Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law
January 17, 2012
Two ostensibly unrelated events in the last two weeks implicate deep questions about the basic role of private ordering and regulation in relation to publicly traded equity securities.
The first of these events was Vice Chancellor John Noble’s opinion in Gerber v. Enterprise Products Holdings, LLC, et al (Del. Ch. Jan. 6, 2012). The Delaware Corporation & Commercial Litigation Blog has a nice summary of the case here, but the nub of the opinion was its determination to dismiss a claims that a 2009 sale of assets to an affiliated person violated the general partner’s fiduciary duties and that a merger subsequently implemented by the general partner improperly failed to consider the value of that pre-existing derivative claim against the general partner. The reasoning underlying that dismissal was that (i) the asset sale and the merger each received one form of what the limited partnership agreement defined as “Special Approval” (approval by a special committee of independent directors), thereby eliminating any claim of breach of fiduciary duty; and (ii) the residual claim that the general partner violated its implied obligation of good faith and fair dealing was precluded by the provision in the limited partnership agreement that the general partner’s “good faith is conclusively presumed where the general partner relief on the fairness opinion of an independent consultant.” In the case at hand, the general partner had obtained and reasonably relied on fairness opinions from Morgan Stanley.
The court’s opinion seems to chafe, to put it gently, at the contractual and legal strictures imposed by the limited partnership agreement:
The facts of this case take the reader and the writer to the outer reaches of conduct allowable under 6 Del. C. § 17-1101. It is easy to be troubled by the allegations. Alternate entity legislation reflects the Legislature’s decision to allow such ventures to be governed without the traditional fiduciary duties, if that is what the partnership agreement or other governing document provides for, and allows conduct that, in a different context, would be sanctioned. Ultimately, 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. Here, those protections were minimal and did not provide EPE’s public investors with anything resembling the protections available at common law.
As the Vice Chancellor expressed in an extended footnote, minimal contractual protection for public investors may potentially result in one of two consequences – discounted trading of the affected securities, or regulatory intervention:
If the protection provided by Delaware law is scant, then the LP units of these partnerships might trade at a discount or another governmental entity might step in and provide more protection to the public investors in these partnerships. Those issues, however, are not ones that this Court need or should address. The General Assembly has decided that this Court has only a limited role in protecting the investors of publicly traded limited partnerships that take full advantage of 6 Del. C. § 17-1101(d), and that is a role this Court must accept.
Meanwhile, and in a superficially very different context, the Carlyle Group, L.P. filed a January 10, 2012 amendment to its Form S-1 registering a public offering of its limited partnership units. Among other things, this amendment disclosed that the Carlyle limited partnership agreement would contain a fairly unusual provision governing the resolution of disputes involving the limited partnership’s internal affairs. In broad outline, it would provide that all limited partners would irrevocably agree that disputes relating to the limited partnership – including claims of breach of fiduciary duty, breach of the partnership agreement, and violation of the federal securities laws – will be subject to arbitration, and not be litigable, and would be arbitrated before three arbitrators in Wilmington, Delaware [wait, it gets better!] who are U.S. lawyers, retired judges, or [wait for it … ]
U.S. law professors [Law professors in Delaware? Can it get any better than this??].
Would a provision like this be valid if it were in a corporation’s certificate of incorporation? Not sure on that one – but I tend to think that a charter provision selecting the Delaware courts as an exclusive forum for hearing controversies involving internal corporate affairs is probably effective, at least if it’s included in an original (pre-IPO) certificate of incorporation. If that’s right, then it should be even easier to validate such an exclusive forum provision contained in a pre-IPO limited partnership agreement. And would an arbitration selection provision be any less effective? If one believes that organizational governing documents are contracts like all others, even when applicable to (“entered into by”) public investors, the answer has to be no, so at least for non-corporate entities a provision mandating arbitration would be effective.
Is this disturbing? That depends, I suppose, on whether you believe that, as Vice Chancellor Noble put it, the limited partnership interests (or shares of stock, if we were dealing with a corporation) would “trade at a discount” reflecting a meaningful market assessment of the value (negative, if one presupposes a discount) of the dispute resolution provision. If one were confident that the market – including the IPO market – would accurately price such provisions (whatever the word “accurately” means), perhaps there’s no real cause for concern: people will get what they pay for. On that view of things, it may not even matter that some investors are individually unaware of what dispute resolution or other rights they may be forgoing. On that view, perhaps even corporations should be allowed to adopt provisions dispensing with fiduciary duties, just as Delaware limited partnerships and LLCs are.
If you lack such abiding faith in market efficiency, however, you are in quite a quandary, because you then have to decide which private ordering innovations to tolerate, and which to regulate. As things stand, Delaware has made that decision, at least in relation to fiduciary duties: if you buy a limited partnership interest, the fiduciary duties you are owed may be limited or eliminated by the limited partnership agreement; if you buy corporate stock, on the other hand, fiduciary duties are mandatory and can’t be eliminated, even by charter provision (although, of course, director monetary liability for breach of the duty of care can be eliminated under Delaware General Corporation Law Section 102(b)(7)).
In regard to fiduciary duties, Delaware could choose to stand by this approach that bifurcates between corporations and other forms of entity. Alternatively, and recognizing that publicly traded noncorporate entities are still a somewhat limited phenomenon, Delaware could at least prospectively put all publicly traded entities on the same footing, by precluding publicly traded limited partnerships and LLCs from limiting or eliminating fiduciary duties. My “alternative entity” friends might gasp at that prospect, but they need to tell me why they are confident that the IPO market for limited partnership interests fairly and accurately prices provisions that limit or eliminate fiduciary duties. And they need to be confident that Vice Chancellor Noble’s concern that “another governmental entity [who ever might he be referring to?] might step in and provide more protections for the public investors” is just remote speculation, or that such regulation would be desirable or at least acceptable. That said, one can question whether the EPE limited partnership agreement addressed by Vice Chancellor Noble really represents the “outer reaches” of the flexibility afforded under the Delaware limited partnership statute: the operative provision addressing conflict transactions did not purport to effect a blanket elimination of all fiduciary duties; all it did was define various forms of effective approval for conflict transactions, including approval by a special committee of directors, a form of approval generally viewed as appropriate under corporate law as well. Likewise, the provision establishing that directors act in good faith when they rely on the opinion of an expert on a matter they reasonably believe to be in the expert’s area of competence doesn’t seem radically different than the rule embodied in Section 141(e) of the Delaware General Corporation Law, protecting directors’ good faith reliance on expert opinions reasonably believed to be within the expert’s professional competence. Perhaps the biggest difference from the corporate statute is that the partnership agreement provision appears to eliminate the predicate that the director’s reliance be in overall good faith, and not just based on a reasonable belief in the expert’s competence. Even if the partnership agreement provisions at issue are somewhat more protective than what is available as a matter of corporate law, however, it seems likely to me that those provisions are relatively modest in their impact, at least compared to what the limited partnership statute might actually permit.
In regard to dispute resolution matters, the law is still largely unsettled. Given the Delaware legislature’s explicit embrace of freedom of contract in noncorporate entities, will mandatory arbitration provisions like Carlyle’s be deemed valid and become commonplace in such entities that are publicly held? And do such provisions offend some mandatory aspect of corporation law such that Delaware public companies will be unable to adopt them? Is litigating in the Court of Chancery a fundamental, non-excludable right for stockholders, but litigating in a court outside of Delaware is not? Or if charter forum selection provisions for Delaware public companies become common, will arbitration selection provisions become similarly common?
Is there a comprehensive way to decide what private ordering – which may amount to no more than a take it or leave it investment choice – should allow, and what is off limits?