Court Opinion

ID: 9779818
Source: CourtListenerOpinion
Date Created: 2023-08-30 00:48:26.909618+00
Date Added: 2024-06-11T07:33:41.896496
License: Public Domain

Ciparick, J. (dissenting).
The majority opinion effectively precludes litigation by derivative corporate plaintiffs or litigation trustees to recover against negligent or complicit outside actors—even where the outside actor, hired to perform essential gatekeeping and monitoring functions, actively colludes with corrupt corporate insiders. In my view, the agency law principles upon which the majority rests its conclusions ignore complex assumptions and public policy that compel different conclusions than those reached by the majority. Accordingly, I respectfully dissent.
As an important threshold matter, the majority acknowledges that under New York law, in pari delicto is an affirmative defense, not a matter of standing (see majority op at 459 n 3). *478The confusion regarding the nature of this doctrine stems from the Second Circuit’s Wagoner case and its progeny (see Shearson Lehman Hutton, Inc. v Wagoner, 944 F2d 114, 118 [2d Cir 1991]; see also In re CBI Holding Co., Inc., 529 F3d 432, 447-448 [2d Cir 2008]; Wight v BankAmerica Corp., 219 F3d 79, 86 [2d Cir 2000]; Hirsch v Arthur Andersen & Co., 72 F3d 1085, 1093 [2d Cir 1995]; cf. Bullmore v Ernst & Young Cayman Is., 20 Misc 3d 667, 670 [Sup Ct, NY County 2008] [distinguishing between the “equitable defense” of in pari delicto and the Wagoner “standing doctrine”]), which incorrectly characterize New York’s version of in pari delicto as a limitation on standing. The application of in pari delicto as an affirmative defense versus its application as a standing rule is more than merely semantics. Viewing in pari delicto as a matter of standing places the burden of pleading and proof on the plaintiff, while treating the doctrine as an affirmative defense places the burden of pleading and proof on the defendant (see e.g. Woods v Rondout Val. Cent. School Dist. Bd. of Educ., 466 F3d 232, 237 [2d Cir 2006]).1
To be sure, even an affirmative defense can, as the majority observes, be decided on the basis of the facts as alleged in the complaint (see e.g. Donovan v Rothman, 302 AD2d 238, 239 [1st Dept 2003] [holding Supreme Court properly dismissed plaintiffs’ claim on the basis of in pari delicto]). However, to the extent that the majority opinion can be read-to suggest that this is the preferable result, or that a pre-answer motion alleging in pari delicto should always result in a dismissal, I respectfully disagree. On a pre-answer motion to dismiss, a court must take as true the allegations of the complaint and give the plaintiff the benefit of every favorable inference that may be drawn from the complaint or from submissions in opposition to the motion (see Matter of Graziano v County of Albany, 3 NY3d 475, 481 [2004]; 511 W. 232nd Owners Corp. v Jennifer Realty Co., 98 NY2d 144, 152 [2002]; Prudential-Bache Sec. v Citibank, 73 NY2d 263, 266 [1989]). Where complex, fact-based issues abound, pre-answer dismissal should be an exception, not the rule (see e.g. Morgado Family Partners, LP v Lipper, 19 AD3d 262, 263 [1st Dept 2005]; see also In re Adelphia Communica*479tions Corp., 365 BR 24, 33 [Bankr SD NY 2007] [“issue is not whether a (claim) will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims”]; Stahl v Chemical Bank, 237 AD2d 231, 231 [1st Dept 1997] [defense of “unclean hands (which is doctrinally similar to in pari delicto) . . . raises issues that require factual exploration”]). The majority, however, is willing to allow dismissal of the complaints at this early stage of litigation based on agency principles and public policy, effectively creating a per se rule that fraudulent insider conduct bars any actions against outside professionals by derivative plaintiffs or litigation trustees for complicitous assistance to the corrupt insider or negligent failure to detect the wrongdoing. The principles underlying this doctrine do not support such a hard-line stance.
In pari delicto is a long-established tenet of law that instructs courts to refrain from intervening in a dispute between two parties at equal fault (see e.g. Woodworth v Janes, 2 Johns Cas 417, 423 [Sup Ct 1800]; Stone v Freeman, 298 NY 268, 271 [1948]; see also Baena v KPMG LLP, 453 F3d 1, 6 [1st Cir 2006] [in pari delicto “prevent(s) a deliberate wrongdoer from recovering from a co-conspirator or accomplice”]; see also id. at 6 n 5). The majority, quoting McConnell v Commonwealth Pictures Corp. (7 NY2d 465, 470 [I960]), opines that the doctrine of in pari delicto should apply “even in difficult cases” and “should not be ‘weakened by exceptions’ ” (majority op at 464). However, those decisions that have characterized the principle as “inflexible” (see Saratoga County Bank v King, 44 NY 87, 94 [1870]) or “not to be weakened” (McConnell v Commonwealth Pictures Corp., 7 NY2d 465, 470 [I960]) have recognized that the doctrine is premised on concepts of morality, fair dealing and justice (see McConnell, 7 NY2d at 470; Saratoga, 44 NY at 94; see also Bateman Eichler, Hill Richards, Inc. v Berner, 472 US 299, 306-307 [1985] [under the “classic formulation” of in pari delicto “(t)here may be on the part of the court itself a necessity of supporting the public interests or public policy in many cases, however reprehensible the acts of the parties may be”]). It is therefore clear that the concept of in pari delicto is not a rigid concept, incapable of shaping itself to the particulars of an individual case.
Before the in pari delicto doctrine can be applied to circumstances such as those presented here, the actions of the corrupt insider/agent must be found to be attributable to the corporate entity/principal. As the majority observes, the agency law rule *480of imputation generally presumes that a principal knows and approves of the acts of, and shares the knowledge of, its agent (see generally Center v Hampton Affiliates, 66 NY2d 782, 784 [1985]). This “general rule” is undergirded by the “presumption that an agent has discharged his duty to disclose to his principal ‘all the material facts coming to his knowledge with reference to the subject of his agency’ ” (id., quoting Henry v Allen, 151 NY 1, 9 [1896]).
An agent’s actions and knowledge cannot be imputed to the principal,. however, if the “agent is engaged in a scheme to defraud his principal, either for his own benefit or that of a third person” (id.). In such circumstances, “the presumption that knowledge held by the agent was disclosed to the principal fails because he cannot be presumed to have disclosed that which would expose and defeat his fraudulent purpose” (id.). This adverse interest exception can apply in circumstances where a corrupt corporate insider acts for its own benefit, rather than for the benefit of its principal. The majority rejects the premise that the adverse interest exception should depend on a “case-by-case assessment of whether” an agent is likely to communicate information to its principal (majority op at 466). Rather, the majority observes that considerations of public policy—including incentivizing the selection of honest agents and careful delegation of duties—require strict imputation. Moreover, the majority reasons that a limited application of the adverse interest exception—where virtually any benefit to the corporation/principal will defeat the exception—serves the same purposes (see majority op at 468-469), and rejects plaintiffs’ arguments that an agent’s intent is relevant to the adverse interest analysis. The majority also concludes that the adverse interest exception requires a showing of harm, and rejects plaintiffs’ argument that benefits to the principal which are merely illusory do not defeat the exception.
It is axiomatic that the adverse interest exception requires a showing of harm to the principal, but the premise that even an illusory benefit to a principal can serve to defeat the adverse interest exception to imputation misses the point. As the Second Circuit noted in CBI Holding, a “corporation is not a biological entity for which it can be presumed that any act which extends its existence is beneficial to it” (529 F3d at 453, quoting In re Investors Funding Corp. of N.Y. Sec. Litig., 523 F Supp 533, 541 [SD NY 1980]). Indeed, “[prolonging a corporation’s existence in the face of ever increasing insolvency may be ‘doing no more *481than keeping the enterprise perched at the brink of disaster’ ” (id., quoting In re Maxwell Newspapers, Inc., 164 BR 858, 869 [Bankr SD NY 1994]). As was borne out here, in the case of Refco, insider fraud that merely gives the corporation life longer than it would naturally have is not a true benefit to the corporation but can be considered a harm. The majority’s assertion that any corporate insider fraud that “enables the business to survive” defeats the adverse interest exception (majority op at 468) would, as alleged here, condone the actions of the defendants.
Moreover, in the corporate context where the fraud committed by corrupt insiders is either enabled by, joined in, or goes unnoticed by outside “gatekeeper” professionals,2 the use of these simple agency principles in such a manner has been rightfully criticized (see NCP Litig. Trust v KPMG LLP, 187 NJ 353, 368, 901 A2d 871, 880 [2006], quoting Morris, Clarifying the Imputation Doctrine: Charging Audit Clients with Responsibility for Unauthorized Audit Interference, 2001 Colum Bus L Rev 339, 353 [2001]). One commentator has observed that the results seemingly required by imputation and in pari delicto are “severe and unmodulated by concern for the specifics of individual cases” (DeMott, When is a Principal Charged with an Agent’s Knowledge?, 13 Duke J Comp & Intl L 291, 319 [2003]). Indeed, these simplistic agency principles as applied by the majority serve to effectively immunize auditors and other outside professionals from liability wherever any corporate insider engages in fraud.
Important policy concerns militate against the strict application of these agency principles. There can be little doubt that the role played by auditors and other gatekeepers serves the public as well as the corporations that contract for such services. Investors rely heavily on information prepared by or approved by auditors, accountants, and other gatekeeper professionals. Corporate financial statements, examined by ostensibly independent auditors, “are one of the primary sources of information available to guide the decisions of the investing public” (United States v Arthur Young & Co., 465 US 805, 810-811 [1984]). It is, therefore, in the public’s best interest to maximize diligence and thwart malfeasance on the part of gatekeeper *482professionals (see generally Coffee, Gatekeeper Failure and Reform, 84 BU L Rev at 345-346 [“public policy must seek to minimize the perverse incentives that induce the gatekeeper not to investigate too closely”]; Shapiro, Who Pays the Auditor Calls the Tune?: Auditing Regulation and Clients’ Incentives, 35 Seton Hall L Rev 1029, 1034 [2005] [the purpose of audits is to “provide some independent assurance that those entrusted with resources are made accountable to those who have provided the resources”]).
Moreover, it is unclear how immunizing gatekeeper professionals, as the majority has effectively done, actually incentivizes corporate principals to better monitor insider agents. Indeed, it seems that strict imputation rules merely invite gatekeeper professionals “to neglect their duty to ferret out fraud by corporate insiders because even if they are negligent, there will be no damages assessed against them for their malfeasance” (Pritchard, O’Melveny Meyers v FDIC: Imputation of Fraud and Optimal Monitoring, 4 Sup Ct Econ Rev 179, 192 [1995]).
For these and other reasons, our sister courts in New Jersey and Pennsylvania have carved out exceptions or limitations to the imputation and in pari delicto rules. In NCP Litig. Trust v KPMG LLP (187 NJ 353, 901 A2d 871 [2006]), the Supreme Court of New Jersey held that “when an auditor is negligent within the scope of its engagement, the imputation doctrine does not prevent corporate shareholders from seeking to recover” (187 NJ at 384, 901 A2d at 890). That court explained its rationale for adopting such a rule as follows: “A limited imputation defense will properly compensate the victims of corporate fraud without indemnifying wrongdoers for their fraudulent activities. To the extent that shareholders are innocent of corporate wrongdoing, our holding provides just compensation to those plaintiffs” (id.).
In explaining its newly-drawn good faith exception or limitation on the rules of imputation and in pari delicto, the Supreme Court of Pennsylvania observed that
“the appropriate approach to benefit and self-interest [as those concepts inform the decision whether to impute an insider’s conduct to the corporate entity] is best related back to the underlying purpose of imputation, which is fair risk-allocation, including the affordance of appropriate protection to those who transact business with *483corporations” (Official Comm. of Unsecured Creditors of Allegheny Health Educ. & Research Found, v PricewaterhouseCoopers, LLP, 989 A2d 313, 335 [2010] [hereinafter AHERF]).
Accordingly, that court drew a “sharp distinction between those who deal in good faith with the principal-corporation in material matters and those who do not” (id.). Ultimately, the court continued to “recognize the availability of the in pari delicto defense (upon appropriate and sufficient pleadings and proffers), via the necessary imputation, in the negligent-auditor context” (id.). As to auditor collusion, however, the Pennsylvania Supreme Court explained that “the ordinary rationale supporting imputation breaks down completely in scenarios involving secretive, collusive conduct between corporate agents and third parties . . . because imputation rules justly operate to protect third parties on account of their reliance on an agent’s actual or apparent authority” (id. at 336).3 Accordingly, the court held that imputation—and therefore in pari delicto—“do[es] not (and should not) apply in circumstances in which the agent’s authority is neither actual nor apparent, as where both the agent and the third party know very well that the agent’s conduct goes unsanctioned by one or more of the tiers of corporate governance” (id.).
In conclusion, I do not quarrel with the majority’s statements of the applicable principles of agency law. Rather, my departure is from the majority’s rigid application of those principles to cases by litigation trustees and derivative plaintiffs against gatekeeper professionals for enabling corporate insider fraud by colluding in or failing to detect such fraud. I agree with the litigation trustee and the derivative plaintiffs that no equitable basis exists for holding that litigation trustees or derivative plaintiffs are in pari delicto with culpable outside professionals. Indeed, in my view, the weight of the equities favors allowing *484suits such as these to go forward to deter active wrongdoing or negligence by auditors and similar professionals (see generally O’Melveny & Myers v FDIC, 512 US 79, 90 [1994, Stevens, J., concurring]). Moreover, I am persuaded by the sound rationales employed by our sister state courts in the AHERF case and the NCP Litig. Trust case that a more reasonable approach is to recognize a carve-out or exception to the in pari delicto doctrine for cases involving corporate insider fraud enabled by complicit or negligent outside gatekeeper professionals.
Accordingly, I would answer the certified questions from both the Second Circuit and the Delaware Supreme Court in accordance with this writing.
Judges Graffeo, Smith and Jones concur with Judge Read; Judge Ciparick dissents in a separate opinion in which Chief Judge Lippman and Judge Pigott concur.
In Kirschner v KPMG LLP: Following certification of questions by the United States Court of Appeals for the Second Circuit and acceptance of the questions by this Court pursuant to section 500.27 of the Rules of Practice of the New York State Court of Appeals (22 NYCRR 500.27), and after hearing argument by counsel for the parties and consideration of the briefs and the record submitted, certified questions answered in accordance with the opinion herein.
In Teachers’ Retirement Sys. of La. v PricewaterhouseCoopers LLP: Following certification of a question by the Supreme Court of Delaware and acceptance of the question by this Court pursuant to section 500.27 of the Rules of Practice of the New York State Court of Appeals (22 NYCRR 500.27), and after hearing argument by counsel for the parties and consideration of the briefs and the record submitted, certified question answered in accordance with the opinion herein.

. Significantly, the majority gives the so-called Wagoner rule continuing validity, at least in part, by characterizing it as a “prudential limitation on standing” derived from “federal bankruptcy law” (majority op at 459 n 3). In pari delicto, as an affirmative defense, does not bear on a plaintiffs standing to assert a claim, only on the relative merits or ultimate success of such a claim. Accordingly, to the extent that Wagoner implies that in pari delicto is a matter of standing, I would expressly disapprove of that case and its progeny.

. Obvious examples of what are sometimes referred to as “gatekeepers” include auditors, accountants, and law firms (see generally Coffee, Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms, 84 BU L Rev 301, 308-309 [2004]).

. Bearing on the underlying premises supporting imputation, agency law generally holds a principal responsible for the actions of an agent that are taken with actual or apparent authority (see generally Standard Funding Corp. v Lewitt, 89 NY2d 546, 549 [1997]; Hallock v State of New York, 64 NY2d 224, 231 [1984]). Whether apparent authority exists is a fact-based determination requiring inquiry into the conduct of the principal. In other words, apparent authority may exist if the principal’s conduct has given rise “to the appearance and belief that the agent possesses authority to” act with respect to the third party (Hallock, 64 NY2d at 231). Notably, a third party with whom the agent deals may only rely on an appearance of authority to the extent that such reliance is reasonable (see id., citing Wen Kroy Realty Co. v Public Natl. Bank & Trust Co., 260 NY 84, 92-93 [1932]).