October 18, 2019

Del. Chancery Says Disclosure of Potential Call Right Exercise Raises Contract Issues

A recent Delaware Chancery Court decision addressed the hazards of navigating a company’s disclosure obligations under the securities laws & its controller’s obligation to abide by contractual restrictions on the timing of disclosure of the exercise of a call right. In Bandera Master Fund v. Boardwalk Pipeline Partners, (Del. Ch.; 10/19), Vice Chancellor Laster was confronted with a situation in which a general partner who owned more than 50% of the partnership’s common units had a call right to acquire the limited partners’ stake upon the occurrence of certain events.

The partnership agreement called for the exercise price of the call option to be determined by reference to the average closing prices of the partnership’s common units over a period of 180 days ending prior to the notice of exercise of the call right. The purpose of this provision was to prevent the exercise price from being influenced by the disclosure of the general partner’s decision to exercise it.

However, because the common units were publicly traded, the partnership was subject to periodic disclosure obligations under the Exchange Act – and it disclosed the possibility that the general partner might exercise this call right in its June 2018 10-Q filing. That disclosure didn’t go over well with the limited partners, who alleged that this disclosure depressed the exercise price & breached the general partner’s fiduciary duties & contractual obligations.

VC Laster dismissed the fiduciary duty allegations because the partnership agreement expressly contracted away fiduciary obligations when the general partner was acting in its individual capacity. But the Vice Chancellor refused to dismiss the breach of contract claim.  In making the contract claim, the plaintiffs pointed to language obligating the general partner to act in a “fair and reasonable manner” when addressing a conflict of interest.

They alleged that the decision to disclose of the general partner’s potential exercise of the call right wasn’t fair and reasonable because it benefited the general partner and harmed the limited partners by reducing the number of trading days during which the market price of their units was unaffected by disclosure of the intent to exercise the call right. Not surprisingly, the general partner defended the disclosure decision on the basis that disclosure was required under the securities laws, and that its conduct was fair and reasonable because complying with those laws was in the best interests of the partnership.

The Vice Chancellor said that this might well be the case, but it depended on whether the information was “material” at the time of the 10-Q filing, and that was a facts & circumstances issue that he wasn’t prepared to rule on in the context of a motion to dismiss:

It is not possible to determine at the pleading stage whether the General Partner was obligated under the federal securities laws to cause the Partnership to make the Potential-Exercise Disclosure when it did. It is reasonably conceivable that the Potential Exercise Disclosure was made early and strategically with the goal of driving down the price of the common units and enabling the General Partner to exercise the Call Right at a lower price.

This is just one issue in a case that’s loaded with them – for instance, in addition to the express breach of contract claim, VC Laster also declined to dismiss claims that the general partner’s alleged manipulation of the exercise price of the call right violated an implied covenant of good faith and fair dealing. The decision is definitely worth reading, particularly for those entities that have included language disclaiming fiduciary obligations and substituting contractual standards for the obligations of controlling persons.

John Jenkins