Auditor Negligence Exception to In Pari Delicto
On September 9, 2008, the United States Court of Appeals for the Third Circuit issued an opinion in Thabault v. Chait & PriceWaterhouseCoopers, LLP, 2008 U.S. App. LEXIS 19227. The opinion is an interesting read for a number of reasons, but I want to focus on only one portion of the Court's ruling in this entry. Specifically, the Third Circuit appears to have crafted a specific "auditor negligence exception" to the doctrines of imputation and in pari delicto.
In Thabault, the Receiver for Ambassador Insurance Company was pursuing claims against Arnold Chait, the former President and CEO of Ambassador, and PwC. Predictably, the claims asserted included breach of fiduciary duty, negligent mismanagement, fraud, negligent misrepresentation and audit malpractice.
PwC argued that the claims asserted against it should have been barred under the doctrine of in pari delicto. More particularly, PWC asserted that Chait's improper conduct should have been imputed to Ambassador, which would necessarily trigger the in pari delicto doctrine and relieve PwC of liability. As described in the Third Circuit's earlier opinion in Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 347, 358 (3d Cir. 2001), "under the law of imputation, courts impute the fraud of an officer to a corporation when the officer commits the fraud (1) in the course of his employment, and (2) for the benefit of the corporation." As the Third Circuit described, the second prong of the imputation doctrine -- benefit to the corporation -- is analyzed under "adverse interest exception." 2008 U.S. App. LEXIS 19227 at *36-37. In other words "fraudulent conduct will not be imputed if the officer's interests were adverse to the corporation and not for the benefit of the corporation." Id. at *36. And, if the agent is the "sole representative of a principal, then that agent's fraudulent conduct will be imputed to the principal regardless of whether the agent's conduct was adverse to the principal's interests." Id. at *37. This latter rule is known as the "sole actor doctrine."
Thus, in determining if the imputation doctrine applied, the Third Circuit needed to determine if Chait was (a) acting in the course and scope of his employment when he committed wrongdoing; (b) if the wrongdoing benefited the company; and (c) if it did not benefit the company, was Chait the only agent of Ambassador.
Unremarkably, the Third Circuit found that "Chait's conduct was committed in the course of his employment." Id. at *38-39. As a result, the Court was required to analyze whether Chait's actions benefited the company or if he was the "sole actor" for Ambassador.
The Third Circuit ruled against PwC on both issues. Specifically, the Thabault Court, relying on the New Jersey Supreme Court's ruling in NCP Litigation Trust v. KPMG, LLP, 901 A.2d 871, 888 (N.J. 2006), found that "Chait's conduct allowed Ambassador to continue past the point of insolvency, [and, therefore], his actions cannot be deemed to have benefited the corporation." 2008 U.S. App. LEXIS 19227 at *40 (emphasis added). Thus, the adverse interest exception applied and precluded the court from imputing Chait's knowledge or wrongful conduct to the company. Furthermore, the Third Circuit held that the "sole actor" doctrine was inapplicable because Chait was not the "sole shareholder of the corporation" and, as such, he did not dominate the corporation. Id. at *41.
But the Third Circuit did not stop here. Interestingly, the Thabault Court went on to "deem applicable the 'auditor negligence' exception recognized by the New Jersey Supreme Court in NCP, which explained 'that a claim for negligence may be brought on behalf of a corporation against the corporation's allegedly negligent third-party auditors for damages proximately caused by that negligence.'" Id. As the Third Circuit noted, "PwC was not a victim of Chait's fraud and allowing it to avoid liability by invoking the in pari delicto doctrine would not serve the purpose of the doctrine -- to protect the innocent." Id. The "auditor negligence exception" is premised on the notion that "one who contributed to the misconduct cannot invoke imputation" as a bar to liability. NCP Litig. Trust, 901 A.2d at 882. Because PwC was not a victim of the officer's fraud, and, in fact, likely contributed to it through their own negligent acts, permitting PwC to escape liability would affirmatively frustrate the purpose of the in pari delicto doctrine.
