In most of the business valuation cases that I’ve litigated, it’s not long before one side accuses the other’s valuation expert of mixing apples and oranges. And at the risk of endorsing the overused expression, it’s easy to see why. Inconsistencies in valuation methodologies or applications often are fertile grounds for criticism, and invocation of the apples-to-oranges idiom is an easy hook to argue that almost any inconsistency requires disregarding the expert’s opinion altogether.
That is exactly what happened to the Plaintiff’s valuation expert in Dieckman v. Regency GP, LP, Del Chancery Feb 15, 2021. In a 129-page post trial opinion, Chancellor Bouchard denied the plaintiff’s bid for $1.6 billion in damages, even after finding that the defendant general partner breached the partnership agreement’s implied duty of good faith and fair dealing. Chancellor Bouchard’s opinion explores a broad range of complex legal and factual issues, not the least of which is his complete rejection of Plaintiff’s damages calculation because it was akin to “comparing apples to oranges.”
The dispute in Dieckman concerned a familiar fixture in Delaware business organizations: the Delaware master limited partnership. An effective, tax-efficient vehicle for capital-intensive ventures—especially in the energy sector—the Delaware master limited partnership features centralized management by the general partner (usually itself a partnership), and limited liability for a potentially large number of passive investors, or unitholders. Like most partnerships, the rules governing the general partner’s management of the master limited partnership are set forth in a partnership agreement.
The Conflicted Conflicts Committee
Energy Transfer Equity (“ETE”) owned controlling interests in two Delaware master limited partnerships, Regency Energy Partners (“Regency”), and Energy Transfer Partners (“ETP”). In January 2015, in consideration of a unit-for-unit merger between Regency and ETP, the Board of Directors of Regency’s General Partner (the “Board”), which governed Regency, tasked its conflicts committee with reporting on the fairness of the proposed merger.
Under Regency’s Master LP Agreement, approval of a proposed merger by a “conflicts committee” gave the Board a safe harbor. In any decision upon which the conflicts committee gave its special approval, good faith of Board would be presumed. At the time the Board sought special approval of the proposed merger between ETP and Regency, however, the conflicts committee was itself conflicted: a newly-appointed member of Regency’s conflicts committee had failed to resign from his directorship at Sunoco, an affiliated entity that was also majority-owned by ETE. Under the language of the Master LP Agreement, a prerequisite to membership on the conflicts committee is that the director not be a director of an affiliated entity.
Because a member of the conflicts committee did not satisfy the criteria for serving on the committee, Plaintiff argued that the Board breached the implied duty of good faith and fair dealing inherent in the Master LP Agreement’s safe harbor provision. Once unmoored from the safe harbor, Plaintiff contended that the merger was unfair to Regency common unitholders because in the unit-for-unit exchange, they received less than they gave up.
The Apples-to-Oranges Damages Calculation
Plaintiff’s valuation expert testified that as a result of the improper merger, Plaintiff (a class of common unitholders) suffered $1.6 billion in damages. The expert calculated that figure as the aggregate difference between the “give”—what Regency common unitholders lost in the merger—and the “get”—what they received in return.
The merger was structured so that for every 1 common unit that Regency unit owners gave up, they received .4124 ETP units in exchange. Plaintiff calculated the “give”—one unit of Regency—to be $29.06 based upon a valuation of Regency performed using the dividend discount valuation method, which calculates the price of a security by discounting to present value all of its future dividends. Although the DDM valuation model is a widely-accepted valuation method, it is not without flaws. For one, it requires a steady stream of dividends, and it generally requires more assumptions than other methods.
Plaintiff then calculated the “get”—.4124 units of ETP—by reference to its market price at the time of the merger, $57.78. The difference between the give ($29.06) and the get ($57.78 * .4124), Plaintiff concluded, resulted in per-unit damages of $5.23 and aggregate damages of $1.68 billion.
Defendants were quick to point out the Plaintiff’s use of different valuation methods for Regency and ETP was a fatal flaw, akin to comparing apples to oranges. In response, Plaintiff’s expert explained that he used two different valuation methods for his damages calculation because ETE, as the controlling owner of both ETP and Regency, had a strong incentive to grow ETP over Regency due to differences in incentive distribution rights. Put simply, before the merger, ETE got more if ETP did well than it would get if Regency did equally well. According to Plaintiff’s expert, this discrepancy kept the market cool to Regency units, rendering Regency’s market price an unreliable indicator of value.
Chancellor Bouchard’s Post-Trial Decision
Following a five-day trial in December 2019 and extensive post-trial briefing, Chancellor Bouchard on February 15 issued his post-trial decision finding that the defendants were entitled to judgment in their favor.
First, the Court agreed with Plaintiff that the Board breached the implied covenants in the safe harbor provisions of the Master LP Agreement as a result of the non-qualified member serving on the conflicts committee. The Court observed that the safe harbor provision is “reasonably read by unitholders to imply a condition that a Committee has been established whose members genuinely qualified as unaffiliated.” Chancellor Bouchard found that the same conduct breached the implied duties of a second safe harbor provision related to majority approval of unitholders.
Having breached the implied covenants in the safe harbor provisions of the Master LP Agreement, the Court found that judicial review of the fairness of the merger was required, and that the defendants bore the burden of proving that the merger was fair and reasonable. Upon an exhaustive review of the facts and circumstances surrounding the merger, however, Chancellor Bouchard determined that the Board satisfied its burden, defeating Plaintiff’s claims.
Chancellor Bouchard’s thorough fairness analysis hinged in large part upon a complete rejection of Plaintiff’s damages calculation. Chancellor Bouchard determined Plaintiff’s calculation was entirely unreliable because of the apples-to-oranges nature of the calculation:
[T]he damages evidence presented at trial confirms the fairness of the Merger consideration. In analyzing the “give-get” of the Merger, Plaintiff’s expert could only demonstrate damages by relying on an illogical apples-to-oranges comparison of Regency’s DDM value to the market price of ETP’s units. Any comparison of DDM-to-DDM or market-to-market yielded no damages.
The Court dismissed Plaintiff’s assertion that ETE’s incentive to favor ETP resulted in “valuation overhang” over Regency. In fact, said the Court, Regency had grown at a faster rate than ETP during the three-year period preceding the merger. If the market was cool to Regency’s common units as a result of ETE’s control, as Plaintiff contended, it would have been equally cool to ETP; any “valuation overhang” affected both sides of the equation, and it was not cause to use different valuation methods.
Chancellor Bouchard seemed most swayed by Defendants’ expert, who testified that any apples-to-apples comparison of the give/get—either DDM-to-DDM or market-to-market—resulted in no damages. He also leaned heavily on past Chancery court decisions rejecting similar apples-to-oranges comparisons of corporate valuations. For instance, in Citron v E.I. Du Pont de Nemours & Co., 584 A2d 490, 509 [Del Ch 1990], the Court rejected a valuation analysis that compared adjusted book value to market price as “akin to comparing apples to oranges.” Likewise, in Emerald Partners v Berlin, 2003 WL 21003437, at *36 [Del Ch Apr. 28, 2003], a comparison of undiscounted going concern value to discounted going concern value was “flawed because it compared apples to oranges.”
For limited partners, Dieckman giveth and taketh away. On the one hand, its enforcement of the implied covenant of good faith and fair dealing in a partnership agreement provides a foothold for limited partners to bring claims against the general partner for actions that violate the spirit of the agreement, if not the letter. On the other hand, Dieckman highlights the difficulty limited partners face in proving that any board action, particularly a board action taken in good faith, caused recoverable damages.
More broadly, Chancellor Bouchard’s rebuke of Plaintiff’s proofs on damages serves as a sharp reminder to business appraisers and advocates at all levels: If man’s first sin was eating the apple, a business valuator’s greatest sin is mixing apples and oranges. A calculation that is inconsistent in its valuation methodologies is likely to face close if not fatal scrutiny.