Damages Awards Based on Controller’s Reliance on Outside Counsel’s Legal Opinion

In Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP (Nov. 12, 2021), the Delaware Court of Chancery ordered the general partner (the “General Partner”) of Boardwalk Pipeline Partners (the “Partnership”) to pay the former limited partners $690 million in damages (plus pre- and post-judgment interest, and costs) in connection with the General Partner’s $1.56 billion take-private of the Partnership. The Partnership’s master limited partnership agreement permitted a take-private if, in the future, certain regulatory changes occurred that were reasonably likely to have a material adverse effect (MAE) on the Partnership based on its pass-through tax status as an MLP. The only conditions to the General Partner’s right to effect a take-private were that it had received an opinion of legal counsel as to the MAE (the “Opinion Condition”) and that the General Partner had deemed the opinion acceptable (the “Acceptability Condition”). The General Partner received the opinion (the “Opinion”), from a highly regarded national law firm (known particularly for its energy, oil and gas practice) (the “Law Firm”). The General Partner deemed the Opinion acceptable and effected the take-private.

The court held that the Opinion Condition was not satisfied, however–because the Law Firm delivered the Opinion in “bad faith” as it had been “contrived” to reach the result that the General Partner and its controller (the “Controller”) wanted. The court also held that the Acceptability Condition was not satisfied–because the General Partner (a limited liability company) relied on its sole member (whose board was comprised entirely of insiders) rather than on its board (which included independent directors) to make the acceptability determination. The court held that (i) the General Partner breached the partnership agreement when it effected the take-private without the conditions having been satisfied; and (ii) the General Partner and its Controller were not exculpated or otherwise protected from liability under the partnership agreement because their actions constituted “willful misconduct.”

Key Points

• Even when a controller’s fiduciary duties are severely circumscribed by contract, the controller may be liable if it acts “manipulatively and opportunistically.” The court wrote that the General Partner “euphemistically” characterized the take-private as having “generated … $1.5 billion in ‘Value Creation,’” but that “much of [that] would be characterized more aptly as value expropriation.” The General Partner was able to achieve this “remarkable result,” the court wrote, because “a bevy of lawyers” on “its in-house legal team and [at its] outside counsel worked hard to generate a contrived Opinion”–an effort in which the General Partner “knowingly participated” and for which it was the “propulsive force.” The court also noted that the General Partner “opportunistically” effected the take-private during a period of “maximum uncertainty” for the partnership and appeared to try to conceal its knowledge about how the uncertainty likely would be resolved.
• The court found that the Law Firm went “too far” in “striving” to provide the legal opinion conclusions that its client wanted. The court criticized the Law Firm for improperly interpreting the Opinion Condition; using “counterfactual assumptions”; creating a “simple syllogism” that “ineluctably led” to the result the General Partner wanted; opining in the face of significant uncertainty on key facts; and (although not a Delaware firm) opining on a complex issue of Delaware law.
• The size of the damages award underscores the court’s willingness, in the context of a conflicted controller transaction, to impose liability for the full amount of the minority’s damages. The court described the very large award as “conservative” given the much larger amount that it “could have awarded.”
• The decision also serves as a reminder of: (i) the need for clear, precise drafting of agreements, with provisions carefully contextualized to the business objectives; and (ii) the critical importance of the record that is established through the parties’ and their lawyers’ contemporaneous emails, notes, notations on drafts, and the like. We note also the court’s recent trend of criticizing individual law firms and individual lawyers, by name, in its opinions when it deems it appropriate to do so.

Background. In 2005, Boardwalk was formed as a limited partnership. Soon thereafter, the Federal Energy Regulatory Commission (FERC) changed its policies such that master limited partnerships (MLPs) became an attractive investment vehicle for pipelines. The General Partner then took Boardwalk public as an MLP. Because the controller of the General Partner (the “Controller”) wanted to be able to take Boardwalk private again in the future (if FERC policies changed such that there would be an MAE on Boardwalk), Boardwalk’s MLP agreement granted the General Partner the right (the “Call Right”) to acquire the limited partnership interests, subject only to the Opinion Condition and the Acceptability Condition.

In 2018, FERC announced proposed policy changes (the “FERC Actions”) that potentially could have an MAE on the Partnership. All of the parties acknowledged that, until FERC had finalized the policies and, at a minimum clarified a certain tax issue (namely, how under the new policy FERC would treat a pipeline’s outstanding balance for accumulated deferred income taxes (the “Tax Issue”)), it was impossible to know whether the FERC Actions would have a negative, neutral, or positive effect on the Partnership. During this period of uncertainty (with the Partnership’s unit price declining), the General Partner obtained the Opinion and exercised the Call Right. The acquisition closed the day before FERC announced the full, final package of policy changes–based on which it was clear that the FERC Actions would have no effect on the Partnership. Certain former limited partners brought litigation challenging the take-private. Vice Chancellor J. Travis Laster, Jr. held in favor of the plaintiffs. The Controller has publicly stated that it intends to appeal.

The MLP agreement provided as follows:

• The Call Right was exercisable by the General Partner in its sole discretion, free of any fiduciary duty or express contractual standard, and subject only to the Opinion Condition and the Acceptability Condition.
• The Opinion Condition required that the General Partner receive an opinion of legal counsel that the Partnership’s status as a pass-through entity for tax purposes was reasonably likely in the future to have an MAE on the maximum applicable rate that could be charged to customers. (As the court noted, and as created numerous interpretive issues, the drafting, by focusing on a rate that could be charged to customers, “meshed imperfectly” with the Controller’s business goal of, more broadly, protecting against future regulatory action that would have an MAE on Boardwalk.)
• The Accessibility Condition required that the General Partner (which was a limited liability company) determine that the Opinion of Counsel was “acceptable.” (As the court noted, the drafting left unanswered whether the acceptability determination could be made by the General Partner’s sole member or by its board.)
• The exculpation provision stated that the General Partner was exculpated from monetary liability “unless it engaged in fraud, bad faith acts, or willful misconduct”; and would be “conclusively presumed” to have acted in good faith if it “relied on opinions, reports, or statements provided by someone that [it] reasonably believed to be an expert,” including reliance on “the advice or opinion of [legal counsel] (including an Opinion of Counsel).”

Discussion

The General Partner was not protected from liability under the partnership agreement. Exculpation was not available, the court held, because the General Partner’s actions, in combination, constituted “willful misconduct.” These actions included the General Partner’s participating knowingly in the effort to create the “contrived” Opinion; relying on the General Partner’s sole member (the board of which was comprised entirely on insiders of the Controller) rather than the General Partner’s board (which included outside directors) to determine acceptability of the Opinion; and exercising the Call Right at a time of “maximum uncertainty” for the Partnership. The good faith presumption when relying on legal opinions did not apply, the court held, because the General Partner (and its Controller) “provided the propulsive force that led the outside lawyers to reach the [Opinion] conclusions that [the Controller] wanted.”

The Opinion Condition was not satisfied because the Opinion was rendered “in bad faith.” “Viewed as a whole, outside counsel’s conduct went too far to constitute a good faith effort to render a legal opinion,” the court wrote. The Opinion “did not reflect a good faith effort by [the Law Firm] to discern the actual facts and apply professional judgment.” To the contrary, “[t]he Opinion was a contrived effort to reach the result that [the Controller] wanted.” According to the court:

• The Law Firm, “stretching” to provide the opinion its client wanted, improperly interpreted the Opinion Condition. The Law Firm interpreted the term “maximum applicable rates” (which had no established meaning in FERC regulatory parlance) to permit a focus on hypothetical rates that could be charged in the future. In the court’s view, however, the business rationale for the Condition (i.e., to protect the Controller against an MAE in the Partnership) required an assessment as to whether there likely would be an MAE based on actual rates that the Partnership would be charging “in the real world.”
• The Opinion was based on a series of “counterfactual assumptions”–because they were needed to reach the conclusions the client wanted. For example: The Law Firm assumed for purposes of the Opinion that the FERC Actions were sufficiently final to assess their effect–even though “everyone knew the proposals were not final.” The Law Firm also assumed that the Tax Issue would be resolved unfavorably for the Partnership (i.e., that no allowance for accumulated deferred taxes would be permitted)–even though (as the Partnership was contemporaneously stating in its comments to FERC and in its public filings) the Tax Issue was completely open and “it was impossible to determine the effect on [the Partnership]’s rates until [the Tax Issue was resolved].” The Law Firm also assumed that, with the Tax Issue resolved unfavorably, the Partnership’s rates would go down–even though its rates actually would go down only if rate cases were brought against it, which was known to be very unlikely.
• The Law Firm created and deployed a “simple” and “fundamentally flawed” syllogism that, by definition, produced the desired conclusion. The syllogism reflected that, “because a tax allowance had been part of the cost-of-service calculation [that would determine rates], a policy change eliminating the tax allowance [would] lead ineluctably to a [material and adverse] change in th[e] abstract concept [of maximum applicable rates].” In other words, just by assuming resolution of the Tax Issue such that there would be no income tax allowance (a conclusion that all acknowledged it was impossible to reach at the time the Opinion was issued–and that ultimately turned out to be incorrect), an MAE ostensibly was established.
• Other issues. The court noted that the Law Firm issued the Opinion at a time of “fatal uncertainty” relating to the key underlying factual issues–and, moreover, that the uncertainty would have been substantially mitigated simply by waiting a short time (rather than acquiescing to the client’s timing demands which served its self-interest in exercising the Call Right during “a fleeting period of maximum uncertainty”). The court also observed that the Law Firm, which was not a Delaware firm, issued a “non-explained opinion on a complex issue of Delaware law” (namely, whether an event constituted an MAE)–as to which, moreover, the two other firms that the General Partner had consulted (a national firm with a Delaware office and a Delaware firm) would not opine.

The Acceptability Condition was not satisfied because the General Partner wrongly interpreted ambiguity in the drafting in its own interest rather than the limited partners’ interest. The General Partner initially wanted the sole member to make the determination as to acceptability of the Opinion. It changed its mind based on additional outside counsel’s advice that the better view was that the board should make the determination (given that the condition likely had been intended to protect the limited partners). When the outside directors raised issues with respect to the Opinion, the General Partner relied instead on the sole member. The court held that ambiguity in the MLP agreement had to be resolved in favor of the limited partners’ interests rather than the General Partner’s interests because the General Partner was the party that had imposed and drafted the Condition.

The court calculated damages based on the stream of distributions that the limited partners were deprived of because the Call Right was impermissibly exercised. The court thus measured the damages as the difference between the present value of those future distributions (which the court determined to be $17.60 per unit) and the take-private transaction price ($12.06 per unit), amounting to a total of $689.83 million. The plaintiffs’ expert had estimated the present value of the future distributions at between $720 million and $901.6 million. The court characterized its $689.83 million damages award as “conservative” given the much higher amount that it “could have awarded under the wrongdoer rule” (which resolves uncertainty about the extent of damages against the breaching party).

Practice Points

• Clearly, a legal opinion should reflect the law firm’s careful, reasoned, objective judgment. A law firm should not reach conclusions in an opinion based on pressure from its client.
• As a general matter, in rendering an opinion, a law firm should not rely on facts that it knows to be untrue; and should not rely on factual representations, or make assumptions that certain facts are true, if the represented facts or the assumptions effectively establish the legal conclusions that are the subject of the opinion. While counterfactual assumptions can be appropriate in some circumstances (for example, if the fact may become true), the assumption and the rationale for making it should be explicitly expressed in the opinion. When delivering an opinion such as the one at issue in Bandera, which called for a conclusion regarding the actual present or future effect of an event (i.e., whether the FERC Actions had or were reasonably likely to have an MAE), the opinion giver can make good faith predictions about the future but cannot assume what will happen in the future–that is, an opinion will not satisfy an opinion condition if the opinion giver constructs a set of assumptions about the existence of future facts that would generate the conclusion that the condition requires.
• Other opinion-related guidance arising from Bandera includes the following:
  • Factual context. Legal counsel should be mindful that, although it is reaching legal conclusions in an opinion, the overall factual context should be considered and (depending on the legal issues involved) detailed factual analysis may be required. (Note that some law firms have a policy of not rendering opinions that require in-depth factual analysis, such as opinions on whether an MAE has occurred.)
  • Business rationale. A law firm rendering an opinion to satisfy a closing condition, when interpreting ambiguity in the condition, should consider the business rationale for the condition having been included. Generally, any interpretations of the drafting (and the rationales therefor) should be explicitly stated in the opinion.
  • Uncertainty. Legal counsel, when rendering an opinion during a time of significant uncertainty relating to the facts underlying the conclusions in the opinion, should take into account whether the uncertainty is likely to be resolved or mitigated in the near-term. In Bandera, the court noted that the “fatal uncertainty” relating to key facts would have been mitigated if the Law Firm had simply waited (in this case, just one day) to render the Opinion.
  • Other counsel. Legal counsel should be wary if other counsel has raised issues about, or refused to provide, a requested opinion. A law firm may want to be proactive in asking whether other counsel has been consulted with respect to a requested opinion on non-routine issues.
  • Delaware expertise. Law firms not expert in Delaware law generally should not issue opinions on complex issues of Delaware law.
• As we consistently emphasize, emails, notes, notations on drafts, and other contemporaneous communications—by the parties and their lawyers—may become an important part of the evidentiary record in the event a transaction is challenged. In this case, the court’s conclusion that the Law Firm delivered the Opinion in bad faith was based in large part on the record that was established regarding pressure that the client exerted on the firm, the firm’s thought process, and the client’s and the firm’s misgivings about the validity of the positions taken in the Opinion. For example, the court highlighted that “notes taken by [one lawyer]…reveal[ed] that everyone [had] focused on the core issue” that was problematic for the Opinion. The note, reproduced in the court’s opinion in the lawyer’s handwriting, read: “Qualitative piece–Hypothetical Rates, not analyzed–No actual change–no effect yet screw minority–Challenging Fact.”

While the decision serves primarily as a primer on good practice with respect to legal opinions, it also provides an important reminder that, notwithstanding exculpation provisions, a controller faces potential liability if the court deems it have acted in bad faith against the minority’s interests.