Delaware Chancery Denies Williams’ Request to Enjoin ETE from Terminating $38 Billion Deal
 

On June 24, 2016, Vice Chancellor Sam Glasscock III of the Delaware Chancery Court issued a memorandum opinion denying a request by plaintiff The Williams Companies Inc. (“Williams”) to enjoin defendant Energy Transfer Equity L.P. (“ETE”) from terminating its merger agreement with Williams.  Williams Cos. v. Energy Transfer Equity, L.P., C.A. No. 12168-VCG, memo op. (Del. Ch. June 24, 2016).  Vice Chancellor Glasscock held that ETE was contractually entitled to terminate the merger because a mutual condition precedent—the issuance of a tax opinion by ETE’s counsel, Latham & Watkins LLP (“Latham”), that the transaction should receive tax-free treatment under Section 721(a) of the Internal Revenue Code (the “721 Opinion”)—was not satisfied.  Central to the decision was the Vice Chancellor’s conclusion that Latham’s determination was made in good faith.  Although Williams has appealed the decision, ETE terminated the merger as of June 29, 2016.

The ETE-Williams merger agreement, signed in September 2015, valued ETE’s acquisition of Williams at nearly $38 billion, including cash, stock, debt assumptions, and a $6.05 billion cash transfer to Williams shareholders.  The Court concluded that while the deal was very attractive to both parties when the agreement was executed, the precipitous decline of the commodities market in late 2015 caused the transaction to become “manifestly unattractive” to ETE.  Williams alleged that ETE was looking for an out and that ETE, in an effort to avoid liability for breaching the merger agreement, pressured Latham to refuse to issue the 721 Opinion.

The decision turned on whether Latham’s decision not to issue the 721 Opinion was made in good faith.  In concluding that the opinion was made in good faith and in Latham’s independent professional judgment, the Court credited testimony that explained why Latham’s opinion on the tax-free treatment of the transaction changed, along with the absence of evidence of misconduct.  The Court also noted that the risk of reputational harm to Latham associated with bad-faith misconduct exceeded the risk of changing its prior position and—contrary to Williams’ argument—any interest in preserving an important client relationship with ETE by acquiescing to ETE’s alleged demands. 

Importantly, Vice Chancellor Glasscock distinguished the cases cited by plaintiffs in their arguments to enjoin defendants from walking away from the deal.  In WaveDivision Holdings, LLC v. Millenium Digital Media Sys., LLC, 2010 WL 3706624 (Del. Ch. Sept. 17, 2010), and Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. 2008), the parties that sought to escape the merger took affirmative steps to destroy the deal.  By contrast, in this case the Court found, “[t]here is simply nothing that indicates to me that the [ETE] has manipulated the knowledge or ability of Latham to render the 721 Opinion, or failed to fully inform Latham, or do anything else…to obstruct Latham’s issuance of the condition-precedent 721 Opinion.” 

The critical issue underlying the 721 Opinion was whether the $6.05 billion cash transfer to Williams shareholders could be viewed by the IRS as a “disguised sale” and accordingly treated as taxable.  The potential that the cash transfer would be considered a disguised sale rose as the commodities market tumbled because the shifting market created a value discrepancy between the partnership shares in Energy Transfer Corp LP (“ETC”), a company created for the merger, and the fixed value of the $6.05 billion cash distribution.  Latham ultimately concluded that the IRS might disregard the separateness of the share transfers and cash contribution and instead treat the cash exchanged in excess of the value of the stock as payment for Williams assets transferred to ETE, possibly exposing the deal to $1 billion of tax liability.  Although both sides hired experts to opine on the likely tax treatment of the proposed transaction, Vice Chancellor Glasscock respected the contractual delegation of the determination to Latham as a reputable third party, and found that the decision not to issue the 721 Opinion was made in good faith.

Out of respect for the terms of the merger agreement, and given the lack of indicia of bad faith on the part of ETE, the Court denied Williams’ request to compel performance, allowing ETE to terminate the merger.