Donald Huddler
The recent Dole and Kinder Morgan Court of Chancery opinions highlight the differing roles of fiduciary duties in corporations and limited partnerships. The Dole shareholder litigation questioned the actions of corporate board members in considering an insider offer to buy the outstanding public shares to take the company private. In Kinder Morgan, limited partners were challenging the general partner’s decisions in negotiating a complex merger transaction that resulted in differing treatments for different classes of limited partners. This post (i) summarizes the basic fiduciary duties of corporate fiduciaries and limited partnership fiduciaries, and (ii) considers how the facts in Dole would be treated if they were governed by the terms of the Kinder Morgan partnership agreement. Thus, this analysis will probe the outer limits of permissible conduct under limited partnership agreements.
In November 2013, Dole Food Company, Inc., was a publicly traded Delaware corporation. David Murdock, the chairman and CEO, held roughly 40% of the company’s common stock, making him the single largest shareholder. Murdock had previously held the company privately, but had sold a portion of Dole’s equity to the public to generate capital during the 2009 economic downturn. He aimed to return the company to his private control. To effect his take-private plan, he pursued typical advisory and planning activities with both financial and legal advisors; however, he also launched a scheme to undermine and short circuit the independent directors and the special committee that would eventually consider his take-private proposal. Working with Dole board member and general counsel, Michael Carter, whom the court termed Murdock’s “right-hand” man, Murdock thwarted the work of the independent directors and the special committee. Carter actively subverted the directors, most effectively by giving them false earnings projections and other fabricated financial forecasts. Carter’s efforts caused the special committee to undervalue the company and to eventually accept an artificially low price from Murdock. The court found that Murdock and Carter’s campaign constituted clear fraud. The fraudulent scheme fundamentally violated the well-established entire fairness standard. Further, Carter specifically breached his “duty of loyalty to the corporation” and acted in bad faith. The court held Murdock and Carter jointly liable for the $148 million price differential between the price accepted by the independent directors because of their scheme and a conservative estimate of the enterprise’s potential market value at the time of the take-private transaction.
Dole highlights the duty of corporate fiduciaries to act in good faith and observe their primary loyalty to the corporation and its shareholders. These duties are the foundation of Delaware corporate law. To escape these duties or to weaken them to allow more flexible decision making, alternative business forms are required. Limited partnership agreements are a means, through contract, to completely customize the fiduciary relationships and duties owed to the enterprise.
Kinder Morgan provides a concrete example of other well-settled Delaware law: Parties get what they bargain for, even if they are unhappy in the end. In this case, the parties modified the duties of the General Partner and eliminated the common law fiduciary duty to the partnership when considering a merger or “other significant transactions.” The Kinder Morgan partnership agreement empowered the General Partner to engage in any transaction authorized under the agreement “so long as such action is reasonably believed by the General Partner to be in, or not inconsistent with, the best interests of the Partnership.” The court points out that the addition of “reasonably” distinguishes the Kinder Morgan partnership agreement from those that have been interpreted to maintain the general good faith standard. This single word insertion transforms the standard, common law duty of loyalty into a less well-defined and reduced duty of reasonable belief.
The core allegation in the Kinder Morgan litigation is that the general partner favored the holders of the General Partnership shares over the holders of the common unit shares and that this favorable treatment stems from the fact that the general partner owned more GP delegate shares than common unit shares. Applying the terms of the partnership agreement, in light of Norton, the court found that the merger and the consideration paid was reasonable and within the scope of the duty outlined in the agreement. Fundamentally, the court recognized the general structural conflict that directors of the general partner confront when they make decisions for the limited partnership: They are not disinterested, independent directors. The parties explicitly bargained for the less than common law fiduciary duty; the outcome was a reasonable decision that reduced the cost of capital for the General Partner, and provided similar consideration to all the shareholders, but distributed the gain to the limited partners yielding significant tax liability, to their unique detriment. Further, the court noted that the primary duty under the agreement was to the partnership, not the holders of the limited partnership common units. The court found, under the provisions of the partnership agreement, the transaction terms, despite the detriment to common unit holders, to be reasonable from the perspective of the partnership.
Considering the two fact patterns and the differing legal framework, an interesting question emerges: What are the limits of the “reasonable belief” standard in the Kinder Morgan partnership agreement? Evaluating the Dole facts, which feature fraud and deception, under the Kinder Morgan regime may be instructive. For this thought experiment, the Dole board will be considered general partners and the shareholders limited partners.
Murdock and Carter, the fraudulent actors, are both decision makers for the general partner. The independent directors are the unconflicted General Partner decision makers. The fundamental question is whether Murdock and Carter’s fraud, the false financial forecasts and efforts to depress the stock price, vitiate a reasonable belief that taking the company private may be in the best interest of the General Partner members. Clearly, the take-private transaction is not in the interest of the Limited Partnership shareholders, but the duties here attach to the partnership proper and not the common unit shareholders.
Who benefits: Here Murdock directly benefits from his and Carter’s actions. For each dollar the publicly traded shares are depressed, Murdock gains and the other LP shareholders lose. Does the partnership proper gain? A close reading of Kinder Morgan suggests that if there were a reasonable belief that the depressed price take-private transaction would be in the interest of the partnership, the merger would pass muster under the reduced partnership agreement duties. Once the Murdock offer was public, other suitors considered acquiring Dole; in the absence of the fraud, those suitors may have paid a higher price for the enterprise. Does this possibility suggest that accepting the Murdock take-private was either not “in the best interests of, or not inconsistent with, the best interests of the Partnership?” Unlike Kinder Morgan G.P., Dole was not facing increasing costs of capital nor other significant business headwinds. The driver for the take-private transaction appears to mostly have been Murdock’s personal desire to completely control the company.
Despite Murdock’s fraud, it is not entirely clear that the minimal duty articulated in the partnership agreement would be violated. Clearly, the limited partners are adversely affected, but they are not owed the fiduciary duty; the partnership proper is. With the freedom of contract, comes the liberty to negotiate weakened duties. Rabkin v. Philip A. Hunt Chem. Corp., illustrates the bedrock principle of Delaware business organization law, that fraud is not tolerated. Perhaps under partnership agreements with weakened fiduciary duties, fraud may not, indeed, vitiate all.
These two recent Court of Chancery cases illustrate the two different options for Delaware business organizations: The corporation with the safeguards of independent directors and, if a conflict is present, the rubric of entire fairness or alternatively the freedom of contract, where parties may construct their own duties under a partnership agreement. The latter case signals that the partnership investor should beware.
Don Huddler is a second-year student at Widener University Delaware Law School and a Staff Editor of the Delaware Journal of Corporate Law. Don is also a Judicial Intern to the Honorable Gregory M. Sleet in the United States District Court, District of Delaware.
Suggested Citation: Donald Huddler, Bargaining Away Fiduciary Duty: Considering Partnership Agreements After Kinder Morgan, Del. J. Corp. L. (Oct. 18, 2015), www.djcl.org/blog.