Exploring the Limits of the In Pari Delicto Defense
by Clarissa M. Raney
Holland & Hart LLP; Denver
In pari delicto stands for the proposition that in a case of mutual fault, the position of the defending party is the better one. The doctrine is “grounded on two premises: first, that courts should not lend their good offices to mediating disputes among wrongdoers; and second, that denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality.” As a result, a plaintiff’s recovery may be barred by his or her own wrongful conduct.
With the increasing number of exposed Ponzi schemes, bankruptcy trustees and state court receivers are suing more and more third parties, under either the Bankruptcy Code or state law, for their participation or purported contributions to the fraudulent scheme. Because trustees and receivers stand in the shoes of the defunct entity in asserting claims against third parties, defendants often argue that the in pari delicto doctrine should operate to bar the trustee’s or receiver’s claims where the failed entity is equally responsible for the claim. However, a defendant’s success in asserting the defense may depend on the type of claim at issue and whether the defendant is being sued by a trustee or a state court receiver.
It is well established that under certain circumstances in pari delicto may bar an action by a trustee against third parties who participated in, or received benefits from, the debtor corporation’s Ponzi scheme. The defense has been used to bar such actions as (1) tort claims, (2) claims of violations of state partnership laws and (3) claims of breach of fiduciary duty.
However, few bankruptcy courts have held that in pari delicto may bar fraudulent- or preferential-transfer claims asserted by a trustee. In fact, a number of courts expressly refuse to apply the in pari delicto doctrine to fraudulent-transfer claims asserted by a trustee. As the court in Kaliner explained, “[t]he applicability of the in pari delicto defense is dependent upon the language of the particular Bankruptcy Code section at issue…. While the in pari delicto defense applies to actions brought by the trustee as successor to the debtor’s interest under § 541, its does not apply to § 544 avoidance actions.”
Moreover, the vast the majority of courts hold that in pari delicto does not apply to state court receivers at all. These courts reason that “[w]hile a party may itself be denied a right or defense on account of its misdeeds, there is little reason to impose the same punishment on a trustee, receiver or similar innocent entity that steps into the party’s shoes pursuant to court order or operation of law.” While some courts are willing to apply the in pari delicto defense to bar a receiver’s claims against a third party, no cases have been located in which the defense was used to bar a state court receiver’s claims of fraudulent transfer.
In jurisdictions that do allow the in pari delicto defense to bar a state court receiver’s claim, whether a court will apply the in pari delicto defense generally at all depends on the balancing of the equities in the case. “Precisely how to balance the equities, however, is less clear.” One court considers three factors: (1) whether the wrongdoer would benefit from the receipt of the funds sought by the receiver, (2) whether the defendant in the case gained some illegitimate benefit from the wrongdoer’s act; and (3) whether applying the in pari delicto defense would frustrate the purposes of the law the receiver seeks to invoke. One could argue that the third factor of this test could never be satisfied when the claim at issue is a fraudulent-transfer claim because applying in pari delicto would frustrate the purpose of fraudulent-transfer laws and could effectively abolish most provisions. In sum, it is clear that the in pari delicto defense may be waning and its viability is highly dependent on the type of claim asserted and the party asserting the claim. If the claim is an avoidance action under 11 U.S.C. § 544 or a fraudulent transfer action under state law, it is doubtful a defendant would be successful in barring the claims by asserting the in pari delicto defense. Moreover, if a state court receiver asserts the claim, the defendant may have an uphill battle convincing the court to apply the doctrine to bar any of the receiver’s claims.
1. Mosier v. Callister, Nebeker & McCullough PC, 546 F.3d 1271, 1275 (10th Cir. 2008) (citation omitted).
3. Pinter v. Dahl, 486 U.S. 622, 632 (1988).
4. See Zimmerman v. Duggan, 86 B.R. 47, 50 (E.D. Pa. 1988) (trustee stands in shoes of debtor); Capitol Life Ins. Co. v. Gallagher, 1995 U.S. App. LEXIS 2374, *5 (10th Cir. Feb. 7, 1995) (receiver stands in shoes of insolvent company).
5. Mosier, 546 F.3d at 1276
6. Sender v. Buchanan (In re Hedged-Investment Assocs.), 84 F.3d 1281, 1284-86 (10th Cir. 1996)
7. Official Comm. of Unsecured Creditors of Color Tile Inc. v. Coopers & Lybrand LLP, 322 F.3d 147, 163-66 (2d Cir. 2003).
8. See Claybrook v. Broad & Cassel PA (In re Scott Acquisition Corp.), 364 B.R. 562, 567-74 (Bankr. D. Del. 2007).
9. See, e.g., McNamara v. PFS (In re Personal & Bus. Ins. Agency), 334 F.3d 239, 245-46 (3d Cir. 2003); Kaliner v. MDC Sys. Corp. LLC, 2011 U.S. Dist. LEXIS 5377, *15 (E.D. Pa. Jan. 19, 2011); Kipperman v. Onex Corp., 411 B.R. 805, 880 (N.D. Ga. 2009); AFI Holding Inc. v. Barclay, 2008 U.S. Dist. LEXIS 79698, *9 (C.D. Cal. Sept. 4, 2008); Forman v. Salzano (In re Novergence Inc.), 405 B.R. 709, 742 (Bankr. D. N.J. 2009); Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp.), 333 B.R. 506, 531 (Bankr. D.D.C. 2005).
10. 2011 U.S. Dist. LEXIS 5377 at *15.
11. See FDIC v. O’Melveny & Myers, 61 F.3d 17, 18-19 (9th Cir. 1995); Scholes v. Lehmann, 56 F.3d 750, 754-55 (7th Cir. 1995); Goldberg v. Chong, 2007 U.S. Dist. LEXIS 49980, *28-29 (S.D. Fla. July 11, 2007).
12. O’Melveny & Myers, 61 F.3d at 19; see also Scholes, 56 F.3d at 754 (“Put differently, the defense of in pari delicto loses its sting when the person who is in pari delicto is eliminated.”).
13. Cf. Knauer v. Jonathon Roberts Fin. Grp. Inc. 348 F.3d 230, 234-35 (7th Cir. 2003) (barring variety of tort claims based on broker/dealer relationship); Myatt v. RHBT Fin. Corp., 635 S.E.2d 545, 547-48 (S.C. App. Ct. 2007) (barring receiver’s tort and contractual claims).
14. Fine v. Sovereign Bank, 634 F.Supp.2d 126, 140 (D. Mass. 2008).
16. Id. at 143.