Delaware Supreme Court Analyzes Duties Imposed by "Reasonable Best Efforts" Covenant

This case summary was prepared by Matthew Arnold.

In The Williams Companies, Inc. v. Energy Transfer Equity, L.P.,[1] the Supreme Court of Delaware was asked to interpret a merger agreement (the “Agreement”) between two energy companies, Energy Transfer Equity, L.P. (“ETE”) and The Williams Companies, Inc. (“Williams”).  In this two step merger, Williams would merge into a new entity, Energy Transfer Corp L.P., in which ETE would transfer $6.05 billion in to the new entity in exchange for 19% of the new entity’s stock.  Further, the $6.05 billion and 81% of the new stock would be transferred to Williams’ shareholders.  The second step involved the new entity transferring Williams’ assets to ETE in exchange for Class E Partnership units.  This transaction was centered upon an opinion by ETE’s counsel, Latham & Watkins LLP (“Latham”) that the second step of the transaction should be a tax-free exchange under Section 721 of the Internal Revenue Code (the “721 Opinion”).
 
After ETE and Williams entered into the Agreement, the energy market declined resulting in ETE’s partnership units to fall between a third and a half of their value when ETE and Williams entered into the Agreement.  As a result of the decline in value, as well as discovering that the Agreement caused for a fixed number of shares and not a floating number of shares, Brad Whitehurst (“Whitehurst”), ETE’s Head of Tax, became concerned that the merger could become a taxable event.  Whitehurst alerted Latham of the issue and Latham indicated it could not, in good faith, be able to produce a 721 Opinion.  After both ETE and Williams consulted with additional counsel, it was determined that the second step of the merger could result in a taxable event.  ETE subsequently backed out of the merger. 
 
Williams sued ETE stating that ETE failed to use “commercially reasonable efforts” to obtain the 721 Opinion from Latham and could not rely on the failure of the 721 Opinion to void the Agreement.  Further, Williams claimed that ETE misrepresented Williams by saying it knew of no facts that would prevent the second step of the transaction from completing.  After determining that Latham acted independently and in good faith in not being able to give the 721 Opinion, the Court of Chancery found in favor of ETE.  Specifically, the Court of Chancery relied on Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).  Relying on Hexion, the Court of Chancery “equated ‘reasonable best efforts’ with good faith, and that ‘reasonable best efforts’ was similar to ‘commercially reasonable efforts.’”  It concluded that ETE was proper in violating the Agreement due to its inability to acquire the 721 Opinion.
 
The Supreme Court of Delaware found that Court of Chancery improperly interpreted Hexion.  Specifically, discussing Hexion and the obligations in Section 5.03 of the Agreement, the Court found that the covenants in the Agreement required ETE to take all reasonable steps to solve problems and consummate the transaction.  Therefore, the burden was on ETE to show that it did everything it could to acquire the 721 Opinion.
 
Having found that ETE had an affirmative obligation to take all reasonable steps to obtain the 721 Opinion, the Court analyzed whether ETE breached its covenants and led to the failure of the transaction.  Relying on a footnote by the Court of Chancery, which stated that regardless of the burden, such breach did not materially contribute to the failure of the 721 Opinion, the Court defaulted to the Court of Chancery’s finding that ETE met its burden of proof.  Lastly, the Court rejected Williams’ argument that ETE misrepresented their belief in the taxable nature of the Agreement.  The Court found that circumstances changed after ETE and Williams entered into the Agreement and, hence, the action should not be estopped. Therefore, Supreme Court of Delaware affirmed the Court of Chancery’s decision in favor of ETE.
 
Key Points of Law:
  •  “Hexion, with which we agree, recognized that covenants like the ones involved here impose obligations to take all reasonable steps to solve problems and consummate the transaction.”
  • “We agree that once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of the transaction.”


[1] No. 330, 2016 (Del. 2017).

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