Morris v. Spectra Energy Partners (DE) GP, LP, No. 489, 2019 (Del. Jan. 22, 2021) (Seitz, C.J.)
In this opinion, the Delaware Supreme Court held that the plaintiff had adequately pled a direct claim challenging the fairness of the merger because the defendant failed “to secure value for his pending derivative claims.” As a result, the Supreme Court reversed the Court of Chancery’s decision dismissing the claim for lack of standing. In reaching its conclusion, the Supreme Court applied the test set forth in In re Primedia, Inc. Shareholders Litigation (“Primedia”) and held that the Court of Chancery had misapplied the materiality analysis and should have concluded that it was reasonably conceivable at the pleadings stage that the value of the derivative claims was material when compared against the overall merger consideration.
Plaintiff’s current suit arose in the context of a prior action against the defendant, which was the general partner of the partnership where plaintiff held units. Plaintiff challenged the consideration received by the partnership pursuant to a reverse drop-down of assets with Spectra Energy Corp., the parent of the general partner. Plaintiff’s prior complaint, which alleged that the defendant had acted in bad faith in approving the reverse drop-down without including the full value of the assets in the consideration received for such assets, survived a motion to dismiss. However, plaintiff lost standing to pursue his derivative suit after a merger in which the partnership was acquired and all of the partnership units were converted into shares of the acquiror. During the negotiations, a conflicts committee, which negotiated the transaction, assigned zero value to plaintiff’s derivative claims. Plaintiff then sued, challenging the fairness of the merger exchange ratio because the defendant had agreed to a merger that did not include any value for his derivative claims. The Court of Chancery, on a motion to dismiss, held that plaintiff lacked standing. In the Court of Chancery’s analysis, the value of the plaintiff’s derivative claims was not material after discounting such claims to represent the percentage value that would be attributable to the public unitholders from such recovery and plaintiff’s likelihood of success in recovering on such derivative claims.
On appeal, the Delaware Supreme Court addressed the standing question, noting that, under the Court’s precedent in El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, a plaintiff who loses standing to bring a derivative claim following a merger can still bring a “direct claim challenging the validity of the merger when the general partner failed to secure the value of material derivative claims in the merger for the minority equity owners.” The Court held that, on a review of the record, plaintiff adequately pled a direct claim challenging the fairness of the merger for failure to include the value of his prior derivative claims.
The Supreme Court also held that Primedia was the appropriate test to apply when conducting “a pleadings-based analysis to evaluate standing on a motion to dismiss” for claims attacking the fairness of the merger for failing to provide value for derivative claims. Under Primedia, the Court must determine whether the prior derivative claim was viable and material, as well as whether the acquiring entity had indicated that it would not assert the prior derivative claim and did not provide value for it when acquiring the target entity. The parties did not dispute that plaintiff’s prior derivative claims were viable (as they had survived a motion to dismiss), that the acquiror would not assert the claims post-merger, and that the defendant had not “secured” any value for the claims in the merger.
The Supreme Court then evaluated the Court of Chancery’s materiality analysis, finding that the Court of Chancery had made two reversible errors. First, the Supreme Court concluded that the Court of Chancery erred in applying a litigation discount risk at the motion to dismiss stage, as it “was inconsistent with the court’s standard of review on a motion to dismiss for lack of standing.” Second, the Supreme Court concluded that, even if a discount was appropriate at the motion to dismiss stage “to reflect the public unitholders’ interest in the derivative recovery,” the Court of Chancery erred by comparing the discounted amount of damages ($112 million) against the entire value of the merger ($3.3 billion). The proper comparison should have been the discounted amount of damages ($112 million) against the consideration to be received by only the public unitholders in the merger ($561 million), which would have been material. The Supreme Court remanded to the Court of Chancery for further proceedings.