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The Essential Resource for Today’s Busy Insolvency Professional
Feature
By GreGory W. Fox
Limits of Expansive Protection of
New York’s In Pari Delicto Defense
Whenever a company tumbles into bank-
ruptcy following the discovery of its man-
agement’s nancial misdeeds, rms that
provided the company with accounting, legal, bank-
ing and nancial advisory services should prepare
to defend themselves against malpractice claims by
a bankruptcy trustee or other estate representative,
who may seek to hold them responsible for the col-
lapse. These claims often allege that the profession-
als participated in, aided and abetted, or negligently
failed to detect and stop the fraudulent acts and
breaches of duty perpetrated by management.
Fortunately for these defendants, courts inter-
preting New York law have repeatedly recognized
a powerful defense that can eliminate such claims
at an early stage of the litigation. The common
law doctrine of in pari delicto bars a plaintiff from
recovering against a third party for a fraud or other
misconduct in which the plaintiff participated.1
Applying this doctrine in the bankruptcy context,
the Second Circuit has firmly held that a “claim
against a third party for defrauding a corporation
with the cooperation of management accrues to
creditors, not the guilty corporation.”2 Thus, under
the so-called “Wagoner Rule,” since a bankruptcy
trustee stands in the shoes of the corporation (not
its creditors), he/she lacks standing to recover from
third parties for participating in fraud or other mis-
conduct perpetrated by the corporation.3
Moreover, the highest appellate court in New
York has ruled that the “adverse-interest exception”
to the in pari delicto defense — which applies when
the corporate misfeasor has “totally abandoned” the
company’s interests in favor of his/her own — only
limits application of in pari delicto in very narrow
circumstances.4 Simply put, New York’s version of
the in pari delicto defense is among the most protec-
tive to professionals in the nation.
The strength of this defense has been on dis-
play in recent years. Banks, accounting rms and
law firms have all successfully used the in pari
delicto defense and the Wagoner Rule to shield
themselves from lawsuits by representatives of
companies accused of large-scale nancial frauds,
such as Bernard L. Madoff Investment Securities,5
Refco Inc.6 and MF Global Holdings Ltd.7 In a July
9, 2014, decision, however, the New York district
court overseeing litigation stemming from the col-
lapse of MF Global Holdings Ltd. halted this trend
of in pari delicto dismissals.8 The court instead
allowed the bankruptcy estate to pursue claims
seeking more than $1 billion of damages against
MF Global’s accounting rm for professional mal-
practice and negligence in connection with allegedly
faulty accounting advice given with respect to MF
Global’s investment strategy.
In so holding, the court drew a ne — but impor-
tant — distinction between claims that a profession-
al helped or negligently failed to stop an unlawful
act (barred by in pari delicto) and claims that a
professional gave improper advice that caused the
Gregory W. Fox
Goodwin Procter LLP
New York
3 Id.; Picard v. JPMorgan Chase & Co. (In re Bernard L. Madoff Inv. Sec. LLC), 721 F.3d
54, 64 (2d Cir. 2013) (“Madoff”) (“These claims fall squarely within the rule of Wagoner
and the ensuing cases: [Trustee Irving] Picard stands in the shoes of BLMIS [the
debtor] and may not assert claims against third parties for participating in a fraud that
BLMIS orchestrated.”).
Gregory Fox is an
associate in the
New York ofce of
Goodwin Procter LLP.
his own misconduct is so strong in New York that we have said [that] the defense applies
even in difficult cases and should not be ‘weakened by exceptions.’”) (citation omitted).
enrichment, breach of fiduciary duty, aiding and abetting fraud, and negligence claims
against several banks that did business with Madoff on in pari delicto/Wagoner grounds).
litigation trustee’s claims against various third parties for aiding and abetting Refco insid-
ers in committing fraud or for negligently failing to discover such fraud).
7 In re MF Global Holdings Ltd. Inv. Litig., No. 11-CV-7866, 2014 WL 667481, *23-25
(S.D.N.Y. Feb. 11, 2014) (“MF Global II”) (dismissing on in pari delicto grounds claims
against debtor’s auditing firm for its alleged failure to ensure that proper controls existed
at company to safeguard customer funds).
8 MF Global Holdings Ltd. v. PricewaterhouseCoopers LLP, No. 14-CV-2197, 2014 WL
3402602 (S.D.N.Y. July 9, 2014) (“MF Global III”).
