(Article from Securities Law Alert, July 2016)
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On June 24, 2016, the Delaware Chancery Court considered the requirement in a merger agreement that the parties use “commercially reasonable” efforts to obtain a tax opinion as a condition precedent to the consummation of the merger. The Williams Cos. v. Energy Transfer Equity, 2016 WL 3576682 (Del. Ch. 2016) (Glasscock, V.C.). In the case before the court, intervening economic circumstances allegedly changed both the buyer’s desire to consummate the merger and the designated law firm’s willingness to issue the favorable tax opinion mandated by the merger agreement. The court found the buyer had not breached the requirement to use “commercial reasonable” efforts to obtain the tax opinion because there was no evidence that the buyer’s “activity or lack thereof caused, or had a material effect upon” the law firm’s “inability” to issue the necessary tax opinion.
Background
Pursuant to the terms of a merger agreement dated September 28, 2015 (the “Merger Agreement”), Energy Transfer Equity (the “Partnership”) was to acquire The Williams Companies in an “unusual structure” in which Williams was to merge into Energy Transfer Corp (“ETC”), an entity created by the Partnership. The acquisition was to be accomplished in multiple steps: “ETC would . . . transfer the former Williams assets and 19% of ETC’s common stock to the Partnership, in return for partnership units equivalent in value to the ETC stock on a one-share-for-one-unit basis, together with $6 billion in cash” that “would then be distributed to the former Williams stockholders.”
The Merger Agreement made “it clear . . . that a tax-free transfer of the Williams [a]ssets between ETC and the Partnership was necessary for the deal to make economic sense.” The parties “conditioned consummation of the deal on the opinion of a third party—Latham [& Watkins]—that the transaction ‘should’ survive an IRS challenge and be considered tax free under Section 721(a)” (the “721 Opinion”). At the time the deal was struck, the transaction “involved assets of equivalent value” and Latham would have been “able, under those conditions, to issue an opinion that the transaction should be considered a tax-free event.”
Williams and the Partnership were both in the gas pipeline business. Sometime after the execution of the Merger Agreement, “the energy market—and thus the value of assets used in the transport of energy, of the type held by Williams and the Partnership—experienced a precipitous decline.” The merger “quickly became financially unpalatable to the Partnership” because it would have “resulted in a value discrepancy amounting to a $3 to $4 billion overpayment by the Partnership.” Latham & Watkins subsequently determined that it could not issue the requisite 721 Opinion because the underlying transaction no longer involved equivalent assets and thus there was “a sufficient likelihood” that the transaction was not tax free.
The Partnership attempted to terminate the Merger Agreement based on Latham’s failure to issue the 721 Opinion. Williams then brought suit asserting that “the Partnership [had] breached the Merger Agreement by failing to use commercially reasonable efforts to obtain the 721 Opinion” and therefore could not “rely on the failure of Latham to deliver the 721 Opinion as a basis to terminate the Merger Agreement.” The parties conducted expedited discovery and the court held a two-day trial to consider the issues.
Court Finds No Material Breach Because the Partnership’s Actions Did Not Cause Latham to Refuse to Issue the Tax Opinion
As an initial matter, the court determined that Latham’s refusal to issue the 721 Opinion was not in bad faith but instead, reflected the changed economics of the deal. In reaching this conclusion, the court found it significant that Latham’s change of position was “not in the reputational interest of the individual tax attorneys at Latham, nor the interest of the firm generally.”
The court then considered whether the Partnership was in “material breach” of its obligation to use “commercially reasonable efforts” to obtain a 721 Opinion from Latham. The court observed that the term “commercially reasonable efforts” was neither “defined in the Merger Agreement” nor “addressed with particular coherence in [Delaware] case law.” In the absence of guidance on the meaning of the term, the court found that “by agreeing to make ‘commercially reasonable efforts’ to achieve the 721 Opinion, the Partnership necessarily submitted itself to an objective standard—that is, it bound itself to do those things objectively reasonable to produce the desired 721 Opinion, in the context of the agreement reached by the parties.”
The court recognized that the Partnership had “experienced a bitter buyer’s remorse.” However, the court explained that Williams could “point to no commercially reasonable efforts that the Partnership could have taken to consummate the [merger].” Williams did not suggest that there were “actions available to the Partnership that would have caused Latham, acting in good faith, to issue the 721 Opinion” either based on “the current structure of” the merger or “any alternative structure suggested to date.” Finding that there were “no such actions available to the Partnership,” the court held the Partnership was not in “material breach” of the Merger Agreement “[d]espite [its] motivations.”
Significantly, the Williams court distinguished an earlier decision in Hexion Specialty Chemicals v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008). There, the Chancery Court held that a buyer who no longer wished to consummate an agreed-upon merger had breached its obligation to use “reasonable best efforts” to obtain financing for the transaction as required under the merger agreement. The Williams court found that in Hexion, “the buyer [had] actively and affirmatively torpedoed its ability to finance” the merger by, among other actions, “knowingly” providing its financial advisor with “misleading or inaccurate information” concerning the transaction. Here, however, the Williams court found no evidence that “the Partnership [had] instructed Latham, directly or indirectly,” to refuse to issue the necessary tax opinion. The court explained that “[i]f the record here reflected affirmative acts by the Partnership to coerce or mislead Latham, by which actions it prevented issuance of the 721 Opinion, the facts here would more resemble Hexion, and the outcome here would likely be different.”
The court therefore denied Williams’ request to enjoin the Partnership from terminating the Merger Agreement based on Latham’s failure to issue a Section 721 tax opinion.