On December 20, 2016, the Delaware Supreme Court narrowed the circumstances in which a limited partner can pursue a claim against a master limited partnership (“MLP”) once the MLP’s existence has been terminated in a merger. The decision clarified the critical distinction between direct and derivative claims by limiting the circumstances where a plaintiff could assert both such claims, and in doing so reaffirmed the court’s Tooley test.
In El Paso Pipeline GP Company, L.L.C. v. Brinckerhoff, a limited partner of El Paso Pipeline Partners, L.P, (“El Paso Pipeline”) claimed that the general partner and the directors violated their duties under El Paso Pipeline’s limited partnership agreement to act in good faith in connection with a dropdown transaction from the sponsor to the MLP. Shortly after a trial on this issue, the MLP merged with a subsidiary of Kinder Morgan, Inc., and the defendants moved to dismiss Brinckerhoff’s claims on the ground that the merger had extinguished his ownership interest, and he therefore lacked derivative standing to bring his claim. The Chancery Court found that a limited partner maintained standing to sue the general partner and its affiliates after the limited partnership had been acquired in a merger. The Delaware Supreme Court reversed.
Because the MLP merged with Kinder Morgan after the trial, the Delaware Court of Chancery decided to rule on the merits of the claim before ruling on the standing issue. The Chancery Court held that the general partner, its board of directors, and the conflicts committee did not fulfill their obligation under the partnership agreement to act in the best interests of the MLP and found that El Paso Pipeline suffered $171 million in damages. In a later opinion issued after the merger closed, the Chancery Court denied the defendant Kinder Morgan’s motion to dismiss, stating that the claim for breach of the limited partnership agreement survived the merger and was “not exclusively derivative” and could either be considered an exclusively direct claim for a breach of contract or a “dual-natured” direct and derivative claim.
On appeal, the Delaware Supreme Court reversed, holding that the plaintiff’s claims were extinguished by the merger since the claims were derivative only. The court reaffirmed the principle that whether a claim is derivative or direct requires an examination of who owns the claim under the established standard set forth in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), and it held that the plaintiff did not have standing to bring the claim once his ownership interest was extinguished in the merger.
The court held that the Chancery Court erred in treating the limited partnership agreement as an ordinary commercial contract because it is a constitutive contract of an entity, serving the function of a charter for a corporation. Limited partnership agreements do not give members of these entities the ability to enforce all the provisions of the agreements by direct claims simply because they are contracts as well as constitutive documents. The court then ran through the two-pronged Tooley analysis to determine whether the claim belonged to El Paso Pipeline and could be asserted only derivatively or if it was “dual in nature” and as such could proceed either derivatively or directly by the partnership’s limited partners. Under Tooley, a court must consider “(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually).” Tooley, 845 A.2d at 1033. Here, in order for his claim to be considered direct, the stockholder would have had to demonstrate the duty allegedly breached was owed to the stockholder, and that he could prevail on his claim without showing an injury to the partnership. Applying the Tooley analysis, the court stated that the claim could be asserted only derivatively, finding: (1) the partnership’s overpayment resulted in immediate harm to the partnership in the form of a reduction of its value, and (2) the benefit of the recovery would be received by the partnership.
The court’s decision has the effect of narrowing the circumstances under which a limited partner can pursue a claim against a general partner and its affiliates and thus simplifies the playing field for MLP unitholder litigation. Indeed, Chief Justice Strine, in a concurring opinion, signaled that the court may have a desire to further limit these circumstances, emphasizing that judicially-crafted exceptions may be even more narrowly limited in the future. Thus the value of derivative claims in the MLP context has clearly been reduced, and even possibly eliminated if the MLP is merged into another entity.
However, the Supreme Court did not disturb the underlying liability finding—specifically that the conflicts committee approved a transaction that it did not believe was in the best interests of the MLP. This Chancery Court’s decision on the merits, which pre-dated the dispute about post-merger standing to enforce that merits ruling, remains influential, since its logic was not challenged by the Delaware Supreme Court when it reversed on other grounds. That decision is the first time that the Chancery Court had found that a general partner of an MLP had violated its duty to subjectively act in the best interests of the partnership. Despite the reversal, it remains a lesson to MLP boards to act in accordance with the duties set forth in their partnership agreements and apply best practices in approving conflict transactions.