Metropolitan Life Insurance Company v. Tremont Group Holdings, Inc.: Plaintiff Did Not Transform Derivative Claims into Direct Claims by Opting Out of Federal Settlement

March 11, 2013

Publication| Corporate Transactions| Corporate & Chancery Litigation

In Metropolitan Life Insurance Company v. Tremont Group Holdings, Inc., 2012 WL 6632681 (Del. Ch. Dec. 20, 2012), Vice Chancellor Parsons of the Court of Chancery further clarified Delaware law with respect to the distinction between direct and derivative claims in litigation involving Delaware limited partnerships. Plaintiffs, each a limited partner in a Delaware limited partnership which invested in a related fund that, in turn, heavily invested in Bernie Madoff’s now-infamous Ponzi scheme, asserted numerous direct and derivative claims against the limited partnership, its general partner and numerous current and former officers, directors and managers of the parent entities. The defendants moved to dismiss the complaint on various grounds, including that claims for breach of fiduciary duty and unjust enrichment, styled as direct claims, were derivative in nature and thus barred by a prior settlement of Madoff-related individual, class and derivative claims brought against the defendants in an action in the United States District Court for the Southern District of New York (the “Settlement”).

The Court began its analysis by reiterating that “[t]he determination of whether a claim is derivative or direct in nature is substantially the same for corporate cases as it is for limited partnership cases.” The Court then set forth the well-known, two-prong standard established by the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), which requires the Court to answer two questions when determining whether a claim is direct or derivative: (1) who suffered the alleged harm; and (2) who would receive the benefit of any recovery or other remedy. Following established Delaware law, the Court further noted that “the manner in which a plaintiff labels its claim and the form of words used in the complaint are not dispositive; rather, the court must look to the nature of the wrong alleged, taking into account all of the facts alleged in the complaint.”

Applying the Tooley standard, the Court concluded that plaintiffs’ breach of fiduciary duty and unjust enrichment claims were derivative, as the harm alleged—the limited partnership’s diminution in value following discovery of the Ponzi scheme—was suffered by the limited partnership and not by the limited partners individually. In short, the complaint alleged simply that the defendants’ purported mismanagement made the limited partnership less valuable, an injury the Court determined was suffered secondarily by the plaintiffs as a function of their pro rata investment in the limited partnership.

Plaintiffs argued that the nature of their claims was altered by their decision to opt out of the Settlement. Specifically, plaintiffs contended that they satisfied the Tooley test because (1) they received no benefit from the Settlement and would suffer a unique harm as they would be left without any recourse for their alleged injuries; and (2) they alone would benefit from any recovery in this litigation, presumably because the limited partnership and its other limited partners all participated in the Settlement. The Court rejected this argument because plaintiffs’ breach of fiduciary duty and unjust enrichment claims were derivative in nature at the time of the Settlement and plaintiffs had no right under Delaware or federal law to opt out of a derivative suit. Accordingly, plaintiffs’ decision to opt out of the Settlement could not serve as a basis to convert their derivative claims into direct causes of action, and their derivative claims were barred by the Settlement under principles of res judicata and release.

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