In Pari Delicto And Imputation Defenses Are Alive And Well In New York

New York's highest court has held that the in pari delicto and imputation defenses remain available to a corporation's outside auditor who allegedly failed to detect the malfeasance of the corporation's executives. Kirschner v. KPMG, LLP, and Teachers' Retirement System of Louisiana v. PricewaterhouseCoopers, LLP (October 21, 2010) (Kirschner). The New York Court of Appeals decision reaffirms New York's public policy to limit auditor liability, even where the corporation's innocent employees, stockholders and creditors may have been harmed.

The decision also clarified the exceedingly narrow scope of the "adverse interest exception" to the imputation doctrine under which auditor liability may still exist. The Court reserved this exception for the rare case where a corporate executive's misconduct "benefits only himself or a third party; i.e., where the fraud is committed against a corporation rather than on its behalf," such as "outright theft or looting or embezzlement."

New York's law is now one of the most favorable to auditors and other third party professionals. It is much more protective than New Jersey law, which bars auditors from asserting the imputation defense and leaves the culpability of corporate insiders to be resolved as a matter of comparative fault. See NCP Litigation Trust v. KMPG, LLP, (N.J. 2006).

Kirschner grew out of the collapse of Refco, a leading brokerage and clearing house. Refco was forced into bankruptcy after it was disclosed that its president and chief executive officer hid hundreds of millions of dollars of uncollectible debt from the public and regulators for years, creating a falsely positive picture of Refco's financial condition. A Litigation Trust, established as part of Refco's Chapter 11 bankruptcy plan, brought suit against Refco's third party professionals (its outside auditors, lawyers and investment banks) for aiding and abetting the fraud and failing to discover it. The District Court dismissed the case, finding that such claims were barred under New York's in pari delicto doctrine because Refco's insiders' misconduct was imputed to the corporation. The Litigation Trust appealed the dismissal to the Second Circuit Court of Appeals. Finding New York law on the point unclear, the Second Circuit certified two questions to the New York Court of Appeals as to the scope of New York's adverse interest exception: (1) "whether the adverse interest exception is satisfied by showing that the insiders...