scheme.” See footnote 23 and related text.
  • The truism was underscored that the Delaware LLP Act gives maximum effect to the principle of freedom of contract and also allows the parties to expand, restrict or eliminate any fiduciary duties a partner may owe–except that the implied duty of good faith and fair dealing cannot be eliminated from the LP agreement. See Section 17-1101 (a) and (c).
  • The court construed the LP agreement to waive all fiduciary duties and replace them with a contractual fiduciary duty which merely required the GP to “reasonably believe that its action is in the best interest of, or not inconsistent with, the best interests of the Partnership.”
  • Importantly, the parties did not raise on appeal, and the high court did not address, the discussion by the Court of Chancery about how the presumption of good faith contained in the agreement interfaced with the implied duty of good faith and fair dealing. See footnotes 62 and 67.
  • Although the facts supported an inference that the GP “may not have” acted in good faith, and extracted an excessive amount for its IDRs at the expense of the limited partners, section 7.10(b) of the LP agreement provided a “conclusive presumption” that the GP acted in good faith if the GP relies on a competent expert’s opinion as to matters the GP reasonably believes to be within that person’s expertise. The court found that the fairness opinion relied on by the GP satisfied this provision of the agreement.
  • If the unitholders were not happy with the terms of the merger, they still had an opportunity to vote against it. Thus, the court explained that their remedy was “the ballot box, not the courthouse”. They should have realized that their remedies were otherwise limited due to the waivers and restrictions in the agreement that bars claims for breach of fiduciary duty that would apply, for example, in the corporate context.
  • Delaware’s high court also rejected claims against the board members of the GP, reasoning that there was no cognizable claim against them for causing the GP to take an action that did not breach the GP’s duties under the LP agreement. See footnote 66.

Supplement: The Delaware Supreme Court issued several other decisions in 2013, in addition to this one, that explored the nuances and contours of good faith in the context of alternative entity agreements. See, e.g., Gerber v. Enterprise Products Holdings, LLC, Del. Supr., No. 46, 2012 (June 10, 2013), highlighted on these pages.