In re El Paso Pipeline Partners, L.P. Derivative Litigation

Under the usual derivative-standing rule, a claim belonging to an entity passes to the surviving entity in a merger, and a former investor plaintiff generally loses standing to continue a derivative action. A direct claim, by contrast, belongs to the investor and survives the merger. The General Partner’s proposed rule would let its affiliates acquire control of both sides of the litigation, leave the $171 million award unvalued in the merger consideration, and thereby eliminate any practical prospect of recovery for the unaffiliated limited partners.

The claim rested on the General Partner’s breach of a specific contractual restriction in the limited partnership agreement: the conflict-of-interest provision. The Delaware LP Act makes both the Partnership and its partners bound by the partnership agreement, and Delaware law permits limited partners to enforce their own contractual rights under that agreement directly.

The court rejected the General Partner’s contention that any claim involving an entity’s overpayment must be derivative. The relevant initial inquiry is whether the plaintiff seeks to enforce a right belonging personally to the investor or a right belonging only to the entity. Here, the limited partners sought to enforce their rights under the Partnership Agreement, which prohibited the General Partner from pursuing a conflicted transaction unless it complied with one of the agreement’s specified safeguards.

Tooley’s familiar inquiry into who suffered harm and who would receive the recovery did not erase direct contractual claims. As the Delaware Supreme Court explained in NAF Holdings, Tooley addresses when fiduciary-duty claims or claims belonging to the corporation must be brought derivatively; it does not prevent a party from suing directly on its own contractual rights.

Treating this claim as direct did not mean that every dispute within a limited partnership becomes direct. The distinction remains between a claim alleging generalized poor management or an overpayment, which ordinarily is derivative, and a claim alleging violation of an identifiable contractual limit on the general partner’s authority. Brinckerhoff proved the latter by showing that the General Partner failed to meet the express good-faith requirement for Special Approval.

The court concluded that Delaware law does not always require an all-or-nothing choice between direct and derivative claims. Some claims possess both characteristics. Under decisions such as Tri-Star and Gentile, a plaintiff may litigate a claim directly or derivatively when the same conduct harms the entity while also extracting value from nonparticipating investors for the benefit of an insider.

The Fall Dropdown directly injured El Paso MLP by causing it to overpay $171 million. But the transaction also inflicted a separate practical injury on the unaffiliated limited partners. The General Partner and its affiliate suffered part of the Partnership’s loss through their own ownership interest, but they also received the full benefit of the overpayment. The unaffiliated limited partners received no offsetting benefit, so value was effectively transferred from them to the insider.

The court illustrated this distinction numerically. Although the insider bore its proportional share of the Partnership-level loss, its direct receipt of the overpayment exceeded that loss. Its net gain equaled the unaffiliated limited partners’ net loss. That extraction of value from outside investors created an injury separate from the Partnership’s general injury.

The available remedies likewise had dual aspects. While the Partnership remained independent, the General Partner could have repaid the entire $171 million to the Partnership. But the court also could remedy the insider’s extraction of value by ordering a payment directly to the unaffiliated limited partners equal to their proportionate share. Thus, the answer to Tooley’s harm question was both the Partnership and the limited partners, and the answer to its remedy question was either an entity-level or investor-level recovery.

Vice Chancellor Laster further explained that Delaware should distinguish between claim initiation and claim continuation. At the outset of litigation, treating a dual-natured claim as derivative serves board- or general-partner-centered governance, demand doctrine, Rule 23.1, and the need to screen weak claims. After a merger ends the entity’s separate existence, those policies no longer justify automatically terminating a previously viable claim, particularly where a related-party acquirer did not pay for and will not pursue a claim against the sell-side insiders.

This approach also avoided the inefficient alternative of requiring a new suit challenging the merger for failing to value the pending claim. Allowing the existing action to continue focused the litigation on the already-tried claim, promoted accountability for insider wrongdoing, and prevented the related-party merger from producing a windfall for the General Partner.

A plaintiff’s label for a claim does not bind the court. Delaware courts determine whether a claim is direct or derivative by examining the nature of the wrong, not the caption of the complaint or the plaintiff’s stated characterization. The General Partner therefore could not reasonably rely on Brinckerhoff’s earlier use of the word “derivative.”

The General Partner likewise could not rely on Brinckerhoff’s initial request for an entity-level remedy. The Court of Chancery has broad equitable authority to tailor relief to the circumstances that exist when relief is granted, and it is not limited to the precise remedy requested in the pleading.

A pro rata investor-level recovery is unusual in a derivative setting, but it is not forbidden. Courts may award it when equity requires, including where wrongdoers control the entity and would regain control over an entity-level recovery, where an entity-level award would benefit guilty investors as well as innocent ones, or where the entity is no longer a viable independent concern.

Those considerations supported pro rata relief here. The General Partner and its affiliates caused the wrongful extraction, would benefit from an entity-level recovery, and later eliminated the Partnership’s separate existence through a related-party merger. The General Partner could not claim prejudice merely because the court refused to let its affiliates turn that merger into an escape from the liability award.

The merger consideration did not include value for the claim or the liability award. The appropriate remedy was therefore to preserve for the unaffiliated limited partners the value of the litigation asset that was excluded from their merger consideration.

The court proposed that the General Partner’s successor pay 58.6% of the $171 million award, plus interest, into a fund for the unaffiliated limited partners who held units at the merger’s effective time. That percentage reflected the aggregate Partnership interest those unaffiliated holders owned immediately before the merger.

The court rejected objections based on differences between holders at the time of the Fall Dropdown and holders at the merger. Rights associated with the units generally travel with the units, so the holders at the merger were the proper recipients. Newly issued units created some imprecision, but not a reason to deny all relief; market purchasers generally paid a price that reflected the contingent value of the pending litigation.

The court also rejected the argument that damages had to be recalculated through the Partnership Agreement’s distribution waterfall. Once the merger occurred, the relevant unvalued asset was the limited partners’ proportionate interest in the liability award itself. Awarding their pro rata share directly was the practical and equitable means to implement the established damages judgment.