The Court of Chancery often hears applications for expedition of a plaintiff's motion to enjoin a merger transaction. While the court "has followed the practice of erring on the side of more hearings rather than fewer" (Giammargo v. Snapple Beverage Corp. (1994)), it will not schedule an expedited hearing unless the plaintiff can show good cause.
The June 10 opinion in In Re K-Sea Transportation Partners L.P. Unitholders Litigation illustrates that, even where a plaintiff can state a colorable claim, the court will not schedule an expedited hearing if the plaintiff fails to show "a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding," (citing Giammargo).
The K-Sea case also illustrates that when parties to agreements governing limited partnerships, limited liability companies or other alternative entities modify or eliminate fiduciary duties, a Delaware court will enforce the agreements as written. Courts will not undo what one party now believes is a bad bargain through the application of fiduciary duties or the implied covenant of good faith and fair dealing.
K-Sea involved the acquisition of a Delaware partnership. The acquirer sought to acquire the limited partnership by merger for either cash or a combination of cash and the acquirer's stock. Representatives of the board of directors of target's general partner negotiated the terms of the merger agreement. A special committee approved the transaction.
The plaintiffs argued that the special committee's approval did not comply with the K-Sea Limited Partnership Agreement (LPA) for two reasons. First, the special committee failed to consider separately an $18 million payment to the general partner for its incentive distribution rights (IDRs). Second, the members of the special committee were not independent because shortly before the beginning of merger negotiations with the acquirer, the target granted them each 15,000 phantom units that would immediately vest upon a change of control.
The plaintiff-unitholders also challenged the disclosure provided the common unitholders in the registration statement.
THE K-SEA LPA
In assessing whether the plaintiffs had asserted a colorable claim, the court rejected the plaintiffs' contention that the special committee did not adequately consider the fairness of the transaction. In so doing, the court turned to the K-Sea LPA, which allowed conflict transactions as long as a special committee of independent directors approved the transaction.
The court found that the special committee had complied with the terms of the LPA in approving the transaction as a whole and was not required, as plaintiffs contended, to assess separately the fairness of the consideration offered to the general partner for the IDRs. The court noted, however, that such approval was effective under the LPA only if the members of the special committee were independent. The court found that, because the phantom options granted shortly before the merger negotiations doubled the total ownership of common units held by special committee members and immediately vested if the special committee members approved the transaction, plaintiffs stated a colorable claim that the members of the special committee were not independent.
DISCLOSURE ALLEGATIONS REJECTED
The court rejected the plaintiffs' disclosure allegations. First, the court held that the LPA required defendants only to provide a copy of the merger agreement and notice of the meeting to vote on the merger. While the court also held that defendants had adequately disclosed the information of which plaintiffs complained, even if the LPA did not limit their disclosure obligations, the court found that the defendants had satisfied their duties by complying with the terms of the LPA.
This decision reflects the court's recognition that traditional fiduciary duties may be supplanted in alternative entities by contract. Citing precedent back to 1998, the court noted that only if the partners have not expressly made provisions in their partnership agreement or if the agreement is inconsistent with mandatory statutory provisions "... will [a court] look for guidance from the statutory default rules, traditional notions of fiduciary duties, or other extrinsic evidence." (See the 2004 Chancery Court opinion in In re LJM2 Co-Inv., L.P., citing its 1998 opinion in Sonet v. Timber Co.) The court's analysis is instructive:
"Certain other provisions of the LPA tightly circumscribe the duties of K-Sea GP and its directors. First, § 7.9(a) provides that: 'In the absence of bad faith by the General Partner, the resolution, action or terms so made, taken or provided by the General Partner with respect to [a potential conflict of interest] shall not constitute a breach of this Agreement or any other agreement contemplated herein or a breach of any standard of care or duty imposed herein or therein or, to the extent permitted by law, under the Delaware Act or any other law, rule or regulation. LPA § 7.9(a).'
This section can be read to eliminate traditional fiduciary duties so long as the persons involved comply with the prescribed process or requirements for resolving conflicts of interest. Second, § 14.3 details the procedure that must be followed to gain approval of the limited partners of a merger or consolidation.
The only information K-Sea is required to provide in that situation is '[a] copy or a summary of the Merger Agreement ... with the notice of a special meeting or the written consent.' Given the significant weight afforded to parties' freedom to contract, I read this provision as reflecting the parties' intent to pre-empt fundamental fiduciary duties of disclosure, limiting the requirements to those detailed in the LPA. Under the plain language of the LPA, therefore, Defendants were required to provide only a copy of the Merger Agreement along with a notice of the shareholder meeting. K-Sea satisfied each of these requirements.
Therefore, because the LPA appears to have eliminated traditional fiduciary duties and Defendants complied with the disclosure requirements under § 14.3, I conclude that Plaintiffs have failed to assert a colorable claim that Defendants failed to comply with their duty of disclosure."
NO IRREPARABLE HARM
The plaintiffs sought a limited injunction allowing the transaction to close with the $18 million payment for the IDRs set aside to satisfy their claim. The court found that they had failed to meet their burden of showing that money damages were not an adequate remedy.
The plaintiffs could not show that the amount of damages was difficult to calculate as the amount at issue was the $18 million for the IDRs. Moreover, the plaintiffs did not contend that the defendants were insolvent or likely to be insolvent at the time of any judgment. Finally, the court rejected as speculation plaintiffs' argument that they could not recover damages if they were successful on their claim because "90 percent of the economic interest in K-Sea GP and the IDRs is owned by single-purpose limited partnerships whose sole asset is their indirect ownership interest in KSea."
The court found that the plaintiffs had failed to allege that the defendants or those associated with them could not satisfy any judgment and that in any event, the plaintiffs likely could recover from the limited partners who held stakes in the limited partnership that held 90 percent of the interest in K-Sea. Therefore, the court found that the plaintiffs could not meet their burden of establishing that any damages they might recover would be uncollectible.
AGREEMENTS CONSTRUED LITERALLY
This case illustrates that a plaintiff who seeks the extraordinary remedy of a preliminary injunction may have a more difficult burden if the transaction under attack involves an alternative entity and the plaintiff cannot show that the defendants failed to comply with the applicable governing agreement. The Delaware courts apply the statutory mandate that agreements governing alternative entities are to be construed in accordance with their literal terms.
Thus, while disclosure limited to the actual merger agreement and notice of a meeting to approve it likely would not accord with corporate directors' fiduciary duties and might support an injunction for corrective disclosure, the same conduct may be compliant with a general partner's duties if the limited partnership agreement adequately supplants traditional fiduciary duties. Similarly, claims attacking the fairness of a transaction involving a Delaware corporation due to unfair process may fail in the alternative entity context if the governing instrument specifies the required process and plaintiff cannot show that defendants did not comply with the literal terms.
Finally, even if a plaintiff can plead a colorable claim of breach of duty under the governing agreement, the burden remains on plaintiff to show that money damages are not an adequate remedy and speculation that defendants will not be able to satisfy a judgment is insufficient. While the standard for expedition of an injunction proceeding is the same for corporations and alternative entities, K-Sea provides guidance to practitioners that, when it comes to alternative entities, the language of the governing instrument likely will control the outcome.