This GM would've only dispelled magical torch effects in the breath weapon's area

I think the shadow drake's supernatural ability stygian breath should've only dispelled the dancing lights effects that were in the area of the stygian breath ability. The Pathfinder Core Rulebook FAQ on Dispelling has a Dispel Example section that says

You are a 5th-level wizard, your opponent is a 6th-level sorcerer. On her turn, the sorcerer casts slow and targets 6 of your allies; all 6 of them fail their saves and are slowed. On your turn, you cast haste and target 5 of your allies; this automatically dispels (no caster level check needed) the slow spell on those allies, leaving them without the effect of slow or haste (your 6th ally is still affected by slow). Note that this does not merely suppress the slow effect for the duration of your haste—the effect is completely dispelled on those 5 allies. Note that it doesn't matter if the target would normally get a saving throw or spell resistance to negate or avoid the spell used to dispel (such as casting slow to dispel an already-caste haste); to speed up gameplay and prevent lopsided applications of this sort of dispelling, the "diametrically opposed" spell automatically dispels its opposite, regardless of the desires of the creature affected by the opposite.

(Emphasis mine.) That is, a spell that has multiple targets and that affects individual targets can be dispelled on each target individually. By extension, then, a spell that creates multiple effects can have each separate effect it creates dispelled separately.

That is, in the same way that a dispel magic spell that successfully affects one creature brought forth by a summon monster spell does not affect the other creatures brought forth by that same summon monster spell, dispelling one torch created by the dancing lights spell shouldn't dispel the entire dancing lights spell. (Note that I would've ruled that the stygian breath ability must encompass that dancing lights spell effect's point of origin for it to be affected, but I don't have the map that tells me if that happened in your game. The stygian breath ability dispels based on the source of the magical light—where its coming from—not based on the magical light that radiating from that source!)

If the GM angles for consistency, the GM's ruling should lead to an entire spell being dispelled if only one part of a spell is dispelled. And this should lead to a ruling that sees dispelling one creature's slow spell with a haste spell dispels that same slow spell on all affected creatures, which is contrary to the rules.