Delaware Chancery Court Applies Implied Covenant of Good Faith and Fair Dealing, Finds Plaintiff Failed To Prove What Would Have Been Agreed Upon

Delaware Chancery Court Applies Implied Covenant of Good Faith and Fair Dealing, Finds Plaintiff Failed To Prove What Would Have Been Agreed Upon

      The implied contractual covenant of good faith and fair dealing, as applied by the Delaware courts, will in one of its aspects look to and enforce what the parties would have agreed to had they thought to actually negotiate on the point. Resolution of that question will involve a factual analysis of matters including how the parties have otherwise allocated risk in the transaction. In a recent decision, the court found that the plaintiff failed to demonstrate that the defendant would have agreed to what it said it would have been the negotiated rule. RoundPoint Mortgage Servicing Corp. v. Freedom Mortgage Corp., C.A. No. 2020-0161-SG, 2020 WL 4199957 (Del. Ch. July 22, 2020).

      RoundPoint Mortgage Servicing acquired, by means of a merger, Freedom Mortgage. The merger agreement, in addition to the usual restrictions on transactions outside the ordinary course between signing and closing, specifically addressed that RoundPoint might, in that period of time, face margin calls on a credit facility that was secured by certain of its assets. In order to make funds available to satisfy those obligations, the merger agreement allowed RoundPoint to borrow money from its controlling shareholder (the “Shareholder Loan”). That same merger agreement required as a closing condition that Round Point “shall have repaid, all amounts outstanding under the [Shareholder Loan].” Pursuant to that authorization, between the signing of the merger agreement and its ultimate close, that controlling shareholder loaned to RoundPoint some $123 million. However, except with respect to $1 million thereof, prior to closing the controlling shareholder forgave the Shareholder Loan without requiring any repayment; this worked to the controlling shareholder’s interest because the purchase price was net asset value plus a 7.5% premium. Had the Shareholder Loan been repaid, the net asset value would have been reduced. But as characterized by the Chancery Court, the controlling shareholder appreciated that with this that each dollar of the loan forgiven “benefits (almost) 7.5 cents per dollar of debt it forgives.” and that “each such dollar [forgiven by the controlling shareholder] requires [Freedom Mortgage] to come up with an additional dollar (plus premium) in cash at closing.” 

      RoundPoint Mortgage sought to avoid its obligation to close on the transaction unless the seller actually repaid, rather than forgave, the Shareholder Loan.

      After first determining that the merger agreement did not expressly prohibit the controlling shareholder from forgiving the Shareholder Loans (and thereby effecting a net increase in the purchase price), it recognized that, in support of its claim under the implied covenant, the buyer would want to prohibit forgiveness of the loan that it first sanctioned. The court, however, was not willing to imply into the agreement a no forgiveness limitation because Freedom Mortgage, the buyer, failed in its burden of demonstrating that, had the parties negotiated the terms, they would have negotiated in a no forgiveness condition. Rather, while it is not conclusive that the parties would have negotiated a no forgiveness limitation, is entirely possible that they would have negotiated something else.  Failing to satisfy that burden, Freedom Mortgage's implied covenant claim failed.

More on the Implied Covenant of Good Faith and Fair Dealing

More on the Implied Covenant of Good Faith and Fair Dealing

      In a late December ruling from the US District Court for the Western District of Kentucky, there was provided additional guidance with respect to the application and effect of the implied contractual covenant of good faith and fair dealing. In this instance, where there had been no breach of contract, there could not be a successful claim for breach of the implied covenant. Pogue v. Principal Life Insurance Company, Civil Action No. 3:14-CV-599 CHB, 2019 WL 7372433 (W.D. Ky. Dec. 31, 2019).

      This dispute arose out of whether or not insurance coverage was available. The plaintiff asserted as well that the insurer had engaged in bad faith in denying the coverage. On the merits, it was found there was no coverage. The central question was whether with the denial of coverage it necessarily followed that there could be no claim for bad faith. In finding that there could not be, on those facts, a bad faith claim, the court considered several prior decisions, all cited by the plaintiff in favor of his argument that bad faith claims could survive a determination that coverage was not available. Reviewing each of these decisions, it was determined that none stood for the proposition that there could exist a valid claim for bad faith in the face of the determination that there is not coverage.

Absent a Special Relationship, Good Faith and Fair Dealing is Not a Standalone Claim

Absent a Special Relationship, Good Faith and Fair Dealing is Not a Standalone Claim

 

      I was recently rereading the decision rendered in Hackney v Vascular Solutions, Inc., Civ. Act. No. 3:12-CV-00170-CRS, 2018 WL 2970767 (W.D. Ky June 13, 2018), and thought it worth a note.

      This dispute arose out of the construction of an employment agreement. In connection therewith, Hackney bought claims including one arising in tort for breach of the implied covenant of good faith and fair dealing. This decision addressed Vascular Solutions’ claim for summary judgment as to that allegation, which was premised on the position that Kentucky does not recognize a claim for tortious violation of the implied covenant of good faith and fair dealing. Previously, the trial court had granted, and there had been affirmed by the 6^th Circuit, summary judgment against Hackney's claim for violation of the contractual obligation of good faith and fair dealing.

       After noting that the obligation of good faith and fair dealing exists in every contract, the court wrote:

Breach of this covenant can also serve as the basis of a tort claim, but only where the contract at issue was entered into by parties with some ‘special relationship’ “not found in ordinary commercial settings.” To date, “Kentucky courts have only recognized the existence of such a relationship in the context of insurance contracts.” Other circumstances which may give rise to a ‘special relationship’ include where the parties bargaining power is unequal or there is some relationship of trust between them, where one party is particularly vulnerable, where the parties have nonprofit motivations for contracting. 2018 WL 2970767, *2 (citations omitted).

        Finding that this what is an employment contract, not an insurance contract, dispute, the court held that there was no special relationship that would give rise to a claim in tort for breach of the implied covenant and good faith and fair dealing.

Delaware Chancery Court Finds Complaint Sufficient to Allege Breach of the Obligation of Good Faith and Fair Dealing; Or, What’s Half a Billion Dollars Among Friends?

Delaware Chancery Court Finds Complaint Sufficient to Allege Breach of the Obligation of Good Faith and Fair Dealing; Or, What’s Half a Billion Dollars Among Friends?

      In a decision from earlier this summer, the Delaware Chancery Court (V.C. Glasscock), denied a motion to dismiss with respect to a challenge to related party transaction involving a master limited partnership. In this decision, the Vice Chancellor found that the discrepancy between the value received for the assets, just under $1 billion, and the value attributed to those assets when contributed to another venture, that being $1.5 billion, was of sufficient magnitude to indicate that something might not be right. Morris v. Spectra Energy Partners (DE) GP, LP, C.A. No. 12110-VCG, 2017 WL 2774559 (Del. Ch. June 27, 2017).

      In that this is a master limited partnership case, the organizational structure is somewhat complicated, even as it is somewhat indecipherable because all of the related companies have nearly indistinguishable names. For these purposes, the party who ultimately controlled a master limited partnership had some time ago contributed certain assets to it. The control entity now wanted to buy those assets back in order to devote them to a new venture with a third party. While the control entity had the right to enter into a transaction with the limited partnership that it ultimately controlled, the terms and conditions of those transactions were subject to a number of protections including review by independent directors, review by independent financial experts and, as always, the non-waivable obligation of good faith and fair dealing.

      Parsing the agreement, the Vice Chancellor determined that certain language in the document would give rise only to a rebuttable presumption of good faith consequent to the reliance upon a fairness opinion.

      In the face of that presumption of good faith, the court found that the plaintiff is obligated to plead facts supporting an inference that either the conflicts committee or the general partner of the limited partnership could not subjectively have believed that the transaction was in the best interest of the limited partnership. In this instance, the court found that pleading obligation to have been satisfied. Essentially, as the limited partnership was receiving just less than $1 billion for the assets, and the control entity had already announced the contribution of those assets to the new venture at a $1.5 billion valuation, the gap of $,0500,000 gave rise to a reasonable inference of a problem and at least the possibility the general partner acted with subjective bad faith.

Delaware Supreme Court Emphasizes the Gap-Filling Role of the Implied Covenant of Good Faith and Fair Dealing

Delaware Supreme Court Emphasizes the Gap-Filling Role of the Implied Covenant of Good Faith and Fair Dealing

      In a decision rendered last week, the Delaware Supreme Court reviewed the gap-filling role of the implied covenant of good faith and fair dealing, emphasizing that it addresses lacuna between negotiated terms in order to give full effect to the agreement. In this instance, notwithstanding asserted compliance with the express terms of the agreement, the plaintiff's case could go forward because the defendant’s actions, even if the in strict compliance with the agreement’s express terms, did not satisfy the obligation of good faith and fair dealing.  Dieckman v. Regency GP LP, No. 208, 2016, 2017 WL 243361 (Del. Jan. 20, 2017.

      The underlying transaction involved a merger between two limited partnerships, both within the same family of a master limited partnership. In that transactions of this nature are anticipated, the partnership agreement contained a pair of mechanisms for addressing the conflict. First, the proposed transaction could be negotiated and approved by an independent committee. In the alternative, the transaction could proceed if it received the approval of a majority of the unaffiliated limited partners. In this instance, a belt and suspenders approach was (purportedly) employed. First, a two-person independent conflicts committee was charged to oversee the transaction. Thereafter, a comprehensive proxy statement (not required by the partnership agreement) was distributed to the limited partners soliciting their consent to the transaction based, in part, upon the independent review of the conflicts committee.

      When a limited partner challenged the transaction, it was defended on the basis that it had received the approval of both the independent conflicts committee and a majority of the unaffiliated limited partners, and on that basis the transaction was not subject to further scrutiny. While the Chancery Court accepted that argument, it was rejected by the Delaware Supreme Court. With respect to the independent conflicts committee, the Supreme Court found that it was not, at least for the standards employed in connection with a motion to dismiss, independent. Rather, of the two members, one of them had begun review of the transaction while still affiliated with the general partner. In fact, the persons comprising the committee had to effect certain resignations in order that they could become “independent”, and immediately after approving the transaction they were rehired to positions that would have created a conflict. Also, the standard for independence included that for members of an audit committee of a company listed on the New York Stock Exchange, but those standards were never satisfied.

As with the contract language regarding Unaffiliated Unit Holder Approval, this language is reasonably read by Unit Holders to imply a condition that a Committee has been established whose members genuinely qualified as unaffiliated with the General Partner and independent at all relevant times. Implicit in the express terms is that the Special Committee membership be genuinely comprised of qualified members and that deceptive conduct not be used to create the false appearance of an unaffiliated, independent Special Committee.

The plaintiff has agreed that the LP Agreement’s safe harbor provisions, if satisfied, would preclude judicial review of the transaction. But we find that the plaintiff has pled sufficient facts to support his claims that those safe harbors were unavailable to the General Partner. Instead of staffing the Conflicts Committee with independent members, the plaintiff alleges that the chair of the two-person Committee started reviewing the transaction while still a member of an Affiliate board. Just a few days before the General Partner created the Conflicts Committee, the same director resigned from the Affiliate board and became a member of the General Partner’s board, and then a Conflicts Committee member.

Further, after conducting the negotiations with ETE over the merger terms and recommending the merger transaction to the General Partner, the two members of the Conflicts Committee joined an Affiliate’s board the day the transaction closed. The plaintiff also alleges that the Conflicts Committee members failed to satisfy the audit committee independence rules of the New Your Stock Exchange, as required by the LP Agreement. In the proxy statement used to solicit Unaffiliated Unit Holder Approval of the merger transaction, the plaintiff alleges that the General Partner materially misled Unit Holders about the independence of the Conflicts Committee members. In deciding to approve the merger, reasonable unit holder would have assumed based on the disclosures that the transaction was negotiated and approved by a Conflicts Committee composed of persons who were not “affiliates” of the general partner and who had the independent status dictated by the LP Agreement. This assurance was one a reasonable investor may have considered a material fact weighing in favor of the transaction’s fairness.

 

Delaware Court Of Chancery Issues Guidance On Step Transaction Doctrine, Good Faith And Fair Dealing

Delaware Court Of Chancery Issues Guidance On Step Transaction Doctrine, Good Faith And Fair Dealing

 

In a December 30 decision, the Delaware Court of Appeals issued useful guidance with respect to both the step transaction doctrine and the application of the implied covenant of good faith and fair dealing. Ellis v. OTLP GP, LLC, C.A. No. 10495-VCN, 2015 WL 535866 (Del. Ch. January 30, 2015).

 

Marquard & Bahls AG (“M & P”) owned all of OTLP GP, LLC (“GP”). GP was in turn the sole general partner in Oiltanking Partners, L. P. (“Oiltanking”). In addition to controlling the general partner, M & B owned 65% of the limited partnership interests in Oiltanking. The balance of the limited partnership interests were held by other parties.

 

Enterprise Products Partners LP (“Enterprise”) inquired of M&B about acquiring the entirety of Oiltanking, including the interest held by the unaffiliated limited partners. M&B  responded to Enterprise that it was willing to discuss selling its interest to Enterprise, but it was not interested in any deal contingent upon the participation of those unaffiliated parties.

 

The Oiltanking limited partnership agreement provided, through November, 2014, that a merger would require the approval of a majority of the unaffiliated partnership interests. After that date, a merger could be approved by a majority of the limited partner units, they all voting as a single class. Essentially, after November 2014, the 65% limited partnership interest held by M&B in Oiltanking could approve a merger.

 

As of October 1, 2014, before the expiration of the period during which the unaffiliated limited partners could block a merger by a class vote, Enterprise acquired both GP and M&B’s limited partnership units in Oiltanking. Prior to the closing, Enterprise gave notice of its intention to acquire all of Oiltanking by means of a merger. Its proposed merger price was referred to a conflicts committee, which was able to negotiate an increase in the tender price. The price remained, however, less than the price that Enterprise was paying M&B for its limited partnership units.

 

In opposition, the unaffected limited partners asserted that they continue to be entitled to a class vote on the basis that Enterprise and M&B “design[ed] the transaction in a conscious effort to defeat their entitlement a class vote.” Slip op. at 6. They theorized that, as the merger was announced during the period when they had rights to a class vote, that right must govern the subsequent vote as to the merger irrespective that the class voting period had otherwise expired. In that the subject limited partnership agreement did not expressly address this point, it was asserted that there was a violation of the implied covenant of good faith and fair dealing in determining that no class vote is required, and that the transaction was structured in such a way that, viewed as a whole, that right should be retained.

 

As to the suggestion that the right to class voting accrued at the time of the announcement of the transaction, rather than being determined as of the time of the vote, that assertion was rejected by the Court of Chancery.  Rather:

 

If the drafters of the LP Agreement had wanted to subject announcement of the merger, as contrasted with a vote on a merger, to certain requirements, presumably they could have done so. They did not do so.  Slip op. at 9.

 

With respect to the step transaction doctrine, the Chancery Court would hold that it is inapplicable.  Reciting the three alternatives under Delaware law for the application of the doctrine (see footnote 9 at slip op. 12), the Court determined that none of them were applicable. Essentially, Enterprise acquired all of the interest of M&B in Oiltanking and then proposed to acquire all of the interest held by the unaffiliated limited partners; the former was not contingent upon the latter.  Furthermore, M&B did not engineer the two step transactions; Enterprise did.

 

With respect to the obligation of good faith and fair dealing, citing In re El Paso Pipeline Partners, L.P. Derivative Litigation, 2014 WL 2768782,*16 (Del. Ch. June 12, 2014), it was reiterated that:

 

The implied covenant is not a free-floating duty that requires good faith conduct in subjectively appropriate ends... [But] rather, the doctrine by which Delaware law cautiously supplies the implied terms to fill gaps in the express provisions of an agreement. Slip op. at 9 (balance of citation omitted).

Sixth Circuit Court of Appeals Considers Good Faith and Fair Dealing Underthe Ohio Motor Vehicle Dealer Act

Sixth Circuit Court of Appeals Considers Good Faith and Fair Dealing Under the Ohio Motor Vehicle Dealer Act

 

In the decision from earlier this year, the Sixth Circuit Court of Appeals considered whether Ford Motor Company violated the obligation of good faith and fair dealing under the Ohio Motor Vehicle Dealer Act. In this instance, where Ford assisted one Ford dealership in acquiring another, the court determined that the obligation of good faith and fair dealing had not been violated.  Franklin Park Lincoln-Mercury, Inc. v. Ford Motor Company, Case No. 14-3543 (6th Cir. Feb. 12, 2015).

 

There were two Lincoln-Mercury car dealerships in Toledo Ohio. The plaintiff in this action, Franklin Park Lincoln-Mercury (“Franklin Park”) had repeatedly asserted to Ford Motor Co. (“Ford”) that the Toledo market could only support one such dealership. That other dealership, Rouen, would ultimately receive an offer to acquire its underlying real estate. Rouen would ultimately determine that he would sell his Lincoln-Mercury dealership, and another existing Ford dealer, Brondes, wanted to be the buyer. Crucially, the Rouen and Brondes dealerships were within a half-mile of one another. When Franklin Park got wind of the proposed transaction, it “gave Ford an ultimatum: either block the Rouen-Brondes merger (thus putting Rouen out of business) or find someone to purchase Franklin Park.”  Slip op. at 2.

 

Ford did nothing to block the deal; in fact they made it possible by affording certain financial concessions and advances to bring the deal about. Franklin Park filed a protest with the Ohio Motor Vehicle Dealer Board, asserting a right to protest based upon statutory provisions applicable when both dealers sell the same brand and stand less than 10 miles apart. That Board would determine that, in contrast, the relocation fell within the statutory exception where the relocating dealership moves less than 1 mile. That determination was upheld by the Ohio Court of Appeals, and the Ohio Supreme Court denied discretionary review. Slip op. at 3.

 

In the meantime, Franklin Park brought suit against Ford in federal court, asserting a lack of good faith consequent to Ford having “desired, facilitated, underwrote, and ultimately cause the Rouen-Brondes transaction, over Franklin Parks that’s repeated objections.” Summary judgment was ultimately granted to Ford, leading to this appeal to the Sixth Circuit. On appeal, that grant of summary judgment would be affirmed.

 

The Ohio Motor Vehicle Dealer Act requires manufacturers “to act in good faith” towards dealerships, with good faith being defined as “honesty in the conduct or transaction concerned in the observance of reasonable commercial standards of fair dealing in the trade…, including, but not limited to, the duty to act in a fair and equitable manner.” Ohio Code 4517.01(BB). Slip op. at 4. The definition of good faith as well cross-references that in the Ohio enactment of the Uniform Commercial Code, it at the applicable time having been defined as “honesty in fact in the conduct or transaction occurred.” Ohio Code § 1303.01(S). Ultimately affirming the determination that Ford had acted in good faith, the Court determined that, inter alia, Ford had a legitimate business reason for supporting the Rouen-Brondes merger, namely that it could make more money from the Toledo market by having more than one Lincoln-Mercury dealership therein.  Furthermore, there had been introduced no evidence indicating that Ford sought to deprive Franklin Park of any of the benefits of being an equal participant in that Toledo market.  Responding to the assertion that the question should go to a jury, the Sixth Circuit determined that:

 

With two legitimate business rationales to support Ford’s actions and with no evidence of bad faith conduct by Ford, a jury could not reasonably infer bad faith here. Slip op. at 7.