Del. Court Clarifies Standing Issue in Paulson Suit

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By Michael Greene

Jan. 27 — Answering a certified question by a federal appeals court, the Delaware Supreme Court concluded Jan. 26 that an investor in a limited liability company that serves as a feeder fund to Paulson & Co. can't bring a direct action against Paulson's general partners and managers over fund losses.

The investor's lawsuit arose out of investment fund Paulson Advantage Plus LP's alleged $460 million loss in a Chinese forestry company. In the wake of the loss, plaintiff Hugh Culverhouse—an investor in HedgeForum Paulson Advantage Plus LLC, a feeder fund that invested nearly all of its assets in Paulson Advantage Plus—filed a would-be class suit against the investment fund's general partners, Paulson & Co. and Paulson Advisers LLC.

In finding Culverhouse's claims to be derivative rather than direct, the Delaware high court reasoned that the purported class only had a legal relationship with the feeder fund, not the general partners.

“The separateness of the Feeder Fund and Investment Fund is not a detail to be disregarded simply because the Feeder Fund acts as a pass-through entity, and does not issue transferrable shares,” Justice Collins J. Seitz Jr. wrote for the court.

“Each fund has its own governing agreements spelling out the rights and obligations of the fund and its investors,” Seitz continued. “To ignore these operative agreements would upset the contractual expectations of the investors and the managers of each fund.”

Direct or Derivative?

The certified question stemmed from a U.S. District Court for the Southern District of Florida judgment dismissing Culverhouse's action for lack of standing, finding that his claims were derivative under Delaware law.

In a derivative suit, a shareholder sues in the corporation's name against parties that allegedly harmed the entity. Under Delaware law, a shareholder generally must ask the board to take action before filing suit or show that pre-suit demand would be futile. The proceeds of a successful derivative action are awarded to the corporation, not the shareholder.

Culverhouse appealed the standing issue to the U.S. Court of Appeals for the Eleventh Circuit, which asked the Delaware Supreme Court for guidance regarding whether the claims are direct or derivative.

In answering the certified question, the Delaware Supreme Court concluded that Culverhouse had to bring his claims derivatively under its ruling in Tooley v. Donaldson Lufkin & Jenrette Inc., 845 A.2d 1031 (Del. 2004).

Specifically, the court said that the alleged harm flowing from the investment fund's losses wasn't suffered directly by Culverhouse. Likewise, the court said the investor wouldn't directly receive the benefit of any recovery of his claims.

Unsettled Area of Delaware Law

The state high court's Jan. 26 ruling represents the second time within the last 12 months that it has answered a question regarding how Tooley applies to the derivative/direct issue.

In response to a query from the U.S. Court of Appeals for the Second Circuit, the Delaware Supreme Court last June ruled that a parent corporation may sue to enforce its own contractual rights directly, even if the harm from the alleged breach is to its subsidiary (123 SLD, 6/26/15).

Looking ahead, the state high court also has been asked to resolve another unsettled issue involving Tooley.

That question—also by the Second Circuit—asks whether a lawsuit over residential mortgage-backed securities brought by Citigroup Inc. shareholders should be considered direct or derivative (229 SLD, 11/30/15).

To contact the reporter on this story: Michael Greene in Washington at

To contact the editor responsible for this story: Yin Wilczek at