This Delaware Supreme Court decision must be read by anyone who hopes to understand the nuances of the rarely successful claim for breach of the implied covenant of good faith and fair dealing, especially in the context of a limited partnership agreement which waives all fiduciary duties. In Dieckman v. Regency GP LP, No. 208, 2016 (Del. Supr., Jan. 20, 2017), the Delaware Supreme Court took the rare step of reversing the Court of Chancery, determining that the claims were supported by the implied covenant of good faith and fair dealing.

Background:  The court described the parties as being “identified by a host of confusing abbreviations.” The plaintiff was a limited partner/unitholder in a publicly-traded master limited partnership (“MLP”). The general partner proposed that the partnership be acquired through merger with another limited partnership in the MLP family. The seller and buyer were indirectly owned by the same entity, creating a conflict of interest. The relevant agreements created two safe harbors to address conflict resolution provisions in the partnership agreement. One was a “Special Approval” by an independent Conflicts Committee, and the other safe harbor was by means of an “Unaffiliated Unitholder Approval.”

Issues Presented: The plaintiff alleged that the general partner failed to satisfy the Special Approval safe harbor because the Conflicts’ Committee was itself conflicted. In addition, the complaint alleged that the safe harbor of the Unaffiliated Unitholder Approval was unavailable because of false and misleading statements in a proxy statement submitted to secure the approval.

Procedural Posture: The Court of Chancery held that the general partners’ satisfaction of the requirements of the safe harbor under the Unaffiliated Unitholder Approval required dismissal of the case. The Court of Chancery reasoned that because fiduciary duty principles were waived, they could not be used to impose disclosure obligations.

Analysis: The Supreme Court found that the Court of Chancery focused “too narrowly” on the disclosure requirements of the partnership agreement instead of focusing on the conflict resolution provisions.

The Supreme Court reasoned in essence that: “The implied covenant is well-suited to imply contractual terms that are so obvious – – like a requirement that the general partner not engage in misleading or deceptive conduct to obtain safe-harbor approvals – – that the drafter would not have need to include the conditions as express terms in the agreement.”

The Supreme Court gave hope to those who might have despaired based on recent decisions upholding the provisions of limited partnership agreements that waived fiduciary duties and past decisions that rejected the argument that the implied covenant of good faith and fair dealing was a basis to assert claims when conflicted transactions followed the safe harbor procedures outlined in the agreement.

In sum, the Supreme Court explained that even when all fiduciary duties are waived, the implied covenant of good faith and fair dealing cannot be waived. In addition, a second potential avenue for relief in an agreement that waived all fiduciary duties is the contra proferentem doctrine which especially applies to give effect to the “investors’ reasonable expectation in connection with ambiguities in publicly-traded limited partnership agreements.” See cases cited at footnote 18 and 19.

Several principles regarding the implied covenant are worth highlighting in bullet points. Although they are not new, their application to the facts of this case is noteworthy:

· The implied covenant applies “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.” The implied covenant applies where the express terms of an agreement “can be reasonably read to imply certain other conditions, or leave a gap, that would prescribe certain conduct, because it is necessary to vindicate the apparent intentions and reasonable expectations of the parties.”

· The court reasoned that the express terms of the agreement did not address, one way or the other, whether the general partner could use false or misleading statements to enable it to reach the safe harbors.

· The Supreme Court held that “implied in the language” of the agreement’s conflict resolution provision is a requirement that the general partner “not act to undermine the protections afforded unitholders in the safe harbor process.”

· Specifically, the Supreme Court imposed, through the implied covenant, terms that the court determined were “easily implied because the parties must have intended them and have only failed to express them because they are too obvious to need expression.” Stated another way, “some aspects of the deal are so obvious to the participants that they never think, or see no need, to address them.” See footnotes 25 and 26.

Bottom Line: The Supreme Court reasoned that although the defendant was not required to provide a 165-page proxy statement to induce the unaffiliated unitholders to approve the transaction, in order to trigger the safe harbor, once it went beyond the minimal disclosure requirements, the implied covenant barred the general partner from making misleading statements.

Moreover: implicit in the express terms is that the Special Committee membership be genuinely comprised of qualified members and that deceptive conduct not be used to create the false appearance of an unaffiliated, independent Special Committee. There were substantial questions raised at the pleading stage regarding the true independence of the members of the Special Committee.