October 18, 2012
Court of Chancery Approves Contractual Mechanisms to Protect Self-Interested Transactions
By Stephen B. Brauerman
One of the reasons for Delaware's popularity as the venue of choice for the formation of limited liability companies, limited partnerships and other alternative entities is its willingness to enforce contracts as written. Delaware's respect for the freedom of contract is reflected yet again in a recent decision by Vice Chancellor Donald F. Parsons Jr., In re Encore Energy Partners Unitholder Litigation, C.A. No. 6347-VCP (Del. Ch. Aug. 31, 2012), dismissing a unitholder derivative suit challenging a self-interested merger approved by the general partner of a master limited partnership.
Prior to the merger challenged in the lawsuit, Encore Energy Partners GP (Encore GP) was a wholly owned, indirect subsidiary of Vanguard Natural Resources and served as the general partner of Encore Energy Partners LP (Encore). Encore is a publicly traded, master limited partnership involved in the acquisition, exploration and development of oil and natural gas reserves from onshore fields in the United States managed by Encore GP. A seven-member board of directors managed Encore GP, four of whom Vanguard appointed and three of whom were independent directors who comprised Encore GP's conflicts committee.
Vanguard acquired approximately 45.5 percent of Encore's outstanding common units and 100 percent of Encore GP on December 31, 2010. The complaint alleged that after this acquisition, Vanguard began a campaign to artificially deflate Encore's unit price in order to reduce the cost of later acquiring the balance of Encore's public equity. The plaintiffs also alleged that Vanguard caused Encore to provide forecasts that were substantially below analysts' expectations to further depress the Encore unit price. Contemplating a merger since its initial acquisition of Encore units, Vanguard was alleged to have monitored the spread between its trading price and Encore's, so it could announce the merger when the implied exchange ratio of Vanguard to Encore units was most favorable.
The exchange ratio troughed on March 24, 2011, and Vanguard publicly proposed a merger of Encore into a Vanguard subsidiary. Under the proposal, each Encore unit would convert into .72 Vanguard units. The Vanguard offer represented a premium of only $.05 more than Encore's trading price on the date of merger. In the merger offer, Vanguard stated it would not entertain any proposal to sell its own interests in Encore, nor would it agree to condition the merger on the approval of a majority of Encore's unaffiliated unitholders.
Vanguard's unwillingness to exclude its 45.5 percent interest from the merger vote was motivated primarily by the conflict of interest provision contained in Encore's limited partnership agreement. Specifically, the limited partnership agreement provided a "special approval" mechanism whereby Encore GP could approve a self-interested transaction on behalf of Encore upon the approval of a majority of the members of the conflicts committee. The conflicts committee consisted of three directors, none of whom had any affiliation with Vanguard. The committee provided "the sole process protection for [Encore's] public investors with respect to the merger" because the Encore limited partnership agreement jettisoned traditional fiduciary duties.
To evaluate the proposed merger, the conflicts committee retained two independent law firms and an independent financial adviser. The committee had broad authority to "study, review, evaluate and negotiate" the terms of the proposed merger or any alternative and to determine whether the merger or any alternative was in the best interests of Encore and its unaffiliated unitholders. After obtaining indemnification agreements from Encore GP and negotiating standstill and confidentiality agreements bet
One of the reasons for Delaware's popularity as the venue of choice for the formation of limited liability companies, limited partnerships and other alternative entities is its willingness to enforce contracts as written. Delaware's respect for the freedom of contract is reflected yet again in a recent decision by Vice Chancellor Donald F. Parsons Jr., In re Encore Energy Partners Unitholder Litigation, C.A. No. 6347-VCP (Del. Ch. Aug. 31, 2012), dismissing a unitholder derivative suit challenging a self-interested merger approved by the general partner of a master limited partnership.
Prior to the merger challenged in the lawsuit, Encore Energy Partners GP (Encore GP) was a wholly owned, indirect subsidiary of Vanguard Natural Resources and served as the general partner of Encore Energy Partners LP (Encore). Encore is a publicly traded, master limited partnership involved in the acquisition, exploration and development of oil and natural gas reserves from onshore fields in the United States managed by Encore GP. A seven-member board of directors managed Encore GP, four of whom Vanguard appointed and three of whom were independent directors who comprised Encore GP's conflicts committee.
Vanguard acquired approximately 45.5 percent of Encore's outstanding common units and 100 percent of Encore GP on December 31, 2010. The complaint alleged that after this acquisition, Vanguard began a campaign to artificially deflate Encore's unit price in order to reduce the cost of later acquiring the balance of Encore's public equity. The plaintiffs also alleged that Vanguard caused Encore to provide forecasts that were substantially below analysts' expectations to further depress the Encore unit price. Contemplating a merger since its initial acquisition of Encore units, Vanguard was alleged to have monitored the spread between its trading price and Encore's, so it could announce the merger when the implied exchange ratio of Vanguard to Encore units was most favorable.
The exchange ratio troughed on March 24, 2011, and Vanguard publicly proposed a merger of Encore into a Vanguard subsidiary. Under the proposal, each Encore unit would convert into .72 Vanguard units. The Vanguard offer represented a premium of only $.05 more than Encore's trading price on the date of merger. In the merger offer, Vanguard stated it would not entertain any proposal to sell its own interests in Encore, nor would it agree to condition the merger on the approval of a majority of Encore's unaffiliated unitholders.
Vanguard's unwillingness to exclude its 45.5 percent interest from the merger vote was motivated primarily by the conflict of interest provision contained in Encore's limited partnership agreement. Specifically, the limited partnership agreement provided a "special approval" mechanism whereby Encore GP could approve a self-interested transaction on behalf of Encore upon the approval of a majority of the members of the conflicts committee. The conflicts committee consisted of three directors, none of whom had any affiliation with Vanguard. The committee provided "the sole process protection for [Encore's] public investors with respect to the merger" because the Encore limited partnership agreement jettisoned traditional fiduciary duties.
To evaluate the proposed merger, the conflicts committee retained two independent law firms and an independent financial adviser. The committee had broad authority to "study, review, evaluate and negotiate" the terms of the proposed merger or any alternative and to determine whether the merger or any alternative was in the best interests of Encore and its unaffiliated unitholders. After obtaining indemnification agreements from Encore GP and negotiating standstill and confidentiality agreements bet