Conflict Transaction Cleansed By Master Limited Partnership’s Special Committee
By Scott E. Waxman and Annamarie C. Larson
In Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc., et al, (C.A. No. 11603-VCG), Vice Chancellor Glasscock granted the defendant’s motion to dismiss claims relating to the purchase of pipeline assets from the general partner’s parent. The Court of Chancery held that the transaction was “fair and reasonable” to the master limited partnership because it was approved by a special committee and that the general partner did not breach the implied covenant of good faith and fair dealing. In this case, the Court of Chancery reaffirmed parties’ abilities to contract freely when forming alternative entities such as a master limited partnership and confirmed that judicial review of such contractual terms is very limited.
The limited partner plaintiff, Employee Retirement System of the City of St. Louis, owned common units in a publicly-traded Delaware master limited partnership, TC Pipelines, LP (the “MLP”). The general partner defendant, TC Pipelines, GP, Inc., had previously caused the MLP to purchase a 70% interest in a gas pipeline stretching from British Columbia to southern Oregon. The transaction at issue in this case was a “dropdown” in which the MLP purchased the remaining 30% interest in the pipeline. The MLP purchased the pipeline assets from the general partner’s parent entity, TransCanada American Investments Ltd., and in exchange for the 30% interest, the MLP paid consideration of cash, assumed debt and issued new Class B units. The transaction was disclosed to the MLP’s conflicts committee and was deemed to be “fair and reasonable” before the transaction occurred.
The plaintiff alleged the terms of the transaction were not “fair and reasonable” to the MLP as required by the MLP’s limited partnership agreement (“LPA”) and alleged that the defendant breached the implied covenant of good faith and fair dealing. The Court of Chancery held that the LPA terms controlled and judicial review was not appropriate.
The LPA expressly contemplated a conflicted asset sale between the MLP and affiliates of the general partner; such transaction would only be permitted to the extent it would be “fair and reasonable” to the MLP. The LPA created a safe harbor in which conflicted transactions could be approved by a majority of a special committee (consisting of at least two independent directors, as required by the LPA) and in which such conflicted transactions are conclusively deemed to be fair and reasonable, so long as the material facts of the conflict are disclosed to the special committee. Here, the facts of the pipeline sale were disclosed and reviewed by the special committee and the committee approved the transaction as “fair and reasonable”, so the Court of Chancery held the general partner did not breach the LPA or any stated or implied duty.
Section 17-1101(d) of the Delaware Revised Uniform Limited Partnership Act allows parties to expand, restrict or eliminate a partner’s duties in the LPA, as long as they do not purport to eliminate the implied contractual covenant of good faith and fair dealing. The Court of Chancery explained that the implied contractual covenant of good faith and fair dealing is cautiously applied to imply contractual terms or gaps that the parties did not anticipate. Here, the plaintiff argued the “gap” was the standard for the special committee to review conflicts of interest. However, the LPA provided the standard of “fair and reasonable” to the MLP. Even if the transaction in question were unfair to the unitholders as of the time of the transaction, conflicts of interest were anticipated in the negotiated LPA and a method for approving conflicts was agreed upon at the time of the LPA’s execution. The court’s holding is a reminder to investors to understand and negotiate the contracts they enter into, as the terms are often the exclusive source of protective rights.