More In Pari Delicto
On May 5, 2008, the United States District Court for the Southern District of New York issued an interesting opinion in Adelphia Recovery Trust v. Bank of America, N.A., 2008 U.S. Dist. LEXIS 36553 (S.D.N.Y. May 5, 2008). This opinion is written in response to a Motion for Reconsideration and further elaborates on an earlier decision largely affirming the Bankruptcy Court's rulings on the Defendants' Rule 12(b)(6) motions.
This opinion further elaborates on a discussion by the Bankruptcy Court concerning the construction of 11 U.S.C. 541 and that provisions interplay with the equitable defense of in pari delicto. Specifically, the Defendants argued, relying principally on the Second Circuit's opinion in Official Committee of Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d 147 (2d. Cir. 2003), that a court could not take into account "post-petition" events when determining the equitable application of the in pari delicto defense. As a result, the Defendants argued that post-petition events, such as the appointment of a bankruptcy trustee and the removal of miscreant management, could not be used to support an "innocent successor" exception to the in pari delicto defense. Defendants argued that Color Tile is binding authority that when facts alleged in a plaintiff's complaint affirmatively establish the in pari delicto defense, the Court must dismiss.
The District Court rejected this argument and found that the Bankruptcy Court was correct in its construction of 11 U.S.C. 541 and that the Bankruptcy Court's application of the Fifth Circuit's decision in Matter of Educators Group Health Trust, 25 F.3d 1281 (5th Cir. 1994) was more persuasive on the issue of the construction of 11 U.S.C. 541. The Court sidestepped Color Tile by noting that it was a case dealing with the pleading standards under Rule 12 and did not address the construction of 11 U.S.C. 541.
Interestingly, the District Court generally accepted the Third Circuit's construction of Pennsylvania's law surrounding the in pari delicto defense in Official Committee of Unsecured Creditors v. R.F. Lafferty & Co. 267 F.3d 340 (3rd Cir. 2001). But rejected Lafferty's construction of 11 U.S.C. 541 when applying the defense of in pari delicto. In fact, the Court determined that the Bankruptcy Court's and the Fifth Circuit's construction of 11 U.S.C. 541 was more persuasive than Lafferty and, ultimately, would permit the consideration of "post-petition" events in applying the in pari delicto defense in the absence of controlling Second Circuit authority on the issue.
The Bankruptcy Court, applying Educators Group Health Trust from the Fifth Circuit, noted that 11 U.S.C. 541 determines what assets or causes of action a debtor-in-possession or trustee may have at the commencement of a case, but does not address what equitable defenses may exist with respect to those claims. Thus, the question of in pari delicto's ultimate applicablity is not addressed by 11 U.S.C. 541. The Bankruptcy Court quoted at length from the Fifth Circuit's opinion, including the following important passage:
"It is well-established that the bankruptcy estate succeeds to the causes of action which the debtor could have brought as of the commencement of the case, subject to any defenses the debtor may have faced. 11 U.S.C. 541(a)(1). However, the plaintiff school districts fail to cite, and we cannot find, any support for the proposition that a defense on the merits of a claim brought by the debtor precludes the debtor from bringing the claim. That the defendant may have a valid defense on the merits of a claim brought by the debtor goes to the resolution of the claim, and not to the ability of the debtor to assert the claim. The latter, of course, determines what is, or is not, property of the bankruptcy estate."
25 F.3d at 1286.
For bankruptcy trustee's continually beating their heads against the proverbial wall when dealing with defendants asserting the imputation defense, this opinion may be helpful in establishing an "innocent succesor" exception.
Caution is warranted, however. How significant the Court's actual opinion may be is debateable because the Court ultimately ruled that the replacement of guilty management with an innocent successor sufficient to defeat the in pari delicto defense actually occurred "pre-petition" in this particular case.
