In its recent decision in El Paso v. Brinckerhoff, the Delaware Supreme Court reversed the Court of Chancery’s decision and, in doing so, helped to clarify how to determine whether a stockholder claim is derivative, direct, or both.
This case before the Court of Chancery comes out of two dropdown transactions in which El Paso Corporation transferred ownership interests down to El Paso Pipeline Partners, L.P.—one in the spring and one in the fall of 2010. The transactions involved the plaintiff, Brinckerhoff, a limited partner of the Partnership, and defendants El Paso Pipeline Partners, L.P., a master limited partnership (the “Partnership”), El Paso Pipeline GP Company, L.L.C. (the “General Partner”), and El Paso Corporation (the “Parent”). During both transactions, as required by the Limited Partnership Agreement (the “LPA”), the General Partner formed a committee to approve both dropdowns. The committees approved the dropdowns and the General Partner closed the transactions. In August 2011, Kinder Morgan, Inc. (“Kinder Morgan”) acquired the Parent.
In December of that year, Brinckerhoff challenged the spring dropdown “derivatively on behalf of [the Partnership].” Brinckerhoff brought suit against the Parent and the General Partner, alleging breach of express and implied duties, aiding and abetting, tortious interference, and unjust enrichment arguing that they overpaid. Brinckerhoff then challenged the fall dropdown early the next year. After several motions, the court dismissed all claims except Brinckerhoff’s breach of duty claim against he General Partner.
In July 2014, Kinder Morgan again wanted to merge—this time with the Partnership (the “Merger”). Taking into account Brinckerhoff’s derivative litigation, the a new merger committee still recommended that the Partnership accept Kinder Morgan’s offer to acquire. The merger committee thought that the value of Brinckerhoff’s claim was “not sufficiently material to impact the Merger consideration” and in November of that year, Kinder Morgan successfully acquired the Partnership. Brinckerhoff declined to challenge the Merger.
After the Merger, the defendants moved to dismiss Brinckerhoff’s claims, arguing that he lacked standing because he no longer had ownership because of the Merger. The court, however, denied the defendants’ motion and held that “because the claim for breach of the LPA was not exclusively derivative, Brinckerhoff could enforce the liability award irrespective of the Merger.”
Here, the Delaware Supreme Court addressed the threshold issue of whether or not Brinckerhoff had standing. The Court wrote, “in corporate derivative litigation, loss of a plaintiff’s status as a shareholder generally extinguishes the plaintiff’s standing.” The Court of Chancery improperly addressed the standing question with too broad a reading of NAF Holdings. The Court of Chancery treated the LPA as if it were a separate commercial contract rather than the constitutive contract of the Partnership. The court believed that a plaintiff’s status as a limited partner meant that every claim arising from the LPA was a direct claim. The Court explained that this application of NAF Holdings was too broad, and the Court of Chancery should have applied the two-pronged Tooley test to determine whether Brinckerhoff’s claim was derivative or direct.
The Tooley test asks, “whether a claim is solely derivative or may continue as a dual-natured claim ‘must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suit stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?’”
In its analysis, the Court determined that the answer to the first question was that Brinckerhoff claimed that the Partnership suffered the alleged harm. Brinckerhoff claims that the defendants overpaid and, thus, caused a reduction in the Partnership’s overall value. The Court wrote, “[w]here all of a corporation’s stockholders are harmed and would recover pro rata in proportion with their ownership of the corporation’s stock solely because they are stockholders, then the claim is derivative in nature.”
For the claim to be derivative under the second-prong of Tooley, “the benefit of any recovery must flow solely to the Partnership.” The Court concluded that the claim was derivative because “[w]ere Brinckerhoff to recover directly for the alleged decrease in the value of the Partnership’s assets, the damages would be proportionate to his ownership interest. The necessity of a pro rata recovery to remedy the alleged harm indicated that his claim is derivative.” Thus, the Court concluded that Brinckerhoff’s claim satisfied both prongs of the Tooley test and was exclusively derivative.
The Court makes a distinction for dual-natured claims—claims that are both derivative and direct. In Gentile, the Court described a dual-natured claim as one that “requires a controlling shareholder and transactions that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.” Brinckerhoff argues that the distinction between economic value and voting power is “immaterial,” and that just an improper transfer of economic value is a direct claim. The Court, however, declined to expand the purview of dual-natured claims, writing that “to do so would deviate from the Tooley framework and ‘largely swallow the rule that claims of corporate overpayment are derivative’ by permitting stockholders to ‘maintain a suit directly whenever the corporation transacts with a controller on allegedly unfair terms.’”
Furthermore, in his concurrence, Chief Justice Strine argued that the Court’s decision in Gentile v. Rossette doesn’t fill any gaps in Delaware corporate law and “cannot be reconciled with the strong weight of our precedent and it ought to be overruled.”
Finally, the Court followed the rule from Lewis v. Anderson that a plaintiff loses standing to continue a derivative suit when a merger occurs because the claim is transferred to the acquiring company. Therefore, Brinckerhoff’s claims transferred to Kinder Morgan and Brinckerhoff lost standing to sue when the two companies merged. The only remedial option Brinckerhoff had was to challenge the merger, but he declined to do so. The Supreme Court reversed the Court of Chancery’s decision because of Brinckerhoff’s lack of standing.
Melaina is a second year student at Widener University Delaware Law School and a Staff Member on the Delaware Journal of Corporate Law.
Suggested Citation: Melaina Hudack, Direct and Derivative Claims in El Paso v. Brinckerhoff, Del. J. Corp. L (Feb. 14, 2017), www.djcl.org/blog.