Thursday, December 03, 2015

With Claim at Once Direct and Derivative, $171M Award Will Stand Post-Merger

By Amy Leisinger, J.D.

The Delaware Court of Chancery refused to dismiss a $171-million award in a breach of contract action. Rejecting the defendant’s argument that the derivative claim was extinguished by a subsequent merger, the court found that a contractual claim based on a partnership agreement is direct regardless of being described as a derivative and that, in any case, the claim may be viewed as “dual-natured” and the award distributed as previously decided (In re El Paso Pipeline Partners, L.P. Derivative Litigation, December 2, 2015, Laster, J.).

Background. El Paso Pipeline Partners, L.P. (El Paso MLP) is the master limited partnership at the heart of the controversy. Through two transactions in 2010, El Paso Corporation (Parent), which owned the sole general partner of El Paso MLP, sold two of its subsidiaries to El Paso MLP. In the March 2010 transaction (the “spring dropdown”), Parent sold El Paso MLP a 51-percent interest in the subsidiaries. In November (the “fall dropdown”), Parent sold El Paso MLP the remaining 49-percent interest, along with a smaller interest in another subsidiary.

The plaintiff initiated a derivative lawsuit challenging both dropdowns. The court granted the defendants’ motion for summary judgment as to the spring dropdown, but held a trial to determine whether the conflicts committee believed in good faith that the fall dropdown was in the best interests of El Paso MLP, as required pursuant to the partnership agreement. The committee members had no explanation at trial to justify their recommendation, which conflicted with their private statements on the matter. The court awarded damages of $171 million against the general partner, amounting to the overpayment caused by its breach of the partnership agreement.

While the litigation was pending, Kinder Morgan, Inc. acquired the El Paso Parent. Shortly after trial, however, Kinder Morgan, Parent, El Paso MLP, and the general partner consummated a related-party merger that brought an end to El Paso MLP’s separate existence as a publicly traded entity, and the general partner moved to dismiss, contending that the plaintiff’s claim was derivative and that the closing of the merger must lead to dismissal.

A “direct” claim. Noting that “[g]ranting the motion to dismiss would generate a windfall for the General Partner at the expense of the unaffiliated limited partners for whose indirect benefit this suit originally was brought,” the court declined to take the general partner’s “bilpolar” view of classification of the breach of contract claim as exclusively direct or exclusively derivative. If the court must choose, then the claim is properly viewed as direct, the court found. In Tooley v. Donaldson, Lufkin & Jenrette, Inc. (Del. 2004), the Delaware Supreme Court suggested that the characterization of a claim as direct or derivative must turn on who suffered the alleged harm and who would benefit from recovery. The plaintiff proved that the general partner violated the agreement and that the limited partners would remain entitled to enforce its terms and would recoup losses, according to the court, and the merger, therefore, did not extinguish the plaintiff‘s standing to pursue the direct claim.

Dual-natured claim. However, the court continued, the “more appropriate way” to view the cause of action is as a dual-natured claim with aspects that are both derivative and direct. “Treating a dual-natured claim as derivative for purposes of claim initiation achieves the important goals of screening out weak claims [while treating the] claim as direct for purposes of claim continuation preserves the ability of investors to pursue legitimate claims, promotes accountability, and provides a superior mechanism for doing so than secondary litigation challenging the transaction that eliminated the plaintiff‘s standing to sue derivatively,” the court stated. The dropdown inflicted injury on both El Paso MLP and the unaffiliated limited partners and enriched the general partner at the expense of the limited partners, the court explained. “Because of the dual nature of the injury, the entity-level remedy is not the only option,” according to the court, and, because the claim that gave rise to the award is a dual claim, the plaintiff may continue to litigate its direct aspects notwithstanding the merger.

Further rejecting the argument that the plaintiff is estopped from enforcing the liability award based on the general partner’s reliance on the description of the claim as derivative, the court declined to dismiss the action and noted that the liability award will be implemented through an order requiring the general partner to pay each unaffiliated limited partner at the time of the merger their pro rata share of the award.

The case is No. 7141-VCL.