Partnership Agreement May Provide Grounds for Relief in Case Involving Drop in Unit Price Following Disclosure of General Partner’s Intent to Exercise Call Right

By: Scott E. Waxman and Serena M. Hamann

In Bandera Master Fund LP, et al. v. Board Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Oct. 7, 2019), the Delaware Court of Chancery (the “Court”) denied the defendants’ Rule 12(b)(6) motion to dismiss breach of contract claims because the plaintiffs had established reasonably conceivable breaches of the governing partnership agreement. These breaches related to the defendants’ public statements concerning the general partner’s possible exercise of a call right leading to a sharp decrease in partnership unit prices prior to the actual exercise of the call right.

Boardwalk Pipeline Partners, LP (the “Partnership”) was a Delaware limited partnership engaged in the natural gas products business. The Partnership’s common units were publicly traded and its internal affairs were governed by a partnership agreement (the “Partnership Agreement”). The Partnership Agreement established a call right (the “Call Right”) exercisable by the Partnership’s General Partner, Boardwalk GP, LP (the “General Partner”). Loews Corporation (“Loews”) owned and controlled both the Partnership and the General Partner. The Call Right allowed the General Partner to acquire all Partnership common units if the General Partner or its affiliates owned more than 50% of the Partnership’s interests and the General Partner received a legal opinion that its pass-through tax-exempt status would have a material adverse effect on the rates charged to customers. Additionally, the Partnership Agreement set out a purchase price composed of the average of the daily closing prices for the common units during the 180 consecutive trading days immediately before the date of exercise.

When the Federal Energy Regulatory Commission (the “FERC”) initiated a regulatory change with regard to rate-setting and tax policy with possible impacts on the Partnership’s revenues, the Partnership announced the potential exercise of the Call Right in its 2018 Form 10-Q. Loews made a similar announcement. During the week after this disclosure, the market price of the Partnership’s common units declined by 16%. Two months later, the General Partner exercised its Call Right to purchase Partnership units at a significantly lower price.         

The plaintiffs, prior unitholders, allege that the Partnership and the General Partner carried out a deliberate scheme to manipulate the unit price downward for their own benefit. Specifically, the plaintiffs asserted six causes of action related to breaches of fiduciary duties and breaches of the Partnership Agreement. The Court immediately rejected all claims related to fiduciary duties noting that the Partnership Agreement eliminated all fiduciary duties.

The Court carefully considered claims regarding breach of express provisions in the Partnership Agreement, breach of the implied contractual covenant of good faith and fair dealing, and tortious interference with the Partnership Agreement. The Court noted that the Partnership Agreement laid out different standards of conduct for the General Partner depending on whether General Partner acted in its individual capacity, in its official capacity as a general partner, or in its official capacity as a general partner in situations involving a potential conflict of interest.

The Court determined the General Partner did not violate the applicable standard of care in exercising its Call Right because this was an instance where the General Partner acted in its individual capacity and was entitled to act free of any fiduciary obligation. On the other hand, the Court determined the General Partner was acting in its official capacity when it disclosed the potential exercise of the Call Right. The Court found a reasonable inference that the General Partner’s prior disclosure of possible exercise involved a potential conflict of interest because disclosure was highly likely to have a downward impact on the average trading price thus enabling the General Partner to pay less if it decided to exercise the Call Right. The defendants argued the Partnership and General Partner were obligated to disclose the potential exercise on the Partnership’s Form 10-Q. In response, the Court noted that it was not possible to determine at the pleading stage whether the General Partner was obligated under federal securities laws to cause the Partnership to make the disclosure when it did. However, it was reasonably conceivable that the disclosure was made early and strategically with the goal of driving down the price of the units.

As the General Partner faced a potential conflict, it was required to follow one of four contractually specified paths laid out in the Partnership Agreement to avoid breach. The four paths include; a good faith approval by a committee of disinterested members of the board, approval by disinterested unitholders, a resolution on arm’s-length terms comparable to what a third party would provide, or a resolution that was fair and reasonable to the Partnership. The defendants provided no evidence either of the first two methods were used, and the Court determined it was reasonably conceivable that neither arm’s-length terms nor a fair and reasonable resolution was utilized by the General Partner in deciding to make the disclosure. The Court further noted that the “fair and reasonable” standard focuses on the Partnership as an entity and allows the General Partner discretion to consider the full range of entity constituencies including limited partners, employees, customers, etc. As the limited partners were one of the Partnership’s constituencies, a transaction in the best interests of the Partnership should not be highly unfair to the limited partners. On the facts pled, the Court found it reasonably conceivable that the disclosure provided no evident benefit to other Partnership constituencies and was so highly unfair to the limited partners as to make the decision not fair and reasonable to the Partnership.

The Court also determined it reasonably conceivable that the General Partner failed to comply with contractual requirements related to the Call Right because the legal opinion upon which the General Partner based its decision to exercise discussed “maximum applicable rates” in terms of recourse rates, FERC-approved standard rates, rather than rates the Partnership could actually charge. The Court found that the Partnership Agreement did not adequately define “maximum applicable rates” and FERC regulatory rulings did not reflect a clear pattern of usage. The defendants failed to establish that their interpretation of the term was the only reasonable interpretation.

Additionally, the legal opinion failed to address what the Court deemed the “elephant in the room,”­­—FERC’s potential treatment of accumulated deferred income tax (“ADIT”) balances. According to the Court, at the pleading stage, the plaintiffs were entitled to the reasonable inference that the law firm responsible for the legal opinion chose not to analyze ADIT balances so that it could reach the conclusion that its client wanted rather than addressing the real-world situation of FERC’s regulatory actions.

The Court also found the plaintiffs stated a claim on which relief could be granted for breach of the implied contractual covenant of good faith and fair dealing. Based on the Partnership Agreement’s explicit mechanisms for providing notice to unitholders and determining call price, the Court determined it reasonable to infer the parties had a reasonable expectation that the General Partner would notify unitholders about its exercise of the Call Right in a manner that would not affect the price. From this expectation, the plaintiffs asserted an implied term that barred the parties from manipulating the price of the units during the 180-trading-day window. The Court agreed that such an implied term was reasonably conceivable and that the plaintiffs alleged facts supporting a reasonable inference of manipulation in breach of the term including the Partnership’s abrupt change in public statements regarding the new FERC policies and previous attempts to settle with unitholders.

Lastly, the Court addressed the claim for tortious interference with contract against the General Partner’s controllers, including Loews. The Court determined the complaint easily pled the four elements of a claim for tortious interference with contract: a contract, about which defendant knew, an intentional act that is a significant factor in causing the breach, without justification, and which causes injury. The controllers were aware of the Partnership Agreement and made the decision to cause the General Partner to make disclosures regarding the potential exercise of the Call Right in a reasonably conceivable breach causing damages to the plaintiffs. In regards to justification, the Court noted the complaint in a case involving parent and subsidiary entities must allege facts supporting a reasonable inference that the interference was motivated by a malicious or bad faith purpose rather than permissible financial goals. The Court noted a fact-specific inquiry would be required but found it reasonably conceivable that the controllers acted maliciously or in bad faith.

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