Third Circuit Finds Limited Partners’ “Direct” Claims to be Masked Derivative Ones
By: Kristen Lasak
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
In In re SemCrude L.P., the U.S Court of Appeals for the Third Circuit found that the claims of breach of fiduciary duty, negligent misrepresentation, and fraud set forth by limited partners against the co-founder and former President and CEO of SemCrude L.P. were derivative of the claims held by SemCrude’s Litigation Trust.[i] SemCrude L.P. is an Oklahoma-based oil and gas company co-founded by Thomas Kivisto, who allegedly drove the company into bankruptcy due to self-dealing and speculative trading strategies.[ii] In July 2008, SemCrude, along with its parent company and certain subsidiaries, filed petitions for relief under chapter 11 with the United States Bankruptcy Court for the District of Delaware.[iii] On October 28, 2009, the bankruptcy court issued an order confirming SemCrude’s plan of reorganization, which established a Litigation Trust.[iv] The plan specifically transferred the claims belonging to SemCrude’s bankruptcy estate to the Litigation Trust and authorized the Litigation Trust to pursue SemCrude’s claims and distribute any money attained to SemCrude’s creditors.[v] The Litigation Trust asserted thirty claims, including breach of fiduciary duty, breach of contract, fraudulent transfer, and unjust enrichment, against Kivisto and certain Semcrude officers.[vi] On November 19, 2010, the bankruptcy court approved a $30 million settlement agreement, which also incorporated a mutual release of all claims.[vii] Particularly, the Litigation Trust released Kivisto and the other officers from being accountable to any party for “contribution or indemnity relating to the released claims.”[viii]
On December 22, 2010, a group of limited partners, known to the court as the “Oklahoma Plaintiffs,” filed a lawsuit again Kivisto and PricewaterhouseCoopers LLP, SemCrude’s pre-bankruptcy auditor in Oklahoma state court.[ix] The Oklahoma Plaintiffs alleged that Kivisto concealed his self-dealing and speculative trading, and vigorously misrepresented SemCrude’s financial health to coax them into investing extra capital or retaining their investments in SemCrude.[x] Specifically, the Oklahoma Plaintiffs attempted to differentiate themselves from other limited partners by arguing that they were personally approached by Kivisto, and contrary to other limited partners, they did not hold board positions and were not privy to “sweetheart side deals.”[xi] On May 4, 2011, Kivisto submitted an emergency motion to the bankruptcy court to enjoin the Oklahoma Plaintiffs’ lawsuit from proceeding in state court and enforce the settlement agreement.[xii] The bankruptcy court granted Kivisto’s motion, finding that the claims were derivative causes of action. On appeal, the District Court reversed and remanded the matter to the bankruptcy court on all three claims, finding that the bankruptcy court did not properly evaluate the Oklahoma Plaintiffs’ assertions that they had been separately harmed and there was a reasonable basis to determine that they had been.[xiii] On remand, the bankruptcy court denied Kivisto’s motion to enjoin, and Kivisto appealed the denial of his motion to the United States Court of Appeals for the Third Circuit.[xiv]
Since the issue of whether a claim is direct or derivative is a question of law, the court exercised plenary review in rendering its decision on the claims in this case.[xv] Under the derivative injury rule, a shareholder cannot sue for “personal injuries that result directly from injuries to the corporation.”[xvi] The Third Circuit determined that under Oklahoma law, the derivative injury rule is not applicable when a shareholder claims that he or she “sustained any loss in addition to the loss sustained by the corporation.”[xvii] The court further noted that this standard applies equally to cases involving limited partnerships.[xviii] The court referred to Dobry v. Yukon Electric Company, which the Third Circuit established provided the governing law on the issue, the Oklahoma court emphasized that where an alleged loss flows from management’s wrong to the company that in turn affects the shareholder’s stock and affects all shareholders alike, the claims are derivative.[xix] Ultimately, the Third Circuit concluded that the Oklahoma Plaintiffs’ claims for negligent misrepresentation, fraud, and breach of fiduciary duty failed to demonstrate any additional loss compared to SemCrude’s loss as a whole, and thus, their claims were derivative of those discharged by the Litigation Trust.[xx] Having found the claims to be derivative, the court directed the bankruptcy court to enter a permanent injunction forbidding the Oklahoma Plaintiffs from proceeding in Oklahoma state court.[xxi]
This case demonstrates the power and effectiveness of creating Litigation Trusts. Distressed investors should be forewarned that they may be barred from bringing certain claims because those claims could be brought by the bankruptcy estate under its powers. The line between direct and derivative claims may be a thin one, and recent cases, including this one, indicate that the claims of investors are likely to be deemed to be derivative of claims owned by the bankruptcy estate. In a similar matter, in Marshall v. Pichard, the Second Circuit enjoined state law tort actions brought by two of Bernie Madoff’s defrauded investors against one of Madoff’s alleged co-conspirators and related defendants.[xxii] There, the court determined that the investors’ claims were derivative of those asserted by the Trustee for the Bankruptcy Estate against the defendant, and rejected the investors’ argument that their claims were “particularized” to the defendants.[xxiii] This earlier decision bolsters the potential importance of the Third Circuit’s decision in In re SemCrude L.P. and illustrates that courts hold in great esteem the rights of the Bankruptcy Estate and require the demonstration of particularized injuries by individual investors before claims can be considered direct. Indeed, though In re SemCrude L.P. was decided under Oklahoma law, the similar state and federal law requirements of a particularized injury claims to be direct signal that the Third Circuit’s decision has important implications for the future of bankruptcy litigation in relation to the comparative rights of individual investors and a bankruptcy estate.
[i] See 796 F.3d 310, 312–13, 322.
[ii] See id. at 312.
[iii] See id. at 314.
[iv] See id.
[v] See id.
[vi] See id.
[vii] See id.
[viii] See id.
[ix] See id.
[x] See id. at 313–14 (discussing how the Oklahoma Plaintiffs alleged they were personally induced into paying million of dollars in capital contributions to SemCrude L.P. through their reliance upon Kivisto’s misrepresentations and omissions).
[xi] See id. at 314.
[xii] See id. at 315.
[xiii] See id.
[xiv] See id.
[xv] See id. at 316; see also Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co, Inc., 267 F.3d 340, 348 (3d Cir. 2001).
[xvi] Id. at 316 (quoting Kaplan v. Firs Options (In re Kaplan), 143 F.3d 807, 811-12 (3d. Cir. 1998) (internal quotation marks omitted)).
[xvii] Id. (quoting Dobry v. Yukon Elec. Co., 290 P.2d 135, 138 (Okla. 1955) (internal quotation marks omitted) (emphasis in original).
[xviii] See id. (citing Okla. Stat. Ann. tit. 54, § 500–1001A(b)).
[xix] See id. at 317 (explaining a quote from Dobry, 290 P.2d at 137).
[xx] See id. at 316-17.
[xxi] See id. at 322.
[xxii] See In re Bernard L. Madoff Inv. Secs., 740 F.3d 81, 84, 96 (2d Cir. 2014).
[xxiii] See id.