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Parmalat Judge: Fraud by Former Executives of Bankrupt Company Bars Trustee's Claims Against Auditors

By Michael Rugen and Corban Rhodes

On September 21, 2009, Judge Lewis Kaplan of the U.S. District Court for the Southern District of New York issued a ruling in In re Parmalat Securities Litigation, No. 04 MD 1653, 2009 WL 2996509 (Sept. 21, 2009), which soundly reaffirmed in pari delicto as a viable defense for accounting firms sued by bankruptcy trustees or other legal successors to their former clients. Judge Kaplan granted summary judgment in favor of Grant Thornton LLP and Grant Thornton International (collectively "Grant Thornton" or "the auditors"), ruling that the acknowledged fraud committed by Parmalat's former officers was attributable to the company's bankruptcy trustee, who "stood in the shoes of" the company, and therefore barred the trustee's claims against the auditors. Plaintiffs in the case were the Extraordinary Commissioner of Parmalat in Italian bankruptcy proceedings (the Italian equivalent of a U.S. bankruptcy trustee, and Parmalat Capital Finance Ltd., a wholly-owned subsidiary of Parmalat). For purposes of this article, the plaintiffs are treated as a single party.

After determining that Illinois law governed the claims against Grant Thornton, the court defined the defense as follows:

The doctrine of in pari delicto prevents a party from suing others for a wrong in which the party itself participated. A court will not aid a fraudfeasor who invokes the court's jurisdiction to relieve it of the consequences of its fraud.

Id. at *7. The evidence demonstrated that Parmalat's former officers and its Italian audit firm, a Grant Thorton affiliate, had conspired over an extended period to falsify the company's financial statements and raise more than 14 billion in loans and equity investments, which were used largely to expand Parmalat's operations. (A default judgment previously had been entered against Grant Thornton's Italian affiliate, so the court addressed the summary judgment motions of the U.S. and international firms. The logic of Judge Kaplan's ruling, however, would appear to apply equally to all three firms.) Judge Kaplan then proceeded to determine how in pari delicto applied to those facts, examining each of the traditional arguments advanced by plaintiffs seeking to avoid application of the defense.

First, the court rejected plaintiff's argument that in pari delicto should not apply against a company now controlled by court appointed liquidators rather than by the former bad actors. The court reasoned that the wrongful conduct of a company's agents is imputed to the corporation, that the successors "stood in the shoes" of Parmalat, and that in pari delicto therefore applied regardless of a change in management, concluding that "there is no innocent successor exception that would prevent application of in pari delicto here." Id.

Plaintiff next argued that, in committing the fraudulent acts, the officers were acting contrary to Parmalat's interests, and that the "adverse interest exception" to the rule of imputation should apply. The court ruled, however, that this exception is not applicable where the corporate agent was serving partially his own self interest and partially the interests of the corporation. Instead, the exception applies only where the agent has totally abandoned the principal's interests, for example by stealing from the company.

The rule of imputation absent total abandonment . . . is not simply a matter of mechanics or rhetoric. It embodies a determination that it would be undesirable to permit principals to avoid responsibility for an agent's actions or knowledge whenever an agent could be said to have acted even in part for the agent's own interests notwithstanding that the agent simultaneously served the interests of the principal.

Id. at *8. The Court determined that the officers' fraud in connection with Parmalat's financing transactions which produced immense amounts of capital to expand the company's operations would be imputed to the corporation, even if the employees had later stolen some of the resulting proceeds.

[T]he adoption of plaintiffs' view would gut the in pari delicto defense altogether, as it always could be said that a defalcating agent in that respect acted to benefit the agent personally and that the defalcation itself did not benefit the corporation. The critical point is that, while the theft from the company of even a pencil is an act solely for the benefit of the employee, the raising of capital for a corporation is part of the corporate business. This is so despite the fact that the financing ultimately provides the money to buy the pencil that the employee steals.

Id. at *9. Judge Kaplan also found that, in any event, plaintiff had adduced no admissible evidence of theft by the officers. The court did note that, if there had been admissible evidence of theft by the officers, "the in pari delicto defense would be no obstacle to recovery from defendants of anything that miscreant officials stole with the defendants' culpable participation." Id. at *11.

The court next rejected plaintiff's argument that the frauds in question ultimately destroyed Parmalat and could not, therefore, be said to have been committed in furtherance of the company's interests: "A corporation may be injured and even destroyed when agents commit fraud on its behalf just as when agents commit fraud upon it." Id. The court rejected as irrelevant the insider's subjective intent in performing those acts.

The court also disagreed with plaintiffs' argument that the in pari delicto defense barred recovery under some of their legal theories, but not others:

[P]laintiffs offer no support for the proposition that the defense is not a categorical bar. Indeed, the nature of the defense is that, where it applies, the law will not aid either party, but will leave them without remedy as against each other. Id. at *17 (quotations omitted).

Plaintiffs next argued that Illinois' "audit interference" doctrine permitted an auditor to escape liability for its alleged negligence only where the acts of the client's agents had interfered with the audit work. The court rejected this argument as well, holding that the rule applied, if at all one Illinois court had found the doctrine inapplicable, even in the comparative fault context only to limit application of comparative fault in the audit malpractice context, and not to the entirely separate doctrine of in pari delicto. Id.

Finally, Judge Kaplan ruled that the defense was not rendered inapplicable by the fact that the Italian auditors, for whom Grant Thornton was alleged to be vicariously liable, were aware of and participated in the officers' bad acts. The court found that such a rule would defeat the entire purpose of the defense, which is "to prevent courts from getting involved in suits among co-conspirators and others who are jointly at fault." Id. at *18.

In short, the recent Parmalat decision provides a sweeping reaffirmation of in pari delicto as a defense available as "a categorical bar" to any claims against auditors and other secondary defendants (such as Parmalat's former bankers, in whose favor summary judgment was granted on essentially identical grounds) by former clients or their legal successors, whose management engaged in fraud or other serious wrongdoing.

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