Last week the Delaware Supreme Court reversed its prior decision interpreting a master limited partnership agreement that provided what Delaware’s high court described as a contractual fiduciary standard. The Court’s opinion is necessary reading for anyone who drafts or litigates alternative entity agreements that waive fiduciary duties but provide other contractual replacement standards. In Brinckerhoff v. Enbridge Energy Company Inc., Del. Supr., No. 273, 2016 (Mar. 20, 2017; revised Mar. 28, 2017), Delaware’s high court was candid enough to describe the contract provisions in this case as “complex,” and the Court’s precedent on the controlling issues as “confusing.” (Four of the five members of the Court on the bench in 2013, the year of the decision reversed in this case, are no longer on the bench. Next month, no member of the Court sitting in 2013 will still be on the bench.)
Background: There were three prior Chancery decisions involving the master limited partnership agreement (LPA) in this matter, and two prior Delaware Supreme Court rulings. Some of these decisions, which provide more factual background, were highlighted on these pages: here, here and here. In this fifth Delaware decision in this matter, to be known hereafter as Brinckerhoff V, the Court reversed the Chancery decision which had dismissed a claim by a unitholder in a publicly traded master limited partnership (MLP). The Court’s opinion included a chart to distinguish the alphabet soup of related entities involved, including the general partner and other entities affiliated with the master limited partnership. For purposes of this short blog post, the important facts are that the LPA waived all fiduciary duties and substituted a contractually defined standard of conduct. A unitholder challenged an affiliated transaction that the unitholder claimed was in violation of the contractual substitute standard, in part because it was unfair to the unitholders and favored the general partner.
The MLP in this case was involved in the oil and gas industry and the transaction related to a project for a proposed $1.2 billion pipeline. Despite declining oil prices and a nearly 20% decrease in projected EBITDA during the intervening period, the partnership paid $200 million more for the rights in the project that it had sold several years earlier.
Although the Court of Chancery followed the Supreme Court’s pleading standard announced in the Supreme Court’s 2013 decision in this matter, known as Brinckerhoff III, this ruling changed course and reversed the standard announced by the Supreme Court in its 2013 decision in Brinckerhoff III.
Delaware’s high court acknowledged the confusing precedent in this area, and cited in footnote 1 to no less than ten decisions of the Delaware Supreme Court within the past few years alone, not including the several decisions by the Court of Chancery addressing similar issues, on the topic addressed in this opinion. See, e.g., Dieckman v. Regency GP LP, Del. Supr., No. 208, 2016 (Jan. 20, 2017), highlighted on these pages.
In connection with its analysis, the Court noted that in light of the statutory authorization allowing expansive variations on standards of conduct, the general principles interpreting such contractual standards need to be nuanced. In this writer’s view, it turns out that attorneys are often not exemplary in their drafting of clearly defined contractual standards of conduct when fiduciary duties are waived.
The high court explained that the Court of Chancery confused the general standard of care in the LPA with more specific requirements in other sections, and observed that the trial court also violated settled rules of contract interpretation requiring that courts prefer specific provisions over more general ones.
Although the general partner was exculpated for actions taken in good faith, good faith was not a defined term in the LPA. Rather, a general standard of conduct allowed actions to be taken by the general partner if the general partner reasonably believed that its action was in the best interest of, or not inconsistent with, the best interest of the partnership. The Supreme Court treated this standard as a contractual fiduciary standard similar to the entire fairness standard.
In explaining the reversal of its decision in the 2013 Brinckerhoff III decision, the Court in this opinion announced the following pleading standard: In order to plead a claim that the general partner did not act in good faith, the facts must support an inference that the general partner did not reasonably believe that the [challenged] transaction was in the best interest of the partnership. Importantly, the Court emphasized that: “as our prior cases established, the use of the qualifier ‘reasonably’ imposed an objective standard of good faith.” See footnote 63 (citing the cases referring to a subjective good faith standard where the LPA at issue did not require a “reasonable” belief).
The Court provided seven specific reasons why the claims challenging the transaction at issue in this matter were sufficient at the pleading stage. The Court also explained why a claim that the fairness opinion used should not be entitled to a conclusive presumption of good faith, also satisfied pleading standards. For example, the Court found that the “financial terms were fully baked” by the time the author of the fairness opinion appeared on the scene.
An important principle reiterated in this opinion was that even if the LPA exculpated a general partner from monetary damages based on good faith behavior, that language did not insulate the general partner from equitable remedies for breaches of the contract. A key ruling in this matter was that based on what the Court regarded as a “contractual fiduciary standard similar if not identical to entire fairness,” the general partner was subject to equitable remedies if the trial court, after remand, found contractual violations even if such actions were taken in good faith.