The Direct Versus Derivative Distinction in Limited Partnerships

The Direct Versus Derivative Distinction in Limited Partnerships

      In a recent decision from Alabama, the Court considered and applied the direct versus derivative distinction in the context of a limited partnership. In this instance, as the injury suffered by the plaintiff limited partner was separate and distinct from any injury to the limited partnership itself, the court found that the suit was direct, not derivative, and on that basis allowed it to proceed. Mid-South Tax Credit Partners 1 v. Junkin, Case No.: 6:19-CV-496-RDP, 2019 WL 4277365 (N.D. Ala. Sept. 10, 2019). 

      Plaintiff Mid-South and others were limited partners in Fayette Properties, Ltd., a limited partnership organized in Alabama. The defendant Junkin was a general partner, along with Oswalt, in Fayette Properties. Junkin and Oswalt caused Fayette Properties to receive, in settlement of certain disputes, $184,912.20. As alleged by the plaintiffs, Junkin and Oswalt then misappropriated the limited partners’ share of those settlement funds. When the plaintiffs learned of this alleged diversion, demand was made upon Junkin and Oswalt, who in the meantime had withdrawn and disassociated from the partnership, for the return of the funds. The plaintiffs settled their dispute with Oswalt, and initiated this action against Junkin for the balance due and owing. 

      In response, and apparently inartfully, Junkin sought dismissal of the complaint on the basis that it needed to be brought as a derivative action, and that, necessarily, a derivative action would involve the limited partnership as a party, thereby destroying diversity jurisdiction. Hence, whether the court could consider the merits of the case would depend upon whether the plaintiff's claim was characterized as direct or derivative.

      Applying the distinction between direct and derivative distinctions as set forth by the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrett, Inc., 845 A.2d 1031 (Del. 2004), and applying as well the pre-Tooley decision rendered in Anglo A.M. SCC. Funds, L.P. v. S.R. Globe Int’l Fund, L.P., 829 A.2d 1043, 1049 (Del. Ch. 2003), the court looked to who had been injured and considered as well the question of preventing a windfall to those not injured by the alleged wrongful conduct. In this instance, because in part of the particular wording of the relevant operating agreements, it was found that the alleged diversion of the settlement funds injured only the plaintiffs in their capacity as limited partners, but not the partnership as a whole.

      As the claims were direct, the limited partnership need not be joined as a necessary party to the action, so diversity jurisdiction was retained.