In re El Paso Pipeline Partners, L.P. Derivative Litigation: Court of Chancery Suggests a New Approach to Evaluating Claims that Are Both Direct and Derivative
February 25, 2016
In In re El Paso Pipeline Partners, L.P. Deriv. Litig., 2015 WL 7758609 (Del. Ch. Dec. 2, 2015), the Court of Chancery denied a motion to dismiss a suit, in which the Court had already entered a $171 million damages award against the defendants, on the grounds that the plaintiff had lost standing as a result of a post-trial merger. In denying the motion to dismiss, the Court addressed the distinction between direct and derivative claims while offering its view with respect to dual-natured claims.
Through two transactions in 2010, El Paso Corporation (“El Paso Parent”), which owned the sole general partner of El Paso Pipeline Partners, L.P. (the “MLP”), sold two of its subsidiaries to the MLP. The plaintiff filed suit derivatively on behalf of the MLP challenging each of the transactions. After consolidation of the two lawsuits, the Court granted the defendants’ motion for summary judgement as to the first transaction. However, trial was held with respect to the second transaction (the “Fall Dropdown”), following which the Court found that the Fall Dropdown did not receive “special approval” (as defined in the MLP’s operating agreement) because the members of the MLP’s conflicts committee had failed to form a subjective belief that the transaction was in the best interests of the MLP. Accordingly, the Court found that approval of the Fall Dropdown had breached the partnership agreement and awarded $171 million in damages, the amount of overpayment caused by the breach.
During the pendency of the litigation, Kinder Morgan Inc. acquired El Paso Parent. Shortly after trial Kinder Morgan, El Paso Parent, the MLP, and El Paso Pipeline GP Company, L.L.C. (“El Paso General Partner”) consummated a related-party merger, which brought an end of the separate legal existence of the MLP. El Paso General Partner then moved to dismiss the lawsuit on the basis that the plaintiff’s claims were exclusively derivative and the plaintiff lacked standing to pursue his claims due to the merger.
The Court rejected the motion to dismiss and found that to the extent Delaware law required it to make a choice between construing the plaintiff’s claim as either exclusively derivative or exclusively direct, the claim was direct in nature. The Court reasoned that the plaintiff had proved that El Paso General Partner violated certain provisions of the MLP’s partnership agreement, a contract to which the plaintiff and the other limited partners of the MLP were parties. The Court stated 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 relied on the public policy underlying the limited partnership statute to give maximum effect to the principle of freedom of contract and enforceability of partnership agreements in finding that limited partners can sue directly to enforce contractual constraints in a limited partnership agreement.
However, the Court declined to accept the defendants’ “bipolar” view of classification of the plaintiff’s claim as either exclusively direct or exclusively derivative. Instead the Court suggested that the “more appropriate way” to view the claim is as dual-natured with aspects that are both direct and derivative. In reaching this conclusion, the Court analyzed the claim under the two-part Tooley test. The Court found the analysis under Tooley straightforward if the claim were considered one for breach of contract: the limited partners suffered a breach of their contract rights and that breach could be remedied appropriately at the limited partner level. The Court also held that, even setting aside the contractual nature of the claim, the claim was both direct and derivative under Tooley. Specifically, the first prong of the Tooley test, adapted for a limited partnership, asks who suffered the alleged injury, the partnership or the limited partners individually. The Court held, in the context of the plaintiff’s claim, the answer was both, because the MLP and its limited partners suffered injuries resulting from El Paso General Partner’s breach of the MLP’s partnership agreement. The MLP suffered by overpaying in the Fall Dropdown, and the limited partners suffered because the transaction effectively reallocated value from them to El Paso General Partner. The second prong of the Tooley test asks who would receive the benefit of any remedy, the partnership or the limited partners individually. The Court determined the answer to this second question was either, because Delaware law supported both an entity-level remedy and a limited partner-level remedy with respect to overpayment claims. Therefore, the Court concluded that the plaintiff’s claim was dual-natured and could be pursued directly or derivatively.
In dicta, the Court also expressed its view that the treatment of dual-natured claims is an area of Delaware law that warrants further development. Specifically, the Court suggested that when considering how a dual-natured claim should be treated for purposes of whether it can be maintained after a merger, Delaware law should prioritize the individual aspects of the claim such that it survives. However, when considering how a dual-natured claim should be treated for purposes of determining demand futility, Delaware law should prioritize the derivative aspects of the claim. This would preserve the policy goals of screening out meritless claims and protecting the primacy of the board’s (or other manager’s) management of the entity.
Finally, the Court rejected El Paso General Partner’s estoppel argument, finding Delaware law is clear that a plaintiff’s characterization of its claims as either direct or derivative is not binding on the Court. The Court ruled that the plaintiff can continue to pursue the claim after the merger and can enforce the $171 million judgment. The Court ordered the current general partner to pay the MLP’s unaffiliated limited partners as of the time of the merger their pro rata share of the $171 million award, plus pre- and post-judgment interest through the date of payment, less an amount for a reasonable award of attorneys’ fees and expenses.