This post was authored by R. Montgomery (“Monty”) Donaldson, a Delaware business and commercial litigator for many years, a friend and colleague of Francis Pileggi, and a follower of this blog.
The implied covenant of good faith and fair dealing has received considerable play in Delaware in recent years. In fact, over the last half-decade, the Delaware Supreme Court has weighed in on the issue in at least three noteworthy decisions, reported previously on this blog here, here, and here. As the matrix of Delaware decisional law has evolved, at least some academicians have questioned whether it offers a uniformly reliable predictive tool in terms of how the covenant may be applied under a given set of circumstances.
Against this backdrop, a recent Delaware Court of Chancery opinion evaluating an implied covenant claim (and other contract-based claims) through the forgiving lens of a Rule 12(b)(6) challenge, In re CVR Refining, LP Unitholder Litigation, C.A. No. 2019-0062-KSJM (Del. Ch. Jan. 31, 2020), provides another useful illustration of where the implied covenant of good faith and fair dealing likely will be found to have traction, at least at the pleading stage.
Broad Contours of the Implied Covenant.
In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), the Delaware Supreme Court described essentially two scenarios in which the implied covenant may come to bear. The first, broadly speaking, is where a contingency arises that was not anticipated by the parties, and therefore was not addressed in the explicit terms of the underlying contract. Here, the implied covenant may serve as a gap-filler. The second scenario, again broadly speaking, is where a party to the contract is given discretion to act with respect to a certain subject matter, but exercises that discretion in a manner that frustrates the purpose of the contract – that is, in a manner implicitly proscribed by the contract’s express terms.
The cases likewise delineate what cannot be accomplished by way of the implied covenant, and the list of prohibited applications is lengthy. Among them, the covenant cannot be used to:
- rebalance economic interests after events that could have been anticipated but were not cause harm to one of the parties (see, e.g., Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, 2019 WL 4927053, *22 (Del. Ch. Oct. 7, 2019));
- “fill a gap” where the contract in fact addresses the conduct at issue (see, e.g., Oxbow Carbon & Minerals Hldgs. V. Crestview-Oxbow Acq., LLC, 202 A.3d 482, 507 (Del. 2010)); or
- effectively re-write the parties’ agreement (or, as famously written by former Chancellor Strine, “[t]he implied covenant of good faith and fair dealing is not a license for a court to make stuff up . . .” Winshall v. Viacom Int’l, Inc., 55 A.2d 629, 631 (Del. Ch. 2011), aff’d, 76 A.3d 808 (Del. 2013)).
Of course, these and other proscribed applications have been analyzed in detail far beyond the general scope of this post
The CVR Refining Decision
The claims in CVR Refining alleged that entities controlled by Carl Icahn engaged in a multi-step scheme (patterned after the one challenged in the Boardwalk Pipeline decision cited above) culminating in the exercise of a call right to buy out the minority unitholders of CVR Refining, L.P. at an unfair price. In particular, the minority unitholders alleged that CVR Energy (the indirect owner of CVR Refining’s general partner) launched a partial exchange offer to achieve the contractually-designated ownership threshold for exercising the call right. The general partner’s board, besprinkled with individuals closely affiliated with Icahn, did not make a recommendation concerning the exchange offer, and publicly disclosed its non-recommendation (this, in the face of a reasonably conceivable possibility that the exchange offer would trigger speculation in the market about the call right, thereby depressing the unit price). In filings made contemporaneously with the launch of the exchange offer, Icahn entities disclaimed any intention to exercise the call right after consummating the exchange offer – the predictable consequence of which (along with the exchange offer itself) was to cause analysts to speculate that the opposite was true, thereby driving down the price of CVR Refining.
As predicted, CVR later announced publicly that it was contemplating exercising its call right, causing the trading price to drop precipitously. When the call right was exercised, CVR Energy paid $393 million less than it would have had the unit price remained unaffected. Aside from breaches of the express terms of the partnership agreement, the minority unitholders alleged that the implied covenant of good faith and fair dealing prohibited the defendants from taking actions to depress the trading price of the units and undermine the price-setting mechanisms contained in the call right.
In denying the defendants’ motion to dismiss the implied covenant claim, the Court of Chancery observed:
- that the claim implicated two partnership agreement provisions designed to protect minority shareholders – a 90-day provision and a 20-day formula. The former was designed to prevent minority unitholders from having their units called at a price below what the General Partner of its affiliates paid to purchase units in the 90 days preceding the exercise date. The latter was designed to ensure that the exercise price was unaffected by any announcement of the exercise by requiring that the price be determined with reference to the average of the daily closing prices for the 20 days immediately prior;
- that it was reasonably conceivable that implicit in the language of the call right provision is a requirement that the defendants not act to undermine the protections afforded to unitholders by the price-protection mechanisms; and
- that it would be “obvious” and “provocative” to demand the inclusion of an express condition that a general partner and its affiliates not subvert price-protection mechanisms through a multi-step scheme designed to manipulate the unit price (see Diekman v. Regency GP LP, 155 A.3d 358, 368 (Del. 2017) (“Partnership agreement drafters, whether drafting on their own, or sitting across the table in a competitive begotiation, do not include obvious and provocative conditions in an agreement . . .”).
- While narrowly construed and cautiously applied, the implied covenant of good faith and fair dealing, where properly invoked, has teeth. CVR Refining drives home the point (once again) that claims predicated on the implied covenant may survive dismissal where well-pled factual allegations support a reasonable inference that a contracting party has, in exercising otherwise-legitimate contractual rights, taken actions to undermine express contractual rights of the other party. This is especially so where the offending actions were such that explicitly proscribing them in the contract would have been too obvious or provocative. And so, the implied covenant marches on.