United States: Delaware Court Re-Iterates The Contractual Nature Of Fiduciary Duties Owed To Limited Partners

Last Updated: March 15 2012
Article by Roland Hlawaty, Jordan Lacy, David Schwartz and Nicholas Venditto

Recognizes that governing agreement may limit the reach of the implied covenant of good faith and fair dealing.

The Delaware Court of Chancery's recent decision in Joel A. Gerber v. Enterprise Products Holdings, LLC1 re-iterates that the partners of a Delaware limited partnership may, by contract, eliminate or restrict express fiduciary duties owed to limited partners. While acknowledging that the implied covenant of good faith and fair dealing may not be contracted away, the Court's ruling also explains that the implied covenant binds only the parties to the limited partnership agreement (and not their non-signatory affiliates), and further, that the parties to a limited partnership agreement may define by contract the type of conduct that is presumed to be taken in good faith.

In Gerber, the Court was faced with a series of transactions between a public limited partnership and several affiliated entities controlled by Dan L. Duncan. Despite obvious conflicts of interest, because the limited partnership agreement significantly circumscribed the common law fiduciary duties owed to the entity and its limited partners, the Court dismissed the limited partner's claims for breach of fiduciary duty, both express and implied. This decision has application not just to limited partnerships, but to other Delaware alternate entities as well.

Background

In May 2007, Enterprise GP Holdings, L.P., a publicly traded Delaware limited partnership ("EPE"), purchased Texas Eastern Products Pipeline Company, LLC ("Teppco") from affiliates of Mr. Duncan in exchange for $1.1 billion worth of EPE limited partnership units, representing 76% of EPE's limited partnership units. Mr. Duncan was the owner of the general partner of EPE, Enterprise Products Holdings, LLC ("Enterprise Products GP").

Two years later, EPE sold Teppco to a Delaware limited partnership, Enterprise Products Partners, L.P. ("Enterprise Products"), whose general partner was 100%-owned by EPE. As consideration for the sale, EPE received Enterprise Products limited partnership units valued at $39.95 million, and the general partner of Enterprise Products received a $60 million increase in its general partnership interest – representing a total of approximately $100 million. As a result, EPE in effect received approximately $100 million for the sale to an affiliated entity of a company (namely, Teppco) that it had purchased for $1.1 billion from an affiliate just two years earlier.

E PE's 2009 sale of Teppco was approved by the Audit, Conflict and Governance Committee (the "ACG Committee") of the board of directors of Enterprise Products GP, and subsequently by the board itself. In connection with the transaction, Morgan Stanley provided an opinion stating that the consideration was "fair from a financial point of view to EPE and accordingly, to the limited partners of EPE."

Beginning in July 2010, Enterprise Products and the board of directors of Enterprise Products GP engaged in discussions regarding a possible merger of EPE with a subsidiary of Enterprise Products. After its initial offers were rejected, Enterprise Products made a final offer providing that each EPE limited partnership unit would be converted into 1.5 Enterprise Products limited partnership units. In support of its decision to approve this transaction, the ACG Committee received an opinion from Morgan Stanley confirming that the proposed exchange ratio was "fair from a financial point of view" to the holders of EPE's limited partnership units. Although the ACG Committee and its financial and legal advisors discussed the possible claims that EPE might have arising from EPE's 2007 purchase of Teppco from, and subsequent 2009 sale of Teppco to, affiliates of Mr. Duncan, at no point during the merger negotiations did EPE obtain any independent valuation of these claims.

Plaintiff's Claims

Soon thereafter, a former public holder of EPE limited partnership units filed suit against Enterprise Products, Enterprise Products GP, certain members of the board of directors of Enterprise Products GP, the estate of Dan L. Duncan and Enterprise Products Company, an affiliate of Enterprise Products, on behalf of two distinct classes:

  • On behalf of the first class – all public holders of EPE's limited partnership units who continuously held their units from the date of the 2009 Teppco sale through the date of completion of the merger with Enterprise Products – plaintiff alleged that the defendants had "breached their express and implied duties under EPE's limited partnership agreement ... by causing EPE to undertake" the 2009 sale of Teppco to Enterprise Products.
  • On behalf of the second class – all public holders of EPE's limited partnership units as of the effective date of the merger – plaintiff alleged that the defendants had "breached their express and implied duties" under the EPE limited partnership agreement "by causing EPE to enter into the Merger" without separately valuing the possible claims that EPE may have arising from the Teppco transactions.

Defendants moved to dismiss all of plaintiff's claims, arguing that (i) EPE's limited partnership agreement insulated them from breach of fiduciary duty claims in connection with conflict of interest transactions and (ii) they had not breached the implied covenant of good faith and fair dealing in the limited partnership agreement.

The Court's Analysis

In considering defendants' motion to dismiss, the Court explained the nature of the fiduciary duties owed to EPE and its limited partners. According to the Court, "[u]nder Delaware law, a limited partnership agreement may expand, restrict or eliminate the duties (including fiduciary duties) that any person may owe to either the limited partnership or any other party to the limited partnership agreement, 'provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing.'" Under the terms of the EPE limited partnership agreement, the Court noted, "Enterprise Products GP may cause EPE to enter into a transaction presenting a potential conflict of interest if the transaction meets certain requirements." The 2009 sale of Teppco to Enterprise Products was just such a transaction. Specifically, a conflict of interest between Enterprise Products GP or any of its affiliates, on the one hand, and EPE or any of its partners, on the other hand, is to be disregarded if it is: (1) approved by "Special Approval", defined as approval by a committee of the board of directors of EPE's general partner composed entirely of three or more directors who meet the independence standards established by the federal securities laws and the New York Stock Exchange; (2) approved by the vote of a majority of the limited partnership units, excluding those units owned by Enterprise Products GP and its affiliates; (3) on terms no less favorable to EPE than those provided to unrelated third parties; or (4) fair and reasonable to EPE, taking into account all of the relationships between the parties involved.

2009 Sale of Teppco

Express Fiduciary Duties. The Court determined that the board of directors of Enterprise Products GP cleansed the conflict of interest inherent in the 2009 sale of Teppco by obtaining "Special Approval" of the transaction by a committee of independent directors in accordance with the EPE limited partnership agreement. The Court found that the ACG Committee was properly constituted for this purpose.

Implied Fiduciary Duties. According to the Court, the implied covenant of good faith and fair dealing "only potentially binds the parties to an agreement." Because Enterprise Products GP was the only defendant who was party to the EPE limited partnership agreement, only Enterprise Products GP (but none of the various defendants affiliated with it) could be found liable for breach of the implied covenant.

Next, the Court explained that the implied covenant demands that Enterprise Products GP "act in good faith if it used the Special Approval process to take advantage of the contractual duty limitations" provided by the EPE limited partnership agreement. Further, the Court noted that "[w]hen a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith." In this connection, plaintiff alleged that Enterprise Products GP's decision to seek "Special Approval" of the Teppco sale was an exercise of bad faith inasmuch as the transaction was grossly unfair and none of the other three conflict cleansing standards of review could be satisfied.

To determine what the implied covenant of good faith and fair dealing required in this context, the Court again turned to the EPE limited partnership agreement. The Court explained that the agreement provided that an act or omission by Enterprise Products GP in reliance upon an expert's opinion was "conclusively presumed to have been done or omitted in good faith." Thus, having received and relied on Morgan Stanley's fairness opinion in connection with its approval of the Teppco sale, the board of Enterprise Products GP was entitled to a presumption of good faith. As such, "Enterprise Products GP is protected from any claims asserting that the action was taken other than in good faith ... [whether] arising under the duty of loyalty, implied covenant, and any other doctrine."

In rounding out its analysis, the Court went on to note that "the implied covenant is a 'limited and extraordinary legal remedy.' It is a gap-filler, and may not be used to 'infer language that contradicts a clear exercise of an express contractual right.'" Moreover, "one generally cannot base a claim for breach of the implied covenant on conduct authorized by the agreement." According to the Court, the drafters of the EPE limited partnership agreement included express contractual language to ensure that no claim for breach of the implied covenant could be asserted if Enterprise Products GP followed a specific procedure (in this case, reliance on an expert opinion). In a footnote, the Court added that because Enterprise Products GP followed the requisite procedures with respect to the Teppco sale, "any possible gap that [the plaintiff] might be able to find in the use of the Special Approval process will be filled with a conclusive presumption of good faith."

Merger of EPE and Enterprise Products

According to the Court, plaintiff's challenge to the merger failed for the same reasons that defeated his claim regarding the 2009 Teppco sale. Like the Teppco sale, the merger received "Special Approval" by the board of Enterprise Products GP, thereby precluding a claim of breach of an express fiduciary duty. Furthermore, any claim that defendants breached the implied covenant of good faith was overcome by the fact that the board relied on an opinion by Morgan Stanley confirming the fairness of the merger exchange ratio.

Conclusion

The Gerber decision serves as a reminder that the partners of a Delaware limited partnership – as well as the members of any other alternate entity created under Delaware law – are entitled to eliminate or restrict express fiduciary duties. Moreover, although the implied covenant of good faith and fair dealing cannot be eliminated, it can be defined by the terms of the governing agreement in a manner that effectively limits its reach.

The decision also highlights an over-arching principle of alternate entity legislation in Delaware. While recognizing that one could easily be "troubled" by plaintiff's allegations from the point of view of equity and fairness, the Court stressed that the limited partnership form allows entities to determine their own governance rules. "Ultimately," noted the Court, "the investor, who is charged with having assessed and accepted the risks of putting his money in an entity without the comfort afforded by fiduciary duties, is left with contractual protections, either those that are expressed or those that are within the implied covenant of good faith and fair dealing." In the case of EPE, those protections were quite limited and, therefore, prevented EPE's investors from successfully challenging transactions with a control group replete with conflicts of interest.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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