In pari delicto is the bane of bankruptcy trustees. Invocation of this judge-made rule of equity can preclude a trustee from suing nondebtor third parties who assisted in the debtor’s wrongdoing.
To no avail, a bankruptcy trustee in South Carolina mounted a frontal assault in the Fourth Circuit on in pari delicto, which means “in equal fault.”
The doctrine was originally invented by English courts to bar one thief from suing a cohort for part of the stolen goods. Today, in pari delicto bars a plaintiff from suing a defendant when the plaintiff was in equal or greater fault.
Some states have adopted exceptions, such as the “adverse interest exception,” which bars the defense when an agent was acting for the agent’s own benefit and abandoned the interests of the corporation.
In the South Carolina chapter 7 case, officers of the corporate debtor had cooked the books with assistance from an outside accounting firm. The trustee sued the corporate officers, the accountants and the debtor’s financial advisors. Everyone defaulted or settled, except the financial advisors. Some of the defendants went to jail.
The suit against the financial advisors asserted claims including common law fraud, breach of fiduciary duty and aiding and abetting breach of fiduciary duty.
After an 18-day bench trial, the bankruptcy judge gave judgment in favor of the financial advisors. The court decided that the trustee had failed to establish the elements of any of the claims. In addition, the bankruptcy court ruled that the defense of in pari delicto barred the suit.
The district court affirmed on the same grounds, prompting another appeal where Circuit Judge Toby J. Heytens affirmed in an opinion on April 19.
The trustee advanced five theories designed to forestall invocation of in pari delicto. Judge Heytens knocked them down one by one.
First, the trustee argued that in pari delicto should not apply because he represented both the debtor and blameless creditors. The argument got nowhere.
Judge Heytens cited the Fourth Circuit for holding in 2013 that “a trustee proceeding under 11 U.S.C. § 541 is subject to the same defenses as the debtor because the trustee stands in the debtor’s shoes in such an action.” Grayson Consulting, Inc. v. Wachovia Secs., LLC, 716 F.3d 355, 367 (4th Cir. 2013). [Emphasis in original.]
In Grayson, Judge Heytens said, the Fourth Circuit “specifically held that this includes in pari delicto.”
Judge Heytens therefore held that “the trustee is plainly subject to in pari delicto to the extent he brings this action under Section 541.” That section creates an estate with all of the debtor’s legal and equitable interests.
Next, the trustee contended that in pari delicto should not apply because he was exercising the powers of a hypothetical judicial lien creditor under Section 544(a)(1).
Under applicable Nevada law, Judge Heytens said that a judgment creditor has no greater rights than the debtor. He therefore held, “[W]hen a bankruptcy trustee steps into the shoes of a hypothetical creditor who would herself stand in the shoes of the debtor in bringing a given action, the trustee is still subject to the same defenses as the debtor, including in pari delicto.”
Third, the trustee argued that someone who colluded with the debtor cannot invoke the doctrine under principles of agency.
On the facts, Judge Heytens alluded to the bankruptcy court’s finding that there was no collusion and therefore no basis for invoking the exception to in pari delicto.
Fourth, the trustee contended that the doctrine did not apply because the corporate officers were acting adversely to the debtor’s corporate interests.
In Nevada, like “most jurisdictions,” Judge Heytens said, the exception only applies when the agent’s actions have been “completely and totally adverse” to the corporation. In response, the trustee argued that South Carolina law only requires that the interests be “clearly adverse.”
Judge Heytens did not “see much daylight” between the two standards. It “simply is not a close case,” he said, because the corporation derived benefits from the misconduct, such as raising capital and extending the life of the business.
Finally, the trustee argued that Nevada and South Carolina would follow Delaware by holding that in pari delicto is inapplicable to violations of fiduciary duties or aiding and abetting.
Judge Heytens said that Nevada “squarely held” to the contrary. In a factually similar South Carolina appellate decision, he said that in pari delicto “barred a breach of fiduciary duty claim.”
Upholding the lower courts, Judge Heytens ended his opinion by saying that the debtor’s “officers and auditors were the authors of the company’s demise — not [the financial advisors]. At worst, the [advisors] simply failed to stop a ship that was already sinking, and the law does not hold them responsible for that failure.”
In pari delicto is the bane of bankruptcy trustees. Invocation of this judge-made rule of equity can preclude a trustee from suing nondebtor third parties who assisted in the debtor’s wrongdoing.
To no avail, a bankruptcy trustee in South Carolina mounted a frontal assault in the Fourth Circuit on in pari delicto, which means “in equal fault.”
The doctrine was originally invented by English courts to bar one thief from suing a cohort for part of the stolen goods. Today, in pari delicto bars a plaintiff from suing a defendant when the plaintiff was in equal or greater fault.