The Court of Chancery denied a motion to expedite an application to preliminarily enjoin the merger of the limited partnership in Lonergan v. EPE Holdings LLC, C.A. No. 5856-VCL (Del. Ch. Oct. 11, 2010), read opinion here, where the plaintiff failed to plead colorable claims of breach of fiduciary duty and the Court refused to find breaches of the implied covenant of good faith and fair dealing. This case involves a complicated factual setting with respect to the structure of the limited partnerships and their limited partners. Because this decision involved only a motion to expedite the proceedings, a brief overview of the facts relevant to that motion will be discussed.
This summary is provided by Kevin F. Brady and Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.
Plaintiff Eugene Lonergan, Sr. is the holder of limited partner units (“LP units”) in Enterprise GP Holdings, L.P. (“Holdings”). Holdings, which is the Partnership’s general partner, is a publicly traded master limited partnership (“MLP”). Holdings entered into a proposed merger (the “Proposed Transaction”) with Enterprise Products Partners L.P. (the “Partnership”), which Holdings controlled by virtue of its 100% ownership in the Partnership’s general partner. Lonergan brought a motion to expedite his action to enjoin the Proposed Transaction. Under the Proposed Transaction, Holdings will merge into a subsidiary of the Partnership – in essence, “flattening” the two-tier MLP structure. In the end, Holdings GP will still have control over the Partnership.
Because there were a number of potential conflicts of interests between Partnership and Holdings, the Holdings GP board of directors formally delegated to the Audit Committee full power to negotiate and accept or reject any deal. Discussions about the Proposed Transaction began in the summer of 2010 and a deal was announced on September 7. A preliminary Form S-4 was filed on September 16. Less than two weeks later, Lonergan filed his complaint and moved for expedited treatment of his petition for preliminary injunction.
Allegations – Fiduciary Duty or Implied Covenant?
The Court characterized the complaint as “seeks[ing] to cloak familiar breach of fiduciary duty theories in the guise of the implied covenant of good faith and fair dealing.” The complaint asserted that the defendants had been sued “for their breaches of duties arising under the implied contractual covenant of good faith and fair dealing.” And yet the Court noted that the complaint contained the types of allegations that sound more in fiduciary duty than in contract. For example, the complaint alleged that “the Board of [Holdings GP], which controls and manages [Holdings], failed to conduct an adequate and fair sales process to sell [Holdings] prior to agreeing to the Proposed Transaction” and “[i]n agreeing to a sale without conducting a fair and adequate sales process, gathering information about the Company’s net worth, or soliciting other bids, [the] Individual Defendants are allowing [Holdings] to be purchased at well below the Company’s true value” which sounds like a Revlon claim. See, Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Moreover, the complaint stated that: “[t]he Proposed Transaction . . . represents a classic case of a party standing on both sides of the transaction. In particular, EPCO and its affiliates own a majority stake in [Holdings] and significant equity interests in [the Partnership] as well, creating divided loyalties that have led to the agreement of [sic] a grossly unfair merger to the detriment of the [Holdings’] minority unitholders,” which sounds like a Lynch claim. See, Kahn v. Lynch Communications Systems., Inc., 638 A.2d 1110 (Del. 1994).
Standard for Expedited Treatment
The Court repeated the oft-stated standard that a motion to expedite will be granted where “the plaintiff has articulated a sufficiently colorable claim and shown a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding.”
No “Quasi-Reformation” Clawback of Fiduciary Duty Claims
As the Court observed, the complaint contained allegations about what should have been done to develop alternatives, negotiate the Proposed Transaction and test its fairness. However, the plaintiff framed each of these theories using the implied covenant of good faith and fair dealing instead of fiduciary duty claims, because the Holdings LP Agreement eliminated in two sections of the Holdings LP Agreement default fiduciary duties in accordance with the authority granted Section 17-1101(d) of the Delaware Limited Partnership Act (the “LP Act”).
The Court found that the implied covenant theory cannot be used where the parties have contracted away fiduciary duties. Citing, among other cases, the recent Delaware Supreme Court’s decision in Nemec v. Shrader, 991 A.2d 1120, 1125 (Del. 2010), the Court stated:
The implied covenant is not a substitute for fiduciary duty analysis. “The covenant is ‘best understood as a way of implying terms in the agreement’ . . . . Existing contract terms control, however, such that implied good faith cannot be used to circumvent the parties’ bargain, or to create a free-floating duty unattached to the underlying legal documents.” The Court must focus on “what the parties likely would have done if they had considered the issues involved.” It must be “clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of . . . had they thought to negotiate with respect to that matter. The doctrine thus operates only in that narrow band of cases where the contract as a whole speaks sufficiently to suggest an obligation and point to a result, but does not speak directly enough to provide an explicit answer…. Delaware law “will only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.” “Parties have a right to enter into good and bad contracts[;] the law enforces both.” When an LP agreement eliminates fiduciary duties as part of a detailed contractual governance scheme, Delaware courts should be all the more hesitant to resort to the implied covenant. Fiduciary duty review empowers courts to determine how a governance scheme should operate under particularized factual circumstances. Although the availability of ex post fiduciary review inherently produces some degree of uncertainty, “there is good reason to suppose it can be efficient.” (citations omitted).
No Colorable Revlon or Lynch Claims
The Court also stated that both of Lonergan’s claims that Holdings GP failed to conduct an adequate sale and failed to include a majority-of-the-minority vote were mistakenly premised on the notion that “Delaware common law decisions identify particular steps that fiduciaries must follow.” Revlon and its progeny require the Court to employ an enhanced scrutiny that “places the burden on the defendant fiduciaries to show that they acted reasonably to obtain for the beneficiaries the best value reasonably available under the circumstances.” Likewise, Lynch is also a standard of review, not a checklist. It does not require specific transactional steps like a majority-of-the-minority vote, but instead entire fairness is “based on all aspects of the entire transaction.”
In this case, the Holdings LP Agreement set up a contractual standard of review, which substitutes for the fiduciary duty analysis. The Agreement established four alternative standards of review. If the Proposed Transaction met any one of the four alternatives, then the transaction would be permitted and “deemed approved by all Partners and shall not constitute a breach of this Agreement….” None of the four alternatives required specific actions by the board. Because the plaintiff failed to plead a colorable claim under the theory of an implied covenant, the Court denied the motion to expedite.
Postscript: Prof. Ribstein discusses this case at the end of a post here in which he argues that “Delaware Uncorporate Law Evolves as Escape from Dodd-Frank”. That is, while corporations are subject to increasing regulations, parties using LLCs and the like are being given greater freedom via contracts.