Friday, December 23, 2016

El Paso merger extinguishes standing, $171M award reversed

By John M. Jascob, J.D., LL.M.

The Delaware Supreme Court has reversed a $171 million award to former limited partners in a suit alleging that a conflicts committee knowingly approved a transaction that was unduly favorable to the general partner. The plaintiff’s contractual overpayment claim was exclusively derivative in nature because under the partnership agreement, the partnership owned the claim. Accordingly, the plaintiff’s standing was extinguished when the limited partnership was acquired in a merger before there was a judicial ruling on the merits of his suit (El Paso Pipeline GP Co. v. Brinckerhoff, December 20, 2016, Valihura, K.).

Conflict transaction. El Paso Pipeline Partners, L.P. was a publicly-traded Delaware master limited partnership based in Houston, Texas. By means of two "dropdown" transactions in 2010, El Paso Corporation, the parent company that owned the sole general partner of El Paso Pipeline Partners, sold two of its subsidiaries to El Paso Pipeline Partners. The plaintiff then initiated derivative lawsuits challenging both dropdowns, alleging that the conflicts committees that reviewed the transactions approved them without believing they were in the best interests of the limited partnership they were charged with protecting.

Although dismissing the claims related to the first dropdown, the Chancery Court ultimately awarded damages of $171 million against the general partner, amounting to the overpayment caused by its breach of the partnership agreement with respect to the second transaction. After the trial was completed and before any judicial ruling on the merits, however, El Paso Pipeline Partners was acquired in a related-party merger with Kinder Morgan, Inc. that brought an end to El Paso Pipeline Partners’ separate existence as a publicly traded entity. The plaintiff did not challenge the merger.

The general partner then moved to dismiss, contending that the plaintiff’s claim was derivative and that the closing of the merger must lead to dismissal. The Court of Chancery, however, rejected the defendants’ argument, reasoning that the plaintiff’s claim, although always treated by him as derivative before the merger was announced, could also be considered direct. In the chancery court’s view, the plaintiff’s claim was “dual-natured” because, even apart from the “contractual angle,” the second dropdown had inflicted injury on both the partnership and the unaffiliated unitholders, allowing him to litigate the claim directly post-merger. And even if considered to be derivative, the claim should survive the merger for the core policy reason that dismissal would leave the unaffiliated limited partners without recompense for the general partner’s prior unfair dealing.

Partnership owned the claim. On appeal, however, the Delaware Supreme Court reversed, holding that the overpayment claim was exclusively derivative in nature. The court observed that under the limited partnership agreement, the limited partnership itself was entitled in the first instance to sue and obtain recovery against the general partner and its co-defendants for any claim that the transaction was economically unfair to the limited partnership. The fact that individual limited partners might press the limited partnership’s rights as derivative plaintiffs did not make the claims ones which belonged to them individually, the court stated.

Claim not “dual-natured.” In addition, the state high court held that the claims of the derivative plaintiff were not dual in nature. Although agreeing that some recent case law could be read as undercutting the traditional rule that dilution claims are classically derivative, the court declined to further expand that case law in the limited partnership context. This was especially true in the present case, the court observed, where the plaintiff sought only monetary relief for the limited partnership and there was no plausible argument that the transaction had the effect of increasing the voting power or control of the general partner at the expense of the unaffiliated unitholders.

Merger extinguished the plaintiff’s claim. Finally, the state high court held that the merger extinguished the plaintiff's standing because a plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing to continue a derivative suit. The claims, which were an asset of the partnership, passed by operation of law to Kinder Morgan as a result of the merger. Accordingly, the merger extinguished the plaintiff’s standing to assert the claims. The plaintiff’s remedy was to challenge the merger, but he elected not to do so.

The case is No. 103, 2016.