PAUL MORRIS, on behalf of all similarly situated unitholders of SPECTRA ENERGY PARTNERS, L.P., Plaintiff Below, Appellant, v. SPECTRA ENERGY PARTNERS (DE) GP, LP, Defendant Below, Appellee.
No. 489, 2019
IN THE SUPREME COURT OF THE STATE OF DELAWARE
January 22, 2021
Submitted: October 28, 2020
Court Below - Court of Chancery of the State of Delaware Consolidated C.A. No. 2019-0097
Before SEITZ, Chief Justice; VALIHURA, VAUGHN, TRAYNOR, and MONTGOMERY-REEVES, Justices, constituting the Court en Banc.
Upon appeal from the Court of Chancery. REVERSED and REMANDED.
Michael J. Barry, Esquire (argued) and Rebecca A. Musarra, Esquire, GRANT & EISENHOFFER P.A., Wilmington, Delaware; Peter B. Andrews, Esquire, Craig J. Springer, Esquire, and David M. Sborz, Esquire, ANDREWS & SPRINGER LLC, Wilmington, Delaware; and Jeremy S. Friedman, Esquire, Spencer Oster, Esquire, and David F.E. Tejtel, Esquire, FRIEDMAN OSTER & TEJTEL PLLC, Bedford Hills, New York; Attorneys for Plaintiff-Appellant Paul Morris and all similarly situated unitholders of Spectra Energy Partners, L.P.
Robert S. Saunders, Esquire, Ronald N. Brown, III, Esquire, Ryan M. Linsay, Esquire, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Wilmington, Delaware; Noelle M. Reed, Esquire (argued) and Daniel S. Mayerfeld, Esquire, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Houston, Texas; Attorneys for Defendant-Appellee Spectra Energy Partners (DE) GP, LP.
With limited exceptions, a merger extinguishes an equity owner‘s standing to pursue a derivative claim against the target entity‘s directors or controller. But the same plaintiff has standing to pursue a post-closing suit if they challenge the validity of the merger itself as unfair because the controller failed to secure the value of a material asset—like derivative claims that pass to the acquirer in the merger. Given the difficulties of pursuing such claims, not the least of which is proof that the equity owner received an unfair merger price for their ownership interest, the plaintiff might not prevail on the merits, but they have sufficiently alleged a direct claim to survive a motion to dismiss for lack of standing.
After a $3.3 billion “roll up” of minority-held units involving a merger between Enbridge, Inc. (“Enbridge“) and Spectra Energy Partners L.P. (“SEP“), Paul Morris, a former SEP minority unitholder, lost standing to litigate an alleged $661 million derivative suit on behalf of SEP against its general partner, Spectra Energy Partners (DE) GP, LP (“SEP GP“). Morris reprised the derivative claim dismissal by filing a new class action complaint that alleged the Enbridge/SEP merger exchange ratio was unfair because SEP GP agreed to a merger
The Court of Chancery granted SEP GP‘s motion to dismiss the new complaint for lack of standing. The court held that, to have standing to bring a post-merger claim, Morris had to allege a viable and material derivative claim that the buyer would not assert and provided no value for in the merger. Focusing on the materiality requirement, the court first discounted the $661 million recovery to $112 million to reflect the public unitholders’ beneficial interest in the derivative litigation recovery. Then, the court discounted the $112 million further to $28 million to reflect what the court estimated was a one in four chance of success in the litigation. After the discounting, the $28 million—less than 1% of the merger consideration—was immaterial to a $3.3 billion merger.
On appeal, Morris argues that the court should not have dismissed the plaintiff‘s direct claims for lack of standing. We agree with Morris and find that, on a motion to dismiss for lack of standing, he has sufficiently pled a direct claim attacking the fairness of the merger itself for SEP GP‘s failure to secure value for his pending derivative claims. Thus, we reverse the Court of Chancery‘s judgment and remand for further proceedings.
I.
The plaintiff, Paul Morris, owned common units of SEP, a master limited partnership that traded on the New York Stock Exchange.1 Enbridge owned 83% of SEP‘s outstanding units through a series of wholly-owned subsidiaries, including SEP GP.2 Spectra Energy Corp (“SE Corp“) was Enbridge‘s predecessor-in-interest.
Prior to selling to Enbridge, SE Corp agreed to a 50-50 joint venture with Phillips 66 whereby Phillips would contribute $1.5 billion and SE Corp would contribute a one-third interest in two long haul natural gas pipelines, implying a $1.5 billion valuation of the contributed assets. Because SEP owned the assets, the parties proposed a “reverse dropdown” to sell the assets from SEP to SE Corp. To purchase the assets from SEP, SE Corp offered to “(i) surrender 20 million SEP limited partner units to SEP for redemption . . . and (ii) waive its right to receive up to $4 million in incentive distribution rights [] for twelve consecutive quarters . . . .”3 SEP GP authorized a conflicts committee to evaluate the reverse dropdown.
SEP‘s limited partnership agreement required the general partner‘s conflicts committee to act in “subjective good faith.”4 According to the complaint‘s allegations, a financial advisor identified three ways the transaction would provide value to SEP: the redeemed units, the waived distribution rights, and other reduced cash flow due to the loss of assets. Later, however, the adviser included only the first two components as consideration—valued at $946 million—and issued a fairness opinion. The conflicts committee recommended approval, and SEP GP‘s board approved the reverse dropdown.
After reviewing SEP‘s books and records, the plaintiff filed a class action derivative
In March 2018, SEP‘s stock price declined by twenty percent in reaction to announcements from the Federal Energy Regulatory Commission (“FERC“). SEP recognized in its filings with the U.S. Securities and Exchange Commission that “[t]he change in FERC‘s policy has had a negative impact on the MLP sector” and that SEP “would attempt to mitigate the impact of the policy change.”8 In May, Enbridge offered a stock-for-stock exchange to buyout SEP‘s public unitholders. SEP‘s public unitholders would receive 1.0123 common shares of Enbridge in exchange for each publicly held common unit of SEP based on the SEP common units’ and Enbridge common shares’ closing price on the NYSE as of May 16, 2018. SEP closed at a unit price of $33.10 and Enbridge common shares closed at $32.70. According to the plaintiff, this was an opportunistic offer to squeeze out the public unitholders due to an artificially depressed trading price. Another three-member SEP GP conflicts committee went to work, two of whom were on the committee that reviewed the reverse dropdown transaction.
Morris‘s counsel sent a letter to the conflicts committee and told them that the derivative claim was worth more than $500 million and must be taken into account when negotiating the merger exchange ratio. Counsel also noted that the proposed offer was “woefully inadequate” and “fail[ed] to provide SEP and its public unitholders with any value associated with” the derivative claim.9 After Morris‘s counsel met with the conflicts committee‘s legal and financial advisors, the conflicts committee ultimately determined that the value of the derivative claim, net of defense costs, “was less than $0.”10 The conflicts
As the parties negotiated the buyout, the conflicts committee decided to give no value to the derivative claim but attributed $4 million in saved litigation costs. They also agreed to an exchange ratio “whereby Enbridge would acquire all publicly held SEP units at an exchange ratio of 1.111 shares of Enbridge stock for each publicly held unit of SEP.”11 On August 24, 2018, SEP announced a definitive merger agreement with Enbridge and its wholly-owned subsidiaries where Enbridge would acquire all publicly held SEP units at an exchange ratio of 1.111 shares of Enbridge stock for each publicly held unit of SEP. The transaction was not subject to approval by a majority of the minority unitholders. The transaction was approved on December 13, 2018. At that time, Enbridge affiliates held about 83% of the outstanding units. About 39% of publicly held units voted in favor of the transaction. After the deal closed, the court dismissed the derivative claim by stipulation of the parties.12
After another books and records request, Morris filed this class action on February 8, 2019 against SEP GP, as SEP‘s general partner, for breaching SEP‘s limited partnership agreement and the implied covenant of good faith and fair dealing. Morris claimed that the conflicts committee and SEP GP‘s board of directors failed to attribute appropriate value to the pre-merger derivative claim or secure any value for the claim. SEP GP moved to dismiss for lack of standing and failure to state a claim.
The Court of Chancery dismissed Morris‘s complaint for lack of standing without reaching the arguments for failure to state a claim. The court applied the three-part test from its decision in In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455 (Del. Ch. 2013).13 The Primedia test applies to claims challenging a merger because the equity owners are not being fairly compensated for the value of material derivative claims. To establish standing the plaintiff must allege a viable derivative claim, that is material to the overall transaction, and will not be pursued by the buyer and is not reflected in the merger consideration.14
The court found Morris‘s derivative claim viable because it had already survived a motion to dismiss.15 Also, the parties did not dispute that SEP‘s public unitholders received no value for the derivative claim, Enbridge did not intend to pursue the derivative claims post-merger, and Morris pled damages of $661 million. But the court dismissed Morris‘s two direct claims. First, the court discounted the $661 potential recovery to $112 million to reflect the public unitholders’ proportionate share of the litigation recovery. And second, the court discounted the $112 million further to about $28 million to reflect a one-in-four chance of prevailing in the litigation. Finally, the court compared the $28 million to the $3.3 billion merger transaction and found it immaterial. Thus, the court granted SEP GP‘s motion to dismiss for lack of standing without reaching SEP GP‘s alternative
II.
On appeal the parties have focused their attention on the Court of Chancery‘s application of its Primedia decision to assess standing. To reiterate, under Primedia‘s three-part test, which applies to claims alleging an unfair merger because the price does not reflect the value of derivative claims, the plaintiff must allege a viable derivative claim assessed by a motion to dismiss standard.16 The plaintiff must also allege that the derivative claim was material to the overall merger transaction, will not be pursued by the buyer, and is not reflected in the merger consideration.17
According to Morris, the Court of Chancery should not have dismissed his complaint for lack of standing because he pled in detail a direct claim that satisfied the Primedia factors. The parties and the court agreed that the derivative claim was viable because it had survived a motion to dismiss. They also agreed that Enbridge would not assert the claim and provided no value for the claim in the exchange ratio. And, as Morris alleged, the $112 million potential recovery was material to the $3.3 billion transaction. According to Morris, if the Court of Chancery had accepted his well-pleaded factual allegations as true and drawn all reasonable inferences in his favor, it would not have discounted the potential value of the claim such that it became immaterial to the merger value.
The defendants counter that Morris supposedly did not challenge the fairness of the exchange ratio, undermining the claim that SEP GP did not negotiate fair consideration for the public unitholders’ SEP units. For the litigation discount issue, the defendants contend that Morris conceded in the Court of Chancery that the derivative claim should be discounted for litigation risk. The defendants also argue that discounting for litigation risk is consistent with prior cases.18 And, according to the defendants, the “fraud exception to the continuous ownership rule” is the proper method to assess the plaintiff‘s standing to assert post-merger claims.19
We review de novo the Court of Chancery‘s finding that the plaintiff lacked standing to pursue his post-merger claims challenging the fairness of the merger consideration for failure to recoup some or all of the value of the derivative claims.20
A.
The Court of Chancery dismissed Morris‘s complaint for lack of standing. Standing “refers to the right of a party to invoke the jurisdiction of a court to enforce a claim or redress a grievance.”21 Standing
The standing inquiry “has assumed special significance in the area of corporate law.”25 Classifying a claim as either direct or derivative bears directly on standing and is in many ways outcome-determinative in post-merger litigation.26 If a plaintiff alleges a direct claim, it means that the equity owner has alleged that they have suffered the injury, and will receive the benefit of any recovery.27 Thus, at least at the pleading stage, the plaintiff has met the injury-in-fact requirement and properly invoked the court‘s jurisdiction to redress an injury.
In contrast, for a derivative action, the equity owner acts in a representative capacity on behalf of an entity. In that representative capacity, the plaintiff steps into the shoes of the entity and asserts the injury on its behalf.28 If the equity holder has successfully jumped over
The Supreme Court and the Court of Chancery are frequently called upon to
On appeal, this Court reversed. First, we noted that standing in corporate cases is a threshold inquiry because it implicates the exercise of the court‘s jurisdiction.33 We observed that derivative standing is a “creature of equity” that allows a court of equity to hear claims by equity owners “to prevent a complete failure of justice on behalf of the corporation.”34 We also viewed standing as a fluid concept, that can change as a result of “a myriad of subsequent legal or factual causes that occur while the litigation is in progress” such as the loss of the plaintiff‘s status as an equity holder.35 If standing is lost, “the court lacks the power to adjudicate the matter, and the action will be dismissed as moot unless an exception applies.”36
Second, we held that the plaintiff brought his claims as derivative claims, and his claims remained derivative claims throughout the litigation. Even though the plaintiff‘s derivative claims involved a limited partnership, where most rights are governed by agreement rather than fiduciary duties, our Court held that Tooley v. Donaldson, Lufkin & Jenrette, Inc.,37 and its two-part test for drawing a line between direct and derivative claims, applied.38 Under Tooley, the court must answer
Finally, and directly relevant to this appeal, we recognized in El Paso that, even though the plaintiff lost standing to pursue derivative claims post-merger, a narrow avenue of relief was still available to the plaintiff—a direct claim challenging the validity of the merger when the general partner failed to secure the value of material derivative claims in the merger for the minority equity owners:
Under our law, equity holders confronted by a merger in which derivative claims will pass to the buyer have the right to challenge the merger itself as a breach of the duties they are owed. In many cases, it might be difficult to allege that the value they are receiving in the merger is unfair simply as a result of the failure to consider value associated with their derivative suit. But that reality may also suggest that, even according full value to the potential recovery in the derivative suit (rarely a guarantee), the plaintiffs still received fair value in the merger. . . . The derivative plaintiff‘s recourse was to file a money damages challenge to the merger and prove that the failure to accord value to the limited partnership in the merger was somehow violative of his rights.40
In reaching this conclusion, we relied on our decision in Parnes v. Bally Entertainment Corp.41 In Parnes, the plaintiff alleged that in negotiations between Bally Entertainment Corp. and Hilton Hotels Corp., the CEO‘s actions—requiring a bribe of “several substantial cash payments and asset transfers” before consenting to a merger—resulted in the stockholders receiving an unfair price.42 After the merger closed, the Court of Chancery found the claim derivative and dismissed the complaint for lack of standing. We reversed, finding that the complaint “directly challenges the fairness of the process and the price in the Bally/Hilton merger.”43
We distinguished the direct claim attacking the merger itself from the derivative claim in Kramer v. Western Pacific Industries.44 In Kramer, the plaintiff alleged “wrongful transactions associated with the merger (such as the award of golden parachutes) [that] reduced the amount paid to [the target‘s] stockholders,” but “did not allege that the merger
Thus, in Kramer what the plaintiff failed to plead was a challenge to the merger itself rather than attack the side benefits secured by some merger participants. After Parnes, “to state a direct claim with respect to a merger, a stockholder must challenge the validity of the merger itself, usually by charging the directors with breaches of fiduciary duty resulting in unfair dealing and/or unfair price.”49 Finally, in Parnes we separated the standing inquiry from whether the complaint states a claim for relief.50 After reversing the court on standing, we also reversed the court‘s conclusion that the complaint failed to state a claim under Rule 12(b)(6) because the complaint alleged sufficient facts of unfairness to overcome business judgment rule review.51
B.
As noted in Parnes, “it is often difficult to determine whether a stockholder is challenging the merger itself, or alleged wrongs associated with the merger . . . .”52 After Parnes, the Court of Chancery was left to fill in the details. It was not an easy assignment. In Golaine v. Edwards,53 the plaintiff challenged a $20 million payment to Kohlberg Kravis Roberts & Co., L.P. (“KKR“) made in connection with a merger between The Gillette Company and Duracell International, Inc. KKR‘s affiliate, KKR Associates, L.P., owned 34% of Duracell‘s outstanding common stock. The defendants filed a motion to dismiss and claimed that Golaine‘s challenge to the $20 million payment was a derivative rather than direct claim because the plaintiff failed to allege that the merger terms were tainted by the $20 million fee. In granting the defendants’ motion to dismiss, the court concluded that the fee did not taint the merger negotiation process or the merger terms. Thus, the transaction was not unfair to Duracell‘s non-KKR stockholders, and the plaintiff failed to state an individual claim. It also held that the complaint failed to plead facts rebutting the business judgment rule‘s presumptive applicability to the Duracell board‘s decision to award KKR the fees or plead facts to support a waste claim.
the derivative-individual distinction as articulated in Parnes is revealed as primarily a way of judging whether a plaintiff has stated a claim on the merits. . . . Parnes can be straightforwardly read as stating the following basic proposition: a target company stockholder cannot state a claim for breach of fiduciary duty in the merger context unless he adequately pleads that the merger terms were tainted by unfair dealing. If the plaintiff cannot meet that pleading standard, then he has simply not stated a claim under Rule 12(b)(6). This merits focus of Parnes is, in my view, a more candid approach that places primary emphasis on whether compensable injury to the target stockholders is alleged rather than on whether the target stockholder‘s complaint has articulated only a waste or mismanagement claim for which there is likely no proper plaintiff on earth.54
In In re Massey Energy Co. Derivative & Class Action Litigation,55 stockholders of a coal mining corporation filed derivative suits against the board and company officers for lack of oversight and to hold them responsible for the financial harm from a tragic mine disaster. While the derivative suits progressed, Massey‘s board entered into a merger agreement with another mining company. The plaintiffs sought a preliminary injunction to prevent the merger from closing, claiming that the Massey Board should have negotiated to have the derivative claims transferred into a litigation trust for the benefit of Massey stockholders. According to the plaintiffs, the merger was unfair because it allowed the buyer to acquire Massey without paying fair value for the value of the derivative claims.
While the merger had not yet closed and the court viewed the case through a preliminary injunction lens, the court had to grapple with the value of derivative claims and the loss of standing to pursue them once the merger closed.56 First, the court found the Caremark57 claims against the defendants viable. Second, and fatal
to the plaintiffs’ preliminary injunction claim, the court found that a best-case successful recovery of $95 million was immaterial to an $8.5 billion merger. Thus, given the relative immateriality of the derivative claims, the court was not persuaded on a preliminary injunction record that the merger would likely be found to be economically unfair to the Massey stockholders for failing to capture the value of the derivative claims. Importantly, the court did not couch its ruling on standing grounds. Instead,The Court of Chancery found the Brophy derivative claim viable because itA plaintiff claiming standing to challenge a merger directly under Parnes because of a board‘s alleged failure to obtain value for an underlying derivative claim must meet a three part test. First, the plaintiff must plead an underlying derivative claim that has survived a motion to dismiss or otherwise could state a claim on which relief could be granted. Second, the value of the derivative claim must be material in the context of the merger. Third, the complaint challenging the merger must support a pleadings-stage inference that the acquirer would not assert the underlying derivative claim and did not provide value for it.60
After finding that the derivative claims were viable and material, the court also found that the acquirer would not assert the Brophy claim post-merger and provided no value for it in the merger consideration. Turning to whether the plaintiffs stated a claim for relief, the court held that it was reasonably conceivable that KKR received a special benefit in the merger because no acquirer likely would have pursued the Brophy claim post-merger, and the defendants did not extract value for or take steps to preserve the Brophy claim. Thus, the entire fairness standard of review applied to the merger, and the plaintiffs alleged sufficient grounds that the merger was not entirely fair.62Clearly there is risk in the litigation, and to succeed, plaintiffs will have to prove materiality and scienter. These challenges, however, are not similar to those that led Chancellor Strine in Massey Energy to discount so heavily the value of the derivative claims. If I assume prevailing on the Brophy claim was a toss-up, or even a 1-in-5 proposition, the risk-adjusted, pre-interest recoveries for the minority of $40 million and $16 million, respectively, remain material when compared to their $133 million share of the proceeds from the Merger.61
C.
In this appeal the procedural issues do not warrant lengthy discussion. After a review of the record, we are satisfied that Morris preserved for appeal a challenge to the fairness of the merger itself, and SEP GP disputed how the court should consider litigation risk when assessing materiality. Morris alleged that former public unitholders were harmed because “SEP GP has allowed Enbridge to engineer the Roll-Up Transaction on terms that were patently unfair and unreasonable to SEP and its public unitholders, and that could not have been approved in good faith by the New Conflicts Committee or the SEP GP Board.”63 Specifically, Morris pled that “the New Conflicts Committee and the SEP GP Board utterly failed to attempt to (i) appropriately value the Derivative Claim, or (ii) secure any value for the Derivative Claim in its negotiations concerning the Roll-Up Transaction.”64 SEP GP also argued that Morris‘s chanceWe see two errors in the court‘s materiality analysis at the motion to dismiss stage of the proceedings. First, as discussed earlier, the court must accept Morris‘s factual allegations as true and draw all reasonable inferences in his favor.74 In its prior decision the court found that Morris‘s complaint “made adequate allegations showing that under reasonably conceivable circumstances a facially unreasonable gap in consideration exists sufficient to infer subjective bad faith.”75 Thus, “it was ‘reasonably conceivable that the General Partner acted in subjective bad faith.‘”76 It wasI find that the chance of success of the Derivative Claim was slim, and certainly less than one-in-four. Twenty-five percent of $112,370,000 is $28,092,500. This represents less than one percent of the total value of the Roll-Up. One percent is not material in the context of the Roll-Up. The Plaintiff consequently does not have standing to pursue his claims.73