Opinion ID: 2482599
Heading Depth: 1
Heading Rank: 5

Heading: Adverse Interest Exception to Imputation

Text: We articulated the adverse interest exception in Center as follows: To come within the exception, the agent must have totally abandoned his principal's interests and be acting entirely for his own or another's purposes. It cannot be invoked merely because he has a conflict of interest or because he is not acting primarily for his principal ( Center, 66 NY2d at 784-785 [emphasis added]). This rule avoids ambiguity where there is a benefit to both the insider and the corporation, and reserves this most narrow of exceptions for those casesoutright theft or looting or embezzlementwhere the insider's misconduct benefits only himself or a third party; i.e., where the fraud is committed against a corporation rather than on its behalf. The rationale for the adverse interest exception illustrates its narrow scope. As already discussed, the presumption that an agent will communicate all material information to the principal operates except in the narrow circumstance where the corporation is actually the victim of a scheme undertaken by the agent to benefit himself or a third party personally, which is therefore entirely opposed (i.e., adverse) to the corporation's own interests ( see Center, 66 NY2d at 784). Where the agent is perpetrating a fraud that will benefit his principal, this rationale does not make sense. A fraud that by its nature will benefit the corporation is not adverse to the corporation's interests, even if it was actually motivated by the agent's desire for personal gain ( Price, 62 NY at 384). Thus, [s]hould the `agent act[ ] both for himself and for the principal,' ... application of the exception would be precluded ( Capital Wireless Corp. v Deloitte & Touche, 216 AD2d 663, 666 [3d Dept 1995], quoting In re Crazy Eddie Sec. Litig., 802 F Supp 804, 817 [ED NY 1992]; see also Center, 66 NY2d at 785 [the adverse interest exception cannot be invoked merely because ... (the agent) is not acting primarily for his principal]). New York law thus articulates the adverse interest exception in a way that is consistent with fundamental principles of agency. To allow a corporation to avoid the consequences of corporate acts simply because an employee performed them with his personal profit in mind would enable the corporation to disclaim, at its convenience, virtually every act its officers undertake. [C]orporate officers, even in the most upright enterprises, can always be said, in some meaningful sense, to act for their own interests ( Grede v McGladrey & Pullen LLP, 421 BR 879, 886 [ND Ill 2009]). A corporate insider's personal interestsas an officer, employee, or shareholder of the companyare often deliberately aligned with the corporation's interests by way of, for example, stock options or bonuses, the value of which depends upon the corporation's financial performance. Again, because the exception requires adversity, it cannot apply unless the scheme that benefitted the insider operated at the corporation's expense. The crucial distinction is between conduct that defrauds the corporation and conduct that defrauds others for the corporation's benefit. Fraud on behalf of a corporation is not the same thing as fraud against it ( Cenco Inc. v Seidman & Seidman, 686 F2d 449, 456 [7th Cir 1982]), and when insiders defraud third parties for the corporation, the adverse interest exception is not pertinent. Thus, as we emphasized in Center, for the adverse interest exception to apply, the agent must have totally abandoned his principal's interests and be acting entirely for his own or another's purposes, not the corporation's ( Center, 66 NY2d at 784-785 [emphasis added]). So long as the corporate wrongdoer's fraudulent conduct enables the business to surviveto attract investors and customers and raise funds for corporate purposesthis test is not met ( Baena, 453 F3d at 7 [A fraud by top management to overstate earnings, and so facilitate stock sales or acquisitions, is not in the long-term interest of the company; but, like price-fixing, it profits the company in the first instance]). The Litigation Trustee suggests that, to the extent that the adverse interest exception requires harm, bankruptcy is harm enough and that, whenever the corporation is bankrupt, it is fair to assume at the pleading stage that the adverse interest exception applies. But the mere fact that a corporation is forced to file for bankruptcy does not determine whether its agents' conduct was, at the time it was committed, adverse to the company ( see e.g. Barnes v Hirsch, 215 App Div 10, 11 [1st Dept 1925] [trustee's claim dismissed where it sought to recover for agents' fraud practiced on these customers of debtor rather than debtor itself], affd 242 NY 555 [1926]). Even where the insiders' fraud can be said to have caused the company's ultimate bankruptcy, it does not follow that the insiders totally abandoned the company. As we have held when considering whether an agent's acts were a fraud on the principal prompted by selfish motives, it is immaterial that it has turned out that it would have been better for the agent to have acted differently ( Price, 62 NY at 385; see also Restatement [Third] of Agency § 5.04, Comment c [the fact that an action taken by an agent has unfavorable results for the principal does not establish that the agent acted adversely]). Critically, the presumption of imputation reflects the recognition that principals, rather than third parties, are best suited to police their chosen agents and to make sure they do not take actions that ultimately do more harm than good ( see Cenco, 686 F2d at 455 [if the owners of the corrupt enterprise are allowed to shift the costs of its wrongdoing entirely to the auditor, their incentives to hire honest managers and monitor their behavior will be reduced]; see also Restatement [Third] of Agency § 5.03, Comment b [Imputation creates incentives for a principal to choose agents carefully and to use care in delegating functions to them]). Consistent with these principles, any harm from the discovery of the fraudrather than from the fraud itselfdoes not bear on whether the adverse interest exception applies. The disclosure of corporate fraud nearly always injures the corporation. If that harm could be taken into account, a corporation would be able to invoke the adverse interest exception and disclaim virtually every corporate fraudeven a fraud undertaken for the corporation's benefitas soon as it was discovered and no longer helping the company. Finally, to focus on harm from the exposure of the fraud would be a step away from the requirement of adversity. Generally, a fraud will suit the interests of both a company and its insiders for as long as it remains a secret (sometimes a considerable number of years, as was the case with Refco), and leads to negative consequences for both when disclosed.