(Article from Securities Law Alert, February 2021)
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On January 22, 2021, the Delaware Supreme Court reversed the Court of Chancery’s dismissal, due to lack of standing, of post-merger claims challenging a merger’s fairness for the controller’s failure to recoup the value of derivative claims. Morris v. Spectra Energy, 2021 WL 221987 (Del. 2020) (Seitz, C.J.). The court explained that “[w]ith limited exceptions, a merger extinguishes an equity owner’s standing to pursue a derivative claim against the target entity’s directors or controller.” However, the court held that “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.”
Background
After a $3.3 billion “roll up” of minority-held units involving a merger between an acquiring corporation and a limited partnership, plaintiff (a former minority unitholder of the limited partnership) lost standing to litigate his alleged $661 million derivative suit on behalf of the limited partnership against its general partner. Subsequently, plaintiff filed a new class action complaint alleging that the merger exchange ratio was unfair because the general partner had agreed to a merger that did not reflect the material value of plaintiff’s derivative claims. The Court of Chancery granted the general partner’s motion to dismiss plaintiff’s new class action complaint for lack of standing, applying the three-part test from In re Primedia, Inc. S’holders Litig., 67 A.3d 455 (Del. Ch. 2013).
The Court Reiterates the Three-Part Primedia Test
The court stated that “[t]he main issue on appeal is whether the Court of Chancery stayed true to the standard of review on a motion to dismiss for lack of standing.” The court then announced that the lower court “strayed from the proper standard of review, and [plaintiff] had standing to pursue his post-merger complaint.” The court stated that in this case, “we think that the Primedia framework provides a reasonable basis to conduct a pleadings-based analysis to evaluate standing on a motion to dismiss.” The court explained that “[f]irst, the court must decide whether the underlying derivative claims were viable, meaning they would survive a motion to dismiss.” The court noted that “[m]eritless derivative claims would have no impact on the merger price.” The court stated that “[s]econd, the derivative claim recovery as pled must be material in relation to the merger consideration.” The court stated that “[a]n immaterial derivative claim would have little or no impact on the merger price.” Third, the court stated that “the court should also assess whether the complaint alleges that the acquirer would not assert the underlying derivative claim and did not provide value for it.”
The Chancery Court Did Not Draw All Reasonable Inferences in Plaintiff’s Favor; Should Not Have Applied a Further Litigation Risk Discount
Applying this standard, the court stated that “the parties do not dispute the viability of the derivative claim.” This was because plaintiff’s derivative claim had survived a motion to dismiss before that lawsuit was ultimately dismissed by stipulation of the parties after the merger closed. The court also stated that the parties “did not dispute that [the general partner] secured no value for the derivative claim, and [the acquiring corporation] would not assert the claim post-merger.”
Turning to materiality, the court stated that there were “two errors in the [lower] court’s materiality analysis at the motion to dismiss stage of the proceedings.” The court explained that “[f]irst . . . the court must accept [plaintiff’s] factual allegations as true and draw all reasonable inferences in his favor.” The court stated that “it was reasonably conceivable that the [g]eneral [p]artner acted in subjective bad faith.” The court continued that “[i]t was also reasonably conceivable that, had [plaintiff] succeeded in the derivative suit challenging the reverse drop down transaction, the recovery could have been at least $660 million.” The court concluded that “[a]pplying a further litigation risk discount at the pleading stage was inconsistent with the court’s standard of review on a motion to dismiss for lack of standing.”
The Chancery Court Did Not Use the Proper Calculation to Determine if the Derivative Claim Was Material; Should Not Have Applied a Percentage-Based Risk Reduction
The court stated that the second error was that “even if it was proper to discount the $660 million in damages alleged in the complaint to reflect the public unitholders’ interest in the derivative recovery, to maintain equivalence, the court should have compared the $112 million pro rata interest in the derivative claim recovery to the public unitholders’ proportional interest in the merger consideration.” The court determined that “[u]nder this calculation, the derivative claim was material at the motion to dismiss stage.” The court noted that “[i]n any event, on a motion to dismiss for lack of standing, we are not addressing the likelihood of success on a preliminary injunction record.” Further, the court stated that “[a] percentage-based risk reduction should not be applied at this stage of the proceedings.”