Shareholders Can Assert Derivative Fraud Claims Against Corporate Officers And Directors Notwithstanding In Pari Delicto Context

• Published date: 28 February 2022
• Subject Matter: Corporate/Commercial Law, Criminal Law, Corporate and Company Law, Directors and Officers, White Collar Crime, Anti-Corruption & Fraud, Shareholders
• Law Firm: Meyer Suozzi English & Klein
• Author: Mr Kevin Schlosser

I have written about and explained the so-called in pari delicto defense in fraud actions. See In Pari Delicto Prevents Equal Wrongdoer from Seeking Damages Relating to Its Own Fraudulent Conduct. Basically, in the corporate context, if corporate officers and/or directors are involved in a fraud on behalf of the corporation, the shareholders are barred from asserting derivative claims on behalf of that very same corporation because the wrongdoing of the agents is imputed to the corporation and the corporation is not permitted to benefit from its own wrongdoing.

In Pari Delicto

As explained by a leading Court of Appeals decision: "[W]here conduct falls within the scope of the agents' authority, everything they know or do is imputed to their principals. . all corporate acts-including fraudulent ones-are subject to the presumption of imputation [and], as with in pari delicto, there are strong considerations of public policy underlying this precedent: imputation fosters an incentive for a principal to select honest agents and delegate duties with care." Kirschner v KPMG LLP, 15 N.Y.3d 446 (2010).

There is a well-recognized exception to this defense of in pari delicto-the adverse interest exception-where the fraudulent corporate agents act solely in their own interests and not in the interests of the corporation, then the corporation is permitted to sue them, or in the case of a shareholder, assert a derivative claim against them on behalf of the corporation for harm the fraud caused the corporation.

A new decision of the Appellate Division, First Department, Community Assn. of the E. Harlem Triangle, Inc. v Butts, 2021 NY Slip Op 07503 (1^st Dep't Decided Dec. 28, 2021), involves an interesting factual context for applying the adverse interest exception.

In Butts, the plaintiffs were shareholders of the subject corporation suing derivatively its officers and directors, along with others who joined with them, in connection with the sale of the corporation's real property. Plaintiffs' amended complaint alleged that the individual defendant officers and directors concealed from the Board of Directors an offer to buy the property at issue for $42 million and convinced a majority of the Board to vote to approve the sale of the property to another entity for only $39 million. Plaintiffs alleged that the corporation suffered damages in the amount of the $3 million difference or the difference between the value of the property at the time of the sale and the $39...