This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The Delaware Supreme Court recently revived an investor’s derivative challenge to a merger of energy companies, finding he retained standing because he sufficiently pled a direct claim attacking the fairness of the deal itself for undervaluing his claim against the controlling partner of one of the merger mates in Morris v. Spectra Energy Partners (DE) GP, LP, No. 489, opinion issued (Del. Supr. Jan. 22, 2021).
The justices unanimously reversed the Chancery Court’s dismissal of plaintiff Paul Morris’ charges that Spectra Energy Partners L.P. unitholders were shortchanged in a merger with Enbridge, Inc. because SEP’s controller failed to include the worth of a $661 million projected recovery from Morris’ suit. Morris v. Spectra Energy Partners (DE) GP, LP, 2019 WL 4751521 (Del. Ch. Sept. 30, 2019).
The high court remanded the case for the Chancery Court to decide whether to use a motion to dismiss or for summary judgment to resolve the matter.
The decision is noteworthy because the en banc court used the so-called Primedia test as a way to determine when a derivative plaintiff qualifies for an exception to the general rule that he loses his standing to continue his suit against his directors or controller if his stock is eliminated in a stock-for-stock or cash-out merger. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013).
The Primedia test, taken from a 2013 Chancery Court merger opinion, 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:
- Was material to the overall merger transaction,
- Will not be pursued by the buyer, and
- Is not reflected in the merger consideration.
“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,” Chief Justice Collins J. Seitz Jr. wrote for the high court.
“The standing inquiry has assumed special significance in the area of corporate law,” the Chief Justice said, noting its pivotal role in merger challenge suits. “Classifying a claim as either direct or derivative bears directly on standing and is in many ways outcome-determinative in post-merger litigation.”
After a $3.3 billion “roll up” of minority-held units that was part of a merger between Enbridge and Spectra, former SEP investor Paul Morris lost standing to litigate an alleged $661 million derivative suit on behalf of SEP against general partner Spectra Energy Partners (DE) GP, LP. Morris filed a new class action complaint that alleged the Enbridge/SEP merger exchange ratio was unfair because SEP GP agreed to a merger that did not reflect the material value of his derivative claims. The Court of Chancery granted SEP GP’s motion to dismiss the new complaint for lack of standing. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013}.
Double discount doubted
The Chancery Court held that to have standing, the plaintiff’s suit must reflect the public unitholders’ beneficial interest in the derivative litigation recovery. The court discounted the worth of the $661 million derivative suit to $112 million and then further reduced it to $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 to the $3.3 billion merger and dismissed it.
Thus, the court granted SEP GP’s motion to dismiss for lack of standing without reaching SEP GP’s alternative argument that Morris failed to state a claim for relief. During the litigation, and with the motion summary judgment pending, Enbridge acquired SE Corp in a stock-for-stock merger, eliminating Morris’ stock, becoming SEP GP’s ultimate parent and controller of SEP.
Morris’ appeal argued that if the Chancery Court 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 to the point that it was immaterial to the merger value. The high court found that Morris properly 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.”
The justices found as to the main issue on appeal, that the Chancery Court had erred twice, in that:.
1. It “strayed from the proper standard of review” under the Primedia test and Morris did retain standing for his claim because “it was ‘reasonably conceivable that the [SEP) general partner acted in subjective bad faith,” and
2. Even if it was proper to discount the $661 million in damages alleged in the complaint to reflect the public unitholders’ interest in the derivative recovery, the court should have compared the $112 million pro rata interest in the derivative claim recovery to the public unitholders’ 17% proportional interest in the merger consideration.
“If the plaintiff has alleged a viable derivative claim, where it is reasonably conceivable that the claim is material when compared to the merger consideration and could result in the damages pled in the complaint, the plaintiff has satisfied the materiality requirement at the motion to dismiss stage for standing purposes,’’ the justices decided.