El Paso Pipeline GP Company, L.L.C. v. Brinckerhoff: Delaware Supreme Court Holds Limited Partner’s Claims Challenging MLP Dropdowns Are Derivative and Were Extinguished by Merger
December 22, 2016
Publication| Limited Liability Company & Partnership Advisory
In El Paso Pipeline GP Company, L.L.C. v. Brinckerhoff, No. 103, 2016 (Del. Dec. 20, 2016), the Delaware Supreme Court reversed the Court of Chancery’s holding that a limited partner maintained standing to pursue his claims challenging a dropdown transaction after the limited partnership was acquired by merger. The Supreme Court rejected the Chancery Court’s holding that the plaintiff’s claims arose out of a breach of the partnership agreement and, therefore, were direct in nature. As the claims were derivative, they passed to the buyer in the merger, thereby extinguishing the plaintiff’s standing.
In the fall of 2010, El Paso Corporation (“El Paso Parent”), which owned El Paso Pipeline GP Company, L.L.C. (the “GP”), the sole general partner of El Paso Pipeline Partners, L.P. (the “MLP”), sold assets to the MLP in a “dropdown” transaction. The plaintiff filed suit derivatively on behalf of the MLP challenging the transaction. While the litigation was pending, Kinder Morgan, Inc. (“Kinder Morgan”) acquired El Paso Parent. After this acquisition, Kinder Morgan acquired the MLP by merger. After the consummation of the MLP merger, the defendants moved to dismiss, arguing plaintiff’s claims were exclusively derivative and that plaintiff lost standing as a result of the merger. The Chancery Court then issued an opinion holding the GP liable for breach of the MLP’s partnership agreement, finding that the conflicts committee of the MLP “did not subjectively believe” that the approval of the dropdown transaction “was in the best interests of the partnership,” and that the MLP suffered $171 million in damages. Subsequently, the Chancery Court denied the defendants’ motion to dismiss. First, the Chancery Court distinguished the case at hand from the test articulated in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), for determining whether a claim is direct or derivative, stating that “Tooley does not apply to contract rights.” Nevertheless, the Chancery Court analyzed the claim under the two-part part test in Tooley—which involves an inquiry into (1) who suffered the alleged harm, and (2) who would receive the benefit of any recovery or other remedy—and concluded that plaintiff had asserted a “dual-natured” claim and thus could pursue the claim post-merger. As to the first prong, the Chancery Court found that the dropdown injured the limited partners by reallocating value from the unaffiliated limited partners to the GP and that, because the GP received benefits to the exclusion of the limited partners generally, the limited partners suffered a distinct injury. As to the second prong, the Chancery Court decided that, because both the MLP and the limited partners were harmed, either could recover for the alleged breach.
On appeal, the Supreme Court determined that plaintiff’s claims were and remained derivative. The Supreme Court explained that, while claims for breach of a commercial contract are normally direct in nature, a partnership agreement is not merely a traditional commercial contract; rather, it is the constitutive contract of a partnership and sets forth the rights and duties of the partners. The Supreme Court found the plaintiff’s claim sounded in breach of a contractual duty owed to the MLP and thus applied Tooley. As to the first prong, the Supreme Court concluded that the harm alleged in plaintiff’s complaint solely affected the MLP, noting that plaintiff alleged the MLP overpaid for the assets in the dropdown and that overpayment claims are normally treated as harming the entity and are, therefore, regarded as derivative. The Supreme Court noted that, where an entity is alleged to have overpaid for an asset, the entity is harmed through the depletion of its assets, which harms its equity holders derivatively through the diminution of the value of their interests. The Court further noted that not every breach of a provision of the partnership agreement is “dual” by reason of rights and duties under the partnership agreement flowing to either the limited partners or the MLP. While recognizing that its opinion in Gentile v. Rossette, 906 A.2d 91 (Del. 2006), allowed for a dual-natured claim in circumstances where there is both an improper transfer of economic value and voting power from the minority stockholders to the controlling stockholder—so-called “equity dilution” claims—the Supreme Court found the plaintiff’s claims failed to satisfy the unique circumstances presented by Gentile. The Supreme Court declined to extend Gentile and dual-natured claims to circumstances where the “extraction of solely economic value from the minority by a controlling stockholder constitutes direct injury.”
As to the second prong of Tooley, the Supreme Court found that any recovery from the claim would benefit the MLP’s partners pro rata in proportion to their partnership interests. The Supreme Court rejected the Chancery Court’s reliance on cases where claims involving “insider transfers” or “stock dilution” were found to be dual-natured. The Supreme Court found that those cases were inapposite, as the plaintiff did not allege that the dropdown affected his voting rights or relative control of the MLP.
While the Supreme Court recognized the Chancery Court’s equitable concerns with a holding that would allow the claims to be extinguished, the Supreme Court declined to change settled law, noting the importance of certainty in the law for all parties. The Supreme Court stated that, in most circumstances, “permitting pending derivative claims to survive a merger would be inefficient and overly costly for public investors” and that “[u]seful transactions would be deterred or priced at a lower value because third-party acquirers would find themselves having bought into litigation morasses, the persistence of which they cannot control.”
In his concurrence, Chief Justice Strine wrote separately to state that the present case “highlights” that Gentile “muddies the clarity of [Delaware] law in an important context,” stating that “it ought to be overruled, to the extent it allows for a direct claim in the dilution context when the issuance of stock does not involve subjecting an entity whose voting power was held by a diversified group of public equity holders to the control of a particular interest.” Even in the case of a transaction that shifts control from a disaggregated investor base to a controller, the Chief Justice noted, stockholders would already have a direct claim under Revlon, leaving no “gap” for Gentile to fill.
This decision provides helpful guidance in finding that the contractual-based nature of Delaware limited partnerships does not eliminate the application of the two-part Tooley test when determining whether certain claims involving Delaware limited partnerships are direct or derivative claims.