Kirschner v. KPMG LLP
938 N.E.2d 941, 15 N.Y.3d 446, 912 N.Y.S.2d 512 (2010)
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Rule of Law:
The doctrine of in pari delicto bars a principal from suing a third-party agent for failing to detect or prevent fraud committed by the principal's own agents on the principal's behalf. The adverse interest exception to imputation is not met if the agent's fraudulent conduct conferred any benefit upon the corporation, such as prolonging its existence or enhancing its value, regardless of the agent's personal motives or the fraud's ultimate negative consequences.
Facts:
- In the first case, senior management at Refco, a financial services provider, orchestrated a series of fraudulent loans beginning around 1998 to hide hundreds of millions of dollars in uncollectible debt.
- These maneuvers created a falsely positive picture of Refco's financial condition, which allowed the company to conduct a leveraged buyout in 2004 and an initial public offering in 2005.
- The fraud was intended to benefit Refco by enabling it to survive, attract investors, and raise capital in the markets.
- In October 2005, the fraud was publicly disclosed, leading to a stock collapse and Refco's bankruptcy.
- In a separate case, senior officers at American International Group, Inc. (AIG) engaged in a fraudulent scheme to misstate the company's financial performance.
- The scheme, which included tax evasion and balance sheet manipulation, was designed to deceive investors into believing AIG was more prosperous and secure than it was.
- The discovery of the fraud at AIG resulted in a $3.5 billion reduction in stockholder equity and over $1.6 billion in fines and litigation costs.
Procedural Posture:
- In the Refco matter, Marc Kirschner, as Litigation Trustee, sued Refco's outside professionals in state court; the case was removed to the U.S. District Court for the Southern District of New York.
- The District Court granted defendants' motion to dismiss, finding the Trustee's claims were barred by the imputation of the insiders' fraud to Refco.
- The Trustee (appellant) appealed to the U.S. Court of Appeals for the Second Circuit.
- In the AIG matter, derivative plaintiffs sued PricewaterhouseCoopers (PwC) for professional malpractice in the Delaware Court of Chancery.
- The Delaware Court of Chancery dismissed the suit, applying New York law and finding the claims barred by the in pari delicto doctrine.
- The derivative plaintiffs (appellants) appealed to the Delaware Supreme Court.
- Both the Second Circuit and the Delaware Supreme Court certified questions to the New York Court of Appeals to clarify the scope of New York's in pari delicto doctrine and the adverse interest exception.
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Issue:
Does the doctrine of in pari delicto, based on the imputation of wrongdoing from corporate insiders to the corporation itself, bar derivative claims against outside professionals for malpractice or negligence in failing to detect the insiders' fraud, where the fraud provided some short-term benefit to the corporation?
Opinions:
Majority - Read, J.
Yes, the doctrine of in pari delicto bars such claims because the wrongdoing of the corporate insiders is imputed to the corporation. To avoid imputation under the adverse interest exception, the agent must have totally abandoned the principal's interests and be acting entirely for their own or another's purposes. This narrow exception cannot be invoked merely because the agent had a conflict of interest or because the fraud ultimately harmed the corporation upon its discovery. So long as the insiders' fraud provided some benefit to the corporation—such as enabling it to survive, attract investors, or raise funds—the exception does not apply, regardless of the insiders' subjective intent to benefit themselves. The court explicitly rejected adopting exceptions for negligent or collusive auditors, as some other states have, holding that public policy favors incentivizing principals to carefully select and monitor their agents rather than allowing them to shift the costs of their agents' misconduct to third parties.
Dissenting - Ciparick, J.
No, the doctrine of in pari delicto should not bar these claims because its rigid application immunizes negligent or complicit outside 'gatekeeper' professionals from liability and ignores important public policy considerations. The majority's view of 'benefit' is flawed; artificially prolonging the life of an insolvent corporation through fraud is a harm, not a benefit. Public policy demands that auditors and other gatekeepers be held accountable for their failures to protect investors and the public. A flexible, equitable application of in pari delicto, such as the approaches adopted in New Jersey and Pennsylvania, would better serve justice by deterring auditor malfeasance and compensating innocent stakeholders.
Analysis:
This decision solidifies a very stringent and defendant-friendly application of the in pari delicto doctrine in New York corporate law. It establishes that the adverse interest exception is exceptionally narrow, making it exceedingly difficult for bankruptcy trustees or derivative plaintiffs to pursue claims against third-party professionals when a corporation's own management was involved in the fraud. The ruling consciously diverges from the trend in other states that have created equitable exceptions to hold auditors accountable, reinforcing the principle that a corporation cannot disclaim its agents' fraudulent acts if those acts provided any benefit to the entity. This precedent significantly shields auditors, law firms, and banks from liability in New York for failing to detect fraud committed by their clients' insiders.
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