In re K-Sea Transportation Partners L.P. Unitholders Litig., C.A. No. 6301-VCP (Del. Ch. Apr. 4, 2012) (Parsons, V.C.)

In this case, the Court, relying on the express provisions of the limited partnership agreement (the “LPA”) of K-Sea Transportation Partners, L.P. (“K-Sea”), granted the defendants' motion to dismiss all counts brought by plaintiffs, common unitholders in K-Sea, challenging the proposed merger between K-Sea and Kirby Corporation (“Kirby”).  In the proposed merger, Kirby offered to  purchase K-Sea’s equity interest for approximately $335 million, with $18 million specifically allocated to pay for the units and incentive distribution rights (“IDRs”) held by K-Sea’s general partner (the “K-Sea GP”).  The K-Sea Board of Directors (the “Board”) recognized that the $18 million allocation to the K-Sea GP created a potential conflict of interest and followed the procedures governing conflict of interest transactions in the LPA.  The LPA expressly permits the consummation of transactions presenting a possible conflict of interest in several ways, one of which is through the approval (a “Special Approval”) of the transaction by a conflicts committee of the Board (the “Conflicts Committee”).  Upon receipt of Special Approval from the Conflicts Committee, the LPA states that the purportedly conflicted transaction is conclusively deemed to be fair and reasonable.  The Conflicts Committee – consisting of three independent, non-employee Board members – relying on a fairness opinion of a financial advisor engaged by it to review the fairness of the transaction, unanimously found that the proposed merger was fair and reasonable to K-Sea and its limited partners and issued a Special Approval of the proposed transaction.  The full K-Sea Board accepted the Conflict Committee’s approval and recommended that the unitholders vote to adopt the merger agreement and approve the merger with Kirby.  The proposed merger was submitted to the unitholders, the required majority of whom voted to approve the merger. 

The plaintiffs alleged that the proposed merger transaction was not fair and reasonable to K-Sea’s limited partners and brought suit against K-Sea, the K-Sea GP, the K-Sea GP’s general partner and the Board of K-Sea alleging (i) breach by the Conflicts Committee of the fiduciary duties of care and loyalty by approving the merger without considering separately the fairness of the $18 million payment in exchange for the K-Sea GP’s units and IDRs, (ii) breach of the LPA by the K-Sea GP, K-Sea GP’s general partner and the Board by approving the merger without evaluating the fairness of the $18 million IDR payment, (iii) breach of the LPA and fiduciary duties by the K-Sea GP, K-Sea GP’s general partner and the Board by approving the merger based on a defective approval by the Conflicts Committee, which committee was not fully disinterested because of phantom units granted to the committee members just prior to its review of the proposed merger, and (iv) breach by the K-Sea GP, its general partner and the Board of their fiduciary duty of disclosure by authorizing the release of a Form S-4 that contained materially misleading information.  The Court found that the defendants’ actions could not constitute a breach of any contractual or fiduciary duties, regardless of whether the Conflicts Committee’s approval was effective, and, because the plaintiffs “[could not] succeed on their claims under any reasonably conceivable set of circumstances,” granted the defendants’ motion to dismiss.

Recognizing that the Delaware Revised Uniform Limited Partnership Act gives “maximum effect to the principle of freedom of contract,” the Court analyzed the LPA to determine whether the LPA specifically addressed the standard of care to be applied in merger transactions, which contractual standard of care would “[supplant] fiduciary duty analysis.”  Because the plaintiffs are only seeking money damages at this point, the LPA specifically provides that an “Indemnitee” (defined to include the K-Sea GP, K-Sea GP’s general partner and the Board) would not be liable for monetary damages to the limited partners if such Indemnitee acted in good faith.   Thus, even if the plaintiffs could prove that the defendants breached their contractual or fiduciary duties, the defendants would only be liable to the plaintiffs if the breach resulted from actions taken in bad faith.  In determining whether the K-Sea GP acted in good faith, the LPA expressly provides that the K-Sea GP is “conclusively presumed to have acted in good faith if it relied on an expert it reasonably believed to be competent to render an opinion on the particular matter.”  The Court, in analyzing the LPA, determined that the LPA established “only one contractual duty applicable to Defendants’ consent to the Merger Agreement: [the] K-Sea GP must exercise its discretion.”  Construing this duty with the LPA’s provision restricting traditional fiduciary duties imposed on the K-Sea GP, the Court noted that, with respect to mergers, the only limitation on the K-Sea GP’s discretion was that it could not exercise its discretion in a manner inconsistent with the best interests of the Partnership as a whole.  In applying this standard, the Court found that plaintiffs’ allegations could arguably support an inference that the K-Sea’s GP requirement of a separate payment for the IDRs “unreasonably exploited the LPA’s limited duties to extract a personal gain that did not advance a proper Partnership purpose and, thus, [the K-Sea GP] failed to act in good faith.”  However, because the K-Sea GP relied on a fairness opinion of a financial advisor, the LPA conclusively presumes that it acted in good faith.  In rejecting the plaintiffs’ claim of breach of the implied contractual covenant of good faith and fair dealing, the Court noted that a plaintiff can’t “plead that a defendant breached the implied covenant when the defendant is conclusively presumed by the terms of a contract to have acted in good faith[.]” 

In analyzing the special approval process, the Court noted that a provision of the LPA is triggered whenever a potential conflict of interest exists – in this case, the $18 million that was allocated only to the K-Sea GP and not shared with the common unitholders.  That provision stated that if there was a conflict between the K-Sea GP, on the one hand, and K-Sea or the limited partners, on the other hand, any resolution by the K-Sea GP in respect of that conflict shall be permitted, and shall not be deemed to be a breach of the agreement or any duty stated or implied by law, if the resolution is deemed to be fair and reasonable to the Partnership.  The provision further provided that any resolution of a conflict of interest would be deemed to be fair and reasonable to K-Sea if such conflict or resolution is approved by Special Approval.  The Court found that the provision acted as a safe harbor – “if there is Special Approval, there is no breach of the LPA or fiduciary duty.”  The plaintiffs claimed that the defendants failed to effectively get Special Approval given that the phantom shares granted to the Conflicts Committee members raised doubts as to their status as disinterested members, raising an inference that the resolution of the conflict was not fair and reasonable and, therefore, the defendants breached the LPA and their fiduciary duties.  The Court rejected the plaintiffs’ application of the inverse of the safe harbor provision, finding that “a failure to utilize effectively that safe harbor does not mean that liability automatically follows.”  Rather, failure to qualify for the safe harbor resulted in the Court’s being required to apply the otherwise controlling standard of care set forth in the LPA – whether the K-Sea GP approved the merger in good faith – which the Court answered in the affirmative as more fully set forth above.  Given that analysis, the Court dismissed the first three counts against the defendants for breach of the LPA and fiduciary duties.

In analyzing the plaintiff’s claim for breach of disclosure duties, the Court noted that the LPA waived the traditional duty of disclosure.  Even had the LPA not modified the traditional duty of disclosure, the Court found that the defendants satisfied their obligations under the traditional duty and, therefore, dismissed the last claim against the defendants.  While the Court noted that the two sentences questioned by the plaintiffs, read alone, could cause a misleading impression, the Court found that reading the disputed sentences in context resolved any ambiguity, such that the arguably misleading statements would not have “altered the ‘total mix’ of information available to the [plaintiffs].”  In addition, because the plaintiffs were seeking monetary damages, and because the LPA limits awards of monetary damage to acts in bad faith, the Court found that the plaintiffs could not allege the defendants “acted in bad faith by authorizing the disclosure of one arguably misleading sentence after first authorizing the disclosure of all of the information necessary to render that statement not misleading” and, therefore, dismissed the plaintiffs’ final claim against the defendants.

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