Court Upholds Allegedly Unfair Master Limited Partnership Transaction
When alternative entities first came into prominence, questions arose concerning the applicability to them and their stakeholders of corporate law fiduciary duty jurisprudence. Eventually the Delaware General Assembly amended the alternative entity statutes to permit the modification or elimination of fiduciary duties, including the duty of loyalty. While stockholders of Delaware corporations since 1986 were permitted to exculpate directors for liability for monetary damages, they cannot modify, much less eliminate, the duty of loyalty. In contrast, the Delaware courts of late have been consistent in enforcing as written the terms of alternative entity foundational documents that modify or eliminate fiduciary duties, often leaving investors with no remedy even though a similar fact pattern in a corporation would state a claim. The well-written April 29 decision from the court's newest vice chancellor, Joseph R. Slights III, in Brinckerhoff v. Enbridge Energy, C.A. No. 11314-VCS, illustrates this trend.
Plaintiff Peter Brinckerhoff challenged a transaction whereby a master limited partnership, Enbridge Energy Partners, reacquired an interest in a crude oil pipeline from the general partner in a conflicted transaction at an allegedly unfair price and on terms unfair to the unaffiliated unitholders. To accomplish the transaction the limited partnership agreement was amended "to allocate to the public unitholders significant items of gross income that [would otherwise] have been allocated to [EEP]." The plaintiff brought class and derivative claims against the general partner and its controller, affiliates and directors claiming breach of the limited partnership agreement; the implied covenant of good faith and fair dealing; and default fiduciary duties. Among the remedies the plaintiff sought were damages on behalf of EEP and the public unitholders for all profits and benefits the defendants obtained, disgorgement and restitution to EEP and the class of public unitholders and their successors and transferees, and rescission, reformation of the partnership agreement or rescissory damages. As explained below, the court dismissed the complaint for failure to state a claim pursuant to Court of Chancery Rule 12(b)(6), primarily because the plaintiff failed to allege any bad-faith conduct, the applicable contractually mandated standard governing the transaction.
Principle of Freedom of Contract
In a prior decision challenging the general partner's acquisition in 2009 of the very interest in the crude oil pipeline that it was now selling back to EEP, the Delaware Supreme Court had affirmed the Court of Chancery's construction of the identical partnership agreement to require a unitholder, to state a claim, to plead facts that the EEP general partner board acted in bad faith in determining that a transaction was fair and reasonable to the partnership. The current Brinckerhoff court found that the plaintiff had failed to so plead. Moreover, the complaint alleges that once Enbridge offered to sell its interest back to the partnership, the designated agent of the general partner formed a special committee of three directors, two of whom the plaintiff conceded were independent and disinterested, which in turn engaged legal and financial advisers. The financial adviser, Simmons & Co. International, had particular experience in the energy industry. Materials attached to the complaint reflected that "Simmons' review was thorough." Additionally, the court was unmoved by the plaintiff's allegation that Simmons did not consider the terms of the 2009 sale because the complaint reflected that Simmons had reviewed 27 comparable transactions between 2011 and 2014. The complaint also alleged multiple meetings with the special committee and Simmons and multiple due diligence calls to discuss with Enbridge financial projections and the special tax treatment. Simmons then issued a fairness opinion that the general partner relied upon in approving the transaction and, under the partnership agreement, that conduct entitled the general partner to a presumption of good faith. Under these circumstances the court found that the plaintiff had failed to allege facts reflecting that the defendants had acted in bad faith. Moreover, because the special tax treatment was integral to the overall transaction and so viewed by Simmons, the court found that the plaintiff had failed to plead facts from which the court might infer that the EEP general partner had acted in bad faith to create a material adverse effect on the unitholders or any class of them or had in bad faith enlarged the obligations of any limited partner in approving the special tax treatment.
the Implied Covenant of Good Faith and Fair Dealing
Plaintiffs often seek to plead a breach of the implied covenant of good faith and fair dealing in breach of contract actions. However, that doctrine generally is only available to fill in gaps. The court found that "on these facts, where the LPA specifically addresses the challenged conduct and expressly eliminates fiduciary duties, the court can discern no reasonable basis to allow the implied covenant claims to stand." Here the court also rejected the plaintiff's attempt to seek reformation where the plaintiff failed to plead that "the contract the parties agreed to does not reflect the parties' actual agreement."
The Delaware courts enforce alternative entity agreements as written. The consequence is that a plaintiff generally can state a claim that will survive a motion to dismiss in a conflict-of-interest transaction, which allegedly unfairly benefits a controlling entity of a corporation, but cannot do so for similar conduct involving a limited partnership or other alternative entity if the relevant limited partnership or operating agreement has eliminated all fiduciary duties and the plaintiff cannot plead a breach of the applicable contractual standard. As this case demonstrates, a plaintiff cannot expect to plead a breach of the implied covenant as a fallback where there are no gaps in the contract to which as an investor the plaintiff is a party. An investor in a limited partnership whose governing agreement eliminates virtually any duties to the public unitholders must weigh the risk of no remedy in what might in other circumstances be recognized as an unfair transaction with the potential for superior returns. As this case demonstrates, a self-dealing transaction that arguably confers substantially greater benefit on an insider may pass muster under a contractual standard of conduct that substitutes for the conventional fiduciary duties of loyalty and care.
Lewis H. Lazarus (email@example.com) is a partner at Morris James in Wilmington and chair of the corporate and commercial litigation group. His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.