In re El Paso Pipeline Partners, L.P. Derivative Litigation , 2015 Del. Ch. LEXIS 295 ( 2015 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN RE: EL PASO PIPELINE PARTNERS, ) C.A. No. 7141-VCL
L.P. DERIVATIVE LITIGATION )
OPINION
Date Submitted: September 3, 2015
Date Decided: December 2, 2015
Jessica Zeldin, ROSENTHAL, MONHAIT & GODDESS, P.A., Wilmington, Delaware;
Jeffrey H. Squire, Lawrence P. Eagel, BRAGAR EAGEL & SQUIRE, PC, New York,
New York; Attorneys for Plaintiff.
Peter J. Walsh, Jr., Brian C. Ralston, Berton W. Ashman, Jr., Matthew F. Davis,
POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Attorneys for
Defendants El Paso Pipeline GP Company, L.L.C., El Paso Corporation, Douglas L.
Foshee, John R. Sult, Ronald L. Kuehn, Jr., D. Mark Leland, Arthur C. Reichstetter,
William A. Smith, and James C. Yardley.
Lewis H. Lazarus, Thomas E. Hanson, Jr., Courtney R. Hamilton, Brett M. McCartney,
MORRIS JAMES LLP, Wilmington, Delaware; Attorneys for Nominal Defendant El
Paso Pipeline Partners, L.P.
LASTER, Vice Chancellor.
In November 2010, El Paso Corporation (―El Paso Parent‖) sold member interests
in three limited liability companies to El Paso Pipeline Partners, L.P. (the ―Partnership‖
or ―El Paso MLP‖). At the time of the sale, El Paso Parent controlled El Paso MLP
through its ownership of El Paso Pipeline GP Company, L.L.C., the sole general partner
of El Paso MLP (the ―General Partner‖ or ―El Paso GP‖). On April 20, 2015, this court
issued a post-trial decision which held that by causing El Paso MLP to buy the member
interests, the General Partner breached the limited partnership agreement governing El
Paso MLP (the ―LP Agreement‖ or ―LPA‖). See In re El Paso Pipeline P’rs, L.P. Deriv.
Litig., 2015 WL 1815846 (Del. Ch. Apr. 20, 2015) (the ―Post-Trial Opinion‖). The Post-
Trial Opinion referred to the transaction as the ―Fall Dropdown,‖ so this decision uses the
same term. The Post-Trial Opinion held that the General Partner was liable for $171
million, plus pre- and post-judgment interest from the date of the transaction (the
―Liability Award‖).
While the litigation was pending, Kinder Morgan, Inc. acquired El Paso Parent.
After that transaction, Kinder Morgan owned 100% of the equity of El Paso Parent and
therefore indirectly owned and controlled the General Partner. The acquisition did not
affect the outstanding common units of El Paso MLP, which remained publicly traded.
Kinder Morgan‘s acquisition of El Paso Parent therefore did not have any implications
for the plaintiff‘s ability to pursue this litigation.
Shortly after trial, however, Kinder Morgan, El Paso Parent, El Paso MLP, and the
General Partner consummated a related-party merger that brought an end to El Paso
MLP‘s separate existence as a publicly traded entity (the ―Merger‖). The General Partner
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moved to dismiss this litigation, contending that because the plaintiff styled his claim as
derivative, the closing of the Merger meant that this case must be dismissed.
Granting 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. Kinder Morgan, El Paso Parent, El Paso MLP, and the General
Partner disclosed in the proxy statement issued in connection with the Merger that the
consideration paid for the common units did not attribute any value to this litigation.
Assuming for purposes of analysis that the consideration fairly valued El Paso MLP‘s
operating business, it did not provide any value for the non-operating asset that the
Liability Award represented. If the General Partner is correct about how the law operates,
then the limited partners never will receive any benefit from the Liability Award, and the
General Partner will evade accountability for breaching the LP Agreement.
To the extent that Delaware law requires this court to choose between construing
the cause of action that led to the Liability Award as either exclusively derivative or
exclusively direct, then the breach of contract claim that supported the Liability Award is
properly viewed as direct. The Merger therefore did not extinguish the plaintiff‘s
standing to pursue the claim. This court can implement the Liability Award by permitting
the limited partners at the time of the Merger who were not affiliated with the General
Partner to receive their proportionate share of the $171 million.
The more appropriate way to view the cause of action that led to the Liability
Award is as a dual-natured claim with aspects that are both derivative and direct. In my
view, Delaware law can and should treat a dual-natured claim as derivative for purposes
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of Rule 23.1 and the doctrine of demand, but as direct for purposes of determining
whether sell-side investors can continue to pursue the claim after a merger. Treating a
dual-natured claim as derivative for purposes of claim initiation achieves the important
goals of screening out weak claims and providing an efficient and centralized mechanism
for conducting the litigation. Treating a dual-natured claim as direct for purposes of claim
continuation preserves the ability of investors to pursue legitimate claims, promotes
accountability, and provides a superior mechanism for doing so than secondary litigation
challenging the transaction that eliminated the plaintiff‘s standing to sue derivatively. In
this case, the plaintiff‘s claim is best viewed as having a dual nature, so the plaintiff can
continue to pursue it, and this court can implement the Liability Award through a pro
rata recovery in favor of the limited partners at the time of the Merger who were not
affiliated with the General Partner.
Contrary to the General Partner‘s arguments, the plaintiff is not estopped from
enforcing the Liability Award through a pro rata recovery. It is true that the plaintiff
described his claims as derivative until the Merger loomed on the horizon, but a
plaintiff‘s description of his claims is not binding on the court. The General Partner
therefore did not have any reliance interest in the plaintiff‘s description. Nor is the
General Partner prejudiced by a characterization that permits pro rata recovery. Even if
the claim supporting the Liability Award was derivative, substantial authority supports a
court‘s ability to grant a pro rata recovery on a derivative claim. Such a recovery is the
exception, not the rule, but it is possible. The General Partner therefore cannot claim
prejudice from a form of relief that it could have faced in any event. And estoppel would
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be inequitable on these facts. The General Partner and its affiliates triggered the need for
a different characterization by engaging in the related-party merger. The General Partner
cannot legitimately complain about a response to action that Kinder Morgan took.
The General Partner‘s motion to dismiss is therefore denied.
I. FACTUAL BACKGROUND
The Post-Trial Opinion made findings of fact on which this decision relies. This
decision also relies on a limited number of publicly available documents relating to the
Merger that the parties submitted. No one has disputed the accuracy of the documents for
purposes of the issues raised by the motion.
A. El Paso Parent, El Paso MLP, And The General Partner In November 2010
At the time of the Fall Dropdown, El Paso Parent was a Delaware corporation
whose shares of common stock traded on the New York Stock Exchange under the
symbol ―EPC.‖ Headquartered in Houston, El Paso Parent focused on the exploration,
production, and transmission of natural gas.
At the time of the Fall Dropdown, El Paso MLP was a Delaware limited
partnership controlled by El Paso Parent. El Paso MLP‘s limited partner interest was
divided into common units that traded on the New York Stock Exchange under the
symbol ―EPB.‖ Through the General Partner, El Paso Parent owned all of El Paso MLP‘s
general partner interest, representing a 2% economic interest in El Paso MLP. El Paso
Parent also owned approximately 52% of El Paso MLP‘s common units and all of its
incentive distribution rights (―IDRs‖). The IDRs were a class of non-voting units
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authorized by the LP Agreement that gave El Paso Parent a preferential claim to El Paso
MLP‘s cash flows.
At the time of the Fall Dropdown, El Paso Parent exercised de jure control over El
Paso MLP through the General Partner. El Paso Parent also exercised de facto control
over El Paso MLP because the Partnership had no employees of its own. Employees of El
Paso Parent managed and operated its business.
The composition of the General Partner‘s board of directors (the ―GP Board‖)
reflected El Paso Parent‘s control. At the time of the Fall Dropdown, the members of the
GP Board were Douglas L. Foshee, D. Mark Leland, James C. Yardley, John R. Sult,
Ronald L. Kuehn, Jr., William A. Smith, and Arthur C. Reichstetter. Foshee, Leland,
Yardley, and Sult held senior management positions with El Paso Parent. Yardley served
as the General Partner‘s President and CEO. Sult served as its CFO. Kuehn, Smith, and
Reichstetter were outside directors who, as required by the LP Agreement, met the
independence standards for service on the audit committee of a NYSE-listed corporation.
B. The Fall Dropdown And The Conflict-Of-Interest Provision
In October 2010, El Paso Parent proposed the Fall Dropdown. Because El Paso
Parent controlled El Paso MLP through its ownership of the General Partner and also
owned the interests that El Paso MLP would acquire, the Fall Dropdown created a
conflict of interest for the General Partner. The LP Agreement established contractual
requirements for such a transaction.
As authorized by the Delaware Revised Uniform Limited Partnership Act (the ―LP
Act‖), the LP Agreement eliminated all common law duties, including fiduciary duties,
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that the General Partner, El Paso Parent, or the members of the GP Board otherwise
might owe to El Paso MLP and its limited partners. LPA § 7.9(e). In place of common
law duties, the LP Agreement substituted contractual commitments.
Section 7.9(a) of the LP Agreement established contractual requirements for any
decision made by the General Partner that involved a conflict of interest. It stated:
[W]henever a potential conflict of interest exists or arises between the
General Partner . . . , on the one hand, and the Partnership . . . , any Partner
or any Assignee, on the other, any resolution or course of action by the
General Partner . . . in respect of such conflict of interest shall be permitted
and deemed approved by all Partners, and shall not constitute a breach of
this Agreement, . . . or of any duty stated or implied by law or equity, if the
resolution or course of action in respect of such conflict of interest is (i)
approved by Special Approval, (ii) approved by the vote of a majority of
the Outstanding Common Units (excluding Common Units owned by the
General Partner and its Affiliates), (iii) on terms no less favorable to the
Partnership than those generally being provided to or available from
unrelated third parties or (iv) fair and reasonable to the Partnership, taking
into account the totality of the relationships between the parties involved
(including other transactions that may be particularly favorable or
advantageous to the Partnership).
LPA § 7.9(a) (the ―Conflict-of-Interest Provision‖).1
Under the Conflict-of-Interest Provision, if the General Partner took action that
involved a conflict of interest, then the action would be ―permitted and deemed approved
by all Partners‖ and ―not constitute a breach‖ of the LP Agreement or ―any duty stated or
1
For decisions discussing the Conflict-of-Interest Provision at greater length, see
Allen v. El Paso Pipeline GP Co., L.L.C., 90 A.3d 1097, 1100-03 (Del. Ch. 2014); In re
El Paso Pipeline P’rs Deriv. Litig., 2014 WL 2768702, at *3-4, *9-13 (Del. Ch. June 12,
2014); Allen v. El Paso Pipeline GP Co., L.L.C., 113 A.3d 167, 173-74, 178-182 (Del.
Ch. 2014), aff’d, --- A.3d ---, 2015 WL 803053 (Del. Feb. 26, 2015) (TABLE).
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implied by law or equity‖ as long as the General Partner proceeded in one of the four
contractually specified ways. Id. If the General Partner did not satisfy the Conflict-of-
Interest Provision by taking one of the contractually specified routes, then the General
Partner would breach the LP Agreement.
C. The General Partner Opts To Proceed By Special Approval.
For purposes of the Fall Dropdown, the General Partner opted to proceed by way
of Special Approval. The LP Agreement defined Special Approval as ―approval by a
majority of the members of the Conflicts Committee acting in good faith.‖ LPA § 1.1.
The LP Agreement in turn defined the Conflicts Committee as
a committee of the Board of Directors of the General Partner composed of
two or more directors, each of whom (a) is not a security holder, officer or
employee of the General Partner, (b) is not an officer, director or employee
of any Affiliate of the General Partner, (c) is not a holder of any ownership
interest in the Partnership Group other than Common Units and awards that
may be granted to such director under the Long Term Incentive Plan and
(d) meets the independence standards required of directors who serve on an
audit committee of a board of directors established by the Securities
Exchange Act and the rules and regulations of the Commission thereunder
and by the National Securities Exchange on which the Common Units are
listed or admitted to trading.
Id.
At El Paso MLP, the Conflicts Committee was not a standing committee of the GP
Board, but rather an ad hoc committee constituted to consider specific transactions. For
the Fall Dropdown, the members of the Conflicts Committee were Kuehn, Smith, and
Reichstetter (the ―Committee‖).
On November 8, 2010, representatives of El Paso Parent and the Committee
reached a tentative agreement on the terms of the Fall Dropdown. On November 12, the
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Committee approved the transaction. El Paso Parent announced the Fall Dropdown on
November 15, 2010. It closed shortly thereafter.
D. Brinckerhoff Sues.
On March 6, 2012, plaintiff Peter R. Brinckerhoff filed a lawsuit challenging the
Fall Dropdown. Brinckerhoff styled his complaint as a Verified Derivative Complaint
(the ―Complaint‖). Consistent with its title, the first paragraph of the Complaint stated
that Brinckerhoff brought the action ―derivatively on behalf of [El Paso MLP].‖ Compl.
¶ 1. The pleading contained allegations to establish demand futility, a subject that is only
relevant to a derivative claim.
Brinckerhoff‘s core theory was that ―the Partnership was injured‖ when the
defendants caused El Paso MLP to pay too much for the member units that El Paso
Parent sold to it. Id. ¶ 7. Brinckerhoff sued not only the General Partner but also El Paso
Parent and the members of the GP Board. The Complaint included four counts that
alleged claims for breaches of express and implied duties of the LP Agreement, aiding
and abetting the alleged breaches of duties, tortious interference, and unjust enrichment.
The Complaint‘s prayer for relief focused on remedies that would benefit the Partnership.
The pleading sought a judgment (i) ordering defendants to account to the Partnership for
its damages as a result of the alleged harm, (ii) directing El Paso Parent to ―disgorge and
make restitution‖ to the Partnership of the unjust enrichment it had received at the
Partnership‘s expense, and (iii) reforming the terms of the documents governing the Fall
Dropdown or, alternatively, awarding rescissory damages to the Partnership. See id. ¶¶
32-33.
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E. Kinder Morgan Acquires El Paso Parent.
In September 2010, while this litigation was pending, Kinder Morgan offered to
purchase all of the outstanding common stock of El Paso Parent for $16.50 per share. See
In re El Paso Corp. S’holder Litig., 41 A.3d 432, 435 n.4 (Del. Ch. 2012) (Strine, C.). El
Paso Parent rejected that offer. In August 2011, negotiations resumed after Kinder
Morgan offered to acquire El Paso Parent for a combination of cash and stock valued at
$25.50 per share. On October 16, 2011, El Paso Parent and Kinder Morgan entered into a
merger agreement. Each share of El Paso Parent common stock was converted into the
right to receive cash, Kinder Morgan stock, or a combination of cash and Kinder Morgan
stock worth $25.91, plus a warrant for Kinder Morgan stock with a strike price of $40.
The transaction closed on May 24, 2012.
The merger brought an end to El Paso Parent‘s status as a separately traded public
entity. El Paso MLP, however, continued to trade as a public entity after the merger
closed.
F. The Summary Judgment Ruling
In October 2013, after the close of discovery, the parties filed cross-motions for
summary judgment. In support of his motion, Brinckerhoff argued that the Partnership
had suffered damages ―measured by the difference between the price [the General
Partner] had [the Partnership] pay . . . and those assets‘ fair value.‖ Dkt. 158 at 27. To
establish damages, Brinckerhoff relied on an expert who opined that the Partnership
overpaid for the member interests and sustained damages as a result.
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The court denied the plaintiff‘s motion and granted the defendants‘ motion except
for one claim against one defendant. The only surviving claim was against the General
Partner for breach of the LP Agreement. In re El Paso Pipeline P’rs L.P. Deriv. Litig.,
2014 WL 2641304 (Del. Ch. June 12, 2014) (ORDER). On July 11, 2014, Brinckerhoff
moved pursuant to Court of Chancery Rule 54(b) for the entry of an appealable final
order as to the issues on which the court ruled in favor of the defendants.
G. Kinder Morgan Announces The Merger.
On August 10, 2014, Kinder Morgan and El Paso MLP announced the Merger.
The transaction was one part of a larger reorganization designed to simplify the corporate
structure of the Kinder Morgan family of companies. Before the Merger, Kinder Morgan
and three of its subsidiaries had issued equity securities that traded on public markets.
After the Merger, Kinder Morgan would be the only publicly traded entity. According to
the announcement, each common unit of El Paso MLP would be converted through the
Merger into the right to receive (i) 0.9451 shares of Kinder Morgan common stock plus
$4.65 in cash, (ii) 1.0711 shares of Kinder Morgan common stock, or (iii) $39.53 in cash.
Kinder Morgan and El Paso MLP stated in their announcement that they expected the
transaction to close by the end of 2014.
On August 13, 2014, Brinckerhoff withdrew his Rule 54(b) motion. On August 22,
Brinckerhoff asked the court to schedule trial before the anticipated closing of the
Merger. Anticipating that the defendants would argue that the Merger deprived the
limited partners of standing to sue, Brinckerhoff posited that he could recast his
remaining cause of action as a direct claim because it asserted that the General Partner
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had breached the LP Agreement by failing to comply with the Conflict-of-Interest
Provision.
The General Partner opposed the motion and sought to defer any trial until after
the Merger closed. The General Partner contended that the closing of the Merger would
terminate the litigation, rendering a trial unnecessary. The General Partner asked for a
definitive determination that Brinckerhoff‘s sole remaining claim was derivative,
belonged to El Paso MLP, and would pass to Kinder Morgan as a matter of law upon the
closing of the Merger.
During a hearing on September 9, 2014, I deferred any decision as to whether the
remaining claim for breach of the LP Agreement was derivative or direct. To my mind,
answering that question involved challenging legal issues, which this court would not
need to address if the General Partner prevailed at trial. If the court had to consider the
matter, then a post-trial ruling could be made on a developed factual record. I therefore
declined to make a pre-trial determination as to the nature of the breach of contract claim.
H. The Proxy Statement For The Merger
On October 22, 2014, El Paso MLP filed its definitive proxy statement for the
Merger (the ―Proxy Statement‖). The section describing the background of the Merger
revealed that Kinder Morgan began considering a corporate reorganization in May 2014.
On July 10, Kinder Morgan proposed a meeting with the members of the GP Board who
qualified as independent directors under the NYSE rules. When the meeting took place
one week later, Kinder Morgan proposed acquiring El Paso MLP through a merger in
which each outstanding common unit would be converted into the right to receive $4.65
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in cash and 0.9337 Kinder Morgan shares. The proposed consideration represented a 10%
premium to the closing price of the common units on July 16.
Kinder Morgan‘s proposal presented a conflict of interest for the General Partner
and therefore implicated the Conflict-of-Interest Provision. The General Partner opted to
proceed by way of Special Approval. The GP Board formed a Conflicts Committee
comprising Kuehn, Reichstetter, and Smith (the ―Merger Committee‖). They were the
same individuals who comprised the Committee for the Fall Dropdown. The Merger
Committee also retained the same financial advisor that advised the Committee on the
Fall Dropdown.
The Merger Committee did not seek value for the breach of contract claim at issue
in this litigation, and the Proxy Statement made clear that the consideration provided in
the Merger did not incorporate any value for the claim. The Merger Committee did not
consider this lawsuit at all until the day before they voted to approve the Merger, after the
consideration had been set. No third-party analysis or valuation of claims was
undertaken. The Merger Committee assumed that the claims would be ―extinguished as a
result of the [Merger]‖ and regarded their value as ―not sufficiently material‖ as to ―merit
adjustments to the [El Paso MLP] merger consideration or otherwise affect the
determinations made by the [Merger Committee] with respect to the [Merger].‖ Proxy
Statement at 45-46.
I. The Trial
Trial was held November 12, 13, and 17, 2014. Both sides presented evidence and
adduced expert testimony directed to whether the General Partner satisfied its contractual
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duty in the Fall Dropdown and, if not, how El Paso MLP was harmed. Brinckerhoff
focused on proving damages by showing that El Paso MLP overpaid in the Fall
Dropdown, and the General Partner sought to rebut that theory. The parties did not
present evidence at trial regarding specific harm to the unaffiliated limited partners.
J. The Merger Closes.
On November 20, 2014, El Paso MLP held a special meeting of its unit holders to
consider the Merger. Kinder Morgan and El Paso MLP solicited proxies in favor of the
Merger. The Merger was not conditioned on the affirmative vote of holders of common
units unaffiliated with Kinder Morgan or the General Partner. The Merger only required
the approval of holders of a majority of the Partnership‘s outstanding common units.
Kinder Morgan and its affiliates (including the General Partner) controlled 40.2% of the
Partnership‘s outstanding common units. The Merger received the necessary vote. The
transaction closed on November 26, 2014.
At the effective time, El Paso Parent owned all of El Paso MLP‘s general partner
interest through the General Partner, representing a 2% economic interest in El Paso
MLP. El Paso Parent‘s affiliates, including Kinder Morgan and the General Partner,
owned a total of 93,380,734 common units. Members of the GP Board held another
353,732 common units. There were 233,151,329 total common units outstanding at the
time of the Merger, meaning that 139,416,863 common units were owned by limited
partners who were not affiliated with the General Partner. The limited partners who were
not affiliated with the General Partner owned, in the aggregate, 59.8% of the common
units that comprised the 98% limited partner interest in El Paso MLP. The limited
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partners who were not affiliated with the General Partner thus owned, in the aggregate, a
58.6% partnership interest in El Paso MLP. Kinder Morgan and its affiliates (including
the General Partner) owned, in the aggregate, 40.2% of the common units that comprised
the 98% limited partner interest in El Paso MLP, plus all of the 2% general partner
interest. Kinder Morgan and its affiliates (including the General Partner) thus owned, in
the aggregate, a 41.4% partnership interest in El Paso MLP. See Appendix A.
After the Merger, El Paso MLP continued temporarily as a wholly owned
subsidiary of Kinder Morgan. On December 31, Kinder Morgan merged El Paso MLP
into another Kinder Morgan-controlled entity, Kinder Morgan Energy Partners, L.P.
(―KM Partners‖). On the same date, Kinder Morgan merged the General Partner with and
into KM Partners. As a result of these mergers, KM Partners is now the successor both to
(i) El Paso MLP‘s right to recover against the General Partner under the Post-Trial
Opinion, and (ii) the General Partner‘s liability for the $171 million, plus pre- and post-
judgment interest, imposed by the Post-Trial Opinion.
K. The Renewed Motion To Dismiss
On December 2, 2014, the General Partner moved to dismiss Brinckerhoff‘s
claims on the ground that the claims were exclusively derivative. The General Partner
asserts that Brinckerhoff lost standing to pursue his claims as a result of the Merger,
necessitating dismissal of this litigation.
II. LEGAL ANALYSIS
The Delaware Supreme Court has held that a cause of action belonging to a
corporation is a corporate asset that passes in a merger to the surviving entity. Lewis v.
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Anderson, 477 A.2d 1040, 1050 n.19 (Del. 1984). Where, as here, the surviving entity
emerges as a wholly owned subsidiary of another entity, the litigation asset comes under
the control of the new parent. See Lambrecht v. O’Neal, 3 A.3d 277, 288 (Del. 2010). If
stockholders were pursuing a corporate claim derivatively at the time of the merger, then
the merger extinguishes the former derivative plaintiffs‘ standing to sue. See Lewis v.
Ward, 852 A.2d 896, 900-901 (Del. 2004). By contrast, if the stockholders were pursuing
an individual claim directly at the time of the merger, then the claim belonged to them,
and they did not lose standing to sue. Under this legal framework, ―the question of
whether the plaintiffs‘ claims are individual or derivative becomes outcome
determinative. If the claims are individual, the plaintiffs‘ claims survive the merger. If
not, the plaintiffs‘ claims are extinguished.‖ In re Gaylord Container Corp. S’holders
Litig., 747 A.2d 71, 82 (Del. Ch. 1999) (Strine, V.C.).
As the General Partner sees it, the claim that led to the Liability Award was
exclusively derivative and belonged to El Paso MLP. Consequently, once the Merger
closed, control over the claim passed to an affiliate of the General Partner, extinguishing
Brinckerhoff‘s standing to sue. Eventually, through subsequent transactions, both the
ownership of the claim and the responsibility for paying it became united in a single
entity: KM Partners. That entity obviously has no interest in enforcing the Liability
Award against itself.
Under the General Partner‘s view of the world, it does not matter that Brinckerhoff
proved at trial that the General Partner breached its contractual obligations under the LP
Agreement. Nor does it matter that by breaching the LP Agreement, the General Partner
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shortchanged the Partnership by $171 million and conferred an unwarranted benefit on El
Paso Parent in the same amount. It also does not matter that the Merger attributed no
value to that claim. Brinckerhoff and the other unaffiliated limited partners in El Paso
MLP are out of luck. Because a related-party merger closed before a final judgment could
be entered and enforced, the General Partner owes nothing and the unaffiliated limited
partners get nothing.
Events unfold differently if Brinckerhoff‘s claim for breach of contract is direct. In
that case, the claim belongs to Brinckerhoff and the limited partners as a group, and they
did not lose standing to sue. Ownership of the claim did not pass in the Merger to the
surviving entity. Only the liability for the claim passed to KM Partners as the successor to
the General Partner. In that case, Brinckerhoff and the other unaffiliated limited partners
in El Paso MLP are not out of luck. Each can enforce against KM Partners a right to a pro
rata share of the Liability Award.
The General Partner contends that this court must choose between two exclusive
alternatives by categorizing the claim that supported the Liability Award as either
derivative or direct. If Delaware law requires that stark choice, then this decision
concludes that the claim was direct. Brinckerhoff proved that the General Partner violated
the LP Agreement, which is a contract to which Brinckerhoff and the other limited
partners were parties. They were and remain entitled to enforce the terms of that
agreement. See infra Part II.A.
But there is a more nuanced reason why Brinckerhoff and the limited partners are
not out of luck. Contrary to the General Partner‘s bipolar mindset, Delaware law does not
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only regard claims as either exclusively derivative or exclusively direct. The Delaware
Supreme Court has recognized that some claims have features of both categories, and the
high court has held that when both features are present, a plaintiff can litigate either type
of claim. When reviewing strong claims involving insider transfers and other conduct that
traditionally fell within the rubric of the duty of loyalty, the Delaware Supreme Court has
used the dual characterization to allow plaintiffs to continue to litigate after a merger. I
believe that the claim that supported the Liability Award is best understood as having
dual aspects such that Brinckerhoff can continue to litigate his claim. See infra Part II.B.
Candor demands conceding that the decisions in which the Delaware Supreme
Court has recognized dual-natured claims have been controversial and stand in tension
with other decisions that have characterized similar claims as purely derivative. 2 In my
2
In recent memory, two notable Delaware Supreme Court decisions to deploy the
dual characterization have been Gentile v. Rossette, 906 A.2d 91 (Del. 2006), and In re
Tri-Star Pictures, Inc. Litig., 634 A.2d 319 (Del. 1993). In Gentile, the Delaware
Supreme Court held that a dilutive stock issuance to a controlling stockholder gave rise to
dual injury such that the plaintiff could continue litigating the claim. In Tri-Star, to the
same effect, the Delaware Supreme Court held that an insider transfer gave rise to dual
injury. The high court‘s analysis in both cases differed from and was more nuanced than
decisions which have held for purposes of Rule 23.1 that similar injuries gave rise to
purely derivative claims. See, e.g., Ryan v. Gursahaney, 2015 WL 1915911, at *9-10
(Del. Ch. Apr. 28, 2015) (characterizing overpayment claim as derivative for purposes of
Rule 23.1 where company selectively bought back stock from hedge fund with board
representation); DiRienzo v. Lichtenstein, 2013 WL 5503034, at *25 (Del. Ch. Sept. 30,
2013) (treating overpayment claim as derivative for purposes of Rule 23.1); In re
Primedia Inc. Deriv. Litig., 910 A.2d 248, 259-60 (Del. Ch. 2006) (treating overpayment
claim in which company repurchased preferred stock from controlling shareholder as
derivative for purposes of Rule 23.1); In re Paxson Commc’n Corp. S’holders Litig.,
2001 WL 812028, at *5 (Del. Ch. July 12, 2001) (characterizing injury from stock
issuance claim as derivative for purposes of Rule 23.1 and asserting that ―to the extent
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view, the tension arises because Delaware law uses a singular inquiry—characterizing a
claim as derivative or direct—in two starkly different litigation contexts. The first
scenario regularly arises at the outset of a case when a court must determine whether a
claim is subject to a heightened pleading standard under Rule 23.1 and the substantive
doctrine of demand. At that stage, framed in the language of corporations, the principal
public policy in play is board centrism.3 Directors—not stockholders—manage and
oversee the business and affairs of the corporation, and the board‘s authority includes
decisions about whether or not to bring litigation.4 Not surprisingly, and for good reason,
this policy leads to more expansive characterizations of actions as derivative rather than
direct. In a close case, it makes sense for the law to err on the side of giving the board of
directors the benefit of the doubt and control over litigation assets. If the claim is strong,
that any alleged decrease in the asset value and voting power of plaintiffs‘ shares . . .
results from the issuance of new equity. . . , plaintiff‘s dilution theory as a basis for a
direct claim fails‖); Leung v. Schuler, 2000 WL 264328, at *7 (Del. Ch. Feb. 29, 2000)
(characterizing a claim challenging a dilutive stock issuance to insiders as derivative for
purposes of Rule 23.1).
3
To date, the bulk of the precedents analyzing the difference between direct and
directive claims have involved corporations. El Paso MLP was a limited partnership. This
decision strives to use the language of limited partnerships or entity-neutral terminology,
but from time to time it necessarily deploys (or lapses into) corporate parlance by
referring to stockholders, boards of directors, and corporations.
4
See 8 Del. C. § 141(a); Braddock v. Zimmerman, 906 A.2d 776, 784 (Del. 2006)
(―The demand requirement of Rule 23.1 is a substantive right designed to give a
corporation the opportunity to rectify an alleged wrong without litigation, and to control
any litigation which does arise.‖ (internal quotation marks omitted)); South v. Baker, 62
A.3d 1, 13-16 (Del. Ch. 2012) (discussing relative roles of board and stockholders when
corporation has suffered injury).
18
it typically will survive a Rule 23.1 analysis regardless. Similar policies apply to limited
partnerships, where a general partner manages the entity.5
5
The LP Act does not contain a provision analogous to Section 141(a) of the
DGCL that succinctly establishes a principle of general partner centrism. Nevertheless, a
combination of provisions in the LP Act lead ineluctably to that conclusion. Section 17-
403(a) states that ―[e]xcept as provided in this chapter or in the partnership agreement, a
general partner of a limited partnership has the rights and powers and is subject to the
restrictions of a partner in a partnership that is governed by the Delaware Uniform
Partnership Law.‖ 6 Del. C. § 17-403(a); see also Kansas RSA 15 Ltd. P’ship v. SBMS
RSA, Inc., 1995 WL 106514, at *2 (Del. Ch. Mar. 8, 1995) (Allen, C.) (stating that a
limited partnership‘s ―general partner‘s powers are the same as those of [] partners of a
general partnership‖). The Delaware Uniform Partnership Law states that (i) ―[e]ach
partner is an agent of the partnership for the purpose of its business, purposes or
activities,‖ 6 Del. C. § 15-301, and (ii) ―has equal rights in the management and conduct
of the partnership business and affairs,‖ id. § 15-401(f). There is no analogous source of
authority for limited partners. Instead, Section 17-303 of the LP Act states that limited
partners only can maintain their limited liability if they refrain from participating in the
management of the partnership. Id. § 17-303. Moreover, unless the limited partnership
agreement eliminates fiduciary duties, the general partner of a Delaware limited
partnership owes fiduciary duties to the partnership and the limited partners, which
functionally recognizes that the general partner manages the partnership on behalf of the
limited partners. See Paul M. Altman & Srinivas M. Raju, Delaware Alternative Entities
and the Implied Contractual Covenant of Good Faith and Fair Dealing Under Delaware
Law, 60 Bus. Law. 1469, 1470 (2005) (noting that general partners owe fiduciary duties
to the limited partnership and its limited partners because they control the partnership‘s
property for the benefit of the partnership and its limited partners). As the leading treatise
on Delaware limited partnerships observes,
[t]ypically, the general partners conduct the day-to-day business and affairs
of the limited partnership and are involved in controlling the management
of the limited partnership‘s business. Generally a limited partner does not
participate in the control of the business of the partnership, but rather
invests money or other property in the limited partnership in exchange for
certain economic rights (including the right to participate in the profits of
the business venture). In addition, under the Act, limited partners may
possess certain voting and informational rights.
19
The second context is the one presented by this case, where a merger has
terminated the separate legal existence of the entity on whose behalf the derivative action
was pursued.6 In contrast to a Rule 23.1 analysis, where strong claims typically proceed
notwithstanding a derivative characterization, Lewis v. Anderson operates as a bright-line,
one-size-fits-all rule that effectively terminates claims regardless of merit. As Chief
Justice Strine observed while a Vice Chancellor, although courts ―may indulge the notion
that [derivative] claims [against officers and directors] still ‗survive‘ [after a merger] . . . ,
they usually die as a matter of fact.‖ Golaine v. Edwards, 1999 WL 1271882, at *4 (Del.
Ch. Dec. 21, 1999). Not surprisingly, with this consequence looming, decisions rendered
Martin I. Lubaroff & Paul M. Altman, Delaware Limited Partnerships § 1.2 (Supp. 2015);
accord Edwin W. Hecker, Jr., Limited Partners’ Derivative Suits Under The Revised
Uniform Limited Partnership Act, 33 Vand. L. Rev. 343, 344 (1980) (―As is the case with
publicly held corporations, ownership is separated from control in the modern limited
partnership. . . . Unlike corporations, however, this separation results not only from the
dispersion of ownership . . . but also from the theoretical of nature of a limited
partnership. By definition, a limited partner is a passive investor.‖).
6
By statute, when a merger becomes effective, ―for all purposes of the laws of this
State the separate existence of all the constituent corporations, or of all such constituent
corporations except the one into which the other or others . . . have been merged, as the
case may be, shall cease and the constituent corporations shall become a new corporation,
or be merged into 1 of such corporations.‖ 8 Del. C. § 259(a). The same is true for limited
partnerships. See 6 Del. C. § 17-211(b). In some direct mergers and all reverse-triangular
mergers, the acquired corporation continues as the surviving corporation. For purposes of
the issues discussed in the opinion, however, the separate existence of the entity ceases.
In a direct merger, the two firms merge, and although the one may survive, the post-
transaction entity represents a consolidation of the two merged firms. Likewise in a
reverse-triangular merger, although the entity survives, it emerges as a wholly owned
subsidiary of the acquirer. See Hamilton P’rs, L.P. v. Englard, 11 A.3d 1180, 1205-06
(Del. Ch. 2010).
20
in this context have tended to find ways to characterize strong claims as direct. This
impetus has led to decisions parsing the derivative-versus-direct distinction in the context
of mergers that are difficult to reconcile.7 In my view, it also led to the recognition of
dual-natured claims.
For present purposes, it would be enough to hold that Brinckerhoff has asserted a
dual-natured claim that he can continue to litigate after the Merger. But in light of the
doctrinal tensions that presently exist regarding how the injuries from similar transactions
are characterized, this decision takes the liberty of suggesting a further development in
how our law addresses dual-natured claims.8 In my view, Delaware law should split the
atom of its now-unitary analysis. Delaware law can and should treat dual-natured claims
7
Compare, e.g., Parnes v. Bally Entm’t Corp., 722 A.2d 1243 (Del. 1999)
(holding that challenge to side payments to management in connection with a merger was
direct) with Kramer v. Western Pac. Indus. Inc., 546 A.2d 348 (Del. 1988) (holding that
challenge to grant of stock options and golden parachutes to management prior to a
merger was derivative) with Elster v. Am. Airlines, Inc., 100 A.2d 219, 222 (Del. Ch.
1953) (holding that challenge to option grants stated derivative claim for mismanagement
of stock as a corporate asset); see Agostino v. Hicks, 845 A.2d 1110, 1118-22 (Del. Ch.
2004) (describing tension); In re Gaylord Container Corp. S’holders Litig., 747 A.2d 71,
76 (Del. Ch. 1999) (Strine, V.C.) (same).
8
This aspect of this decision is admittedly dictum, but because this decision
effectively decides the fate of the Liability Award, the losing party can be expected to
appeal. It therefore seems likely that the Delaware Supreme Court will be presented with
the issue and, given that reality, it seemed beneficial to touch on an issue relevant to
Delaware‘s continued recognition of dual-natured claims. This approach is also
consistent with precedents in which members of this court, who must wrestle regularly
with the derivative-versus-direct distinction, have made suggestions for clarifying this
area of the law. See, e.g., Agostino, 845 A.2d at 1121-22; Gaylord, 747 A.2d at 77-83;
Golaine, 1999 WL 1271882, at *4-7.
21
differently for purposes of claim initiation, when Rule 23.1 and the demand doctrine
should apply, and claim termination, when the plaintiff should be able to continue to
litigate a dual-natured cause of action post-merger as a direct claim. See infra Part II.B.3.
Just as the framers of our federal constitution resolved difficult issues of national polity
by ―split[ing] the atom of sovereignty,‖9 so too can the members of the Delaware
Supreme Court, as framers of the equitable parameters of entity law, resolve difficult
issues of entity polity using a similar technique.10
Finally, the decision considers whether estoppel should bar Brinckerhoff from
characterizing his claim as anything other than derivative. The grounds for estoppel are
lacking. A court is not bound by whether a plaintiff describes its claim as derivative or
direct, so the General Partner did not have a reliance interest in Brinckerhoff‘s derivative
characterization. See infra Part II.C.1. The General Partner also is not prejudiced from an
order that implements the Liability Award through a pro rata recovery by unaffiliated
limited partners. Although it is rare for a court to grant an investor-level recovery on an
9
U.S. Term Limits, Inc. v. Thornton, 514 U.S. 779, 838 (1995) (Kennedy, J.,
concurring) (―Federalism was our Nation‘s own discovery. The Framers split the atom of
sovereignty. It was the genius of their idea that our citizens would have two political
capacities, one state and one federal . . . .‖); see Randy J. Holland, State Constitutions:
Purpose and Function, 69 Temp. L. Rev. 989, 992 (1996) (quoting Term Limits and
describing implications of dual sovereignty).
10
See Schoon v. Smith, 953 A.2d 196, 204 (Del. 2008) (―The judicial creation of
equitable standing for a stockholder to bring a derivative action demonstrates that
equitable doctrine can be judicially extended to address new circumstances.‖).
―Judicially-created equitable doctrines may be extended so long as the extension is
consistent with the principles of equity.‖ Id. at 205.
22
entity-level claim, ample authority establishes that such a remedy is possible. See infra
Part II.C.2. The General Partner cannot claim prejudice from a remedy that it might have
faced in any event. Moreover, the reason for recasting the remedy is a reorganization
implemented by the General Partner and its affiliates. Although the General Partner
admittedly will be worse off than if the Merger enabled the General Partner to extract
$171 million in breach of the LP Agreement and then escape any contractual
consequence, a comparison to the General Partner‘s hoped-for result (and concomitant
windfall) does not establish prejudice. From a different standpoint, the General Partner is
better off, because it need only pay 58.6% of the Liability Award rather than 100%.
A. First Order Analysis: Derivative Or Direct
The General Partner frames its motion to dismiss as turning on whether the claim
that gave rise to the Liability Award was derivative or direct. According to the General
Partner, those are the only categories of investor claims that Delaware law recognizes and
a claim must be one or the other. Moreover, according to the General Partner, the
Delaware Supreme Court established the exclusive test for determining whether a claim
is derivative or direct in Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031
(Del. 2004). In that decision, the Delaware Supreme Court stated:
We set forth in this Opinion the law to be applied henceforth in determining
whether a stockholder‘s claim is derivative or direct. That issue must turn
solely on the following questions: (1) who suffered the alleged harm (the
corporation or the suing stockholders, individually); and (2) who would
receive the benefit of any recovery or other remedy (the corporation or the
suing stockholders, individually)?
Id. at 1033.
23
In my view, the General Partner errs by treating Tooley as if its holding required
all claims, whether sounding in tort, contract, or a statutory cause of action, to be brought
derivatively whenever an entity in which the plaintiff is an investor can be said to have
suffered harm such that some component of the plaintiff‘s loss could be framed as having
been suffered indirectly. To my mind, that position overstates Tooley‘s reach. See NAF
Hldgs., LLC v. Li Fung (Trading) Ltd., 118 A.3d 175, 176 (Del. 2015). Instead, Tooley
and its progeny ―deal with the distinct question of when a cause of action for breach of
fiduciary duty or to enforce rights belonging to the corporation itself must be asserted
derivatively.‖ Id. The Tooley decision did not obviate the need to address an ―important
initial question‖: ―[D]oes the plaintiff seek to bring a claim belonging to her personally or
one belonging to the corporation itself?‖ Id. at 180.
As the General Partner interprets Tooley, Delaware law recognizes only two types
of claims that investors can bring: direct claims and derivative claims. Accepting this
dichotomous outlook for purposes of analysis, Brinckerhoff‘s claim for breach of the LP
Agreement is properly categorized as direct. Brinckerhoff sued to enforce a contract to
which he and the other limited partners were parties. They had standing to enforce that
claim individually and directly. Their claim therefore survived the Merger, and it now
can be remedied by awarding the unaffiliated limited partners at the time of the Merger
their pro rata share of the Liability Award.
1. Direct Claims
24
Direct claims are one category of claims that investors in Delaware entities bring.
The General Partner‘s binary view of the world accommodates the existence of this
category.
Direct claims encompass causes of action that belong to a plaintiff and which the
plaintiff can assert in its own name. The direct claims governed by Delaware law that
equity investors most commonly advance rely on particular rights that a holder of an
equity security can exercise by virtue of being the owner of that security. For
stockholders in a corporation, direct claims include the causes of action conferred on
stockholders by specific statutory provisions of the DGCL.11 Direct claims also include
causes of action to enforce contract rights that stockholders possess under the
corporation‘s certificate of incorporation and bylaws.12 Stockholders similarly can sue
11
See, e.g., 8 Del. C. § 205 (right to bring action to validate a defective corporate
act); id. § 231(c) (right to bring action challenging ballot, proxies, or votes); id. § 262(a)
(right to bring appraisal proceeding).
12
See Tooley, 845 A.2d at 1037-39; Ruffalo v. Transtech Serv. P’rs Inc., 2010 WL
3307487, at *9 (Del. Ch. Aug. 23, 2010); MCG Capital Corp. v. Maginn, 2010 WL
1782271, at *7, *13-14 (Del. Ch. May 5, 2010); Manzo v. Rite Aid Corp., 2002 WL
31926606, at *5 (Del. Ch. Dec. 19, 2002), aff’d, 825 A.2d 239 (Del. 2003) (TABLE);
Rich Realty, Inc. v. Potter Anderson & Corroon LLP, 2011 WL 743400, at *4 (Del.
Super. Feb. 21, 2011); see also Wells Fargo & Co. v. First Interstate Bancorp., 1996 WL
32169, at *7 (Del. Ch. Jan. 18, 1996) (Allen, C.) (observing that if a lawsuit ―seeks a
remedy to compensate for the invasion of a property right of a stockholder,‖ then the
claim is direct and ―the recovery will be for the stockholder‖); Garrard Glenn, The
Stockholder’s Suit—Corporate and Individual Grievances, 33 Yale L.J. 580, 592 (1924)
(explaining that a suit to enforce the constitutive corporate agreements is an individual,
not a derivative, claim). As Tooley specifically held, stockholders suffer direct injury and
may sue individually for breach of their contractual rights, even when all stockholders
25
directly to enforce contractual constraints on a board‘s authority under the charter,
bylaws, and provisions of the DGCL.13 The availability of a direct cause of action in
these situations comports with Delaware‘s longstanding recognition that the DGCL, the
certification of incorporation, and the bylaws together constitute a multi-party contract
among the directors, officers, and stockholders of the corporation.14 As parties to the
contract, stockholders can enforce it.15
A limited partner in a Delaware limited partnership possesses analogous rights.
The universe of direct claims starts with the causes of action granted to limited partners
had the same right and suffered the same injury. Tooley, 845 A.2d at 1039. See generally
Allen v. El Paso Pipeline GP Co., L.L.C., 90 A.3d 1097, 1105-09 (Del. Ch. 2014).
13
See Grimes v. Donald, 673 A.2d 1207, 1213 n.15 (Del. 1996); Shaev v.
Adkerson, 2015 WL 5882942, at *3 (Del. Ch. Oct. 5, 2015); Grayson v. Imagination
Station, Inc., 2010 WL 3221951, at *5 (Del. Ch. Aug. 16, 2010).
14
E.g., 8 Del. C. § 394 (―This chapter and all amendments thereof shall be a part
of the charter or certificate of incorporation of every corporation.‖); Boilermakers Local
154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 940 (Del. Ch. 2013) (Strine, C.) (―[O]ur
Supreme Court has long noted that bylaws, together with the certificate of incorporation
and the broader DGCL, form part of a flexible contract between corporations and
stockholders.‖); accord Airgas, Inc. v. Air Prods. & Chems., Inc., 8 A.3d 1182, 1188
(Del. 2010) (―Corporate charters and bylaws are contracts among a corporation‘s
shareholders . . . .‖); STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991)
(―[A] corporate charter is both a contract between the State and the corporation, and the
corporation and its shareholders.‖).
15
See Grimes, 673 A.2d at 1212; Grayson, 2010 WL 3221951, at *6; see also
Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651, 660 (Del. Ch. 1988) (Allen, C.) (noting
that the scope of a restriction on a fiduciary‘s authority is ―not . . . a question that a court
may leave to the [fiduciary] finally to decide so long as he does so honestly and
competently; that is, it may not be left to the [fiduciary‘s] business judgment‖).
26
by specific statutory provisions of the LP Act.16 It also includes causes of action to
enforce the contract rights that the limited partners possess under the partnership‘s
certificate of limited partnership and its partnership agreement.17 A limited partner‘s
ability to sue in contract is arguably more compelling than a stockholder‘s because ―[i]t is
the policy of [the LP Act] to give maximum effect to the principle of freedom of contract
and to the enforceability of partnership agreements.‖ 6 Del. C. § 17-1101(c); accord Elf
Atochem N. Am. v. Jaffari, 727 A.2d 286, 290 (Del. 1999) (―The policy of freedom of
contract underlies . . . the LP Act.‖). Allowing parties to the limited partnership
agreement to enforce the agreement as a contract is consistent with public policy.
In addition to claims to enforce rights under the operative statutes and the
constitutive documents of an entity, investors may possess other direct claims that belong
to them personally. ―Quintessential examples of personal claims would include a contract
claim for breach of an agreement to purchase or sell shares or a tort claim for fraud in
connection with the purchase or sale of shares.‖ In re Activision Blizzard, Inc. S’holder
16
See, e.g., 6 Del. C. § 17-110(a) (right to bring action to determine the validity of
any admission, election, appointment or removal or other withdrawal of a general partner
of a limited partnership, and the right of any person to become or continue to be a general
partner); id. § 17-205(b) (right to bring action to compel execution of partnership
agreement or amendment); id. § 17-207 (right to recover damages from general partner
for false statement in certificate contemplated by LP Act).
17
See Allen, 90 A.3d at 1109; Brinckerhoff v. Tex. E. Prods. Pipeline Co., 986
A.2d 370, 383 (Del. Ch. 2010); Anglo Am. Sec. Fund LP v. S.R. Glob. Int’l Fund, L.P.,
829 A.2d 143, 151, 154 (Del. Ch. 2003); In re Cencom Cable Income P’rs, L.P., 2000
WL 130629, at *6 (Del. Ch. Jan. 27, 2000).
27
Litig., --- A.3d ---, 2015 WL 2438067, at *25 (Del. Ch. May 20, 2015). The Delaware
Supreme Court recently considered another example of this type of direct claim. See NAF
Hldgs., LLC v. Li Fung (Trading) Ltd., 118 A.3d 175, 176 (Del. 2015). There, a parent
corporation agreed to buy a company called Hampshire Group, Limited (―Hampshire‖),
using two acquisition subsidiaries as the purchasing vehicles. The parent corporation was
not a party to the acquisition agreement. As part of the transaction, however, the parent
corporation entered into a commercial contract with Li & Fung (Trading) Limited (―Li &
Fung‖) to have Li & Fung act as a sourcing agent for Hampshire after the acquisition. Li
& Fung subsequently repudiated its contract with NAF and refused to serve as the
acquired company‘s sourcing agent, forcing the acquisition subsidiaries and Hampshire
to terminate the transaction agreement. The parent corporation sued Li & Fung for breach
of their commercial agreement, alleging that it suffered damages of $30 million when Li
& Fung repudiated the contract. Relying on Tooley, Li & Fung argued that the acquisition
subsidiaries, not the parent, suffered the harm, and that the parent only suffered loss
derivatively as the owner of the subsidiaries. Li & Fung contended that the parent could
not sue directly on its contact rights.
The United States Court of Appeals for the Second Circuit asked the Delaware
Supreme Court whether Li & Fung‘s argument was correct. The Delaware Supreme
Court said no:
The case law under [Tooley] and its progeny deal with the distinct question
of when a cause of action for breach of fiduciary duty or to enforce rights
belonging to the corporation itself must be asserted derivatively. That body
of law has no bearing on whether a party with its own rights as a signatory
to a commercial contract may sue directly to enforce those rights.
28
Id. The Delaware Supreme Court recognized that the injury suffered by the parent
corporation might well be co-extensive with the injury suffered by the subsidiaries. Li &
Fung observed that the subsidiaries had settled their claims, and the Delaware Supreme
Court recognized that such a fact could conceivably affect the damages analysis. But it
did not affect whether the parent had standing to sue. For that purpose, ―a more important
initial question has to be answered: does the plaintiff seek to bring a claim belonging to
her personally or one belonging to the corporation itself?‖ Id. at 180. Where the parent
corporation possessed its own contractual cause of action, the parent could sue directly to
enforce it.18
2. Derivative Claims
Derivative claims are another category of claims that investors in Delaware
entities bring. This is the other category of claims that the General Partner recognizes.
For a Delaware limited partnership, the LP Act codifies the concept of a derivative
action:
A limited partner or an assignee of a partnership interest may bring an
action in the Court of Chancery in the right of a limited partnership to
recover a judgment in its favor if general partners with authority to do so
have refused to bring the action or if an effort to cause those general
partners to bring the action is not likely to succeed.
18
Id. It bears emphasizing that NAF Holdings involved a separate commercial
agreement between the parent and Li & Fung. The nature of the cause of action was thus
one step removed from a cause of action under a constitutive entity agreement, such as a
certificate of incorporation or limited partnership agreement. The additional degree of
separation makes the contract right easier to identify, but the underlying rationale applies
equally to a right that an investor possesses under a constitutive entity agreement.
29
6 Del. C. § 17-1001. The limited partner‘s derivative action is a statutory descendant of
the corporate derivative action. ―Devised as a suit in equity, the purpose of the derivative
action was . . . to protect the interests of the corporation from the misfeasance and
malfeasance of ‗faithless directors and managers.‖‘ Kamen v. Kemper Fin. Servs., Inc.,
500 U.S. 90, 95 (1991) (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548
(1949)). The claims that nineteenth century jurists confronted when originally
recognizing the concept of the derivative action typically involved allegations of
mismanagement or the misappropriation of funds from the corporate treasury.19 Courts of
equity responded by analogizing the role of a director to that of a trustee, ―thus bringing
the dispute within the ambit of existing and unquestioned doctrine, . . . provid[ing] a
ready-made set of substantive rules to govern the directors and at the same time
satisfy[ing] the requirement of a ground for equitable jurisdiction.‖20 The stockholders
were the beneficiaries of the quasi-trustees‘ duties and occupied a role analogous to the
19
See Bert S. Prunty, Jr., The Shareholders’ Derivative Suit: Notes On Its
Derivation, 32 N.Y.U. L. Rev. 980, 982-83, 986-89 (1957) (tracing history of derivative
actions and their initial focus on recovering funds misappropriated by management); see
also Donna I. Dennis, Contrivance and Collusion: The Corporate Origins of Shareholder
Derivative Litigation in the United States, 67 Rutgers U. L. Rev. 1479, 1481-85 (2015)
(describing origins of derivative suit).
20
Prunty, supra, at 986; see Maldonado v. Flynn, 413 A.2d 1251, 1261 (Del. Ch.
1980) (explaining that the ―initial purpose‖ of the derivative action ―was to provide the
stockholder a right to call to account his directors for their management of the
corporation, analogous to the right of a trust beneficiary to call his trustee to account for
the management of the trust corpus‖), rev’d on other grounds sub nom. Zapata Corp. v.
Maldonado, 430 A.2d 779 (Del. 1981).
30
cestui que trust.
Notably, under this theoretical paradigm, the stockholders‘ ability to sue did not
depend on or run through the corporation. ―Originally, in the United States the
shareholder‘s suit, although on behalf of his corporation, was not based on a strict
concept of the corporate entity.‖21 The nineteenth century courts regarded the corporation
as a necessary party, but the ―[r]easons for the requirement, if given at all, were advanced
with less certainty.‖ Prunty, supra, at 988. The opinions were grounded in analogies to
trust law and treated the stockholders as beneficiaries who could bring their fiduciaries to
account without the need for a separate, entity-based cause of action. Id. at 989. The
corporation‘s role was pragmatic, ―that of a passive recipient of the proceeds as the most
logical and convenient mode of aggregate recovery.‖ Id. Consequently, ―[f]or a time [the
cause of action] bore none of the accoutrements of a thing secondary or derivative; it
belonged to the shareholders and to them alone, although they could exercise it
collectively through the corporation or individually through the representative suit.‖ Id. at
994. ―The plaintiff brought the action as representative of all the shareholders, except any
that might be defendants, even though the recovery inured to the corporation.‖ Grenier,
supra, at 165-66.
21
Edward J. Grenier, Jr., Prorata Recovery By Shareholders on Corporate Causes
of Action As A Means Of Achieving Corporate Justice, 19 Wash. & Lee L. Rev. 165, 165
(1962); accord Prunty, supra, at 989.
31
The centrality of the corporation‘s role emerged from a different source—―from
attempts, eventually successful, to extend the shareholders‘ right beyond the management
group‖ to encompass corporate rights of action ―against extracorporate defendants.‖
Prunty, supra, at 994.
For this purpose, trust law was inadequate in its then state of development.
To span the difficulty, the derivative concept was forged through the union
of the concepts of corporate entity and breach of trust. Both were necessary.
Without the breach of trust the shareholder had no litigable complaint
against the administration of affairs by his appointed representatives.
Without the corporate entity the shareholder could invoke no trust doctrine
recognizing a right of substitution in the enforcement of aggregate legal
rights.
Id. The concept of the derivative action as two actions in one bridged the gap by
permitting the stockholder to sue the corporation‘s managers for failing to pursue a claim
against a third party belonging to the corporation. Grenier, supra, at 166; accord Prunty,
supra, at 990-92.
Courts naturally looked with disfavor on efforts by stockholders to usurp the
managers‘ authority to decide whether to bring a claim against third parties, and they
relied on the corporation‘s ownership of the claim to limit the stockholder‘s ability to sue.
The seminal decision was Forbes v. Whitlock, 3 Edw. Ch. 446 (N.Y. Ch. 1841). There, a
third party defendant sold property to a corporation in return for stock. The plaintiffs sued
in their capacity as stockholders, seeking to set aside the contract on grounds of fraud and
to recover damages for its breach.
[T]he court viewed the situation as one in which all rights vested in the
corporation to which the covenants ran. . . . Only the rights of the corporate
personality were at stake and those must be asserted in the corporate name.
. . . Thus, to avoid what was vaguely referred to as ―endless difficulty and
32
embarrassment,‖ the corporate entity concept was employed to defeat a
shareholders‘ action. But plaintiffs also sought to hold defendant for
misconduct in the office of treasurer to which he succeeded as a result of
his sale of property for corporate stock. To this extent the bill presented
managerial abuse, but the court applied its conceptualism to this part of the
case as well.
Prunty, supra, at 990. Subsequent New York decisions built on Forbes to develop the
idea that when a stockholder plaintiff sues, he sues in a derivative capacity and asserts a
corporate cause of action. See id. at 991. The necessary role that the entity played in a suit
against third parties came full circle and fed back into the concept of how a stockholder
sued the internal corporate managers.
During the nineteenth century, derivative actions proliferated, not because of
stockholders pursuing internal claims against corporate management, but because
corporate management encouraged supportive stockholders to assert claims against third
parties on the corporation‘s behalf. See Dennis, supra, at 1486-1517. Through a
stockholder derivative action, corporate management could ―achieve ends which were
felt to be beyond their reach in normal corporate litigation.‖ Prunty, supra, at 994. One
end was access to the federal courts,22 but that end was an instrumental one in service of a
22
See 7 Charles Alan Wright et al., Federal Practice and Procedure § 1830 (3d
ed. 2007) (explaining that ―it was not uncommon for a corporation that had a direct claim
against a party who was a cocitizen of the state of its incorporation to seek to have the
claim litigated in a federal court as a derivative suit brought by a nominal shareholder-
plaintiff who was chosen because the shareholder‘s citizenship was different from that of
the corporation and its officers, as well as that of the prospective defendant‖ and noting
that ―[i]f an accommodating stockholder could not be found, one could be created by
transferring stock to an individual whose citizenship enabled that person to bring the suit‖
33
greater purpose. The real goal was to obtain a favorable forum to challenge the
constitutionality of taxes and other forms of regulation. Dennis, supra, at 1511.
Stockholder derivative litigation had a remarkably successful run, generating a series of
landmark decisions involving constitutional challenges to regulatory statutes. See id. at
1511-13. Corporations only stopped using the derivative suit instrumentally after (i) the
―switch in time that saved nine‖ produced a new reticence among the federal judiciary
towards invalidating economic regulation on constitutional grounds and (ii) expansions in
federal standing doctrine facilitated corporate access to the federal courts directly. See id.
at 1517-18.
Because of the frequency and prominence of management-facilitated suits in
which the corporation played a necessary role, the concept of a derivative action as two
suits in one was firmly fixed by the early twentieth century. Chancellor Josiah O.
Wolcott, one of Delaware‘s greatest jurists, wrote in 1932 that
[t]he complainants‘ case, being asserted by them in their derivative right as
stockholders, has a double aspect. Its nature is dual. It asserts as the
principal cause of action a claim belonging to the corporation to have an
accounting from the defendants and a decree against them for payment to
the corporation of the sum found due on such accounting. In this aspect, the
cause of action is the corporation‘s. It does not belong to the complainants.
Inasmuch however as the corporation will not sue because of the
domination over it by the alleged wrongdoers who are its directors, the
complainants as stockholders have a right in equity to compel the assertion
of the corporation‘s rights to redress. This is their individual right. A bill
filed by stockholders in their derivative right therefore has two phases—one
(citing Hawes v. City of Oakland, 104 U.S. 450, 452-53 (1881))); Dennis, supra, at 1486-
1511 (same).
34
is the equivalent of a suit to compel the corporation to sue, and the other is
the suit by the corporation, asserted by the stockholders in its behalf,
against those liable to it. The former belongs to the complaining
stockholders; the latter to the corporation.23
In Aronson v. Lewis, the Delaware Supreme Court embraced the two-suits-in-one
concept: ―The nature of the [derivative] action is two-fold. First, it is the equivalent of a
suit by the shareholders to compel the corporation to sue. Second, it is a suit by the
corporation, asserted by the shareholders on its behalf, against those liable to it.‖ 24 Later
Delaware Supreme Court decisions have reaffirmed the two-fold nature of the derivative
23
Cantor v. Sachs, 162 A. 73, 76 (Del. Ch. 1932) (citations omitted); accord Harff
v. Kerkorian, 324 A.2d 215, 218 (Del. Ch. 1974), aff’d in part, rev’d in part on other
grounds, 347 A.2d 133 (Del. 1975).
24
473 A.2d 805, 811 (Del. 1984). In Brehm v. Eisner, 746 A.2d 244, 253-54 (Del.
2000), the Delaware Supreme Court overruled seven precedents, including Aronson, to
the extent those precedents reviewed a Rule 23.1 decision by the Court of Chancery
under an abuse of discretion standard or otherwise suggested deferential appellate review.
See id. at 253 n.13 (overruling in part on this issue Scattered Corp. v. Chi. Stock Exch.,
701 A.2d 70, 72-73 (Del. 1997); Grimes v. Donald, 673 A.2d 1207, 1217 n.15 (Del.
1996); Heineman v. Datapoint Corp., 611 A.2d 950, 952 (Del. 1992); Levine v. Smith,
591 A.2d 194, 207 (Del. 1991); Grobow v. Perot, 539 A.2d 180, 186 (Del. 1988);
Pogostin v. Rice, 480 A.2d 619, 624-25 (Del. 1984); and Aronson, 473 A.2d at 814). The
Brehm Court held that going forward, appellate review of a Rule 23.1 determination
would be de novo and plenary. Brehm, 746 A.2d at 254. The seven partially overruled
precedents otherwise remain good law. In this decision, I do not rely on any of them for
the standard of appellate review. Although the technical rules of legal citation would
require noting that each was reversed on other grounds by Brehm, I have chosen to omit
the cumbersome subsequent history, which creates the misimpression that Brehm rejected
core elements of the Delaware derivative action canon.
35
suit.25 The corporation‘s role in a derivative suit against management, originally a
secondary feature with a utilitarian purpose, has become conceptually central.
Today, claims against internal managers and claims against external third parties
are treated as equivalent for purposes of doctrinal analysis. ―‗Any claim belonging to the
corporation may, in appropriate circumstances, be asserted in a derivative action,‘
including claims that do—and claims that do not—involve corporate mismanagement or
breach of fiduciary duty.‖26 While it is usually easy to identify the derivative nature of a
25
See Schoon v. Smith, 953 A.2d 196, 201-02 (Del. 2008) (tracing history of
derivative action and explaining its dual nature); Spiegel v. Buntrock, 571 A.2d 767, 773
(Del. 1990) (quoting Aronson for the ―two-fold‖ nature of the derivative action);
Sternberg v. O’Neil, 550 A.2d 1105, 1124 n.41 (Del. 1988) (―The normal derivative suit
was ‗two suits in one: (1) The plaintiff brought a suit in equity against the corporation
seeking an order against it; (2) to bring a suit for damages or other legal injury for
damages or other relief against some third person who had caused legal injury to the
corporation.‘‖ (quoting Robert C. Clark, Corporate Law § 15.1, at 639-40 (1986)));
Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988) (quoting
Aronson in describing the ―two-fold‖ nature of the derivative action); Zapata Corp. v.
Maldonado, 430 A.2d 779, 784 (Del. 1981) (citing ―the ‗two phases‘ of a derivative suit,
the stockholder‘s suit to compel the corporation to sue and the corporation‘s suit‖).
26
3 Stephen A. Radin, The Business Judgment Rule 3612 (6th ed. 2009) (quoting
Midland Food Servs., LLC v. Castle Hill Hldgs. V, LLC, 792 A.2d 920, 931 (Del. Ch.
1999) (Strine, V.C.)); see also Ross v. Bernhard, 396 U.S. 531, 542-43 (1970) (holding
right to jury trial existed for breach of contract claim asserted by stockholder derivatively
because ―[t]he corporation, had it sued on its own behalf, would have been entitled to a
jury‘s determination‖); First Hartford Corp. Pension Plan & Tr. v. United States, 194
F.3d 1279, 1293 (Fed. Cir. 1999) (permitting ―contract actions brought derivatively by
shareholders on behalf of the contracting corporation‖); Slattery v. United States, 35 Fed.
Cl. 180, 183 (1996) (same); Suess v. United States, 33 Fed. Cl. 89, 93 (1995) (denying
motion to dismiss a derivative claim for breach of contract against the United States); 1
R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and
Business Organizations § 13.10, at 13-24 (3d ed. Supp. 2014) (explaining that a
36
claim that an investor seeks to bring on the entity‘s behalf against a third party, it is much
harder to determine whether a claim that an investor seeks to bring against internal
managers is derivative or direct.27 This is because the nature of the fiduciary claim has
derivative action can be used to bring any corporate right that the corporation ―has
refused for one reason or another to assert‖).
27
See, e.g., Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031, 1036
(Del. 2004) (―Determining whether an action is derivative or direct is sometimes difficult.
. . .‖); Grimes v. Donald, 673 A.2d 1207, 1213 (Del. 1996) (―Although the tests have
been articulated many times, it is often difficult to distinguish between a derivative and
an individual action.‖ (internal quotation marks omitted)); Kramer v. W. Pac. Indus., Inc.,
546 A.2d 348, 351-52 (Del. 1988) (―[T]he line of distinction between derivative suits and
those brought for the enforcement of personal rights asserted on behalf of a class of
stockholders is often a narrow one.‖ (internal quotation marks omitted)); In re Ebix, Inc.
S’holder Litig., 2014 WL 3696655, at *15 (Del. Ch. July 24, 2014) (describing the
process of determining whether a challenge to an anti-takeover device is derivative or
direct as ―a less-than-precise exercise‖); Kelly v. Blum, 2010 WL 629850, at *9 (Del. Ch.
Feb. 24, 2010) (―The distinction between the rights of an LLC and the individual rights of
its members if often quite narrow.‖); Agostino v. Hicks, 845 A.2d 1110, 1117 (Del. Ch.
2004) (―The distinction between direct and derivative claims is frustratingly difficult to
describe with precision.‖); Anglo Am. Sec. Fund LP v. S.R. Glob. Int’l Fund, L.P., 829
A.2d 143, 149-50 (Del. Ch. 2003) (describing the determination of whether a claim is
director or derivative as ―a rather nuanced test‖); In re Ply Gem Indus., Inc. S’holders
Litig., 2001 WL 755133, at *4 (Del. Ch. June 26, 2001) (―The line that separates an
individual action from a derivative action is sometimes difficult to discern.‖); Behrens v.
Aerial Commc’ns Inc., 2001 WL 599870, at *3 (Del. Ch. May 18, 2001) (―The distinction
between a direct and a derivative claim . . . sometimes is difficult to apply in specific
circumstances . . . .‖), overruled on other grounds, Gentile v. Rossette, 906 A.2d 91 (Del.
2006); In re Triarc Cos., Inc., 791 A.2d 872, 878 (Del. Ch. 2001) (―The distinction
between claims belonging to the corporation and those that can be prosecuted directly by
stockholders individually is often ‗a narrow one.‘‖); In re Cencom Cable Income P’rs,
2000 WL 130629, at *3 (Del. Ch. Jan. 27, 2000) (―Determining whether a claim is
derivative or direct requires application of a rather subtle test.‖); Turner v. Bernstein,
1999 WL 66532, at *10 (Del. Ch. Feb. 9, 1999) (Strine, V.C.) (―[A] thin grey line often
marks the difference between derivative and individual claims that arise in the merger
context.‖).
37
not changed since the early nineteenth century. It continues to derive from the trust law
principles applied by the nineteenth century jurists and therefore, from the standpoint of
legal theory, does not require the presence of the corporate intermediary. The corporation
plays an instrumental and practical role.
From the standpoint of legal realism, the act of characterizing a claim against
entity managers as derivative owes more to substantive policy goals than to fine
metaphysical distinctions. Classifying a claim as derivative furthers at least two major
policies: ―First, it ensures that injury to a whole association [of investors] is adjudicated
on behalf of that whole and not just for the benefit of the individuals who have
undertaken to pursue the claims.‖ Cencom, 2000 WL 130629, at *4. This policy rests on
the same pragmatic considerations that drove nineteenth century courts to bring the
corporation into the lawsuit, even though the corporation‘s presence was not theoretically
necessary given the analogy to trust law.
As Chief Justice Strine observed while serving on this court, derivative claims
against entity managers ―should be seen for what they are, a form of class action.‖ Parfi
Hldg. AB v. Mirror Image Internet, Inc., 954 A.2d 911, 940 (Del. Ch. 2008) (Strine,
V.C.). That does not mean, however, that it is optimal to prosecute them as class actions.
―Where the remedy in a shareholder action will necessarily affect all shareholders . . . not
only is such a case permissible as a class action (Rule 23(b)(1)) but, speaking
prudentially, protection of all interests requires that it be litigated once, for all (Rule
23.1). A derivative characterization accomplishes that result.‖ Wells Fargo & Co. v. First
Interstate Bancorp, 1996 WL 32169, at *7 (Del. Ch. Jan. 18, 1996) (Allen, C.).
38
Particularly in a publicly traded entity, the derivative suit ―has efficiency advantages over
a class action. . . . For example, class actions can readily cause an enormous amount of
the legal system‘s resources to be devoted to the task of class definition and certification,
the giving of notices, and the processing and administration of individual claims. The
derivative suit elegantly sidesteps these problems.‖ Robert C. Clark, Corporation Law §
8.5, at 289 (1986).
There is also a second and perhaps more important policy served by a derivative
characterization: protecting the entity and all of its investors against excessive litigation.
A derivative characterization achieves this goal by triggering the substantive
requirements of demand doctrine and the heightened pleading requirements of Rule 23.1.
Together, the requirements serve a gatekeeping function by screening out weak claims.28
The net effect is to reduce the overall volume of litigation, constrain the extent of
interference with managerial decision-making, and limit the resource-drain that excessive
litigation would impose.29 By enforcing the demand doctrine through the heightened
pleading requirements of Rule 23.1, a derivative characterization ―guarantee[s] that the
statutory power of directors to manage the legal affairs of the company [is] not
28
See Aronson, 473 A.2d at 812; Agostino, 945 A.2d at 1116-17; Seaford Funding
L.P. v. M&M Assocs. II, L.P., 672 A.2d 66, 71 (Del. Ch. 1995).
29
See Kaplan, 540 A.2d at 730 (noting the potential for conflict between directors‘
power to manage the corporation and the ability of stockholders to bring a derivative
action); accord Levine v. Smith, 591 A.2d 194, 200 (Del. 1991).
39
disregarded except when necessary to serve the policy purpose justifying the recognition
of the derivative suit in the first instance.‖30
3. Evaluating The Claim That Resulted In The Liability Award
30
Cochran v. Stifel Fin. Corp., 2000 WL 286722, at *10 n.41 (Del. Ch. Mar. 8,
2000) (Strine, V.C.), rev’d in part on other grounds, 809 A.2d 555 (Del. 2002). The same
principles can be seen at work in the law‘s recognition of the power of an independent
committee of directors to assume control of a derivative claim that has passed the demand
phase so as to ensure that the resolution of the claim serves the best interests of the
corporation. See Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981).
A third policy goal is sometimes cited, namely the notion of promoting intra-
corporate dispute resolution by requiring stockholders to first make a demand on the
board. See, e.g., Agostino, 845 A.2d at 1116; Seaford Funding, 672 A.2d at 71. If
Delaware embraced a universal demand rule that did not penalize a plaintiff for making a
demand, then the rationale of promoting an internal dispute mechanism would make
sense. See, e.g., Grimes, 673 A.2d at 1218 n.21 (noting alternative of the universal
demand rule). Under Delaware law, however, a plaintiff that makes demand waives the
argument that demand was futile and concedes that the board is disinterested and
independent for purposes of considering the demand, thereby causing the business
judgment rule to govern the question of demand refusal. Spiegel v. Buntrock, 571 A.2d
767, 774 (Del. 1990). Because of the difficulties inherent in overcoming the business
judgment rule for purposes of establishing demand refusal, a stockholder that believes it
has a chance at pleading demand futility will not make a demand. In practice, therefore,
Delaware law dissuades stockholders from making demands and does not promote
internal dispute resolution. That approach, however, is not irrational. To the contrary, in
my view, it is likely more efficient for corporations and their investors than promoting
demand. That is because when a board receives a demand, it cannot stand neutral.
Kaplan, 540 A.2d at 727. The board must conduct an investigation, which can be costly
and disruptive, and determine what action to take. Any stockholder with one or more
shares can force a corporation to incur that expense simply by firing off a letter.
Anecdotal experience has taught me that it is usually less disruptive, cheaper, and
therefore preferable from the corporation‘s standpoint to litigate demand futility based on
the allegations of a complaint, rather than spend hundreds of thousands of dollars to
investigate a demand. Channeling stockholders away from demand therefore makes
sense, but it causes me to doubt that Delaware law can fairly be described as seeking to
encourage demand and promote internal dispute resolution.
40
The claim that resulted in the Liability Award was a claim for breach of the LP
Agreement. If forced under the General Partner‘s framework to choose between an
exclusively direct characterization and an exclusively derivative characterization, then I
believe it is a direct claim for breach of contract.
―Limited partnership agreements are a type of contract.‖ Norton v. K-Sea Transp.
P’rs L.P., 67 A.3d 354, 360 (Del. 2013). By statute, both the partners and the limited
partnership are parties to and bound by the limited partnership agreement, regardless of
whether or not they sign it:
A partner of a limited partnership . . . is bound by the partnership
agreement whether or not the partner . . . executes the partnership
agreement. A limited partnership is not required to execute its partnership
agreement. A limited partnership is bound by its partnership whether or not
the limited partnership executes the partnership agreement.
6 Del. C. § 17-101(12). Just as stockholders can sue directly to enforce contractual
constraints on a board‘s authority under the charter, bylaws, and provisions of the DGCL,
limited partners can sue directly to enforce contractual constraints in the limited
partnership agreement.31
As noted, recognizing the right of limited partners to sue to directly under the
limited partnership agreement is particularly compelling because the public policy
underlying the LP Act is ―to give maximum effect to the principle of freedom of contract
31
See Allen v. El Paso Pipeline GP Co., L.L.C., 90 A.3d 1097, 1109 (Del. Ch.
2014); Brinckerhoff v. Tex. E. Prods. Pipeline Co., 986 A.2d 370, 383 (Del. Ch. 2010);
Anglo Am. Sec. Fund LP v. S.R. Glob. Int’l Fund, L.P., 829 A.2d 143, 151, 154 (Del. Ch.
2003); Cencom, 2000 WL 130629, at *6.
41
and to the enforceability of partnership agreements.‖ 6 Del. C. § 17-1101(c). The LP Act
authorizes drafters of a limited partnership agreement to eliminate all other sources of
duty and create a contractual entity:
To the extent that, at law or in equity, a partner or other person has duties
(including fiduciary duties) to a limited partnership or to another partner or
to another person that is a party to or is otherwise bound by a partnership
agreement, the partner‘s or other person‘s duties may be expended or
restricted or eliminated by provisions in the partnership agreement;
provided that the partnership agreement may not eliminate the implied
contractual covenant of good faith and fair dealing.
Id. § 17-1101(d).
The LP Agreement took full advantage of this authority. See LPA § 7.9(e). In
place of common law duties, the LP Agreement substituted contractual commitments.
One of those commitments was the Conflict-of-Interest Provision. That section provided
that if the General Partner took action in its capacity as the General Partner, and if the
decision involved a conflict of interest for the General Partner, then the action would be
―permitted and deemed approved by all Partners‖ and ―not constitute a breach‖ of the LP
Agreement or ―any duty stated or implied by law or equity‖ as long as the General
Partner proceeded in one of four contractually specified ways. Id. § 7.9(a).
The Conflict-of-Interest Provision placed a contractual limit on the General
Partner‘s authority. Unless the General Partner followed one of the four contractually
permitted routes, the General Partner could not cause the Partnership to engage in a
conflict-of-interest transaction. The Post-Trial Opinion determined that the General
Partner breached that contractual requirement. Brinckerhoff and the other limited partners
had the right to seek to enforce the Conflict-of-Interest Provision and to obtain damages
42
if the provision was breached. Once again, a claim for breach of a constitutive entity
agreement, like a certificate of incorporation or a limited partnership agreement, is a
direct claim.
The General Partner responds to this analysis by rejecting the role of the Conflict-
of-Interest Provision and arguing that any claim that rests on an overpayment by an entity
is inherently derivative, regardless of whether the overpayment violated a specific
contractual provision. See Dkt. 229 at 14-17. Not so. A claim for breach of a specific
contractual provision is a claim for breach of contract.
An analogy to a different type of contract right may help illustrate the point.
Assume that an investor in a corporation purchased a series of preferred stock, and that a
right in the certificate of designations for the preferred stock states that the corporation
shall not make any expenditure in excess of $1 million without the affirmative vote of a
majority of the outstanding shares of that series of preferred stock (the ―Blocking Right‖).
Further assume that the corporation paid $2 million to purchase assets from a third party
that the investor believed were only worth $1.5 million. If the investor challenged the
asset purchase on the theory that the board of directors breached its fiduciary duties by
paying too much, that challenge would be a derivative claim. But the Blocking Right
changes matters. The Blocking Right says that without an affirmative vote from the
investor‘s series of preferred stock, the corporation cannot engage in the transaction. The
43
Blocking Right gives the investor a claim for breach of contract that the investor can
assert directly.32
The Conflict-of-Interest Provision operated like the Blocking Right, although its
terms were more complex. The Blocking Right would bar the corporation from engaging
in corporate expenditures above a particular dollar amount without the affirmative vote of
that series of preferred stock. The Conflict-of-Interest Provision barred the General
Partner from causing El Paso MLP to engage in any transaction that (i) involved a
potential conflict of interest and (ii) failed to comply with one of the four contractual
paths. If both conditions were met, then the General Partner could not proceed with the
transaction, just as the corporation could not proceed with the corporate expenditure
without violating the Blocking Right. The claim that the General Partner proceeded with
the Fall Dropdown without complying with the Conflict-of-Interest Provision is thus a
direct claim for breach of contract.
Anticipating this response, the General Partner next argues that the concept of
Special Approval under the Conflict-of-Interest Provision inherently involves the
members of the Committee exercising their judgment, and that traditionally Delaware
courts have not regarded claims challenging the exercise of judgment as sounding in
32
See, e.g., Matulich v. Aegis Commc’ns Gp., Inc., 942 A.2d 596, 602 (Del. 2008)
(describing preferred shareholders‘ blocking right as contractual and explaining that ―an
exercise of that contractual right in a voting format is legally distinct from the statutory
right to vote on the merger‖); OTK Assocs., LLC v. Friedman, 85 A.3d 696, 704 (Del. Ch.
2014) (explaining that preferred stock gave its holder ―contractual blocking rights‖).
44
contract. See Dkt. 229 at 19-20. In this case, however, the contract right was framed in
terms of the Committee‘s judgment. A contract provision can turn on a party‘s mental
state. See, e.g., Hexion Specialty Chems., Inc. v. Huntsman Corp., 965 A.2d 715, 746-48
(Del. Ch. 2008) (interpreting merger agreement in which contractual limitation on
liability did not apply to a ―knowing and intentional breach‖). Once the Committee‘s
judgment reached the level of bad faith, the General Partner breached the Conflict-of-
Interest Provision, giving rise to a direct claim.
Finally, the General Partner argues that in Tooley, the Delaware Supreme Court
overturned the decades of case law that permitted stockholders to enforce DGCL, charter,
and bylaw provisions directly. See Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845
A.2d 1031 (Del. 2004). The Tooley decision accomplished this, says the General Partner,
when it discarded the concept of special injury. That is not how I read Tooley.
Before Tooley, Delaware Supreme Court decisions had used the concept of special
injury to determine when a plaintiff could sue directly. See Lipton v. News Int’l, Plc, 514
A.2d 1075, 1079 (Del. 1986). A special injury was defined as a wrong ―separate and
distinct from that suffered by other shareholders . . . or a wrong involving a contractual
right of a shareholder.‖ Moran v. Household Int’l, Inc., 490 A.2d 1059, 1070 (Del. Ch.
1985), aff’d, 500 A.2d 1346 (Del. 1985). If the plaintiffs had suffered special injury, then
the plaintiffs could sue directly, even if the same wrong injured the corporation as well.
It is true that Tooley discarded the term ―special injury,‖ but Tooley did not
overrule the results in the cases that used that term or alter the longstanding principle that
a stockholder suffered injury when its contractual rights were breached. Instead, Tooley
45
rejected an argument that defendants regularly advanced in favor of characterizing such
claims as derivative, namely that if all of the stockholders held the same right, and if all
of the stockholders were injured equally, then the claim should be regarded as derivative.
Tooley explained that this argument was incorrect and that claims of this type remain
direct.
Tooley involved a third-party, two-step acquisition in which the target corporation
consented to the acquirer postponing the closing of the first-step tender offer by twenty-
two days. Stockholder plaintiffs sued, claiming that the stockholders of the target
corporation had a contractual right to have the offer close on time. The plaintiffs claimed
that if the offer had closed on time, then the stockholders would have gotten their money
faster. As damages, the plaintiffs sought the time value of money that the stockholders
lost from the delay.
The Court of Chancery dismissed the complaint, reasoning that the claims were
derivative. The Court of Chancery held that there was no meaningful distinction between
the contract rights of the tendering and non-tendering stockholders, such that they all held
parallel contract rights. The decision then reasoned that ―[b]ecause this delay affected all
DLJ shareholders equally, plaintiffs‘ injury was not a special injury, and this action is,
thus, a derivative action at most.‖ Tooley v. Donaldson, Lufkin & Jenrette, Inc., 2003 WL
203060, at *4 (Del. Ch. Jan. 21, 2003). In other words, the Court of Chancery accepted
the argument that it was appropriate to treat a contractual claim as derivative if all of the
stockholders held the same contractual right and all suffered the same injury to their
parallel contractual rights.
46
The Delaware Supreme Court reversed. The high court conscientiously conceded
that the concept of special injury had become ―amorphous and confusing.‖ Tooley, 845
A.2d at 1035. The Delaware Supreme Court traced much of the confusion to Bokat v.
Getty Oil Co., 262 A.2d 246 (Del. 1970), where it held that ―[w]hen an injury to
corporate stock falls equally upon all stockholders, then an individual stockholder may
not recover for the injury to his stock alone, but must seek recovery derivatively in behalf
of the corporation.‖ Id. at 249. In Tooley, the Delaware Supreme Court described this
statement as both ―confusing and inaccurate.‖ Tooley, 845 A.2d at 1037.
It is confusing because it appears to have been intended to address the fact
that an injury to the corporation tends to diminish each share of stock
equally because corporate assets or their value are diminished. In that sense,
the indirect injury to the stockholders arising out of the harm to the
corporation comes about solely by virtue of their stockholdings. It does not
arise out of any independent or direct harm to the stockholders,
individually. That concept is also inaccurate because a direct, individual
claim of stockholders that does not depend on harm to the corporation can
also fall on all stockholders equally, without the claim thereby becoming a
derivative claim.
Id. (second emphasis added). As demonstrated by this passage, the Tooley decision
sought to clarify Bokat by distinguishing between (i) an injury that fell indirectly on all
stockholders equally, which supported a derivative claim, and (ii) an injury that affected
stockholders directly, even if all stockholders suffered the same injury, which gave rise to
a direct claim.
Having revisited the concept of special injury, the Delaware Supreme Court
surveyed the post-Bokat decisions that addressed the distinction between direct and
derivative claims. Despite having rejected the concept of special injury, the Delaware
47
Supreme court re-affirmed its precedents as having reached correct results on the facts
presented. Id. at 1039. Far from overruling those cases, as the General Partner claims,
Tooley reinforced them by clarifying that stockholders continue to suffer direct injury and
can sue individually when they invoke their statutory or contractual rights, even if all
stockholders possessed the same rights and suffered parallel injuries.
The actual outcome in Tooley confirms this. The Delaware Supreme Court ruled
that the stockholders‘ claim was not derivative, even though all of the stockholders had
the same contractual right to a timely closing and the defendants‘ action affected all
stockholders similarly. The Delaware Supreme Court reached this conclusion because the
right that was implicated belonged to the stockholders. This holding confirmed the direct
nature of a stockholder‘s cause of action for injury to its contractual rights as a
stockholder, even when a plaintiff asserts the same contractual right in a representative
capacity on behalf of all stockholders.
More recently, NAF Holdings re-affirmed this point by rejecting the contention
that a parent corporation that owned 100% of the equity of its two subsidiaries had to sue
derivatively through its subsidiaries because the parent was injured indirectly as a result
of harm to those entities. NAF Hldgs., LLC v. Li Fung (Trading) Ltd., 118 A.3d 175, 180
(Del. 2015). The defendant there argued that under Tooley, an investor always had to sue
derivatively ―whenever the corporation of which the plaintiff is a stockholder suffered the
alleged harm,‖ regardless of the nature of the investor‘s claim. Id. The Delaware Supreme
Court agreed that if this proposition were true, then ―NAF‘s suit for compensation for the
diminution in value of its stock in the NAF Subsidiaries could not be brought as a direct
48
action.‖ Id. But the Delaware Supreme Court disagreed with the premise, stressing that ―a
more important initial question has to be answered: does the plaintiff seek to bring a
claim belonging to her personally or one belonging to the corporation itself?‖ Id. In NAF
Holdings, the plaintiff sought to bring a breach of contract claim belonging to the parent
corporation and so was not required to sue derivatively through its subsidiaries. Other
post-Tooley cases likewise have recognized that stockholders suffer direct injury and may
sue individually for breach of their contractual rights, even when all stockholders held the
same right and suffered the same injury.33
In my view, the two-part test that the Delaware Supreme Court created in Tooley
does not apply to contract rights. It deals with a different subject: ―determining the line
between direct actions for breach of fiduciary duty suits by stockholders and derivative
actions for breach of fiduciary duty suits subject to demand excusal.‖ NAF Hldgs., 118
A.3d at 179. This case did not involve any claims for breach of fiduciary duty, the Post-
Trial Opinion did not address breaches of fiduciary duty, and the Liability Award does
not rest on a breach of fiduciary duty.
To obtain the Liability Award, Brinckerhoff proved that the General Partner had
breached the LP Agreement, thereby violating the contract rights of the limited partners.
If the claim that supported the Liability Award must be categorized either as exclusively
33
See, e.g., Ruffalo v. Transtech Serv. P’rs Inc., 2010 WL 3307487, at *9 (Del.
Ch. Aug. 23, 2010); MCG Capital Corp. v. Maginn, 2010 WL 1782271, at *7, *13-14
(Del. Ch. May 5, 2010); Rich Realty, Inc. v. Potter Anderson & Corroon LLP, 2011 WL
743400, at *4 (Del. Super. Feb. 21, 2011).
49
direct or exclusively derivative, then Brinckerhoff‘s cause of action states a direct claim.
The claim therefore survived the Merger and can be remedied by permitting the
unaffiliated limited partners at the time of the Merger to recover their pro rata share of
the Liability Award.
4. “Ye Olde Slippery Slope”34
The General Partner finally seeks to avoid the implications of the foregoing
analysis by complaining that if Brinckerhoff‘s claim is contractual and direct, then all
intra-entity limited partnership disputes will be direct claims. In other words, unless this
case is dismissed and the Liability Award rendered a nullity, the concept of derivative
actions no longer will have meaning for alternative entities. Not so.
This court‘s decisions in the limited partnership context have distinguished
between suits for breach of the limited partnership agreement and suits challenging the
discretion afforded to the general partner. See Litman v. Prudential-Bache Props., Inc.,
611 A.2d 12 (Del. Ch. 1992). In Litman, limited partners filed suit against the general
partners after the limited partnership announced a reduction in its quarterly per-unit
distributions. The court distinguished between (i) a claim that the general partner had
breached a contractual provision governing distributions and (ii) a generic theory that the
general partners had ―inadequately investigat[ed] and monitor[ed] investments.‖ Id. at 16.
The complaint asserted only the latter, not the former, and therefore stated a derivative
34
Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 818 (Del. Ch. 2007) (Strine,
V.C.).
50
claim. Later, in Cencom, limited partners asserted the type of contractual claim
contemplated by Litman, arguing that the general partner breached the limited partnership
agreement by improperly terminating their priority distributions. In re Cencom Cable
Income P’rs, 2000 WL 130629, at *3 (Del. Ch. Jan. 27, 2000). The court agreed that the
limited partners had stated a direct claim for violation of their contractual right. This
court reached the same conclusion in the Anglo American case. See Anglo Am. Sec. Fund
LP v. S.R. Glob. Int’l Fund, L.P., 829 A.2d 143, 151 (Del. Ch. 2003). The limited
partners asserted that the general partner breached the terms of the limited partnership
agreement when withdrawing funds from its capital account, and the court held that the
breach of contract claim was direct. The court also held that the plaintiffs stated a direct
claim when they asserted that the general partner failed to provide a contractually
required year-end report.
The distinctions drawn in Litman, Cencom, and Anglo American continue to apply.
The question is whether the limited partner has identified a specific provision of the
partnership agreement that governed the conduct in question. Here, Brinckerhoff asserted
and proved a specific violation of the Conflict-of-Interest Provision. Unlike in Litman,
Brinckerhoff did not advance general allegations about poor or feckless decision-making.
Brinckerhoff also did not argue ―simply that the Partnership paid too much.‖ Allen v. El
Paso Pipeline GP Co., L.L.C., 90 A.3d 1097, 1110 (Del. Ch. 2014). He proved that the
General Partner fell short of the express contractual standard in the Conflict-of-Interest
Provision that required a good faith determination by the Committee.
51
It is likely true that when parties have formed a contractual entity, more claims
will be deemed direct, but that is a consequence of the choice that the sponsor of the
entity made. Picking a form of entity
involves several considerations. For example, choice of form and structure
necessarily requires understanding the needs and nature of the business or
activity being organized, the benefits and limitations of alternative legal
forms or entities that are available . . . , the structures that can be used in
implementing those forms or entities, and any other relevant matters that
should be considered in organizing a . . . business. The ultimate choice of
form and structure, however, results from a weighed analysis of available
forms and internal structures as applied to the unique characteristics of
a . . . particular deal or transaction.
Robert R. Keatinge & Ann E. Conaway, Keatinge and Conaway on Choice of Business
Entity: Selecting Form and Structure For a Closely Held Business § 1:1 (2015). The
choice of entity necessarily affects the nature and types of claims that investors in the
entity can bring. Parties who choose an alternative entity—and particularly those who
form a contractual entity—cannot expect the automatic trans-species application of
corporate principles. Cf. Twin Bridges Ltd. P’ship v. Draper, 2007 WL 2744609, at *19
(Del. Ch. Sept. 14, 2007) (―Because the conceptual underpinnings of the corporation law
and Delaware‘s limited partnership law are different, courts should be wary of
uncritically importing requirements from the DGCL into the limited partnership
context.‖).
―[A]n alternative entity . . . is not the same thing as a corporation.‖ 2009 Caiola
Family Tr. v. PWA, LLC, 2015 WL 6007596, at *1 (Del. Ch. Oct. 14, 2015). More to the
point, a contractual alternative entity is not the same thing as a corporation. Creating such
an entity has many advantages. In theory, obligations and rights can be defined more
52
explicitly and better addressed ex ante, rather than leaving issues for ex post judicial
evaluation.35 Although the contractual flexibility could be used to provide investors with
greater protection, in practice the agreements establish litigation standards that are more
defendant-friendly than traditional fiduciary duty standards.36 As the sponsor of El Paso
MLP, El Paso Parent followed that course, ―borrow[ed] its basic framework from the
common law, but replace[d] the common law rules with contractual standards more
favorable to the General Partner.‖ Allen, 90 A.3d at 1103.
An additional benefit from a contractual entity is the ability to limit the number of
potential defendants who face litigation risk, as well as the scope of that risk. The parties
to the contract only can sue other parties, and the nature of the available remedies shifts
35
See Leo E. Strine, Jr. & J. Travis Laster, The Siren Song of Unlimited
Contractual Freedom, in Research Handbook on Partnerships, LLCs and Alternative
Forms of Business Organizations 11, 15-16 (Robert W. Hillman & Mark J. Loewenstein
eds., 2014) (―Another argument often made in favor of alternative entity statutes is that
they allow for the elimination of fiduciary duties and the establishment of a purely
contractual relationship between entity managers and investors.‖); Rutheford B.
Campbell, Jr., Bumping Along the Bottom: Abandoned Principles and Failed Fiduciary
Standards in Uniform Partnership and LLC Statutes, 96 Ky. L.J. 163, 169 (2007)
(describing the argument that permitting a fully contractual entity is ―respectful of the
autonomy of rational beings (broadly, a Kantian notion) and promotes the maximization
of overall utility or happiness (a utilitarian goal)‖); Reza Dibadj, The Misguided
Transformation of Loyalty Into Contract, 41 Tulsa L. Rev., 451, 464 (2006) (describing
the argument that permitting the existence of fully contractual entities is wealth-
maximizing).
36
See 6 Del. C. § 17–1101(d); Brent J. Horton, The Going–Private Freeze–Out: A
Unique Danger for Investors in Delaware Non–Corporate Business Associations, 38 Del.
J. Corp. L. 53 (2013); Mohsen Manesh, Contractual Freedom Under Delaware
Alternative Entity Law: Evidence from Publicly Traded LPs and LLCs, 37 J. Corp. L. 555
(2012).
53
from the broader strains of equity to the narrower lineaments of contract law. 37 El Paso
Parent and its affiliates benefitted from the limited number of possible defendants in this
litigation, which enabled all of the defendants except the General Partner to prevail on
their motion for summary judgment. See In re El Paso Pipeline P’rs L.P. Deriv. Litig.,
2014 WL 2641304 (Del. Ch. June 12, 2014) (ORDER). An alternative entity also has
greater flexibility to provide indemnification and to adopt contractual restrictions on
investor litigation.38 The LP Agreement took advantage of this feature as well. See LPA
§ 7.7.
37
See Allen v. El Paso Pipeline GP Co., L.L.C., 113 A.3d 167, 194 (Del. Ch.
2014) (―When parties establish a purely contractual relationship, they have chosen to
limit themselves to pursuing contractual remedies against their contractual counterparties.
Under those circumstances, a claim for aiding and abetting cannot be used to expand the
possible range of defendants.‖); Gerber v. EPE Hldgs., LLC, 2013 WL 209658, at *11
(Del. Ch. Jan. 18, 2013) (holding that defendants could not aid and abet a breach of a
limited partnership agreement where the agreement eliminated fiduciary duties); Daniel
S. Kleinberger, Two Decades of ―Alternative Entities‖: From Tax Rationalization
Through Alphabet Soup to Contract as Deity, 14 Fordham J. Corp. & Fin. L. 445, 467-68
(2009) (―As for remedies, the difference between contract claims and breach of fiduciary
duty claims is substantial.‖).
38
See Samuel T. Hirzel & Dawn Kurtz Crompton, Finding (and Funding) the Cost
of Freedom: Indemnification and Advancement for Alternative Business Entities, 15 Del.
Rev. 83, 86-94 (2015) (―While the DGCL provides a default structure of indemnification
and advancement for Delaware corporations, the LLC Act and the LLP Act simply permit
the members or partners to provide for such rights contractually.‖). Compare ATP Tour,
Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 558 (Del. 2014) (permitting non-stock
corporation to adopt fee-shifting bylaw) with 8 Del. C. § 102(f) (―The certificate of
incorporation may not contain any provision that would impose liability on a stockholder
for the attorneys‘ fees or expenses of the corporation or any other party in connection
with an internal corporate claim, as defined in § 115 of this title.‖) and id. § 109(b) (―The
bylaws may not contain any provision that would impose liability on a stockholder for the
attorneys‘ fees or expenses of the corporation or any other party in connection with an
54
One consequence of a contractual entity is that the resulting rights are contractual.
Consequently, parties to the contract can enforce them directly. Procedural hurdles to
derivative actions, such as Rule 23.1 and the demand doctrine, do not apply to a
contractual cause of action. Generally speaking, the test for distinguishing between direct
and derivative claims in the limited partnership context is substantially the same as in the
corporate context,39 but the answers that test gives when applied to a contractual entity
are different.40
In this case, when El Paso Parent created El Paso MLP, it formed a contractual
entity. El Paso MLP and its affiliates gained many benefits from that choice. In this case,
those contractual benefits enabled El Paso Parent and its affiliates to prevail at the motion
to dismiss stage against certain claims regarding the Fall Dropdown and a related
transaction. Similar contractual benefits enabled El Paso Parent and its affiliates (other
than the General Partner) to prevail on the balance of Brinckerhoff‘s claims at the
internal corporate claim, as defined in § 115 of this title.‖). The LP Act does not contain
provisions analogous to Sections 102(f) and 109(b).
39
See Brinckerhoff v. Enbridge Energy Co., Inc., 2011 WL 4599654, at *5-6 (Del.
Ch. Sept. 30, 2011); Anglo Am. Sec. Fund LP., 829 A.2d at 149-50; Litman, 611 A.2d at
15.
40
See Anglo Am., 829 A.2d at 151 (explaining that claims ―which in a corporate
context might be classified as derivative, must be brought as direct claims [in the limited
partnership context] in order to enable the injured parties to recover while preventing a
windfall to the individuals or entities whose interests were not injured‖); In re Cencom,
2000 WL 130629, at *2 (―Mechanistically applying the corporate law rule surrounding
derivative claims can sometimes defeat efficient resolution of claims in other
contexts . . . .‖).
55
summary judgment stage. Having received the benefits of a contractual entity, the
General Partner now wants to obtain dismissal of the remaining claim for breach of
contract and the resulting Liability Award by invoking non-contractual doctrines.
―There is much democratic wisdom in the trite phrase ‗you can‘t have your cake
and eat it too.‘ That phrase applies here.‖ In re Gen. Motors Class H S’holders Litig., 734
A.2d 611, 621 (Del. Ch. 1999) (Strine, V.C.). Having chosen the contractual path and
enjoyed many of its benefits, the General Partner cannot now complain that the surviving
claim for breach of the LP Agreement is a claim for breach of contract and therefore
direct.
B. Second Order Analysis: Dual
As discussed in the preceding section, the General Partner construes Delaware law
as recognizing only two types of claims that investors can bring: direct claims and
derivative claims. In the preceding section, this decision assumed for purposes of analysis
that the General Partner‘s bi-partite conceptualization accurately described Delaware law
and concluded that Brinckerhoff‘s claim for breach of the LP Agreement was direct. In
my view, however, the General Partner‘s assessment is overly narrow. In reality,
Delaware law recognizes a third category—dual-natured claims—that have both direct
and derivative characteristics.41 Dual-natured claims exist because some injuries affect
41
See, e.g., Gatz v. Ponsoldt, 925 A.2d 1265, 1268 (Del. 2007) (―[T]he claims
before us are not exclusively derivative and could be brought directly.‖); Gentile v.
Rossette, 906 A.2d 91, 99-100 (Del. 2006) (describing scenario giving rise to dual-
natured claims); Lipton v. News Int’l, Plc, 514 A.2d 1075, 1079 (Del. 1986) (finding that
56
both the corporation and the stockholders and can be remedied either at the corporate or
the stockholder level.42 The Delaware Supreme Court has held that when this dual aspect
is present, ―[b]oth types of claims may be litigated.‖ Loral Space & Commc’ns Inc. v.
Highland Crusader Offshore P’rs, L.P., 977 A.2d 867, 868 (Del. 2009).
To determine whether a claim has dual characteristics, Delaware decisions have
used the Tooley test. The General Partner argues that under Tooley, only El Paso MLP,
and not anyone else, suffered an injury from the Fall Dropdown. The General Partner
complaint pled ―claims that support both individual and derivative causes of action‖);
Dubroff v. Wren Hldgs., LLC (Dubroff I), 2009 WL 1478697, at *3 (Del. Ch. May 22,
2009) (―Gentile and its progeny make clear that a shareholder‘s claim can be both
derivative and direct.‖); Thornton v. Bernard Techs., Inc., 2009 WL 426179, at *3 n.28
(Del. Ch. Feb. 20, 2009) (―It is possible for a claim to be both derivative and direct.‖).
See generally Kurt M. Heyman & Patricia L. Enerio, The Disappearing Distinction
Between Derivative And Direct Claims, 4 Del. L. Rev. 155, 169 n.53 (2001) (―Delaware
courts also recognize that some claims . . . are both derivative and direct in nature, in
which case they can be pursued in either fashion.‖).
42
See Grimes v. Donald, 673 A.2d 1207, 1212 (Del. 1996) (―Courts have long
recognized that the same set of facts can give rise both to a direct claim and a derivative
claim.‖); Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 655 (Del. Ch. 2013)
(discussing a dual injury giving rise to direct and derivative claims); Sagarra Inversiones,
S.L. v. Cementos Portland Valderrivas, S.A., 2011 WL 3371493, at *5 n.31 (Del. Ch.
Aug. 5, 2011) (―Although the Tooley formulation provides a two-part analysis for
determining whether an asserted claim is direct or derivative, there are some limited
exceptions where the same facts may support both direct and derivative claims.‖); San
Antonio Fire & Police Pension Fund v. Bradbury, 2010 WL 4273171, at *9 n.68 (Del.
Ch. Oct. 28, 2010) (―The same facts may support both direct and derivative claims.‖); Big
Lots Stores, Inc. v. Bain Capital Fund VII, LLC, 922 A.2d 1169, 1181 n.54 (Del. Ch.
2006) (acknowledging the ―common sense principle‖ that the same set of facts can set
forth both direct and derivative claims seeking different forms of relief); Odyssey P’rs v.
Fleming Co., 1998 WL 155543, at *3 (Del. Ch. Mar. 27, 1998) (―[I]n some
circumstances, the same conduct (or aspects thereof) may give rise to both derivative and
direct claims.‖).
57
then argues that the injury only could be remedied through an award of damages to El
Paso MLP and not by any other means. I disagree on both points.
For purposes of this section‘s analysis of Tooley, this decision sets aside the
contractual injury suffered by the limited partners. Taking the contractual injury into
account makes the Tooley analysis relatively straightforward: the limited partners
suffered a distinct injury in the form of the breach of their contract rights, and that injury
can be remedied at the limited partner level. See Allen, 90 A.3d at 1109; Brinckerhoff v.
Tex. E. Prods. Pipeline Co., 986 A.2d 370, 383 (Del. Ch. 2010). In my view, however,
even without considering the contractual angle, the Fall Dropdown inflicted injury on
both El Paso MLP and the unaffiliated limited partners. The injury suffered by the
unaffiliated limited partners is related to but distinguishable from the entity-level injury
suffered by El Paso MLP. The remedy in this case could operate at the entity level, and as
long as El Paso MLP remained a separate, independent entity, that approach made the
most practical sense. But the injury also could be—and still can be—remedied at the
limited partner level.
In my view, because the claim that gave rise to the Liability Award is a dual claim,
Brinckerhoff can continue to litigate the direct aspects of that claim notwithstanding the
Merger. This means that Brinckerhoff and the other limited partners can recover their pro
rata share of the Liability Award.
1. The First Prong Of Tooley
Adapted to a limited partnership, Tooley‘s first prong asks who suffered the
alleged injury, the partnership or the limited partners individually? See Tooley v.
58
Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004). The Tooley
decision framed the inquiry as if these options were exclusive alternatives (the
partnership or the limited partners). See id. In this case, however, the answer is both: El
Paso MLP and the limited partners each suffered injuries.
Setting aside the injury to the limited partners‘ contract rights, El Paso MLP and
the limited partners each suffered injuries because of the nature of the transfer effected
through the Fall Dropdown. That transaction did not only result in an overpayment from
the Partnership to the General Partner; it also effectively reallocated value from the
unaffiliated limited partners to the General Partner.43
The most obvious consequence of the Fall Dropdown was the infliction of harm
on the Partnership. In this case, by causing El Paso MLP to overpay in the Fall
Dropdown, the General Partner left the Partnership $171 million poorer. El Paso MLP
would have suffered the same harm from any overpayment, including a wrongful transfer
to a third party. Whenever money leaves an entity wrongfully, it impoverishes the entity
and enriches the recipient. See In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d
808, 819 (Del. Ch. 2005), aff’d, 906 A.2d 766 (Del. 2006).
43
Technically, the Fall Dropdown reallocated value to El Paso Parent. In the Fall
Dropdown, El Paso Parent sold the member units in the LLCs to El Paso MLP, so
although the General Partner was the party to the LP Agreement and liable for breach of
contract, El Paso Parent received the benefit of the $171 million. El Paso Parent owned
100% of the General Partner. For simplicity, this decision refers to the benefit as running
to the General Partner, even though technically it ran to the General Partner‘s affiliate.
59
An equally obvious consequence of the overpayment was that the harm inflicted
on the Partnership injured all of the investors in the Partnership proportionately. The
value of a Delaware entity inures ultimately to the owners of its equity in their capacity as
residual claimants. When funds wrongfully leave a Delaware entity, the investors suffer
harm indirectly in proportion to their ownership interests.44 For purposes of the Fall
Dropdown, at this level of analysis, the General Partner reduced the aggregate value of
the equity investors‘ ownership interests by $171 million, divided proportionately across
their ownership interests. Notably, this interpretation of the harm applies regardless of
who receives the benefit of the wrongful transfer. As with the direct harm suffered by the
entity, investors suffer indirectly regardless of the identity of the recipient, even if it is a
third party.
In cases addressing the distinction between derivative and direct claims, this is
often as far as the assessment of the injury goes. But a more realistic evaluation takes the
additional step of recognizing that a wrongful third party transfer operates differently
than a wrongful insider transfer. A wrongful third party transfer takes value out of the
entity and away from the existing entity claimants. A wrongful insider transfer also takes
value from the entity, but in doing so it reallocates value among the existing entity
44
More accurately, investors suffer harm in order of their priority in the capital
stack, and then proportionately within each level of priority based on the extent of their
investment at that level of priority. The presence of creditors or other parties with
superior claims to the value of a litigation asset is a consideration whenever a court
evaluates the possibility of a pro rata remedy. See infra Part III.C.2.
60
claimants. All of the claimants suffer a proportionate loss according to the priority of
their claims, but the insider receives an offsetting benefit that exceeds the insider‘s share
of the loss. In reality, the insider isn‘t injured at all. The insider gains at the expense of
the other investors. The net effect is to extract value from the unaffiliated investors for
the benefit of the insider.
The Fall Dropdown illustrates this process. At the time of the transfer, the General
Partner held a 2% general partner interest in the Partnership and, in that capacity,
indirectly suffered 2% of the $171 million loss—a decline in value of approximately
$3.42 million. The General Partner also held a 52% limited partner interest and, in that
capacity, indirectly suffered 52% of the $171 million loss—a decline in value of
approximately $88.92 million. The unaffiliated limited partners held the remaining 46%
partnership interest and suffered the balance of the loss—a decline in value of
approximately $78.66 million. Unlike the unaffiliated limited partners, however, the
General Partner received a direct gain of $171 million, which more than overcame the
General Partner‘s proportionate indirect loss. By extracting $171 million and suffering an
indirect loss of $92.34 million ($3.42 million + $88.92 million), the General Partner came
out ahead by $78.66 million.45
45
The real-world benefit to the General Partner is actually somewhat greater.
Because of the endowment effect, parties prefer actual ownership to indirect ownership.
See generally Daniel Kahneman, Jack L. Knetsch & Richard H. Thaler, Anomalies: The
Endowment Effect, Loss Aversion, and Status Quo Bias, 5 J. Econ. Perps. 193 (1991).
Parties therefore value more highly the receipt of cash rather than a proportionate
ownership interest in an entity that owns cash. A party like the General Partner would not
61
The limited partners, by contrast, did not receive an offsetting gain. They only
suffered a loss. Moreover, their loss was the General Partner‘s gain ($78.66 million loss =
$78.66 million net gain). Through the transfer, the General Partner extracted value from
the unaffiliated limited partners. When one group of limited partners suffers an injury of
$78.66 million so that the General Partner can receive a net benefit of $78.66 million, it
seems to me that the limited partners have suffered a separate and distinct loss.
When the insider transfer involves the issuance of stock, Delaware cases have
recognized the dual nature of the injury and the separate harm inflicted on the non-
participating stockholders through the extraction of value.46 In Gentile, the Delaware
Supreme Court described these effects as follows:
be indifferent between $78.66 million owned directly and the same $78.66 million held
through the entity. The General Partner naturally prefers cash. Extracting the $78.66
million is therefore worth more than leaving the same amount in the entity and benefiting
indirectly.
46
See Gatz, 925 A.2d at 1281 (concluding that transaction in which stockholder
gained controlling position and public stockholders were diminished to a minority
position were not exclusively derivative and could have been brought directly); Gentile,
906 A.2d at 90 (discussing dual attribute claims based on expropriation caused by a
dilutive stock issuance); Carsanaro, 65 A.3d at 655 (discussing direct and derivative
claims caused by a dilutive stock issuance); Robotti & Co., LLC v. Liddell, 2010 WL
157474, at *6-7 (Del. Ch. Jan. 14, 2010) (noting that claims alleging overpayment and
subsequent common stock dilution are typically regarded as derivative but claims
alleging that a controlling stockholder caused the corporation to overpay for stock
thereby increasing the controllers ownership and decreasing minority stockholders‘
ownership are direct); Dubroff I, 2009 WL 1478697, at *3 (―Gentile and its progeny
make clear that a shareholder‘s claim can be both derivative and direct in a unique
situation: where a controlling shareholder causes the corporate entity to issue more equity
to the controlling shareholder at the expense of the minority shareholders.‖); Oliver v.
Bos. Univ., 2006 WL 1064169, at *17 (Del. Ch. Apr. 14, 2006) (characterizing claim
62
A breach of fiduciary duty claim having [a] dual character arises where: (1)
a stockholder having majority or effective control causes the corporation to
issue ―excessive‖ shares of its stock in exchange for assets of the
controlling stockholder that have a lesser value; and (2) the exchange
causes an increase in the percentage of the outstanding shares owned by the
controlling stockholder, and a corresponding decrease in the share
percentage owned by the public (minority) shareholders. Because the
means used to achieve that result is an overpayment (or ―over-issuance‖) of
shares to the controlling stockholder, the corporation is harmed and has a
claim to compel the restoration of the value of the overpayment. That
claim, by definition, is derivative.
But, the public (or minority) stockholders also have a separate, and direct,
claim arising out of that same transaction. Because the shares representing
the ―overpayment‖ embody both economic value and voting power, the end
result of this type of transaction is an improper transfer—or
expropriation—of economic value and voting power from the public
shareholders to the majority or controlling stockholder. For that reason, the
harm resulting from the overpayment is not confined to an equal dilution of
the economic value and voting power of each of the corporation's
outstanding shares. A separate harm also results: an extraction from the
public shareholders, and a redistribution to the controlling shareholder, of a
portion of the economic value and voting power embodied in the minority
interest. As a consequence, the public shareholders are harmed, uniquely
and individually, to the same extent that the controlling shareholder is
(correspondingly) benefited. In such circumstances, the public shareholders
are entitled to recover the value represented by that overpayment—an
alleging equity dilution following a preferred stock issuance as a derivative claim but
noting that ―[v]oting power dilution may constitute a direct claim, because it can directly
harm the shareholders without affecting the corporation, and any remedy for the harm
suffered under those circumstances would benefit the shareholders‖); J.P. Morgan, 906
A.2d at 818 (noting that dilution claims alleging the diminishment of voting power may
be considered direct claims ―where a significant stockholder‘s interest is increased at the
sole expense of the minority‖ (quoting In re Paxson Commc’n Corp. S’holders Litig.,
2001 WL 812028, at *5 (Del. Ch. July 12, 2001))); In re Triarc Cos., Inc., 791 A.2d 872,
874 (Del. Ch. 2001) (discussing direct and derivative claims resulting from the issuance
of cash bonuses and stock options in excess of what was permitted by a stockholder
approved compensation arrangement). See generally 3 Edward P. Welch et al., Folk On
The Delaware General Corporation Law § 327.02[A][7] (6th ed. 2015).
63
entitlement that may be claimed by the public shareholders directly and
without regard to any claim the corporation may have.
906 A.2d at 99-100 (footnotes omitted). The Delaware Supreme Court declined to
categorize this type of claim as one for ―dilution,‖ adopting ―a more blunt
characterization—extraction or expropriation—because that terminology describes more
accurately the real-world impact of the transaction upon the shareholder value and voting
power embedded in the (pre-transaction) minority interest, and the uniqueness of the
resulting harm to the minority shareholders individually.‖ Id. at 102 n.26.
Subsequent cases have recognized that the principle recognized in Gentile was not
limited to dilutive issuances involving majority stockholders; it applies equally to stock
transfers involving significant stockholders.47 Indeed, Gentile‘s core insight applies to
any insider stock issuance where the value transferred directly to the insider exceeds the
share of the loss that the insider suffers through its stock ownership.48
47
See Gatz, 925 A.2d at 1274 (―[W]here a significant or controlling stockholder
causes the corporation to engage in a transaction wherein shares having more value than
what the corporation received in exchange are issued to the controller, thereby increasing
the controller‘s percentage of stock ownership at the public shareholders‘ expense, a
separate and distinct harm results to the public shareholders, apart from any harm caused
to the corporation, and from which the public shareholders may seek relief in a direct
action.‖ (emphasis added)); Gentile, 906 A.2d at 100 (describing doctrine as applying to a
stockholder ―having majority or effective control‖ (emphasis added)); accord Loral, 977
A.2d at 869 (quoting Gentile).
48
See Carsanaro, 65 A.3d at 658; accord In re Nine Sys. Corp. S’holder Litig.,
2014 WL 4383127, at *27-28 (Del. Ch. Sept. 4, 2014); see also Avacus P’s. L.P. v. Brian,
1990 WL 161909, at *6 (Del. Ch. Oct. 24, 1990) (Allen, C.) (holding under then-
prevailing special injury test that stockholders could assert a direct claim where a board
of directors issued stock to allegedly friendly holders).
64
Not only that, but the expropriation principle actually applies to insider transfers
generally, regardless of whether the nature of the consideration received by the insider is
cash, stock, or other corporate property. Whenever the value of the transfer to the insider
exceeds the share of the loss that the insider suffers through its stock ownership, the
insider transfer expropriates value from the unaffiliated investors. This effect happens
precisely because the insider receives benefits to the exclusion of the other investors,
resulting in a distinct injury to the other investors and a corresponding benefit to the
insider.49
49
Writing while a Vice Chancellor, Chief Justice Strine recognized the different
benefits that inure to insiders from actions that in theory affect the corporation as a
whole. See In re Gaylord Container Corp. S’holders Litig., 747 A.2d 71, 79 (Del. Ch.
1999). In Gaylord, the Chief Justice examined the ruling in Moran v. Household
International, Inc., 490 A.2d 1059 (Del. Ch.), aff’d, 500 A.2d 1346 (Del. 1985), which
addressed whether a challenge to the adoption of a stockholder rights plan stated a
derivative or individual claim. The Moran decision distinguished between a challenge to
a rights plan deployed in the face of an active proxy contest, where the claim was deemed
direct, and the use of a plan to defend against potential takeovers, where the claim was
treated as derivative. In a typically incisive analysis, Chief Justice Strine exposed the lack
of substance in this distinction, and he suggested that ―there might be some practical and
doctrinal utility to reconsidering whether properly pled Unocal claims should continue to
be regarded as presumptively derivative, rather than individual, in nature.‖ Gaylord, 747
A.2d at 77.
As part of his analysis, the Chief Justice responded to the argument that the
adoption of a rights plan affected all stockholders equally, including insiders:
If the derivative-individual distinction in Moran rests on the fact that
defensive measures such as rights plans affect all stockholders equally, that
distinction must deal with the reality that in most situations the directors
and managers of the corporation hold shares. The inside holders‘ interests
qua shareholders might not be affected all that differently by defensive
measures, but their total economic interest in the corporation is often
65
The Delaware Supreme Court recognized this principle in Tri-Star, labeling it
―cash-value dilution.‖ In re Tri-Star Pictures, Inc. Litig., 634 A.2d 319, 330 (Del. 1993).
The plaintiffs in Tri-Star were former minority stockholders of Tri-Star Pictures, Inc.
Through voting agreements with two other large shareholders, Coca-Cola Company
effectively controlled 56.6% of Tri-Star‘s stock, and all seven of Tri-Star‘s directors were
affiliated with Coca-Cola. The Delaware Supreme Court held that Coca-Cola was Tri-
Star‘s controlling stockholder. Id. at 329. The plaintiffs challenged a transaction in which
Coca-Cola transferred assets to Tri-Star with a book value of $745 million in exchange
for shares of Tri-Star common stock valued at $900-$977 million (the ―Asset Transfer‖).
After agreeing on the terms of the transaction, Coca-Cola wrote down the value of the
transferred assets by nearly $200 million. The plaintiffs thus contended that Coca-Cola
received consideration worth $900-$977 million in return for assets worth approximately
$550 million.
affected quite differently by defensive measures than are the interests of
public stockholders having only an ownership stake. Hence, the
justification for the Unocal standard of review. In addition, the inside
holders have deprived only the non-inside stockholders of the right to freely
receive purchase offers, since the insiders—in their capacity as directors—
can decide to tear down the defenses when they themselves wish to accept
such an offer.
Id. at 79. In other words, although the adoption of a rights plan might superficially affect
all shares equally, it actually affects outsider stockholders differently and distinctly. If a
comparable degree of realism is brought to bear on an insider transfer, similar principles
reveal that the insider‘s ―total economic interest in the corporation‖ is affected ―quite
differently‖ by the insider transfer. This difference in turn calls for recognizing the
existence of a distinct injury to the unaffiliated stockholders.
66
After the transaction closed, Tri-Star was acquired by a third party, Sony USA,
Inc., in a reverse triangular merger. As in this case, the defendants argued that the merger
extinguished the plaintiffs‘ standing to sue because the challenge to the Asset Transfer
was merely an overpayment claim that was derivative. The Court of Chancery agreed,
reasoning that all of Tri-Star‘s stockholders suffered a proportionate loss from the
overpayment.
The Delaware Supreme Court reversed, holding that the plaintiffs suffered two
direct injuries. One of the injuries resulted from the consideration taking the form of
stock, which inflicted the same type of injury later described in Gentile. For present
purposes, the relevant part of the Tri-Star decision is its discussion of the second injury:
cash-value dilution. The Delaware Supreme Court recognized that in substance, the Asset
Transfer affected Coca-Cola and the non-participating stockholders differently because
―[a]ny diminution in the . . . value of [Coca-Cola‘s shares] . . . was totally offset by the
windfall profits plaintiffs allege Coca-Cola accumulated.‖ Id. at 330. The non-
participating stockholders only suffered the injury, without any offsetting benefit. As a
result, ―the practical effect‖ of the transaction was ―to increase the value of the
controlling stockholder‘s interest at the sole expense of the minority.‖ Id. The Delaware
Supreme Court incisively perceived that this type of injury was ―quite different‖ from a
case involving waste or mismanagement, where there is no offsetting transfer and the
injury truly ―diminishes the value of all stockholders‘ interests equally.‖ Id. In the Asset
Transfer, ―Coca-Cola suffered no similar loss, but reaped a substantial profit.‖ Id. at 332.
Because of the transfer of value to the insider, the effect of the Asset Sale was to
67
―diminish the value of the minority interests‖ and inflict individual injury. Id. at 330. The
Delaware Supreme Court concluded that in light of ―the singular economic injury to
minority interests alone, the minority have stated a cause of action‖ that was direct and
survived the third party merger.50
In support of its analysis in Tri-Star, the Delaware Supreme Court went further
and analogized the Asset Transfer to a squeeze-out merger governed by Weinberger v.
UOP, Inc., 457 A.2d 701 (1983). Conceptually, the comparison is a fair one. In each
case, for purposes of Delaware law, the entity as a whole has a certain intrinsic value. In a
squeeze-out merger, the controller takes the entity and leaves the stockholders with
consideration ostensibly equal to their pro rata share. In a successful challenge to a
squeeze-out merger, the minority stockholders prove that they received consideration
having less value than their pro rata share. In an insider transfer, the situation is reversed.
Rather than taking the entity, the controller takes the consideration. In a successful
50
Id. at 332. On occasion, Court of Chancery decisions have recognized the
distinct injury that an insider transfer imposes on a minority stockholder. See Boyer v.
Wilm. Mat’ls, Inc., 754 A.2d 881, 903 (Del. Ch. 1999) (crediting plaintiff‘s argument that
he suffered individual injury and could sue directly where an insider transfer left the
plaintiff ―with his 25% interest in WMI, a worthless company, while defendants
purchased the hot mix plant at an unfair price and simply continued WMI‘s business at a
new location under a new corporate name‖; relying on Tri-Star and regarding the
existence of individual injury as ―clear and requir[ing] little discussion‖); Fischer v.
Fischer, 1999 WL 1032768, at *3-4 (Del. Ch. Nov. 4, 1999) (relying on Tri-Star to hold
that minority stockholder was injured distinctly and could sue individually following
insider transfer of corporate asset in exchange for cash and a note, when corporation then
failed to sue insider on the note); see also Stevanov v. O’Connor, 2009 WL 1059640 at
*6 (Del. Ch. Apr. 21, 2009) (denying motion to dismiss because it was reasonably
conceivable that plaintiff could prove individual injury based on insider transfers).
68
challenge to an insider transfer, the minority stockholders prove that the controller took
more consideration than it should have, leaving the minority stockholders with less than
their pro rata share of the entity. In both cases, the controller takes too much and leaves
the minority stockholders with too little. In both cases, the controller extracts a benefit at
the expense of the minority stockholders—in the cash out merger by paying the minority
too little, and in the insider transfer by taking too much out of the entity. In both cases,
the minority stockholders suffer an injury equal to the benefit to the controller.
An example with numbers may help. To illustrate the reciprocal nature of the two
types of transactions, envision a corporation which, for purposes of Delaware law post-
Weinberger, has an intrinsic value of $1 billion. The corporation has issued ten million
shares, giving each share an intrinsic value of $100. Assume the controller owns
6,000,000 shares, with the remainder trading publicly at prices hovering around $85 per
share. Further assume that the controller engages in a squeeze-out merger at $90 per
share. To complete that transaction, the controller pays $360 million to the minority
(4,000,000 x $90/share) to acquire shares worth $400 million (4,000,000 x $100/share).
The minority stockholders lose $40 million in the transaction, and the controller receives
an equivalent gain.
Now envision that instead of a squeeze-out merger, the controller owns another
business that is just entering its expansion stage and is realistically worth $200 million.
The controller takes a more aggressive view of its prospects and sells the business to the
corporation for $300 million. The corporation has overpaid by $100 million, so it
suffered harm in that amount. But the transaction did not affect all stockholders equally.
69
Although the controller lost $60 million indirectly because of its 60% interest in the
corporation, the $100 million overpayment more than made up for it. On a net basis, the
controller came out ahead by $40 million. The minority did not receive any offsetting
benefit. Their 40% share of the overpayment was $40 million, which is the source of the
value received by the controller.
In both cases, the minority suffered an injury of $40 million. In both cases, the
controller benefitted by extracting $40 million from the minority. In both cases, the
minority‘s injury was distinct and separate from both the injury the entity suffered and
the benefit that the controller achieved. Given these effects, an insider transfer can be
viewed as the flipside of a squeeze-out merger. Both transactions inflict a distinct injury
on the non-participating stockholders in the form of expropriation. The only difference is
whether the injured stockholders are kept in the entity or forced out.
Although Tri-Star and Gentile recognized the nature of the distinct injury that non-
participating stockholders suffer, both were controversial. Given the potential for the
principle recognized in Gentile to undercut the traditional characterization of stock
dilution claims as derivative, some have understandably resisted its implications. See,
e.g., Feldman v. Cutaia, 956 A.2d 644, 657 (Del. Ch. 2007) (seeking to avoid an
interpretation of Gentile that ―would swallow the general rule that equity dilution claims
are solely derivative‖), aff’d, 951 A.2d 727 (Del. 2008).
Both Tri-Star and Gentile notably involved the question of whether stockholders
lost their standing to sue due to a merger under circumstances where the claim otherwise
could be expected to ―die as a matter of fact.‖ Golaine v. Edwards, 1999 WL 1271882, at
70
*4 (Del. Ch. Dec. 21, 1999) (Strine, V.C.). Ruling in that context, both decisions reached
outcomes that permitted the breach of fiduciary duty claims to continue, but those
outcomes differed from how other cases had analyzed similar transactions for purposes of
determining whether claims were derivative for purposes of Rule 23.1 and the demand
doctrine. 51
As I will suggest below, I believe that dual-natured claims should be analyzed
differently for purposes of Rule 23.1 than for purposes of what happens to them in a
merger. At present, in terms of the first prong of Tooley, it is enough to note that the
injury from the Fall Dropdown affected both El Paso MLP and the non-participating
limited partners. The Fall Dropdown superficially left the Partnership $171 million
poorer, but it actually enriched the General Partner at the expense of the limited partners
by reallocating $78.66 million from the limited partners to the General Partner. Those are
distinct injuries, and the answer to Tooley‘s first question is therefore ―both.‖
2. The Second Prong Of Tooley
Adapted to a limited partnership, the second prong of Tooley asks who would
receive the benefit of any recovery or other remedy, the partnership or the limited
51
See, e.g., supra note 2; Del. Cty. Empls. Ret. Fund v. Sanchez, --- A.3d ---, 2015
WL 5766264, at *1-2 (Del. Oct. 2, 2015) (characterizing a claim of ―gross overpayment‖
by company as derivative for purposes of Rule 23.1); In re J.P. Morgan Chase & Co.
S’holder Litig., 906 A.2d 766, 768 (Del. 2006) (affirming dismissal of overpayment
claim involving stock as derivative for purposes of Rule 23.1); In re Paxson Commc’n
Corp. S’holders Litig., 2001 WL 812028, at *5 (Del. Ch. July 12, 2001) (characterizing
challenge to stock issuance as derivative for purposes of Rule 23.1).
71
partners individually? Just as the injury in this case operated at both the entity and the
investor levels, so can the remedy.
As with the nature of the injury, the entity-level remedy is the most obvious. As
long as El Paso MLP continued to exist as a separate legal entity, the harm that resulted
from the General Partner‘s extraction of $171 million from El Paso MLP could be
remedied by having the General Partner pay $171 million to El Paso MLP. The payment
of $171 million to El Paso MLP parallels the remedy for a third party transfer and fixes
the harm by returning the full amount to the entity.
Because of the dual nature of the injury, however, the entity-level remedy is not
the only option. The General Partner could pay $78.66 million to the unaffiliated limited
partners. That remedy focuses on the extraction of value from unaffiliated limited
partners, but fixes the overall harm by recasting the transaction as one in which all
partners receive pro rata treatment.52
52
See, e.g., Iroquois Master Fund Ltd. v. Answers Corp., 105 A.3d 989, 989 n.1
(Del. 2014) (TABLE) (―When a large stockholder . . . receives the same per share
consideration as every other stockholder, that is ordinarily evidence of fairness, not of the
opposite . . . .‖); Sinclair Oil Corp. v. Levien, 280 A.2d 717, 721-22 (Del. 1971) (holding
that although a parent corporation caused its subsidiary corporation to pay a dividend, the
dividend did not constitute self-dealing because minority stockholders received their
proportionate share); In re Morton’s Rest. Gp., Inc. S’holders Litig., 74 A.3d 656, 662
(Del. Ch. 2013) (Strine, C.) (―When a large stockholder . . . spreads the transactional
consideration ratably across all stockholders, Delaware law does not regard that as a
conflict transaction.‖); In re Synthes, Inc. S’holder Litig., 50 A.3d 1022, 1040 (Del. Ch.
2012) (Strine, C.) (―[W]hen a controlling stockholder . . . shares its control premium
evenly with the minority stockholders, courts typically view that as a ‗powerfu[l]‘
indication ‗that the price received was fair.‘‖ (quoting Cinerama, Inc. v. Technicolor,
Inc., 663 A.2d 1134, 1143 (Del. Ch. 1994), aff’d, 663 A.2d 1156 (Del. 1995))).
72
As with the analysis of the injury under Tooley, Delaware cases have recognized
the availability of alternative remedies when dealing with insider transfers involving
stock. When an insider has received too many shares for too little consideration, our
decisions recognize that the harm can be addressed at either the entity level or the
stockholder level. One remedy, of course, is to require the defendant to pay more to the
corporation, fixing the underpayment by requiring a greater investment. This remedy
parallels the possibility of having the General Partner repay $171 million to El Paso MLP
in this case. But other remedies in stock dilution cases operate at the stockholder level,
without any payment to the corporation, such as an order adjusting the rights of the stock
or invalidating a portion of the shares.53
In my view, the answer to the second prong of Tooley is similar to the first. Just as
the answer to the first question was ―both,‖ the answer to the second question is ―either.‖
3. The Conclusion Under Tooley And Its Implications
Given the foregoing analysis under Tooley, the claim that gave rise to the Liability
Award has a dual nature. Under current Delaware law, that means a plaintiff can pursue
53
Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 656-57 (Del. Ch. 2013)
(explaining that a ―remedy could operate at the stockholder level, without any payment to
the corporation, by adjusting the rights of the stock or invalidating a portion of the
shares‖); see also In re Loral Space & Commc’ns Inc., 2008 WL 4293781, at *32 (Del.
Ch. Sept. 19, 2008) (reforming securities purchase agreement to convert preferred stock
into non-voting common stock), aff’d sub nom. Loral Space & Commc’ns, Inc. v.
Highland Crusader Offshore P’rs, L.P., 977 A.2d 867 (Del. 2009); Linton v. Everett,
1997 WL 441189, at *7 (Del. Ch. July 31, 1997) (invalidating shares that directors issued
to themselves for inadequate consideration).
73
the claim directly or derivatively. See Loral, 977 A.2d at 868. Brinckerhoff therefore can
continue to sue for breach of the LP Agreement, and this court can implement the
Liability Award through a pro rata recovery.
Although that holding is sufficient for purposes of this case, I believe that the
treatment of dual-natured claims is one area where further jurisprudential development is
warranted. In my view, Delaware law should not have two strains of cases that
characterize similar injuries differently. Instead, Delaware law should distinguish openly
between (i) how it treats dual-natured claims for purposes of Rule 23.1, demand, and
other doctrines relevant to an on-going entity, and (ii) how it treats dual-natured claims
for purposes of standing after a merger or other situation where the separate existence of
the entity has terminated. The two situations implicate different policy considerations and
should be treated differently. Acknowledging the difference removes the tension between
the Gentile/Tri-Star line of authority and other decisions that have treated similar claims
as derivative for purposes of Rule 23.1.
When considering how a dual-natured claim should be treated for purposes of
Rule 23.1 and other doctrines that protect the board‘s central role in overseeing the
business and affairs of the corporation, Delaware law can and should prioritize the
derivative aspects of the claim. Classifying the claim as derivative for purposes of this
stage of the litigation serves the policy goal of screening for meritless claims through a
combination of the demand doctrine and the heightened pleading standards of Rule 23.1.
These standards weed out weak claims while permitting strong claims involving breaches
of the duty of loyalty to survive. Treating a dual-natured claim as derivative during this
74
stage also serves the pragmatic goal of ensuring that ―injury to a whole association [of
investors] is adjudicated on behalf of that whole and not just for the benefit of the
individuals who have undertaken to pursue the claims.‖ In re Cencom Cable Income
Partners, L.P., 2000 WL 130629, at *4 (Del. Ch. Jan. 27, 2000).
When considering how a dual-natured claim should be treated for purposes of
whether it can be maintained after a merger, Delaware law can and should prioritize the
individual aspects of the claim. The policies supporting a derivative characterization no
longer apply once the separate legal existence of the represented entity has terminated.
There is no need to screen again for weak claims, because the Rule 23.1 analysis already
has served that purpose. Nor is there a continuing need for the entity to play its pragmatic
role as a collection agent. In a merger, at the singularity of the effective time, the
identities of the investors on whose indirect behalf the derivative action was being
pursued become forever fixed. See Brinckerhoff v. Tex. E. Prods. Pipeline Co., 986 A.2d
370, 383 (Del. Ch. 2010). The constituent entities know the identities of those investors
because they send them the merger consideration. From that point on, a dual-natured
claim ―should be seen for what [it is], a form of class action.‖ Parfi Hldg. AB v. Mirror
Image Internet, 954 A.2d 911, 940 (Del. Ch. 2008) (Strine, V.C.).
There is also another public policy consideration: accountability. ―The equitable
standing of a stockholder to bring a derivative action on behalf of a corporation has long
been grounded upon the interests of justice.‖ Schoon v. Smith, 953 A.2d 196, 201 (Del.
2008). ―It is important for shareholders to bring derivative suits because these suits, filed
after the alleged wrongdoing, operate as an ex post check on corporate behavior.‖
75
Seinfeld v. Coker, 847 A.2d 330, 333 (Del. Ch. 2000). For purely derivative claims,
however, the rule from Lewis v. Anderson causes the closing of a triangular merger to
extinguish stockholder standing universally, regardless of the claims‘ merit.
If derivative actions promote firm value, even marginally, then a rule that
forecloses some number of both meritorious and meritless derivative
actions will, all things being equal, inherently transfer some degree of
wealth from corporations to the individuals who commit corporate wrongs.
The resulting wealth transfer confers a windfall on faithless fiduciaries and
creates perverse incentives for misbehavior.
Hamilton P’rs, L.P. v. Englard, 11 A.3d 1180, 1206 (Del. Ch. 2010). At the same time,
the risk that a plaintiff will invest resources in a viable claim only to lose standing
through a merger disincentivizes stockholders from engaging in monitoring under
circumstances where it is already ―likely that in a public corporation there will be less
shareholder monitoring expenditures than would be optimum from the point of [view of]
the shareholders as a collectivity.‖ Bird v. Lida, Inc., 681 A.2d 399, 403 (Del. Ch. 1996)
(Allen, C.).
If the merger consideration compensated stockholders for lost derivative claims,
then the wealth transfer would not exist and the windfall would not be a problem. But a
related-party acquirer will not pay for the opportunity to recover from itself. That
certainly was the case here, where the Proxy Statement recognizes that Merger
consideration did not include any value for the claim that resulted in the Liability Award.
Moreover, to the extent the related-party acquirer purports to price a claim against itself
as part of the merger consideration, its judgment is self-interested and unreliable: ―[T]he
law, sensitive to the weakness of human nature and alert to the ever-present inclination to
76
rationalize as right that which is merely beneficial, will accord scant weight to the
subjective judgment of an interested director concerning the fairness of transactions that
benefit[] him.‖ Merritt v. Colonial Foods, Inc., 505 A.2d 757, 765 (Del. Ch. 1986)
(Allen, C.); accord Gottlieb v. Heyden Chem. Corp., 90 A.2d 660, 663 (Del. 1952)
(―Human nature being what it is, the law, in its wisdom, does not presume that directors
will be competent judges of the fair treatment of their company where fairness must be at
their own personal expense.‖). For a dual-natured claim, the Gentile/Tri-Star approach
provides a straightforward method for investors to continue to litigate only the disputed
portion of value of the merger. The investors thereby receive a definitive answer from a
court as to that element of the bundle of rights associated with their investment.
The principal alternative to the Gentile/Tri-Star approach is to treat the claims as
derivative, then permit investors to file a new, secondary lawsuit challenging the merger
that extinguished the stockholders‘ standing for failing to value those causes of action. In
Merritt, Chancellor Allen followed that path for a related-party merger. Subsequently, the
Delaware Supreme Court appeared to endorse that concept for mergers generally. See
Parnes v. Bally Entm’t Corp., 722 A.2d 1243, 1244-46 (Del. 1999). Since Parnes, a
number of Delaware decisions have addressed secondary lawsuits of this type.54
54
See, e.g., In re Primedia, Inc. S’holder Litig., 67 A.3d 455, 477-90 (Del. Ch.
2013) (denying motion to dismiss secondary challenge to merger based on extinction of
standing to litigate pending derivative claim); In re Massey Energy Co., 2011 WL
2176479, at *2-4 (Del. Ch. May 31, 2011) (Strine, V.C.) (considering secondary action in
which plaintiffs challenged merger because it would extinguish their standing to litigate
pending derivative claim; denying preliminary injunction to enjoin transaction); Kohls v.
77
It might be that for true derivative claims, there is no alternative to the lengthier
and indirect route of a secondary lawsuit challenging the merger. For dual-natured
claims, however, the Gentile/Tri-Star approach is superior. To my mind, it better reflects
the economic realities of a merger, and it results in a more efficient litigation framework.
From the standpoint of economic realism, the Gentile/Tri-Star framework
appropriately recognizes that a related-party acquirer does not pay for the right to recover
from itself, as was admittedly the case here. Third-party acquirers don‘t pay for
derivative claims against sell-side management either.
For purposes of evaluating this proposition, it is helpful to divide the litigation
assets that an acquirer might purchase and assert into two categories: (i) external claims
against third parties, such as contract claims, tort claims, and similar causes of action
(―External Claims‖) and (ii) internal claims against sell-side managers (―Internal
Claims‖), such as the claim that gave rise to the Liability Award. 55 There is no reason to
think either that the acquirer would not determine disinterestedly whether to assert the
External Claims or that the merger price would not incorporate an assessment of the
Duthie, 765 A.2d 1274, 1284-85 (Del. Ch. 2000) (same; noting that Court previously
denied motion to dismiss the merger challenge); see also Brinckerhoff, 986 A.2d at 386-
96 (assessing strength of derivative claims for which standing was extinguished by
merger when evaluating fairness of settlement); In re Countrywide Corp. S’holders Litig.,
2009 WL 846019, at *8 (Del. Ch. Mar. 31, 2009) (same).
55
See Primedia, 67 A.3d at 483-84; Note, Survival of Rights of Action After
Corporate Merger, 78 Mich. L. Rev. 250, 263-70 (1979) [hereinafter Survival of Rights].
78
value of those claims.56 By contrast, there is ample reason to think that an acquirer would
never assert, and therefore would not pay for, Internal Claims.57 ―Acquirers buy
businesses, not claims,‖ and ―[m]erger-related financial analyses focus on the business,
not on fiduciary duty litigation.‖ Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 664
(Del. Ch. 2013). There are also human dynamics at work that make suits against sell-side
managers improbable:
The acquiring company has just purchased the target company in a process
run by the same directors and officers who the acquiring corporation would
be suing. Would the deal have happened if the directors and officers
thought they would face a suit from the buyer? For companies who
regularly make acquisitions, a reputation for pursuing claims against sell-
side fiduciaries would not help their business model. Moreover, directors of
the acquired corporation may join the combined entity‘s board, and senior
officers of the acquired company may become part of the ongoing
management team. Those individuals would become defendants in the
acquirer's lawsuit.
Id. And there are legal impediments. The acquirer may have agreed contractually as part
of the deal documents not to sue the sell-side managers.58 More likely, the acquirer will
have committed to maintain the sell-side managers broad indemnification and
56
See Primedia, 67 A.3d at 483-84; Survival of Rights, supra, at 263-66.
57
Golaine v. Edwards, 1999 WL 1271882, at *5 (Del. Ch. Dec. 21, 1999) (Strine,
V.C.) (noting that such claims ―usually die as a matter of fact‖); Penn Mart Realty Co. v.
Perelman, 1987 WL 10018, at *2 (Del. Ch. Apr. 15, 1987) (―I agree that it is highly
unlikely that Pantry Pride, which now controls Revlon, will seek to redress the allegedly
excessive severance payments or allegedly excessive fees and therefore these abuses (if
they are abuses) are not likely to be addressed.‖).
58
See Golaine, 1999 WL 1271882, at *4 (noting the acquirer could give up the
right to sue ―in the merger agreement‖); Bershad v. Hartz, 1987 WL 6092, at *3 (Del.
Ch. Jan. 29, 1987) (same).
79
advancement rights or provide even broader third party rights.59 An acquirer who sued
would foot the bill for both sides, making litigation economically unattractive.
Given these factors, the premise that Internal Claims should transfer to the
acquirer in a merger because the acquirer has paid for them is a counter-factual fiction.
The acquirer has paid for and should receive External Claims. The acquirer has not paid
for and will not assert the Internal Claims. The acquirer is most likely to treat any
pending Internal Claims against the sell-side managers ―as done‖ and focus instead on
―mov[ing] forward‖ with the business. Massey Energy, 2011 WL 2176479, at *26 n.173.
As a result, those claims ―usually die as a matter of fact.‖ Golaine, 1999 WL 1271882, at
*4.
The Gentile/Tri-Star framework also appropriately realizes that as between the
sell-side stockholders and the acquirer, the equities favor channeling any recovery from
the Internal Claims to the sell-side stockholders. A line of cases culminating in the United
States Supreme Court‘s decision in Bangor Punta recognizes this point. See Bangor
Punta Operations v. Bangor & A. R. Co., 417 U.S. 703 (1974). There, the United States
Supreme Court reasoned that when sell-side managers had extracted excessive value
59
See, e.g., Homestore, Inc. v. Tafeen, 888 A.2d 204, 212 (Del. 2005)
(―[M]andatory advancement provisions are set forth in a great many corporate charters,
bylaws and indemnification agreements.‖); La. Mun. Police Empls.’ Ret. Sys. v.
Crawford, 918 A.2d 1172, 1179-80, 1180 n.8 (Del. Ch. 2007) (noting arms‘ length, third
party stock-for-stock merger agreement provided significant protections for directors and
officers of acquired company who were defendants in then-pending derivative actions,
including direct contractual indemnification from the acquirer).
80
from their business before the acquisition, they depressed the value of the business, so the
acquirer ended up paying less to buy it. Having purchased the business for less, the
acquirer got what it paid for. The acquirer therefore had no equitable right to sue the sell-
side managers, recoup a portion of its purchase price, and effectively re-trade the deal. Id.
at 710-11. Notably, under Bangor Punta and its predecessors, this rule applied to the
acquirer both as the owner of the new business and to the extent the acquirer sought to
have the business assert the claim itself.60 At the same time, the Bangor Punta doctrine
did not leave the acquirer without remedies. If the acquirer believed it bought a lemon or
was otherwise aggrieved by its deal, it could sue in contract under its acquisition
agreement or, in an extreme case, for fraud. The only thing the acquirer could not do was
assert what had been sell-side Internal Claims.
To illustrate this concept, recall our example of the Delaware corporation with an
intrinsic value of $1 billion. Assume that the controller caused the corporation to pay
$300 million for the expansion-stage company that was legitimately worth $200 million.
Given that the purchasing corporation was harmed by $100 million, an arms‘ length
acquirer should only pay $900 million for the entity. In the resulting transaction, the
60
Id. at 713; see also Midland Food Servs., LLC, v. Castle Hill Hldgs. V, LLC, 792
A.2d 920, 929-35 (Del. Ch. 1999) (Strine, V.C.) (explaining and applying the Bangor
Punta doctrine); Golaine, 1999 WL 1271882, at *4 n.16 (―Depending on the
circumstances, the new acquiror may be barred from causing the target corporation [to
sue its former fiduciaries] under . . . the [Bangor Punta] doctrine.‖); Courtland Manor,
Inc. v. Leeds, 347 A.2d 144, 147 (Del. Ch. 1975) (same). But see Lewis v. Anderson, 477
A.2d 1040, 1050-51 (Del. 1984) (declining to apply Bangor Punta).
81
acquirer gets what it paid for: a business worth $900 million. The parties that suffered
harm from this combination of transactions are the sell-side minority stockholders. They
are the parties from whom the controller extracted $40 million through the interested sale
of the expansion-stage company. In this setting, the Bangor Punta doctrine bars the
acquirer from re-trading its deal under the guise of having the acquired corporation assert
an entity-level claim against the controller. Under Gentile and Tri-Star, the claim for
expropriation has a dual nature, so it properly remains with the injured sell-side
stockholders, who can continue to maintain their suit against the sell-side controller. For
dual-natured claims, the Gentile/Tri-Star approach operates in harmony with a faithful
application of the Bangor Punta doctrine. Because of Gentile/Tri-Star, the sell-side
investors can continue to pursue their dual-natured claims post-merger. Because of the
Bangor Punta doctrine, the acquirer and the acquired entity cannot assert similar claims.
The Gentile/Tri-Star approach also has significant practical advantages. First, it
avoids ―the graceless creature of a suit within a suit,‖ which a secondary action
challenging the merger necessarily generates. Merritt v. Colonial Foods, Inc., 505 A.2d
757, 766 (Del. Ch. 1986) (Allen, C.). Under the Parnes/Merritt approach, rather than
having the original parties continue to litigate the underlying action and obtain an answer
to the claim that was properly at issue in that lawsuit, the investor plaintiffs must start
over and litigate those issues indirectly in the guise of a secondary action challenging the
merger. That process often involves expert testimony about what might have happened if
the original action had continued. Rather than speculating about what might have
happened if the original action had continued, it seems more efficient to allow the
82
original action to continue. For dual-natured claims, the Gentile/Tri-Star framework
adopts this more straightforward approach.
Second, the Parnes/Merritt approach expands the scope of the litigation and
introduces additional and unnecessary transaction costs. Because the secondary lawsuit
challenges the merger, it no longer focuses only on the Internal Claim that was being
pursued pre-merger. The secondary lawsuit opens up to discovery and eventual judicial
scrutiny the merger as a whole and the process leading up to it. Areas of discovery and
legal issues that might never have been litigated in the original action now must be
litigated as part of the secondary claim. If no one legitimately disputes the value that the
transaction placed on the operating business, then the expanded litigation is wasteful and
unnecessary. Here, for example, Brinckerhoff does not currently challenge the
consideration provided in the Merger to the extent it valued El Paso MLP‘s operating
business. At present, Brinckerhoff only objects to the fact that he received no value for
the Liability Award. It seems wasteful and unnecessary to start a new and more
expansive lawsuit just so Brinckerhoff could litigate indirectly the same claim that
already has been tried. The Gentile/Tri-Star approach enables the investor-plaintiffs to
continue litigating the narrow claim they originally pursued without having to expand
their litigation into a broader and potentially unnecessary inquiry into other aspects of the
merger.
83
Third, the fact that the secondary action focuses on the adequacy of the merger
consideration introduces a potential defense that also must be litigated: the argument that
the potential recovery on the extinguished claim is immaterial and should be ignored.61 In
addition to making the secondary litigation more complex, this defense potentially
insulates insider transfers that may divert significant wealth from investors. The standard
for materiality varies, but in a large deal priced in the billions, a materiality-based
exclusion can encompass quite a bit.
The current case provides an example of how materiality can be raised as a
defense to insulate potentially large insider transfers from challenge. The General Partner
already has suggested that the $171 million Liability Award was not material in the
context of the $6 billion Merger. Brinckerhoff disagrees, but the General Partner‘s
position on materiality is not a frivolous one. Personally, I believe Brinkerhoff has the
stronger of the argument, because the pro rata value of the Liability Award, plus interest,
approximates 2.8% of the value of the Merger consideration that the unaffiliated holders
of common units received. Then-Chancellor Strine‘s approval of a settlement in litigation
challenging Kinder Morgan‘s acquisition of El Paso Parent supports Brinckerhoff‘s
61
Compare Massey Energy, 2011 WL 2176479, at *29 (noting that the court was
unable to conclude, after reviewing an extensive evidentiary record, that it was ―probable
that the Derivative Claims have a value that is material in relation to the value of Massey
as an entity‖) with Primedia, 910 A.3d at 259 (concluding for purposes of a motion to
dismiss that it was reasonably conceivable that the value of a derivative claim for which
standing had been extinguished in a merger was material in the context of what the
minority stockholders received).
84
position. There, the Chief Justice regarded a cash settlement payment equal to
approximately one-half of one percent of the merger consideration as ―a very large
monetary settlement,‖ ―a very substantial achievement for the class,‖ ―real money,‖ and a
―very good settlement for the class.‖62 The value of the $171 million Liability Award also
ranks as one of the largest aggregate recoveries that investors have obtained from the
Court of Chancery.63 Nevertheless, the fact that the General Partner can argue that the
Liability Award should be disregarded as immaterial illustrates the magnitude of self-
dealing that the Parnes/Merritt approach could permit.
In my view, the Delaware Supreme Court‘s decisions in Gentile and Tri-Star
appropriately balance the various equitable and practical considerations by permitting a
62
See Transcript of Settlement Hearing at 36-37, 39-40, In re El Paso Corp.
S'holder Litig., C.A. No. 6949-CS (Del. Ch. Dec. 3, 2012). I learned of this ruling from a
scholarly and insightful article that examines how the rule of Lewis v. Anderson
extinguishes potentially valuable claims and argues for a different approach. See S.
Michael Sirkin, Standing at the Singularity of the Effective Time: Reconfiguring
Delaware’s Law of Standing Following Mergers and Acquisitions, 69 Bus. Law 429, 447
(2014). I agree with the article‘s diagnosis of the patient, but part ways with aspects of
the treatment that it prescribes. At the risk of oversimplification, the article proposes that
Delaware law embrace Parnes/Merritt and rely on secondary actions challenging mergers
as a means of preserving the value of lost derivative claims. For the reasons set forth in
the text, and at least for dual-natured claims, I regard that route as a second-best
alternative to Gentile/Tri-Star.
63
See Tom Hals, Delaware Judge Hits El Paso Pipeline Deal with $171 Mln
Judgment, Reuters (Apr. 20, 2015), http://reut.rs/1El3J2a; see also Bradley R. Aronstam
& S. Michael Sirkin, Post-Closing Litigation Risk in M&A Actions, INSIGHTS, May
2012, at 9; Kevin LaCroix, Largest Derivative Lawsuit Settlements, The D&O Diary
(Dec. 5, 2014), http://www.dandodiary.com/2014/12/articles/shareholders-derivative-
litigation/largest-derivative-lawsuit-settlements/.
85
limited category of claims with some derivative characteristics to continue to be litigated
as direct claims following a merger. Those claims involve insider transfers that
traditionally implicate the duty of loyalty where the cost of extinguishing the plaintiffs‘
standing to sue is high. At the same time, the Gentile/Tri-Star approach preserves the
general rule of Lewis v. Anderson, which is particularly appropriate for External Claims.
Although I personally think that the Gentile/Tri-Star framework correctly
perceives the dual nature of cases involving insider transfers, I believe that the
implications of that analysis should be limited to the question of whether a stockholder
can continue to litigate a dual-nature claim after a merger or similar transaction that
otherwise would extinguish the plaintiffs‘ standing to sue. Once so limited, the
Gentile/Tri-Star analysis need not seep back to undermine the policies served by the
demand doctrine and Rule 23.1.
In the current case, for as long as El Paso MLP retained its separate legal
existence, it was preferable for the action to proceed in the name of El Paso MLP and for
any remedy to run through El Paso MLP. Now that El Paso MLP no longer exists as a
separate entity, the possibility of remedying the situation through a payment to the entity
no longer exists. In my view, that does not mean that the harm no longer exists or that a
remedy is no longer warranted. The Proxy Statement admits that the consideration that
holders of common units received in the Merger did not incorporate any value for this
litigation. Under the circumstances, it does not seem logical or equitable to disregard the
Liability Award, dismiss this action, and invite the plaintiff potentially to start all over
again by challenging the Merger. Rather, it seems to me that the remedy should be
86
implemented differently. I believe that the direct aspects of the remaining breach of
contract claim should enable the unaffiliated limited partners to receive their pro rata
share of the Liability Award.
C. Third Order Analysis: Estoppel
So far, the decision has concluded for two separate reasons that the Merger did not
extinguish Brinckerhoff‘s standing to enforce the Liability Award. First, if the General
Partner is correct about the court having to characterize the claim as either direct or
derivative, then the claim is a direct claim for breach of contract. Second, if the Tooley
test applies, then the claim has dual attributes that enable Brinckerhoff to continue to
pursue it notwithstanding the Merger. Anticipating these conclusions, the General Partner
argues that Brinckerhoff should be estopped from contending that his lawsuit is anything
other than derivative.
The General Partner does not clearly articulate which species of estoppel
ostensibly applies. In substance, the General Partner argues that it justifiably relied on
Brinckerhoff‘s characterization of his claim and suffered prejudice as a result. One can
safely assume that estoppel requires some form of representation (or promise) plus
prejudicial reliance.64 Here, neither is present.
64
See Haveg Corp. v. Guyer, 226 A.2d 231, 236-37 (Del. 1967) (describing
promissory estoppel in terms of a promise plus reasonable reliance on it); Wilson v. Am.
Ins., 209 A.2d 902, 903-04 (Del. 1965) (describing equitable estoppel in the form of
conduct suggesting a certain state of facts on which another reasonably relied to his
detriment); Norman v. Paco Pharm. Servs., Inc., 1992 WL 301362, at *4 (Del. Ch. Oct.
21, 1992) (framing alternative formulations of judicial estoppel as encompassing a
87
1. No Reliance Interest In Brinckerhoff’s Characterizations
For starters, estoppel requires that a party have justifiably relied on some conduct
or representation by another party. It is true that Brinckerhoff originally labeled his claim
as derivative in his Complaint and did not waiver from a derivative characterization until
Kinder Morgan announced the Merger. He also sought an entity-level remedy in his
Complaint, continued to frame the injury as one to El Paso MLP during discovery and in
his expert report, and described the injury in those terms at trial. For purposes of estoppel,
however, the General Partner lacked any reliance interest in Brinckerhoff‘s
characterizations, because Delaware law makes clear that they are not binding on the
court.
Brinckerhoff‘s characterization of his claim as derivative in his Complaint did not
give rise to any reliance interest on the part of the General Partner. ―To determine
whether a complaint states a derivative or an individual cause of action, [a court] must
look to the nature of the wrongs . . . , not to the plaintiff‘s designation or stated
intention.‖ Lipton v. News Int’l, Plc, 514 A.2d 1075, 1078 (Del. 1986). The court is ―not
bound by the designation employed by the plaintiff.‖65 In light of these legal principles,
representation to the court together with either detrimental reliance by the other party or a
ruling from the court based on the prior representation).
65
Anglo Am. Sec. Fund LP v. S.R. Glob. Int’l Fund, L.P., 829 A.2d 143 (Del. Ch.
2003); see also Moran v. Household Int’l, Inc., 490 A.2d 1059, 1069-70 (Del. Ch. 1985);
accord In re Cencom Cable Income P’rs, L.P. Litig., 2000 WL 130629, at *3 (Del. Ch.
Jan. 27, 2000).
88
the General Partner could not have reasonably relied on Brinckerhoff‘s characterization
of his claim.
The same is true for Brinckerhoff‘s proposed remedy. This court has ―broad
discretion to tailor a remedy to suit the situation as it exists.‖ Gilliland v. Motorola, Inc.,
873 A.2d 305, 312 (Del. Ch. 2005). The ―protean power of equity‖ allows a court to
―fashion appropriate relief,‖ and a court ―will, in shaping appropriate relief, not be
limited by the relief requested by plaintiff.‖ Texas Instruments Inc. v. Tandy Corp., 1992
WL 103772, at *6 (Del. Ch. May 12, 1992) (Allen, C.). ―Unlike its extinct English
ancestor, the High Court of Chancery of Great Britain, Delaware‘s Court of Chancery has
never become so bound by procedural technicalities and restrictive legal doctrines that it
has failed the fundamental purpose of an equity court—to provide relief suited to the
circumstances when no other remedy is available at law.‖ William T. Quillen & Michael
Hanrahan, A Short History of the Delaware Court of Chancery: 1792-1992, in Court of
Chancery of the State of Delaware: 1792-1992 21, 22 (1992).
―When equity takes jurisdiction of a cause and decides that relief shall be granted,
the relief, including damages, if any, will be tailored to suit the situation as it exists on the
date the relief is granted and the choice of relief is largely a matter of discretion with the
trial judge.‖ Guarantee Bank v. Magness Constr. Co., 462 A.2d 405, 409 (Del. 1983)
(holding that the Court of Chancery did not err in awarding a remedy that diverged from
the parties‘ stipulated facts).
Fundamentally, once a right to relief in Chancery has been determined to
exist, the powers of the Court are broad and the means flexible to shape and
adjust the precise relief to be granted so as to enforce particular rights and
89
liabilities legitimately connected with the subject matter of the action. It is
necessary for the Court to adapt the relief granted to the requirements of the
case so as to give to the parties that to which they are entitled.
Wilmont Homes, Inc. v. Weiler, 202 A.2d 576, 580 (Del. 1964) (citations omitted). ―The
choice of relief to be accorded a prevailing plaintiff in equity is largely a matter of
discretion with the Chancellor, and Delaware, with its long history of common law equity
jurisprudence, has followed that tradition.‖ Lynch v. Vickers Energy Corp., 429 A.2d 497,
500 (Del. 1981) (citations omitted), overruled on other grounds, Weinberger v. UOP,
Inc., 457 A.2d 701 (Del. 1983). Because the court, not the plaintiff, shapes the remedy,
the General Partner could not have reasonably relied on Brinckerhoff‘s characterization
of the appropriate remedy.
2. No Prejudice From A Remedy That Could Be Awarded In A
Derivative Action
Next, estoppel requires that the party asserting it have suffered some prejudice.
Inherent in the General Partner‘s claim of prejudice is the notion that a derivative cause
of action can never support a pro rata recovery, such that a pro rata recovery in this case
prejudices the General Partner. It is certainly true that the recovery in a derivative action
generally goes to the entity,66 but that rule is not absolute.67 As treatise authors68 and
66
See, e.g., 13 Fletcher Cyclopedia of Corporations § 6028, at 323 (rev. ed. 2013)
(―Any recovery in a derivative proceeding generally belongs to the corporation and not to
the plaintiffs or other shareholders.‖); Robert C. Clark, Corporation Law § 15.1, at 639
(1986) (―Ordinarily . . . any damages recovered in the suit are paid to the corporation.‖).
67
Eshelman v. Keenan, 194 A. 40, 43 (Del. Ch. 1937) (Wolcott, C.) (endorsing
and applying general rule of an entity-level recovery where a derivative claim is brought
90
on behalf of a profitable corporation operating as a going concern, but positing that
circumstances could support a pro rata recovery, such as if ―the corporation had ceased
to operate, its controlling stockholder had converted all of its assets and it was denuded of
all of its property‖), aff’d, 2 A.2d 904, 912 (Del. 1938) (affirming general rule of entity-
level recovery while allowing for possibility of pro rata recovery in ―exceptional cases‖);
see also In re Cencom Cable Income P’rs, L.P. Litig., 2000 WL 130629, at *1-3 (Del.
Ch. Jan. 27, 2000) (permitting individual recovery by limited partner where partnership
had dissolved and ―superimposing derivative pleading requirements upon claims
needlessly delays ultimate substantive resolution and serves no useful or meaningful
public policy purpose‖); Fischer v. Fischer, 1999 WL 1032768, at *1, 3 (Del. Ch. Nov. 4,
1999) (permitting individual recovery on overpayment claim and waste claim where
defendants were also stockholders such that an entity-level recovery would put the
plaintiff in the ―awkward position‖ of requesting relief that would benefit the
defendants); In re Gaylord Container Corp. S’holders Litig., 747 A.2d 71, 82 (Del. Ch.
1999) (Strine, V.C.) (recognizing that the adoption of a rights plan would affect different
types of stockholders differently and suggesting that characterizing the claim as
derivative could prevent the stockholders who were also defendants from benefitting
from their wrongdoing by ―awarding relief to the class of innocent stockholders‖); Boyer
v. Wilm. Mat’ls, Inc., 754 A.2d 881, 903 (Del. Ch. 1999) (permitting individual recovery
where majority stockholders purchased corporate assets for inadequate consideration and
continued business to exclusion of minority stockholder). See generally Heyman &
Enerio, supra, at 178-85 (discussing implications of Delaware cases that contemplated
individual recoveries on claims traditionally viewed as derivative).
68
See, e.g., Henry Winthrop Ballantine, Ballantine on Corporations § 143, at 336
(Rev. ed. 1946) (―In certain situations recovery may be allowed by the plaintiff of his
individual damages in a representative suit on a corporate right of action in lieu of the
corporate recovery.‖); 3A Fletcher, supra, § 1342, at 577 (―The decree may, in a proper
case, order payment directly to the complaining shareholder or creditor, but ordinarily,
where the right to recover is as the representative of the corporation, the damages should
be ordered paid to the corporation.‖); Ernest L. Folk, III, The Delaware General
Corporation Law: A Commentary and Analysis 455 (1972) (―It is true that ‗exceptional
cases‘ may arise where it is equitable to enforce recovery against the wrongdoing
defendants ‗in an amount sufficient to satisfy non-assenting stockholders measured by
their stockholdings.‘‖ (quoting Keenan v. Eshelman, 2 A.2d 904 (Del. 1938))); William J.
Grange, Corporation Law for Officers and Directors 328-29 (5th ed. 1946) (―[I]n some
exceptional cases, . . . the court may order the money or property recovered distributed
directly to the stockholders in proportion to their holdings.‖); 2 George D. Hornstein,
Corporation Law & Practice § 602, at 101 (1959) (citing examples where court gave an
individual recovery to stockholders on a derivative claim and concluding that ―[t]he
91
commentators69 have noted, courts will grant pro rata recovery where the equities
demand it. Indeed, one of the earliest English cases to recognize the viability of a
moral to be drawn from these exceptions to the general rule is that treatment of the
corporation as a separate legal entity will not be permitted if it will interfere with the
court‘s doing justice to human beings‖); Christine Rohrlich, Law and Practice in
Corporate Control 146-47 (1933) (―Under exceptional circumstances the plaintiffs may
receive directly their proportionate interest in any recovery which would ordinarily go to
the corporation.‖); Robert S. Stevens, Handbook on the Law of Private Corporations
§ 162, at 662 (1936) (―The third class of cases in which a shareholder may recover his
individual loss includes those . . . though the injury is one which may be termed
corporate, the courts have, in fixing the amount of recovery, looked at the realities of the
corporate structure, and have protected those shareholders who have been actually injured
and were deserving of reimbursement.‖); 6 Seymour D. Thompson & Joseph W.
Thompson, Commentaries on the Law of Corporations § 4571, at 466 (3d ed. 1927)
(―Where, however, in awarding recovery to the corporation it would result in stockholder
receiving a portion thereof to which he was not entitled, a court of equity may look
beyond the corporation and decree the recovery to those stockholders entitled to it.‖).
69
See, e.g., Richard A. Booth, A Note On Individual Recovery In Derivative Suits,
16 Pepp. L. Rev. 1025, 1025 (1989) (―There have been . . . a few important cases in
which the courts have held that it is the individual shareholders who may recover.‖); Gail
Gutsein, Railroad May Prosecute Corporate Cause of Action, Despite Lack of
Stockholder Injury, to Vindicate Public Interest, 74 Colum. L. Rev. 528, 530 n.11 (1974)
(―This [pro rata] approach, while not unique, is rejected in the vast majority of cases.‖);
Mary Elizabeth Matthews, Derivative Suits and the Similarly Situated Shareholder
Requirement, 8 DePaul Bus. L.J. 1, 1 n.1 (1995) (―[R]ecovery may be awarded to the
shareholders pro rata in limited instances.‖); John W. Welch, Shareholder Individual and
Derivative Actions: Underlying Rationales and the Closely Held Corporation, 9 J. Corp.
L. 147, 181 (1984) (―[I]in a few cases, courts have ordered that the judgment be paid
directly to the shareholders, even while reaffirming the derivative nature of the
proceeding.‖); Barbara E. Bruce, Note, Equitable Principles Applicable To The Issue Of
Standing, 16 B.C. Indus. & Comm. L. Rev. 525, 536 (1974) (―There are a number of
cases where pro-rata recovery has been awarded because the circumstances dictate that to
do otherwise would be inequitable.‖); id. at 1319 (describing the view that individual
relief can never be awarded on a derivative claim as ―overly restrictive‖ but
recommending that ―courts should proceed cautiously in decreeing pro rata recovery‖);
Note, Equitable Considerations in Suits by Corporations Against Former Controlling
Shareholders, 88 Harv. L. Rev. 227, 231 (1974) (―Courts have created exceptions to the
92
derivative claim rejected the contention that an individual recovery would never be
permitted:
If a case should arise of injury to a corporation by some of its members, for
which no adequate remedy remained, except that of a suit by individual
[stockholders] in their private characters, and asking in such character the
protection of those rights to which in their corporate character they were
entitled, I cannot but think that the . . . claims of justice would be found
superior to any difficulties arising out of technical rules respecting the
mode in which corporations are required to sue.
Foss v. Harbottle, 67 Eng. Rep. 189, 202 (Ch. 1843). See generally Raoul Berger,
―Disregarding The Corporate Entity‖ For The Stockholders’ Benefit, 55 Colum. L. Rev.
808 (1955). The rule requiring the corporation to sue and receive the recovery ―must
always yield to the requirements of equity, and is cast aside in view of the fact that the
rule‖ that ―minority shareholders cannot obtain pro rata recovery on a corporate cause of
action.‖); Note, Personal Recovery By Shareholders For Injury To The Corporation, 2 U.
Chi. L. Rev. 317, 321 (1935) [hereinafter Personal Recovery] (―In some
circumstances . . . , courts have granted recovery to a shareholder in lieu of corporate
recovery.‖); Note, Situations Where Pro Rata Recovery Is Granted, 69 Harv. L. Rev.
1314, 1314 (1956) [hereinafter Situations] (―In certain circumstances, however, some
courts have given the recovery in derivative suits to individual stockholders.‖); cf.
Edward J. Grenier, Prorata Recovery by Shareholders on Corporate Causes of Action as
a Means of Achieving Corporate Justice, 19 Wash. & Lee L. Rev. 1165, 1201 (1962)
(―[P]rorata recovery, under certain circumstances, provides a useful and desirable method
for redressing wrongs to the corporation. Through it, the derivative suit is likely to
become a far more refined instrument for achieving corporate justice.‖); William D.
Harrington, Business Associations, 42 Syracuse L. Rev. 299, 339 (1991) (―Justice would
have been better served if the court had adopted the pro rata recovery rule, or at least
taken more trouble to explain why it was rejecting it.‖) Comment, Corporations—
Shareholders’ Derivative and Direct Actions—Individual Recovery, 35 N.C. L. Rev. 279,
284 (1957) [hereinafter Individual Recovery] (―From the above, it can be seen that courts
have refused to be restrained by lack of precedents where inequitable results would be
reached if they followed the general rule [of only permitting an entity-level recovery].‖).
93
stockholders are the real beneficiaries whenever the usual course is not open.‖ Home Fire
Ins. Co. v. Barber, 93 N.W. 1024, 1033 (Neb. 1903) (Pound, C.) (emphasis added).
Because the derivative action is fundamentally an equitable proceeding, the court
has the power to craft a remedy that is appropriate based on the specific facts and equities
of the case.70 For a corporate claim, that most often means a corporate remedy, but not
always. Seeking to generalize from the various precedents, commentators have identified
recurring scenarios that can support an investor-level recovery on an entity-level claim.71
Three have particular salience for this case:
 Cases where the defendants are insiders who misappropriated corporate property
such that an entity-level recovery would return the property to the wrongdoers‘
control.72
70
See Schoon v. Smith, 953 A.2d 196, 201 (Del. 2008) (describing equitable roots
of derivative action); Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 817 A.2d 160,
176 (Del. 2002) (―[T]he Court of Chancery‘s ‗powers are complete to fashion any form
of equitable and monetary relief as may be appropriate.‘‖); Hanby v. Wereschak, 207
A.2d 369, 370 (Del. 1965) (―[T]he Court of Chancery [has] the inherent powers of equity
to adapt its relief to the particular rights and liabilities of each party . . . .‖).
71
Different commentators group the cases differently. See, e.g., 13 Fletcher,
supra, § 6028, at 325 (identifying six recurring fact patterns in which ―[c]ourts have been
willing to award a pro rata recovery to shareholders‖); Grenier, supra, at 167 (identifying
four typical scenarios in which ―prorata recovery on a corporate cause of action has been
decreed); Bruce, supra, at 536 n.79 (identifying ―three fact situations predominantly
involved‖ in opinions where pro rata recovery has been ordered); Individual Recovery,
supra, at 280 (―[I]n at least two general classes of cases, the shareholder has been
allowed to recovery directly.‖); Situations, supra, at 1314 (observing that ―[c]ourts have
decreed pro rata recovery in three principal situations‖).
72
13 Fletcher, supra, § 6028, at 325 (―when the defendants hold a controlling
interest in the corporation‖); Grenier, supra, at 167 (―to protect shareholders from
dissipation of a corporate recovery because of foreseeable future mismanagement by the
94
defendants, who will remain in control of the corporate affairs‖); Bruce, supra, at 536
n.79 (―when the corporate action is against insiders who have appropriated funds in order
to prevent funds disgorged from the wrongdoers from reverting to their control‖);
Individual Recovery, supra, at 280 (noting that where insiders have misappropriated
funds, individual recovery by non-participating stockholders has been allowed);
Situations, supra, at 1314 (―Where the derivative action is against insiders who have
appropriated corporate funds, courts have sometimes decreed individual awards to
prevent the funds disgorged by the wrongdoers from reverting to their control.‖).
For illustrative Delaware cases, see In re Cencom Cable Income P’rs L.P. Litig.,
2000 WL 130629, at *5-6 (Del. Ch. Jan. 27, 2000) (permitting direct challenge to
transaction in which general partner purchased assets of limited partnership, then caused
entity to dissolve); Boyer v. Wilm. Mat’ls, Inc., 754 A.2d 881, 903 (Del. Ch. 1999)
(crediting plaintiff‘s argument that he suffered individual injury and could sue directly
where an insider transfer left the plaintiff ―with his 25% interest in WMI, a worthless
company, while defendants purchased the hot mix plant at an unfair price and simply
continued WMI‘s business at a new location under a new corporate name‖); Fischer v.
Fischer, 1999 WL 1032768, at *1, *3-4 (Del. Ch. Nov. 4, 1999) (permitting individual
recovery where defendants controlled entity, sold key asset to themselves in return for
cash and a note, distributed the cash, and then caused the entity not to pursue recovery on
the note); see also Stevanov v. O’Connor, 2009 WL 1059640 at *6 (Del. Ch. Apr. 21,
2009) (denying motion to dismiss because it was reasonably conceivable that plaintiff
could prove individual injury based on insider transfers). See generally Heyman &
Enerio, supra, at 181-83 (describing a possible ―unjust enrichment exception‖ under
which ―plaintiffs could pursue direct claims, rather than derivative claims, in order to
exclude the defendants from the group of persons entitled to any recovery‖).
For illustrative cases from other jurisdictions, see Perlman v. Feldmann, 219 F.2d
173 (2d Cir. 1955) (awarding individual recovery to minority stockholders where former
controller and principal officer sold his control block in transaction that was held to
constitute a breach of duty and where corporate recovery would result in greater total
liability and permit culpable parties to benefit); Rankin v. Frebank Co., 121 Cal. Rptr.
348 (Cal. Ct. App. 1975) (awarding pro rata recovery in suit involving misappropriation
of corporate opportunity); Holi-Rest, Inc. v. Treloar, 217 N.W.2d 517 (Iowa 1974)
(incorporating individual recovery for minority stockholder into remedy awarded in
derivative action challenging controller‘s extraction of excessive salaries and loans from
corporation as well as other self-dealing transactions); Matthews v. Headley Chocolate
Co., 100 A. 645 (Md. 1917) (awarding pro rata recovery to minority stockholders in
derivative suit where controlling shareholders caused the corporation to pay themselves
excessive salaries, then sold their control block to a new buyer); Di Tomasso v. Loverro,
95
 Cases where an entity-level recovery would benefit ―guilty‖ stockholders, but an
investor-level recovery could be more narrowly tailored to benefit only ―innocent‖
stockholders.73
293 N.Y.S. 912 (N.Y. App. Div. 1937), aff’d, 12 N.E.2d 570 (N.Y. 1937) (per curiam)
(awarding pro rata recovery to minority stockholder after directors conspired with
competition); Alexander v. Quality Leather Goods Corp., 269 N.Y.S. 499 (N.Y. Sup. Ct.
1934) (permitting minority stockholder to recover individually where corporation was
dissolved, all creditors had been paid, and court could identify party who should benefit
from judgment); Joyce v. Congdon, 195 P. 29 (Wash. 1921) (ordering pro rata award to
minority in derivative suit challenging transaction in which corporation purchased stock
with corporate funds then distributed shares to majority holders); see also Jones v. Mo.
Edison Elec. Co., 144 F. 765 (8th Cir. 1906) (explaining that trial court could award pro
rata recovery in self-dealing transaction); Backus v. Finkelstein, 23 F.2d 357 (D. Minn.
1927) (ordering pro rata recovery where the defendants took excessive salaries, kept
inadequate records, and used the corporation‘s credit for their own benefit); Fougeray v.
Cord, 24 A. 499 (N.J. Ch. 1892) (ordering dividend paid to innocent shareholder), rev’d
on other grounds sub nom., Laurel Springs Land Co. v. Fougeray, 26 A. 886 (N.J. 1892)
(directing payment of reasonable dividend); Hyde Park Terrace Co. v. Jackson Bros.
Realty Co., 146 N.Y.S. 1037 (N.Y. App. Div. 1914) (awarding pro rata recovery where
defendants usurped payments directed towards company); Von Au v. Magenheimer, 110
N.Y.S. 629 (N.Y. App. Div. 1908) (permitting individual suit by stockholder where
defendants took excessive salaries, refused to pay dividends, and committed waste as part
of a successful attempt to induce plaintiff to sell shares), aff’d, 89 N.E. 1114 (N.Y. 1909);
Dill v. Johnston, 179 P. 608 (Okla. 1919) (awarding pro rata recovery after majority
stockholder converted assets for personal use); Easton v Robinson, 31 A. 1058 (R.I.
1895) (per curiam) (ordering pro rata recovery where majority stockholders, who were
also directors, voted themselves excessive salaries); Nichols v. Olivia Veneer Co., 246 P.
941 (Wash. 1926) (awarding pro rata distributions when some shareholders received
excessive salaries); Chounis v. Laing, 23 S.E.2d 628 (W. Va. 1942) (awarding pro rata
recovery for dissenting stockholders and not for the stockholders who voted in favor of
challenged transaction); Jenkins v. Bradley, 80 N.W. 1025 (Wis. 1899) (directing pro
rata recovery because other shareholders settled with company).
73
13 Fletcher, supra, § 6028, at 325 (―where corporate recovery would benefit
shareholders who participated or acquiesced in the wrongdoing‖); Grenier, supra, at 167
(―to limit recovery to ‗innocent‘ shareholders‖); Bruce, supra, at 536 n.79 (―where
‗guilty‘ and ‗innocent‘ stockholders would benefit by corporate recovery‖); Situations,
supra, at 1314 (―Where there are ‗innocent‘ and ‗guilty‘ stockholders, [courts] have
occasionally employed individual awards to limit recovery to the ‗innocent‘ ones.‖).
96
 Cases where the entity is no longer an independent going concern, such that
channeling the recovery through the corporation is no longer feasible or a pro rata
recovery is more efficient.74
For illustrative cases, see Perlman v. Feldmann, 219 F.2d 173 (2d Cir. 1955)
(excluding from investor-level recovery stockholders who gained from the fruits of the
wrongful act), cert denied, 349 U.S. 952 (1955); Atkinson v. Marquart, 541 P.2d 556
(Ariz. 1975) (en banc) (awarding individual recovery to one shareholder for a breach of
fiduciary duty by the other shareholder); Rankin v. Frebank Co., 121 Cal. Rptr. 348 (Cal.
Ct. App. 1975) (awarding pro rata recovery where defendant misappropriated corporate
assets); Brown v. De Young, 47 N.E. 863 (Ill. 1897) (excluding from recovery
stockholders who participated in fraud); Samia v. Cent. Oil Co. of Worcester, 158 N.E.2d
469 (Mass. 1959) (directing forced sale of wrongdoers‘ equity to prevent unjust
enrichment); Harris v. Rogers, 179 N.Y.S. 799 (N.Y. App. Ct. 1919) (ordering pro rata
award to plaintiff because other shareholders acquired stock from culpable parties);
Ritchie v. People’s Tel. Co., 119 N.W. 990 (S.D. 1909) (ordering dividend distributions
to innocent shareholders until wrongdoer repaid the corporation for misappropriated
funds); Joyce v. Congdon, 195 P. 29 (Wash. 1921) (ordering pro rata recovery although
defendant was innocent but purchased stock from wrongdoers); Chaunis v. Laing, 23
S.E.2d 628 (W. Va. 1942) (excluding from recovery stockholders who settled separately
with defendants); Young v. Colum. Oil Co. of W. Va., 158 S.E. 678, 685 (W. Va. 1931)
(awarding pro rata recovery after defendant directors usurped corporate opportunity);
Spaulding v. N. Milwaukee Town Site Co., 81 N.W. 1064 (Wis. 1900) (excluding from
recovery stockholders who settled separately with defendants).
For a Delaware case suggesting a similar approach, see In re Gaylord Container
Corp. S’holders Litig., 747 A.2d 71, 82 (Del. Ch. 1999) (Strine, V.C.) (recognizing that
the adoption of a rights plan would affect different types of stockholders differently and
suggesting that characterizing the claim as derivative could prevent the defendants who
were also stockholders from benefitting from their wrongdoing by ―awarding relief to the
class of innocent stockholders‖).
74
13 Fletcher, supra, § 6028, at 325 (―where the corporation has ceased doing
business and direct recovery would facilitate the distribution of assets‖); Berger, supra, at
820 (noting that cases have permitted individual stockholders to sue directly, rather than
derivatively, after a corporation has been dissolved, ―indicat[ing] judicial awareness of
the need for a stockholders‘ suit when the corporation is unable to sue‖); Grenier, supra,
at 167 (―to provide a convenient method for ultimate distribution when the corporation is
in liquidation or when its assets have been sold‖); Bruce, supra, at 536 n.79 (―where the
corporation is no longer a viable concern‖); Situations, supra, at 1314 (―[W]here the
97
corporation is no longer a going concern, [courts] have allowed individual awards to
facilitate distribution of the funds.‖).
For illustrative Delaware cases, see Cencom, 2000 WL 130629, at *5-6
(classifying claim as direct in part because of liquidation of partnership); Fischer, 1999
WL 1032768, at *3-4 (classifying claim as direct in part because of liquidation of
corporation); Abelow v. Symonds, 156 A.2d 416, 420 (Del. Ch. 1959) (―I am not
convinced that plaintiffs should be summarily denied the right to couch their complaint in
terms which seek a remedy for alleged personal injury to a class of stockholders as
opposed to the theoretical injury to a now dissolved corporate entity.‖); Eshelman v.
Keenan, 194 A. 40, 43 (Del. Ch. 1937) (Wolcott, C.) (positing that circumstances could
support a pro rata recovery, such as if ―the corporation had ceased to operate, its
controlling stockholder had converted all of its assets and it was denuded of all of its
property‖), aff’d, 2 A.2d 905 (Del. 1938). See generally Heyman & Enerio, supra, at 178-
81) (positing the re-discovery of a ―liquidation exception‖ under which investors could
sue directly once an entity had liquidated or was in the process of liquidating and was
distributing its assets to its equity holders).
For illustrative non-Delaware cases involving dissolution, see May v. Midwest
Refining Co., 121 F.2d 431 (1st Cir. 1941) (limiting relief to plaintiffs after directors
engaged in fraud while liquidating company), cert. denied, 314 U.S. 668 (1941); Am.
Seating Co. v. Bullard, 290 F. 896 (6th Cir. 1923) (affirming trial court decision to award
plaintiffs‘ an interest in wrongfully transferred property); Ervin v. Or. Ry. & Nav. Co., 20
F. 577 (C.C.S.D.N.Y. 1884) (awarding pro rata relief to minority shareholders of
dissolved corporation where majority directors engaged in self-dealing transactions);
Ward v. Graham-Jones Motor Co., 219 P. 776 (Colo. 1923) (allowing direct suit where
former shareholder of dissolved corporation showed directors‘ engaged in pre-dissolution
fraud); Geltman v. Levy, 207 N.Y.S.2d 366 (N.Y. App. Div. 1960) (denying motion to
dismiss where plaintiffs sought pro rata recovery after company was liquidated because
defendant misappropriated corporate assets); Alexander v. Quality Leather Goods Corp.,
269 N.Y.S. 499 (N.Y. Sup. Ct. 1934) (ordering pro rata recovery where director-
shareholders engaged in fraud in connection with dissolution of company); Sale v.
Ambler, 6 A.2d 519 (Pa. 1939) (granting direct recovery to plaintiff when directors of
dissolved company misappropriated corporate funds); Bailey v. Jacobs, 189 A. 320 (Pa.
1937) (granting direct payment to plaintiffs for liquidated but undissolved corporation);
Commonwealth Title Ins. & Tr. Co. v. Seltzer, 76 A. 77 (Pa. 1910) (permitting
stockholders to pursue an individual recovery involving assets of an undissolved
corporation in liquidation); Kingsbury v. Phillips, 142 S.W. 73 (Tex. Civ. App. 1911)
(granting plaintiffs right to pursue as direct claims that would otherwise be derivative
after directors of dissolved corporation misappropriated corporate assets).
98
In considering whether to grant a pro rata recovery, courts also consider the rights of
parties having a higher priority in the capital structure, such as creditors. 75 ―The ultimate
For illustrative non-Delaware cases involving mergers, see Watson v. Button, 235
F.2d 235 (9th Cir. 1956) (affirming award of pro rata recovery when defendant had
embezzled funds in connection with a sale of all the company‘s stock); Kirk v. First Nat’l
Bank of Columbus, 439 F. Supp. 1141 (M.D. Ga. 1977) (permitting stockholders of
merged corporation to bring post-closing suit based on undiscovered pre-transaction
breach of fiduciary by corporate president as a direct claim); DeHaas v. Empire
Petroleum Co., 300 F. Supp. 834 (D. Colo. 1969) (ordering equitable lien on post-merger
corporation for benefit of stockholders of acquired company after finding liability under
Rule 10b-5), rev’d on other grounds, 435 F.2d 1223 (10th Cir. 1970) (noting ―we
consider plaintiff‘s stock interest to be the practical equivalent of record stock and
sufficient to satisfy the requirements of Rule 23.1(1)‖); Gertsle v. Gamble-Skogmo, Inc.,
298 F. Supp. 66 (E.D.N.Y. 1969) (limiting award to stockholders of acquired company
injured by misleading statements in proxy), modified on other grounds, 478 F.2d 1281
(2nd Cir. 1973); Miller v. Steinbach, 268 F. Supp. 255 (S.D.N.Y. 1967) (permitting
derivative action brought under federal securities laws against the corporation‘s officers
and directors to continue after a merger as an individual action with the possibility of a
pro rata recovery); Atkinson v. Marquart, 541 P.2d 556 (Ariz. 1975) (en banc)
(permitting direct suit by stockholder of dissolved corporation); Gabhart v. Gabhart, 370
N.E.2d 345 (Ind. 1977) (ruling that ―a Court of Equity may grant relief, pro-rata, to a
former shareholder, of a merged corporation, whose equity was adversely affected by the
fraudulent act of an officer or director and whose means of redress otherwise would be
cut off by the merger‖); Indep. Inv. Protective League v. Time, Inc., 412 N.Y.S.2d 898
(N.Y. App. Div. 1979) (permitting former stockholders of merged corporation to pursue
claim for pre-merger mismanagement relating to issuance of stock as a post-closing direct
claim brought on behalf of former corporation‘s stockholders); Platt Corp. v. Platt, 249
N.Y.S.2d 75 (N.Y. App. Div. 1964) (refusing to hold that derivative claims for breach of
fiduciary duty were ―obliterated by the merger of the wronged corporation into another
corporation‖ and permitting the claims to be litigated as a direct action), aff’d, 204
N.E.2d 495 (N.Y. 1965); see also Duffy v. Cross Country Indus., Inc., 395 N.Y.S.2d 852,
853 (N.Y. App. Div. 1977) (―[T]he cause of action that [plaintiff] would have against its
officers and directors for self-dealing and corporate waste would survive the
merger . . . .‖).
75
See, e.g., Berger, supra, at 823 (―The objection remains that individual
stockholders‘ actions may deprive corporate creditors of protection [but] [i]n the absence
of creditors, that objection should carry no weight.‖); Individual Recovery, supra, at 283
99
problem before the courts is how to protect the interests of all the parties involved: the
corporation, its creditors and its shareholders.‖ Individual Recovery, supra, at 284. Pro
rata recovery can be ―the most effective technique for dealing with the parties‘ varying
equities.‖ Booth, supra, at 1025 n.4 (quoting W. Cary & M. Eisenberg, Cases &
Materials on Corporations 905 (5th ed. 1980)). If a court decides to grant an investor
level recovery, then ―[e]ach stockholder‘s award is computed by multiplying the sum
which the corporation would have received had individual recovery not been allowed by
the ratio of that stockholder‘s shares to the total number of shares outstanding.‖
Situations, supra, at 1314.
Notably, courts at times have granted pro rata recoveries in derivative actions at
the request of the defendants, who thereby could pay less in terms of the aggregate
amount of damages.76 In Delaware, defendants frequently use a variant of this approach
(―The real objection to permitting a shareholder to recover directly for his proportionate
share of the damage inflicted upon the corporation . . . [is] that the result of such recovery
is a return of corporate assets to shareholders without first satisfying corporate
creditors.‖).
76
See, e.g., Eshelman, 194 A. at 43-44 (rejecting request by defendants for an
individual recovery that would reduce their aggregate liability); De Young, 47 N.E. at 865
(noting defendant‘s request that relief should be limited to non-assenting shareholders);
Headley Chocolate Co., 100 A. at 651 (explaining that it would not be fair to require
defendants to pay back full amount to corporation); Shanik v. Empire Power Corp., 58
N.Y.S.2d 176, 181-82 (N.Y. Sup. Ct. 1945) (noting that it would award proportionate
recovery consistent with ―defendants‘ plea that a decree be moulded consonant with the
true equities‖); Congdon, 195 P. at 30 (stating that the plaintiff complained that the
recovery was to him personally and not the corporation); Personal Recovery, supra, at
321.
100
to settle derivative actions in exchange for some form of stockholder-level consideration,
such as either a dividend to stockholders or a buyout to the minority. Examples include:
 Settlement Hearing, In re Clear Channel Outdoor Hldgs. Inc., Deriv. Litig.,
Consol. C.A. No. 7315-CS (Del. Ch. Sept. 9, 2013). This case involved derivative
claims alleging that the parent company of the nominal defendant caused the
nominal defendant pre-IPO to loan the parent money on favorable, unsecured
terms. Post-IPO, the loan balance continued to grow while the parent company‘s
credit rating decreased. The complaint attacked the defendants‘ actions in
approving the initial loan and allowing the loan balance to balloon. The defendants
formed a Special Litigation Committee under Zapata Corp. v. Maldonado, 430
A.2d 779 (Del. 1981), evidencing their view that the claims were derivative. The
case was settled by, among other things, having the nominal defendant demand
partial repayment of the loan ($200 million) and pay a dividend in the same
amount for stockholders. Then-Chancellor Strine approved the settlement, noting
―[i]t‘s a derivative action, which is actually, if you think about it, a form of class
action‖ and that ―the dividend feature of it, the reduction of the outstanding
amount [of the loan] plus the dividend out, in particular to the public stockholders,
is a substantial benefit.‖ Id. at 35, 38.
 Settlement Hearing, Davis v. Holmes, C.A. No. 638-N (Del. Ch. June 23, 2006).
The plaintiffs claimed that the defendants violated their fiduciary duties to the
nominal defendant, New Century Equity Holding Corp., by (i) operating New
Century as an unregistered investment company, (ii) paying excessive
compensation, (iii) selling substantially all of its assets, and (iv) engaging in self-
dealing. The settlement included the creation of a $3.2 million fund that was
distributed to New Century‘s unaffiliated stockholders. Vice Chancellor Lamb
approved the settlement, observing that the claim was ―really a derivative claim‖
but that the pass-through structure was a ―very favorable outcome.‖ Id. at 23.
 Settlement Hearing, In re Freeport-McMoRan Copper & Gold Inc. Deriv. Litig.,
Consol. C.A. No. 8145-VCN (Del. Ch. Apr. 7, 2015). In this purely derivative
case, the plaintiffs alleged that the members of the board of directors of nominal
defendant Freeport-McMoRan Copper & Gold Inc. (―Freeport‖) caused Freeport
to overpay to acquire a company in which the defendants had an interest. The
defendants moved to dismiss pursuant to Rule 23.1, evidencing their view that the
claims were derivative. While those motions were pending, the parties settled with
the principal consideration consisting of a gross settlement fund of $147.5 million
plus interest that was paid directly to Freeport stockholders as a special dividend.
 Franklin Balance Sheet Inv. Fund v. Crowley, 2007 WL 2495018 (Del. Ch. Aug.
30, 2007). This action involved what was primarily a derivative suit challenging
101
arrangements between the nominal defendant and its majority stockholder
regarding split-dollar life insurance policies on the life of the majority
stockholder‘s relatives for which the nominal defendant paid the premiums but
which the majority stockholder owned. The plaintiffs claimed that the nominal
defendant suffered millions of dollars of damages. The defendants moved to
dismiss, relying on derivative standing doctrines such as the continuous ownership
requirement and the failure to make demand. See Franklin Balance Sheet Inv.
Fund v. Crowley, 2006 WL 3095952, at *2 (Del. Ch. Oct. 19, 2006) (reciting
procedural history). The case was settled by having the defendants make a tender
offer to the minority and take the nominal defendant private. Crowley, 2007 WL
2495018, at *4. Only the stockholders who owned stock at the time of the tender
offer—not those who held stock at the time of the alleged wrongs—were
permitted to participate in the tender offer and receive the benefit of the
settlement. Id. at 8 n.8. The minority stockholders thus received a remedy for a
derivative claim that consisted of their pro rata share of the value of the
corporation, including some value attributed to the derivative claim.
 Settlement Hearing, Gerber v. EPE Hldgs. LLC, C.A. Nos. 5989-VCN and 3543-
VCN (Del. Ch. July 1, 2014). This settlement involved two actions. In the first
action, the plaintiffs alleged a derivative claim for breach of fiduciary duty arising
out of the nominal defendant‘s acquisition of a related party. In the second action,
the plaintiffs alleged direct and double derivative claims alleging that a merger
failed to compensate the plaintiffs for their extinguished derivative claims. Both
cases were settled in exchange for a direct payment by the defendants to those
investors who held units at the time of the merger.
These settlements demonstrate that when not arguing that a derivative claim should be
extinguished after a merger, defense counsel understand that the functional and equitable
equivalent of an entity-level recovery is an investor-level recovery in which the injured
investors receive their pro rata share of the amount that otherwise would go to the
entity.77 There is nothing prejudicial to the defendants in recasting an entity-level
77
Similar, albeit converse, reasoning justifies requiring the corporation to pay a
fee award to class counsel when the class claims conferred benefits on all stockholders
but did not create a common fund. See In re First Interstate Bancorp Consol. S’holder
102
recovery as an investor-level recovery. Indeed, the defendants typically benefit because
they have to come up with less money to fund the recovery, and that reduced amount in
turn supports a lower attorneys‘ fee award.
Applying these principles to the current case indicates that even while El Paso
MLP continued as an independent entity, a pro rata recovery was possible. The Fall
Dropdown was a transaction in which the party in control of the entity—the General
Partner—extracted value at the expense of the Partnership, so an entity-level remedy
would have benefitted the General Partner by preserving its control over the funds. The
General Partner also would have received the benefit of the entity recovery through its
ownership interest in the Partnership, so the entity-level remedy would have benefited the
―guilty‖ as well as the ―innocent.‖ Faced with those factors, the court could have awarded
an investor-level remedy, even accepting for purposes of analysis that Brinckerhoff
described his claim as derivative for much of the litigation. Indeed, in his Gaylord
decision, Chief Justice Strine, then a Vice Chancellor, questioned the propriety of
awarding damages to the entity (and the resulting derivative characterization) where the
alleged wrongdoers owned a significant stake in the entity. See Gaylord Container Corp.
S’holders Litig., 747 A.2d 71 (Del. Ch. 1999) (Strine, V.C.). If the defendants were
proven to be wrongdoers, he asked, ―should [they] be entitled to recover damages for the
economic injury they inflicted on themselves‖? Id. at 80. He then reasoned, ―If the
Litig., 756 A.2d 353, 358 (Del. Ch. 1999); Richman v. DeVal Aerodynamics Inc., 185
A.2d 884, 886 (Del. Ch. 1962).
103
answer is no because of the fact that they created the harm, this factor would support
awarding relief to the class of innocent stockholders, not to the corporation.‖ Id. The
Chief Justice‘s sound reasoning could have applied to this case.
Before of the pre-Merger possibility of a pro rata, investor-level remedy, the
General Partner cannot claim prejudice now if, after the Merger, this court implements
the Liability Award through a pro rata recovery. If anything, the different form of award
benefits the General Partner by calling for a lesser amount of total damages. The General
Partner should prefer this result, as did the defendants in the precedent settlements who
chose to use pro rata payments to resolve derivative claims.
D. The Resulting Award
Because Brinckerhoff‘s claim for breach of the LP Agreement was not exclusively
derivative, Brinckerhoff can continue to pursue it after the Merger and enforce the
Liability Award. One means of enforcing the award would be to have KM Partners, as
the successor to the General Partner, pay an amount equal to 58.6% of the $171 million,
plus pre-and post-judgment interest through the date of payment, into a common fund
administered by plaintiff‘s counsel. The 58.6% represents the aggregate partnership
interest owned pre-Merger by limited partners unaffiliated with the General Partner, as
disclosed in the Proxy Statement and in El Paso MLP‘s 10-Q dated October 24, 2014,
two days after the Proxy Statement. Through a claims administration process, those
limited partners can claim their pro rata share of the fund, net of any award of attorneys‘
fees and expenses approved by this court.
Alternatively, once any award of attorneys‘ fees and expenses has been quantified,
104
KM Partners can make a pro rata payment to the unaffiliated limited partners in El Paso
MLP at the time of the Merger using the same method that its affiliates used to provide
those limited partners with the consideration paid in the Merger. Kinder Morgan, or more
accurately its transfer agent, necessarily knows the identities of those limited partners and
their respective limited partnership interests, because Kinder Morgan previously sent
them checks and shares. The same administrative procedure can be used to distribute
each unaffiliated limited partner‘s pro rata share of the net amount of the Liability
Award.
Setting aside the arguments that this decision already has addressed, the General
Partner offers two objections to this remedy. The first is that the identities of the
unaffiliated limited partners at the time of the Merger who will receive the award are not
the same as the identities of the unaffiliated limited partners at the time of the Fall
Dropdown, who were the limited partners whose contract rights were violated. That is
true, but not an impediment to relief. The claim that any limited partner at the time of the
Fall Dropdown had for breach of the LP Agreement arose out of that limited partner‘s
status as a holder of common units and passed to that limited partner‘s successor when
the partner sold its common units.78 The owners of the common units at the time of the
Merger therefore have the right to recover on the direct claim.
78
See Schultz v. Ginsburg, 965 A.2d 661, 667-68 (Del. 2009); In re Activision
Blizzard, Inc. S’holder Litig., --- A.3d ---, 2015 WL 2438067, at *20-21 (Del. Ch. May
20, 2015).
105
The answer that the claims travel with the shares does not address the
consequences of newly issued units, which admittedly complicate matters. Purchasers of
newly issued units occupy a position somewhat analogous to the acquirer under the
Bangor Punta doctrine. Recall that a buyer under the Bangor Punta doctrine is treated as
having conducted due diligence, obtained confidential information, and secured
representations from the sell-side managers about the value of the target company—or at
least to have had the opportunity to do those things. The negotiated price that the acquirer
pays for the entity, therefore, should fairly reflect what the business is worth. It is
unlikely that the seller intends for the acquirer to buy the business and then assert what
this decision has labeled Internal Claims, or that the acquirer negotiates based on its
anticipated ability to recover on those claims. The Bangor Punta doctrine therefore bars
an acquirer from re-trading its deal by pursuing those claims. By analogy to the Bangor
Punta doctrine, if the purchasers of El Paso MLP‘s newly issued shares paid a price that
reflected the value of El Paso MLP after the Fall Dropdown and did not include any
prospect of a contingent recovery, then to allow them to participate now would give them
a windfall.
In my view, there are important differences between a broad market issuance and a
negotiated acquisition. From an informational standpoint, the purchasers of El Paso
MLP‘s newly issued units were not in the same position as an acquirer under the Bangor
Punta doctrine, nor is there reason to think that they eschewed participation in any
recovery on pending or prospective Internal Claims. They did have access to the market
price and El Paso MLP‘s SEC filings, and under the semi-strong version of the efficient
106
capital markets hypothesis, the market price of El Paso MLP should have reflected (to the
extent of the information available) both (i) the loss in value to El Paso MLP resulting
from the Fall Dropdown and (ii) the asset value of the contingent recovery that
Brinckerhoff was pursuing.79 Thus, unlike the acquirer under Bangor Punta who pays a
negotiated price that does not incorporate the prospect of a contingent recovery on
Internal Claims, the buyers of El Paso MLP‘s newly issued units paid a market price that
did reflect the contingent prospect of participating in the potential recovery. Allowing
those units to participate therefore does not confer a windfall but rather allows those
holders to receive the payoff for an element of contingent value that they paid for when
they purchased their units.
Admittedly it is not clear that the market would have priced fully and accurately
either the harm that the Fall Dropdown caused or the value of the Liability Award. Much
of this case was conducted within the confines of a confidentiality order, and the bulk of
the information that the market received was from insiders who had natural and
understandable reasons to discount the lawsuit‘s chances of success. Recognizing that
litigants have preferential access to material information about a lawsuit that the market
lacks, this court has restricted the ability of plaintiffs in representative actions to trade
79
See J. Travis Laster, Goodbye to the Contemporaneous Ownership Requirement,
33 Del. J. Corp. L. 673, 685 (2008). Recent empirical research suggests that the market
does react to the filing of derivative actions in the Delaware Court of Chancery,
particularly to lawsuits with indicia of higher quality. See Alan B. Badawi & Daniel
Chen, The Shareholder Wealth Effects of Delaware Litigation 24 (Sept. 5, 2015)
(working paper).
107
while a case is pending. See Steinhardt v Howard-Anderson, 2012 WL 29340, at *8-9
(Del. Ch. Jan. 6, 2012) (collecting cases). In addition, the Post-Trial Opinion found that
the General Partner and El Paso Parent did not provide clear or accurate pricing
information about the components of the Fall Dropdown. For cosmetic reasons, they only
disclosed the aggregate price paid in the Fall Dropdown. See Post-Trial Opinion at 13
(―Neither El Paso MLP nor Parent ever announced the price breakdown, only an
aggregate price. Parent made the decision to present the Fall Dropdown as a unitary
transaction. . . . The Committee members understood that aggregating the price helped
Parent and was done for cosmetic reasons.‖).
Given these factors, it seems likely some of the holders of El Paso MLP units at
the time of the Merger either paid relatively too much or relatively too little, and that
what they will receive as their share of a pro rata recovery is therefore slightly more or
slightly less than what an infallible and perfect system of justice would award. From the
standpoint of dilution, the same issue exists to a much greater degree under Lambrecht v.
O’Neal, where the Delaware Supreme Court held that after a stock-for-stock merger, a
stockholder of the target corporation who received stock in the merger had standing to
bring a double-derivative claim on behalf of the post-transaction entity. See 3 A.3d 277,
286 (Del. 2010). As Chief Justice Strine observed while a Vice Chancellor, ―a recovery
on behalf of the [post-transaction entity], which will be owned only [by a fraction of the]
current stockholders, is not the same as a recovery on behalf of the current . . .
stockholders alone.‖ In re Massey Energy Co., 2011 WL 2176479, at *30 (Del. Ch. May
31, 2011).
108
In short, while the General Partner raises a fair point about the implications of
newly issued units, that objection provides at most a reason to regard a pro rata award as
less than perfect. In my view, it is not a reason to deny relief altogether and confer what
would be an unconscionable windfall on the General Partner and its affiliates. As
humans, we can only strive for the best possible result, recognizing that we inevitably fall
short of what the divine could accomplish.
The General Partner‘s other objection is that to the extent this court awards a pro
rata remedy, it must assume that El Paso MLP paid $171 million less in the Fall
Dropdown, making that amount available for potential distribution, then determine how
much of that amount would have flowed to the unaffiliated limited partners through the
distribution provisions of the LP Agreement. That would be one way to calculate
damages, but when a merger has intervened, it is not the only way.
If El Paso MLP had continued as an independent entity, then the limited partners
would have received returns in the form of distributions, and a portion of any entity-level
recovery on the Liability Award eventually would have reached the limited partners in
that form. Once the defendants engaged in the Merger, however, the calculus changed. At
this point, the court can assume that the Merger consideration fairly valued the bundles of
rights held by the holders of common units at the time of the Merger, except for their
share of the claim for the breach of the LP Agreement. Because the only right left to be
valued is the entitlement to a pro rata share of the $171 million, plus interest, the court
can award the limited partners their pro rata share of that asset.
109
III. CONCLUSION
The Post-Trial Opinion held that the General Partner was liable for breach of
contract in connection with the Fall Dropdown. The Liability Award determined that the
amount of damages that the General Partner inflicted on the Partnership through the Fall
Dropdown was $171 million. In light of the Merger, the Liability Award will be
implemented through an order requiring the General Partner to pay each unaffiliated
limited partner at the time of the Merger their pro rata share of the Liability Award, plus
pre- and post-judgment interest through the date of payment, less an amount for a
reasonable award of attorneys‘ fees and expenses.
110
APPENDIX A
Ownership Description Source
4,758,190 Total number of GP Units El Paso MLP 10-Q, dated as of
Oct. 24, 2014.
93,380,734 Common units held by Kinder Proxy Statement at 99.
Morgan and its affiliates
353,732 Common units held by El Paso GP Proxy Statement at 99.
Directors
139,416,863 Common units held by unaffiliated Total common units – Common
investors units held by Kinder Morgan and
its affiliates – Common units held
by El Paso GP Directors
233,151,329 Total common units El Paso MLP 8-K, dated as of
November 20, 2014, at 1 and El
Paso MLP 10-Q, dated as of Oct.
24, 2014.
237,909,519 Total units Total common units + Total
number of GP units
2.00% GP percentage ownership Total number of GP units ÷ Total
units
59.80% Percentage of common units held Common units held by unaffiliated
by unaffiliated investors investors ÷ Total common units
58.60% Percentage of total units held by Common units held by unaffiliated
unaffiliated investors investors ÷ Total units
40.20% Percentage of common units held (Common units held by Kinder
by Kinder Morgan, its affiliates, Morgan and its affiliates +
and El Paso GP Directors Common units held by El Paso GP
Directors) ÷ Total common units
41.40% Percentage of total units held by (Common units held by Kinder
Kinder Morgan, its affiliates, and Morgan and its affiliates +
El Paso GP Directors Common units held by El Paso GP
Directors + Total number of GP
Units) ÷ Total units
40.05% Percentage of total common units Common units held by Kinder
held by Kinder Morgan, its Morgan and its affiliates ÷ total
affiliates, and El Paso GP Directors common units
A-1