Monday, March 27, 2017

Dissent asserts wrong question asked in failure of pipeline company merger

By R. Jason Howard, J.D.

On appeal from the Court of Chancery, the Delaware Supreme Court has affirmed the decision that Energy Transfer Equity, L.P. (ETE) did not breach its representations and warranties and that The Williams Companies, Inc.’s argument that ETE was estopped from terminating the pending merger agreement between the two companies failed, despite a dissent by the Chief Justice that reasoned the majority was entertaining the wrong issue just as the lower court had done (The Williams Companies, Inc., v. Energy Transfer Equity, L.P., March 23, 2017, en banc).

Merger. Both companies are involved in the transmission of fossil fuels and the contemplated merger involved two steps. The first step would involve the merger into a new entity, Energy Transfer Corp LP (ETC) and the transfer of over $6 billion in cash to ETC in exchange for 19 percent of ETC stock to be distributed to Williams’ stockholders in exchange for their Williams stock. Step two would involve the transfer of the Williams assets to ETC in exchange for newly issued ETE Class E partnership units. The number of Class E units transferred and ETC shares issued would be the same number and the two were expected to be similar in value.

Condition. The merger was conditioned upon the issuance of an opinion by ETE’s tax counsel, Latham & Watkins LLP (Latham), that the second step of the transaction, the transfer of Williams’ assets to ETE in exchange for the Class E partnership units, “should” be a tax-free exchange of a partnership interest for assets under Section 721(a) of the Internal Revenue Code 2 (the “721 opinion”). The agreement also contained provisions that required the parties to use “commercially reasonable efforts” to obtain the 721 opinion and to use “reasonable best efforts” to consummate the transaction.

A severe market decline, however, led to a significant loss in the value of assets of the type held by Williams and ETE, causing the transaction to become financially undesirable to ETE and raising the specter of possibility that the IRS might view a portion of the over $6 billion not as payment only for the ETC stock, but as payment in part for the Williams assets, thus rendering the second step of the merger taxable. That issue led to Latham being unwilling to issue the 721 opinion and as a condition of the transaction, ETE indicated it would not proceed with the merger.

Court of Chancery. Williams sought to enjoin ETE from terminating the merger, arguing that ETE breached the agreement by failing to “use commercially reasonable efforts” to obtain the 721 opinion and “reasonable best efforts” to consummate the transaction. Williams had also argued that ETE was estopped from terminating the agreement by a representation it made in the agreement that it knew of no facts that would prevent the second step of the transaction from being treated as tax-free at the time the parties entered into the agreement.

The court, however, took the position that Latham’s determination that it could not issue the 721 opinion was a good faith determination made by it independent of any conduct, or lack of conduct, by ETE and that ETE was not estopped from terminating the agreement.

Supreme Court majority. The majority agreed with the Court of Chancery and explained that a footnote in the lower court’s opinion, when analyzed, demonstrated that ETE met its burden by showing that the record was barren of any indication that the action or inaction of the partnership, other than simply drawing Latham’s attention to the tax issue, contributed materially to Latham’s inability to issue the 721 opinion.

As to the estoppel argument, the court explained that there was “nothing to indicate that ETE knew of this potentially problematic theory of tax liability at the time it made its representations and chose not to disclose it to Williams.”

Dissent. Chief Justice Strine, in dissenting, explained that while his friends in the majority affirmed the outcome of the Chancery Court’s decision, they did so by focusing on the wrong issue. The issue was not whether the Latham Tax Lawyer was honest when he said he could not give the required tax opinion but, rather, the question was why the Latham Tax Lawyer did not give the required opinion.

The affirmative covenant in the merger agreement imposed the specific duty on ETE in connection with the 721 opinion in which it use “commercially reasonable” efforts to obtain the opinion and “instead of determining whether ETE in fact used commercially reasonable efforts to obtain the 721 opinion, the Court of Chancery focused on whether ETE had somehow prevented the Latham tax lawyer from giving the 721 opinion and concluded that, although ETE had certainly not desired the 721 opinion because it wished to get out of the deal, ETE had not coerced or misled Latham to prevent the issuance of that opinion.”

The Chief Justice reasoned that “the Court of Chancery’s sympathy toward the Latham Tax Lawyer had the effect of ignoring the covenant-breaching behavior that put the Latham Tax Lawyer under undue professional pressure in the first place.” He continued, explaining that the “multiple forms of behavior that breached ETE’s affirmative obligation are exactly the kind of conduct that compromised the ability of the Latham Tax Lawyer to find a way to yes, and that foreclosed any meaningful consideration of economically immaterial adjustments to the transaction that might have solved any genuine tax concern.”

The Chief Justice concluded, saying that he would remand and require a new trial “at which ETE would be required to prove that its breach did not materially contribute to the failure of the Latham Tax Lawyer to deliver the 721 opinion.”

The case is No. 330, 2016.

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