Tuesday, January 26, 2021

Chancery erred in dismissing merger challenge for lack of standing

By Anne Sherry, J.D.

The full Delaware Supreme Court reversed and remanded a decision of the Court of Chancery dismissing a post-closing challenge to the merger between Enbridge and Spectra Energy Partners. The chancery court erred by discounting the value of a derivative suit to reflect the public unitholders’ interest in the recovery, applying a litigation risk discount, and then concluding that the result was not material compared to the full merger consideration. At the motion to dismiss stage, the court should have accepted the challenger’s reasonable factual allegations as true, and its comparison of a portion of the derivative recovery against the full merger consideration was not apples to apples (Morris v. Spectra Energy Partners (DE) GP, LP, January 22, 2021, Seitz, C.).

A "roll up" connected to a merger extinguished a former Spectra minority unitholder’s standing to bring an alleged $661 million derivative suit on behalf of Spectra against its general partner. The plaintiff then filed a new class action alleging that the merger exchange ratio was unfair because Spectra agreed to a merger that did not reflect the material value of the derivative claims. On the general partner’s motion to dismiss, the chancery court dismissed the new complaint for lack of standing. First, the court discounted the potential recovery to $112 million to reflect the public unitholders’ beneficial interest in the $661 million lawsuit. Then, the court discounted the $112 million to $28 million to reflect a one-in-four chance of success in the litigation. The chancery court then concluded that the resulting $28 million was immaterial to a $3.3 billion merger.

The chancery court looked to its own framework for post-merger claims set forth in Primedia, and the Supreme Court agreed that this "provides a reasonable basis to conduct a pleadings-based analysis to evaluate standing on a motion to dismiss." Namely, the court must first decide whether the underlying derivative claims would survive a motion to dismiss. Second, the derivative claim recovery as pleaded must be material in relation to the merger consideration. Third and finally, the court should assess whether the complaint alleges that the acquirer would not assert the underlying derivative claim and did not provide value for it.

The parties did not dispute that the derivative claim, which had already survived a motion to dismiss, was viable, that the general partner secured no value for it in the merger, or that the acquirer would not assert the claim after the merger. The issue on appeal was whether the chancery court stayed true to the standard of review on a motion to dismiss for lack of standing by accepting reasonable factual allegations as true and considering whether it was reasonably conceivable that the plaintiff asserted a direct claim that could lead to a $661 million recovery on the derivative claims. The Supreme Court concluded that the chancery court strayed from the proper standard of review in two ways.

First, the court was bound to accept the plaintiff’s reasonable factual allegations as true and draw all reasonable inferences in his favor. It was an error to apply a litigation risk discount to the $661 million potential recovery when it was reasonably conceivable that the general partner acted in subjective bad faith and that a successful lawsuit could have recovered at least $661 million. Discounting the recovery was inconsistent with the standard of review on a motion to dismiss for lack of standing.

Second, the court erred by applying a further discount to reflect the public unitholders’ proportional interest in the derivative claim recovery and then comparing that, for the materiality analysis, against the entire merger consideration. An apples-to-apples comparison would have also reduced the merger consideration to reflect the public unitholders’ interest. This would have meant comparing $112 million to $561 million, rendering the derivative claim material at the motion-to-dismiss stage. The court remanded to chancery to consider the general partner’s motion to dismiss for failure to state a claim, which it raised for the first time on appeal.

The case is No. 489, 2019.