El Paso Pipeline GP Company, L.P. et al., v. Brinckerhoff, No. 103, 2016 (Del. Dec. 20, 2016)
In this unanimous en banc decision, the Supreme Court of Delaware reversed a $171 million judgment of the Court of Chancery, holding that the plaintiff limited partner lost standing to pursue the underlying derivative claim when the limited partnership was acquired in a merger. Reaffirming the applicability of the two-pronged “Tooley” test for determining whether claims are direct or derivative in nature, the Court found that simply because a claim is predicated on contract rights in a limited partnership agreement does not necessarily mean that it can be pursued directly. Here, the claim was found to be exclusively derivative in nature and an asset of the partnership under the Tooley analysis. The claim having passed to the acquiring entity in the merger, plaintiff lacked standing to pursue it.
At issue before the Court of Chancery was whether El Paso Pipeline GP Company, L.L.C. (the “General Partner”), a subsidiary of El Paso Corporation (the “Parent”) breached the limited partnership agreement of El Paso Pipeline Partners, L.P. (the “LPA”), a publicly traded Delaware master limited partnership (the “Partnership”) in approving a drop-down transaction whereby the Partnership acquired certain assets from Parent. Parent controlled both the General Partner and the Partnership. Brinckerhoff, a limited partner, sued derivatively and challenged the drop-down transaction, claiming that defendants caused the Partnership to overpay for the drop-down assets. Shortly after trial, Kinder Morgan acquired the Partnership. Brinckerhoff did not challenge the merger.
After Kinder Morgan acquired the Partnership, defendants moved to dismiss the case on the grounds that plaintiff’s claims were exclusively derivative in nature and that he had lost standing to pursue them by operation of the merger. The Court of Chancery, however, proceeded to try and decide the matter while defendants’ motion to dismiss remained pending, finding that the General Partner breached the LPA and that the Partnership suffered $171 million in damages. In a subsequent opinion on defendants’ motion to dismiss, the Court of Chancery held that Brinckerhoff’s claim was “dual-natured,” i.e., both derivative and direct, allowing him to pursue the case post-merger even though the Partnership had been acquired.
On appeal, the Court held that Brinckerhoff’s claims were exclusively derivative and therefore Brinckerhoff lost standing to pursue his claims when Kinder Morgan acquired the Partnership. The Supreme Court held that the Court of Chancery had read NAF Holdings, LLC v. Li & Fung (Trading) Ltd., 118 A.3d 175 (Del. 2015) too broadly in finding that Tooley does not apply to contract-based claims. The Supreme Court explained that in NAF Holdings, the Tooley analysis was not necessary to determine whether the contract claim in that case was direct or derivative because “when a plaintiff asserts a claim based upon the plaintiff’s own right, such as a claim for breach of a commercial contract, Tooley does not apply.” The Court further explained that “NAF Holdings does not support the proposition that any claim sounding in contract is direct by default, irrespective of Tooley.” Rather, the application of Tooley demonstrated that the benefit of any recovery would flow directly to the Partnership and only indirectly o the limited partners pro rata in accordance with their ownership of the Partnership. Thus, the Court held that Brinckerhoff’s overpayment claim was exclusively derivative under Tooley and therefore his standing to pursue the claim extinguished when Kinder Morgan acquired the Partnership.
In reaching its decision, the Supreme Court also distinguished Brinkerhoff’s claim from the “dual-natured” claim described in Gentile v. Rosette, 906 A.2d 91 (Del. 2006). According to the Court, Gentile involved both an overpayment claim and a dilution claim asserted against a controlling stockholder. The transactions underlying those claims allegedly resulted in the improper transfer of both economic value and voting power from the minority to the controlling stockholder, the latter of which constituted direct harm to the minority stockholders. The Supreme Court held that Gentile did not apply here because Brinkerhoff never alleged, and failed to prove, that the overpayment increased the General Partner’s or the Parent’s control to the limited partners’ detriment.
Chief Justice Strine wrote separately to express his opinion that Gentile should be overruled to the extent that 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 then, Chief Justice Strine reasoned, there is no gap for Gentile to fill as Revlon already allows stockholders to bring a direct claim in a change of control situation.