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The Williams Companies, Inc. v. Energy Transfer Equity, L.P.
Citations: 159 A.3d 264; 2017 WL 1090912; 2017 Del. LEXIS 128Docket: 330, 2016
Court: Supreme Court of Delaware; March 23, 2017; Delaware; State Supreme Court
Original Court Document: View Document
The Supreme Court of Delaware addresses an appeal involving a merger agreement where Energy Transfer Equity, L.P. (ETE) was set to acquire The Williams Companies, Inc. (Williams). The merger included two steps: first, Williams would merge into a new entity, Energy Transfer Corp LP (ETC), with ETE paying $6.05 billion for 19% of ETC’s stock, while 81% would be distributed to Williams shareholders. In the second step, ETC would transfer Williams' assets to ETE for newly issued ETE Class E partnership units. A critical condition for the merger was obtaining a tax opinion from ETE's counsel, Latham & Watkins LLP, confirming a tax-free exchange under Internal Revenue Code Section 721(a). However, a downturn in the energy market led to ETE questioning the transaction's financial viability and the IRS's potential interpretation of the $6.05 billion payment. As a result, Latham declined to issue the required tax opinion, prompting ETE to withdraw from the merger. Williams sought to prevent ETE's termination of the Merger Agreement, claiming a breach of the obligation to use "commercially reasonable efforts" to obtain the 721 opinion and "reasonable best efforts" to complete the deal. The court ultimately affirmed the decision of the Court of Chancery, ruling in favor of ETE. Williams contended that ETE was estopped from terminating their Merger Agreement due to a representation regarding the absence of facts that could prevent the transaction from being tax-free. The Court of Chancery dismissed these claims, determining that ETE's obligations were interpreted too narrowly as merely a negative duty not to obstruct the Agreement, rather than imposing affirmative responsibilities. Williams argued on appeal that ETE should have had an obligation to actively ensure the Agreement's performance and that ETE's actions did not meet its affirmative duties, particularly regarding obtaining a necessary tax opinion from Latham. Moreover, Williams claimed the burden of proof regarding ETE’s breach should have rested with ETE, not Williams. The Court of Chancery found that Latham's decision not to issue the opinion was a good faith judgment independent of ETE's conduct, a finding not challenged on appeal. Consequently, the court concluded that ETE's actions did not materially contribute to Latham's decision. Thus, the court affirmed that ETE was not estopped from terminating the Agreement. Williams, a Delaware corporation in energy infrastructure, and ETE, a Delaware limited partnership, entered into the Merger Agreement in September 2015, which was contingent on Latham issuing a tax opinion under Section 721(a) of the Internal Revenue Code, stipulating that both parties would employ "commercially reasonable efforts" to secure this opinion. At the time of entering the Agreement, both parties and their tax advisors believed that the second step of the transaction would qualify as tax-free under Section 721(a). However, following a significant decline in the energy market, ETE's partnership units lost substantial value, raising concerns about ETE's ability to meet its $6.05 billion cash obligation to ETC. Attempts to restructure or terminate the Agreement were unsuccessful, and ETE sought financing alternatives, ultimately opting to issue a new class of equity units to reduce short-term cash distributions. However, Williams withheld necessary financial information for SEC filings, leading ETE to complete a private offering of convertible units on March 8, 2016. In March 2016, ETE's Head of Tax, Brad Whitehurst, recognized that the $6.05 billion was to be exchanged for a fixed number of ETC shares, which, due to the decline in ETE’s unit price, would result in the ETC shares being valued at only about $2 billion. This raised concerns that the IRS might view part of the $6.05 billion as allocated to acquiring Williams assets, potentially turning the transaction into a taxable event. Whitehurst informed ETE's chairman and sought legal advice from Latham regarding the tax implications. Initially, Latham was prepared to issue a favorable Section 721 opinion but, after analyzing the transaction and consulting with other law firms, concluded that it could not issue the opinion due to the risk of IRS recharacterization under disguised sale rules in Section 707 of the Internal Revenue Code. On April 11, 2016, Latham confirmed its inability to provide the 721 opinion, fearing IRS attribution of the excess cash over the ETC stock value to the Williams assets. Meanwhile, Morgan Lewis, without consulting Latham, also concluded it could not provide a 721 opinion for similar reasons. Cravath disagreed with Latham's assessment and proposed two solutions on April 14, 2016, but Latham determined that neither would resolve the issue. On April 18, 2016, ETE disclosed in an amendment to its proxy statement that Latham would not be able to deliver a 721 opinion. Subsequently, Cravath consulted with Gibson, Dunn, and Crutcher, LLP, which determined it could provide a “weak-should” opinion but initially found it challenging to reach such a conclusion. Latham maintained that it would not issue the 721 opinion by the closing date. Williams filed its first complaint against ETE and LE GP, LLC on April 6, 2016, regarding ETE’s private offering of convertible partnership units, followed by a second complaint on May 13, 2016, addressing ETE’s efforts to obtain the 721 opinion from Latham. The Court of Chancery consolidated both complaints for trial on June 20-21, 2016, focusing solely on the claims about the 721 opinion in the second complaint. Williams alleged that ETE breached the Agreement by failing to exert “commercially reasonable efforts” to secure the 721 opinion and misrepresented its knowledge concerning the transaction's tax-free status, which prevented ETE from terminating the Agreement. Williams sought a declaration of material breaches and a permanent injunction against the termination. The Court began its analysis by assessing Latham's good faith in concluding it could not issue the 721 opinion, thoroughly examining the circumstances surrounding this decision. The Court recognized Latham's conflicting interests: benefiting ETE by withholding the opinion while also prioritizing its reputation for delivering consistent opinions. Ultimately, the Court concluded that Latham acted independently and in good faith, determining the 721 opinion condition was unmet. The Court then considered whether ETE had breached its obligation to use commercially reasonable efforts to obtain the opinion, noting that the term was not defined in the Agreement and lacked clear legal precedent. The Court of Chancery analyzed the term "reasonable best efforts" as defined in Hexion Specialty Chemicals, Inc. v. Huntsman Corp. It concluded that this term equated to good faith and was akin to "commercially reasonable efforts." ETE was deemed obligated to take objectively reasonable actions to secure a 721 opinion from Latham. However, the Court noted that Williams failed to demonstrate any commercially or objectively reasonable efforts that ETE could have undertaken to obtain the opinion. It ruled that Whitehurst did not breach the covenant of "commercially reasonable efforts" by merely raising the 721 issue with Latham, as Latham acted independently and in good faith. The Court distinguished the current case from Hexion, where misleading information was provided to an advisor; here, no evidence indicated that ETE misled Latham or obstructed the issuance of the 721 opinion. The Court also addressed Williams’ claim of false representation regarding ETE's knowledge of potential issues with the 721 opinion, stating that Latham’s analysis was a theoretical concern not requiring disclosure at the time of signing. Ultimately, the Court found no breach by ETE concerning its representations and warranties about the 721 opinion, thus denying Williams' request to block ETE from terminating the merger. Williams subsequently appealed. The standard of review involves de novo evaluation of legal conclusions and deference to factual findings. Williams argued that the Court of Chancery misinterpreted ETE's obligations, contending that ETE had affirmative duties to secure the 721 opinion. However, the Vice Chancellor found no evidence of ETE withholding information or manipulating Latham’s ability to issue the opinion, reinforcing that ETE did not materially breach its obligations. The Court of Chancery's interpretation in the Hexion case was overly restrictive regarding the buyer's responsibilities for securing financing. The court indicated that the buyer was obligated to take reasonable actions to facilitate financing, particularly when concerns about the solvency of the merged entity arose. The court highlighted that a reasonable response would have involved discussing these concerns with the seller's management. However, the buyer's failure to engage in such discussions was deemed a knowing and intentional breach of its covenants under the merger agreement. The merger agreement's Section 5.03 mandates that both parties use their "reasonable best efforts" to ensure the merger's completion, imposing a duty to take all necessary actions to satisfy closing conditions. Section 5.07 further obligates the parties to cooperate in obtaining a favorable tax opinion necessary for the merger. The Court of Chancery mistakenly focused on the lack of evidence that ETE caused Latham to withhold the tax opinion, despite existing evidence indicating ETE's failure to engage adequately with necessary parties and its lack of proactive efforts in the merger process. Williams contended that, upon determining ETE's breach, the burden should shift to ETE to demonstrate that its breach did not materially affect the failure of the closing condition. This perspective is supported, as once a breach is established, the burden lies on the breaching party to prove that it did not contribute materially to the transaction's failure. The Vice Chancellor's comments suggested an incorrect allocation of the burden of proof regarding causation, improperly placing the onus on Williams. Williams failed to demonstrate that ETE took commercially reasonable actions that would have led Latham to issue the required 721 Opinion for the merger. The Court of Chancery found no breach of covenant by ETE, thus not needing to assess whether any breach materially contributed to the transaction's failure. In a footnote, the Court acknowledged the burden of proof issue raised by Williams, stating that if a breach contributes materially to the failure of a condition, the burden shifts to the defendant to prove that the breach did not materially cause the failure. However, the Court concluded that the evidence did not indicate that any actions or inactions by ETE, apart from notifying Latham, materially impacted Latham's inability to issue the opinion. This finding was based on factual determinations that were not clearly erroneous. Consequently, Williams' argument for reversal on burden allocation failed. Additionally, Williams argued that ETE should be equitably estopped from terminating the Merger Agreement based on ETE's representations regarding the lack of knowledge of preventing facts for the transaction qualifying under Section 721(a). To prove equitable estoppel, it must be shown that Williams lacked knowledge of the true facts, relied on ETE's conduct, and suffered a prejudicial change in position due to that reliance. Williams asserts reliance on ETE's representation regarding the tax-free nature of the transaction under the Merger Agreement, which included a 721 opinion condition. Williams argues that ETE's concerns about the 721 opinion arose without any changes in the relevant facts or law, claiming that Latham should have anticipated a potential decline in the value of ETE’s partnership units. However, ETE did not withhold any known facts at the agreement's signing; rather, the change stemmed from Latham's evolving tax liability theory, which did not exist at that time. Williams contends that ETE highlighted the tax issue only to escape the agreement once it became unfavorable financially. Nonetheless, the Court of Chancery accepted testimony indicating that ETE’s potential tax issue was only recognized in light of the energy market downturn, suggesting ETE was unaware of any problematic tax theory when it made its representations. Consequently, the court found no breach of representations by ETE, and Williams' estoppel argument was rejected. The judgment of the Court of Chancery was affirmed, with a shortened timeframe for reargument motions. Chief Justice Strine dissented, criticizing the Majority for not properly assessing why the Latham Tax Lawyer failed to provide the required tax opinion, noting that the focus of the Court of Chancery was misaligned with the critical question of intent and the circumstances surrounding the tax opinion requirement. The case involved a merger agreement between ETE and Williams dated September 28, 2015, necessitating a Latham Tax Lawyer's opinion on the tax-free classification of the asset transfer under Section 721(a) of the Internal Revenue Code. The Merger Agreement required ETE to make “commercially reasonable” efforts to obtain a 721 opinion, which is classified as a strong affirmative covenant. Additionally, ETE was obligated to utilize “reasonable best efforts” to complete the overall transaction. The Court of Chancery did not evaluate whether ETE met this standard but instead examined whether ETE had obstructed the Latham Tax Lawyer from issuing the opinion. The court concluded that ETE did not coerce or mislead Latham, despite ETE's lack of desire for the opinion to avoid the deal. The court accepted the Tax Lawyer's testimony, which indicated he could not provide the opinion despite being ready to do so prior to ETE's engagement. The court noted that the structure of the deal was clearly established, with fixed amounts of cash and stock, and ETE had affirmed it was unaware of any issues preventing the opinion's issuance. Ultimately, the Tax Lawyer's inability to issue the opinion was based on new insights recognized after the signing, despite having prior knowledge of the deal's terms. The significance of the purchase price and the structure of the transaction were emphasized as fundamental elements of the agreement. The document addresses the obligations of parties involved in a merger agreement, specifically focusing on the conditions that must be met for a merger to close. It highlights that if one party fails to meet these conditions due to a breach of covenant, they bear the burden of proving that their breach did not materially contribute to the failure of the closing condition. The excerpt discusses a specific case where ETE was required to demonstrate that its failure to take "commercially reasonable efforts" did not impact the ability to obtain a necessary tax opinion (the 721 opinion). The Court of Chancery's ruling was critiqued for not properly placing this burden on ETE, which could have changed the outcome of the case. It notes the complications arising from ETE's interactions with the Latham Tax Lawyer, suggesting ETE’s actions put the lawyer in a difficult position that may have hindered the issuance of the opinion. The text emphasizes that the breaching party must show that no viable options existed to fulfill their contractual obligations without incurring significant financial detriment. The excerpt outlines the events surrounding the merger between ETE and Williams Companies, Inc. Following the signing of the Merger Agreement, both companies faced a significant downturn in the energy markets, leading to a substantial decrease in their market values. ETE's concerns regarding its ability to take on additional debt for the merger grew, especially as it perceived Williams to be more vulnerable to the economic downturn. Initially, ETE had agreed to pay $6 billion in cash for ETC stock, which was also valued at approximately $6 billion at the time of the agreement. However, due to the market decline, the value of the ETC stock plummeted to around $2 billion, creating an imbalance where ETE was effectively giving $4 billion more in cash than the current value of the stock. By January, ETE's chairman suggested terminating the Merger Agreement due to these economic changes. A crucial development occurred in late March when Brad Whitehurst, ETE’s senior executive responsible for tax matters, expressed concerns regarding the fixed nature of the cash and stock exchange. He mistakenly believed that the number of shares exchanged would adjust according to their value, which was no longer the case given the decline in stock value. Whitehurst's realization raised concerns that the IRS might view the excess cash as triggering a taxable event. This prompted a review by the Latham Tax Lawyer regarding the issuance of the tax opinion, which had not been questioned prior to Whitehurst's revelation. The excerpt emphasizes that there was no prior indication that Latham would have reconsidered its opinion had Whitehurst not raised his concerns. Whitehurst testified he did not realize the stock amount was fixed, despite having opportunities to review the deal documents. Williams contested Whitehurst’s claim, noting the Court of Chancery did not accept his narrative of ignorance six months after signing. The court avoided addressing Whitehurst's truthfulness, considering it immaterial to the main issue. This avoidance is criticized for neglecting the significance of whether Whitehurst, as a senior executive at ETE, genuinely did not understand the fluctuating nature of a key merger consideration linked to market conditions. The Vice Chancellor expressed skepticism regarding Whitehurst's sudden realization and sidestepped questions about his motivations in contacting Latham for a legal opinion. While the Majority concluded that Williams did not dispute Latham's good faith in declining the 721 opinion, the dissent argues that Williams did challenge whether ETE’s conduct influenced Latham's decision, asserting that the Court should have required ETE to demonstrate that its actions did not prevent the satisfaction of the opinion condition, in line with Delaware law. The text concludes by acknowledging the inherent loyalty lawyers have towards their clients, which is a fundamental aspect of their professional conduct. Whitehurst's communications with the Latham Tax Lawyer indicate that ETE was not interested in proceeding with the deal, and there was an implicit pressure on the lawyer regarding the legal opinion related to tax implications. ETE attempted to portray this pressure as a legitimate inquiry into potential tax issues, but the circumstances suggest otherwise. ETE's actions, including withholding engagement with Cravath, hastily publishing Latham's views, and neglecting to explore solutions to Latham's concerns, reflect a breach of its obligations to cooperate in the transaction. The outcome of Latham's resolution of the issues is uncertain, especially given ETE's failure to comply with its obligations to secure the necessary tax opinion. Whitehurst's claims of ignorance about the transaction's tax implications are called into question, given his professional background, which raises concerns about the motivations behind his inquiries. ETE's duty was to act reasonably to obtain the tax opinion, making their conduct problematic in light of these obligations. ETE's approach to fulfilling its covenant to act in a commercially reasonable manner is called into question. Contrary to the Majority's assertion that ETE encouraged collaboration between its counsel, Wachtell, and Latham Tax Lawyer regarding a tax issue, the evidence indicates that ETE did not facilitate such cooperation. When Wachtell was approached about the tax issue—significantly delayed by nine days—their response was that there was no issue, suggesting they could have worked with Latham to resolve the matter. Instead, ETE actively prevented Wachtell from collaborating with Latham, instructing other tax lawyers at Morgan Lewis not to communicate with them. Moreover, ETE's handling of communication was problematic; it took two weeks for Latham to inform Williams’ counsel, Cravath, about their inability to deliver the necessary 721 opinion, which was the first time any of Williams’ advisors were made aware of the problem, and only after Latham had reached a firm conclusion. Shortly thereafter, ETE filed an amended proxy statement that publicly disclosed Latham's stance, which could be interpreted as an attempt to corner the Latham Tax Lawyer into a position of having to publicly revise their earlier stance. Cravath objected to this disclosure, having not received feedback from Latham on proposed solutions, further indicating that the timing and necessity of the public statement were questionable. The excerpt highlights the challenges of persuading a judge to change a ruling compared to maintaining openness before a decision is made. It notes that ETE concealed an issue from Williams for 14 days while attempting to resolve it with them in just six days. During this rushed process, Cravath's proposals to address concerns raised by Latham were submitted only two days after they were first communicated. However, Latham delayed their response until 15 days after the proxy was filed, ultimately rejecting Cravath's proposals as unworkable. Testimony indicated that some at Latham believed at least one proposal could be beneficial, and Morgan Lewis also saw potential merit in it. Despite this, Latham appeared unwilling to collaborate, and Whitehurst did not advocate for a collective effort to resolve the issue. The Court of Chancery's fact-finding suggested that Latham's feedback to Williams and Cravath was largely unilateral. The failure to reach an agreement was further complicated by the general skepticism towards Whitehurst's theory, which was not endorsed by either side's legal teams. Expert testimony from Williams and ETE's own experts indicated a lack of support for Latham's theory, pointing out that adjusting specific factual assumptions could change their conclusions. While the Court of Chancery expressed sympathy for Latham's inability to reach an agreement, the record suggests a need to reassess the evidence to understand Latham's conduct better. Abraham N. M. Shashy, Jr., a Tax Practice Group Leader at King & Spalding LLP, and Professor Ethan Yale from the University of Virginia School of Law provided expert affidavits stating concerns about the tax-free treatment of a transaction involving ETE and ETC. Shashy indicated a "substantial" risk of failing to secure tax-free status, while Yale expressed "serious doubt" about it. The central issue revolved around ETE's assertion that there was no non-tax motive for transferring shares to itself, despite the Court of Chancery suggesting that the transfer aligned interests between ETE and ETC. This misrepresentation potentially led ETE's tax experts to inaccurate conclusions. The Court's leniency towards the Latham Tax Lawyer overlooked ETE's behavior that pressured the lawyer and compromised their ability to address tax concerns adequately. A minor amendment to the merger agreement could have mitigated tax issues without affecting ETE's economic interests, highlighting the irony that if the provisions were not deemed significant by the lawyer, then adjusting them should not have posed a problem. The Court recognized that breach of contract obligations, particularly under duress, should not excuse ETE from responsibility for failing to assist in achieving necessary conditions for tax opinions. The conclusion suggests a remand for a new trial to determine whether ETE's breach materially impacted the Latham Tax Lawyer's ability to provide a favorable tax opinion.