In this en banc decision, the Delaware Supreme Court affirmed in part and reversed in part the Court of Chancery’s decision to dismiss a complaint alleging that former public holders of limited partnership units of Enterprise GP Holdings, L.P. (“EPE”), a Delaware master limited partnership, did not receive fair value in connection with a series of conflicted, related-party transactions. Specifically, the Court the affirmed the dismissal of claims alleging breach of contractual and fiduciary duties, but reversed and remanded claims based on breach of the implied covenant of good faith and fair dealing against the general partner (and related tortious interference and aiding and abetting claims against the other defendants).
The challenged transactions included (1) EPE’s sale in 2009 of Texas Eastern Products Pipeline Company, LLC to Enterprise Products Partners, L.P. (“Enterprise Products”), the general partner of which was a wholly-owned subsidiary of EPE (the “Teppco GP Sale”) for $100 million (only two years after EPE had purchased Texas Eastern for $1.1 billion) and (2) the subsequent merger in 2010 of EPE into a wholly-owned subsidiary of Enterprise Products, which allegedly was done to eliminate derivative claims related to the Teppco GP Sale (the “Merger” and together with the Teppco GP Sale, the “Transactions”). The defendants in this action included Enterprise Products, EPE’s general partner (“EPE GP”), certain members of EPE GP’s board of directors, and the estate of the individual who controlled EPE, Enterprise Products and its general partner (“Duncan”). Among other things, the plaintiff alleged that the defendants breached their contractual obligations under EPE’s Limited Partnership Agreement (the “LPA”) as well as the implied contractual covenant of good faith and fair dealing. The plaintiff also alleged that certain defendants aided and abetted the foregoing breaches and tortiously interfered with the LPA by causing the Transactions to occur.
In its dismissal, the Court of Chancery recognized that the LPA supplanted traditional fiduciary duties with a “good faith” standard under which EPE GP and its affiliates were required to take actions with a belief that the decision or action was in the partnership’s best interest. The LPA also contained two provisions designed to protect the defendants’ actions from judicial review. First, the LPA created a “safe harbor” that would shield EPE GP and its affiliates from claims for breach of contract or any other duty in connection with conflicted transactions if the conflicted transaction received “special approval” by a majority of the members of EPE GP’s audit, conflicts and governance committee (“ACG”). The LPA also contained a provision that established a “conclusive presumption” that EPE GP acted in good faith (thus satisfying the LPA’s good faith standard) if it took actions based on consultations with, and in reliance on, the opinion of investment bankers or other experts.
The Court of Chancery held that the Transactions were conflicted and that absent any contrary provision of the LPA, the defendants would have owed default fiduciary duties to EPE’s public holders. However, the Court of Chancery concluded that the LPA eliminated and supplanted traditional fiduciary duties with a duty to act in “good faith.” The Court of Chancery further held that because both Transactions received “special approval” of the ACG, the complaint failed to state a claim for breach of the express “good faith” duty against any defendant. Regarding the implied covenant of good faith and fair dealing, the Court of Chancery held that the implied covenant only binds parties to the agreement and, thus, only EPE GP was subject to an implied covenant claim. In examining the claims against EPE GP, the Court of Chancery found that EPE GP was entitled to a conclusive presumption of good faith under the LPA because the ACG relied on fairness opinions from Morgan Stanley in approving both Transactions. The Court of Chancery held that the conclusive presumption of good faith defeated the plaintiff’s claim for breach of the implied covenant even though the plaintiff had alleged facts sufficient to demonstrate bad faith in connection with the Transactions. Accordingly, the Court of Chancery dismissed the implied covenant claim and also dismissed the claims for aiding and abetting and tortious interference with the LPA because they were tied to the success (or failure) of the implied covenant claim.
The Delaware Supreme Court addressed three issues on appeal: (1) whether the conclusive presumption of good faith in the LPA barred the plaintiff’s claim for breach of the implied covenant of good faith and fair dealing; (2) whether the plaintiff’s complaint pled facts sufficient to state a claim for breach of the implied covenant; and (3) whether the Court of Chancery properly dismissed the aiding and abetting and tortious interference claims.
First, the Supreme Court held that the conclusive presumption of good faith in the LPA did not bar the plaintiff’s claim for breach of the implied contractual covenant of good faith and fair dealing. The Supreme Court stated that the Court of Chancery improperly conflated two distinct concepts—the implied covenant and the LPA’s contractual fiduciary duty of “good faith.” With respect to the implied covenant, “good faith” refers to implied terms in a contract that the parties would have agreed to had they thought to address them at the time of contracting, whereas the LPA’s presumption of good faith applied only to the contractual fiduciary duty and could not operate retroactively to change the parties’ expectations at the time of contracting. Thus, the Supreme Court held that the conclusive presumption of good faith in the LPA did not bar the implied covenant claim.
Second, the Supreme Court held that the plaintiff adequately pled breaches of the implied contractual covenant of good faith and fair dealing against EPE GP in connection with both Transactions. Importantly, the Supreme Court affirmed the dismissal of plaintiff’s claims alleging violations of the LPA’s contractual fiduciary duty of good faith, given that such claims were eliminated by the use of the “special approval” safe harbor and the conclusive presumption of good faith that resulted from reliance on a fairness opinion. However, EPE GP’s decision to rely upon those same protective provisions was subject to the implied covenant. The Supreme Court noted that applying the implied covenant is a “cautious enterprise,” that the plaintiff must show that EPE GP acted arbitrarily or unreasonably and thereby frustrated the fruits of the bargain, and that the Court must assess the parties reasonable expectations at the time of contracting. Regarding the Teppco GP Sale, the Supreme Court found the complaint alleged that Morgan Stanley’s opinion for the Teppco GP Sale did not evaluate the fairness of the consideration in the Teppco GP Sale on its own; it attested only to the fairness of the consideration for the Teppco GP Sale, together with the consideration paid in a related sale of Teppco Partners, LP, as a whole. The Court held that the plaintiff adequately alleged an implied covenant claim where, at the time of contracting, the plaintiff “could hardly have anticipated” that EPE GP would attempt to satisfy its contractual obligations by relying on a fairness opinion that did not value the consideration that the LP unitholders actually received. The Court further held that the plaintiff sufficiently pled that EPE GP “engaged in a manifestly unfair transaction, and then relied on an unresponsive fairness opinion, to ensure that its contractual fiduciary duty would be conclusively presumed to have been discharged. This is the type of arbitrary, unreasonable conduct that the implied covenant prohibits.” The “special approval” process with respect to the Teppco GP Sale was similarly subject to the implied covenant, and the Court held that the plaintiff had pled claims that EPE GP breached the implied covenant in its attempt to obtain special approval. In particular, the Court noted that although the ACG “had no contractual duty to obtain a fairness opinion, the parties would not have agreed that the [ACG] could obtain and rely on a fairness opinion so flawed.”
Similarly, regarding the Merger, the Supreme Court found the complaint alleged that a principal purpose of the Merger was to eliminate certain derivative claims, and that neither EPE GP nor Morgan Stanley valued those derivative claims in fixing the consideration or opining on the fairness of the Merger. The Supreme Court concluded that the parties would have agreed, at the time of contracting, that any fairness opinion contemplated by the conclusive presumption provision “would address the value of derivative claims where (as here) terminating those claims was a principal purpose of the merger.” Moreover, notwithstanding the special approval process, the Supreme Court concluded that the “LP unitholders had a reasonable expectation that if the general partner chose to terminate their investment by way of a merger primarily intended to eliminate valuable assets of the limited partnership (here the [derivative claims]), the LP unitholders would be compensated for the value of those eliminated claims.” Thus, the complaint adequately pled that EPE GP breached the implied covenant in connection with the Merger.
Finally, the Supreme Court reversed and remanded the Court of Chancery’s dismissal of the aiding and abetting and tortious interference claims. As noted above, those secondary liability claims were contingent on the success (or failure) of the plaintiff’s claims for breach of the implied contractual covenant of good faith and fair dealing. Therefore, because the Supreme Court reversed the Court of Chancery’s dismissal of the implied covenant claim, it accordingly remanded the secondary liability claims for reconsideration.