June 28, 2013

In Pari Delicto Defense The importance of the in pari delicto defense in accounting and other professional liability cases

Pennsylvania has long acknowledged the in pari delicto defense in accounting cases, particularly in the auditor situation. The in pari delicto defense holds that when a plaintiff and defendant are mutually at fault in causing the harm it suffered, the plaintiff cannot avoid its own liability and make a recovery against the defendant. See Feld & Sons, Inc. v. Pechner, Dorfman, Wolfee, Rounick & Cabot, 458 A.2d 545 (Pa. Super 1983); see also Official Committee of Unsecured Creditors of Allegheny Health Education and Research Foundation v. PriceWaterhouseCoopers, LLP. 989 A.2d 313 (Pa. 2010) [hereinafter “Allegheny Health”].

The basic theory is that the plaintiff, as an admitted wrongdoer, should not benefit and therefore wrongdoing will be deterred. The Pennsylvania Supreme Court most recently in the Allegheny Health case affirmed the in pari delicto defense while acknowledging that in the instance of collusion by the auditor, the defense would not be a bar to the claims. Proceeding forward, it remains to be seen exactly how the courts will apply this important doctrine.

This situation most commonly arises when a large company enters bankruptcy and claims are made that there was fraud on the part of corporate management which went undetected by the company’s outside auditors. Obviously, companies often go bankrupt and become insolvent in the wake of fraud on the part of corporate management. The bankruptcy trustee or receiver will bring claims against the auditor in an effort to recover for the auditor having negligently failed to detect the fraud. The in pari delicto defense is generally raised along side the imputation doctrine.[i]This is exactly what happened in three recent cases in Pennsylvania, New York, and New Jersey.[ii]

Without getting bogged down in the details of the cases, the essential holdings are as follows. The most recent decision was that of New York’s highest court, the New York Court of Appeals, which was in the combined cases of Marc S. Kirschner, as Trustee of the Refco Litigation Trust v. KPMG LLP et al. and Teachers’ Retirement System of Louisiana et al., Derivatively on Behalf of Nominal Defendant American International Group, Inc. v. PricewaterhouseCoopers LLP, 15 NY3d 446 (NY Court of Appeals October 21, 2010) [hereinafter “Kirschner”]. In Kirschner, the NY court affirmed and upheld the in pari delicto defense. The Pennsylvania Supreme Court upheld the in pari delicto defense, with one small exception. Prior to both of these decisions, the New Jersey Supreme Court decided NCP Litigation Trust v. KPMG LLP, 901 A.2d 871 (N.J. 2006). It is unfortunate for auditors, that the New Jersey Supreme Court held that the auditor could not assert the in pari delicto defense if the auditor was negligent.

The problem for auditors is that generally while the corporation itself may not have any right of recovery, the law gives trustees and receivers much greater power and ability to claw out a recovery even when the corporation itself cannot. This doctrine is vitally important in defending auditors and other third party professionals when there is wrongdoing on the part of corporate officers.

We’ll monitor the in pari delicto defense as it continues to be used in Pennsylvania and surrounding states. If you have any questions about the in pari delicto defense or the cases please contact jmcguire@c-wlaw.com.

[i]The imputation doctrine holds that the actions and fault of a corporation’s officer(s) are imputed to the company, and it is as if the company itself took the actions. Thus, the fraud of a corporate officer could be imputed to and held against the company itself. This generally requires some benefit to the company from the actions of the corporate officer(s).

[ii]A split across the country exists as to whether the in pari delicto defense can be applied to a trustee or receiver. Take the time to understand the law in your jurisdiction.

What It Means to You

What This Means for Accountants and Other Professionals

            According to the U.S. Chamber of Commerce, Commission on the Regulation of U.C. Capital Markets in the 21st Century, Report and Recommendations (March 2007), the accounting profession is significantly burdened by litigation arising from a widened scope of liability and plaintiffs seeking “deep pockets.” You can see why this defense can be vitally important.

            The jurisdiction of the litigation will matter as to the application of this defense. In Pennsylvania, you will have trouble asserting this defense if you participated in any way with the fraudulent activity. If you discover fraud, consult with your attorney, and then with your insurance company. Depending on what you find, you may need to withdraw from the engagement.

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What It Means for Professional Liability Adjusters

            Be certain to discuss and consider the application of this defense under the circumstances of the claim. Consult with counsel to determine the latest development on how the court is applying this defense. Remember that this can be a complete bar to a claimant’s recovery even if the claimant is a trustee or receiver.