The Wirecard scandal—a revelation that corporate cash worth €1.9 billion was missing and that one of the largest accounting firms in the world, Ernst & Young (EY), failed to notice—rocked the financial world in 2020, with some experts dubbing the scandal the “Enron of Germany.”
More recently, FTX’s bankruptcy has sparked public interest in the failure of the company’s auditors and lawyers to prevent its collapse.
These scandals have reminded the world of the infamous WorldCom and Enron bankruptcies plaguing the 2000s.
Both then and now, commentators underscore the blameworthiness of professional third parties—lawyers, auditors, and banks, among others—who failed to protect these corporations from fraud and misconduct.
Despite failing to guard against corporate misconduct, professional third parties often are not held accountable.
The scandals bring again into sharp focus the role of professional third parties in protecting against company fraud.
At a time when public appetite has resurged in demanding accountability against these parties,
claims against them—often brought on behalf of the corporation or its bankruptcy representative, shareholders, or creditors—are a means to call such professionals to account.
Professional third parties, however, wield the traditionally powerful shield that is in pari delicto (or in pari delicto potior est conditio possidentis in full): “[W]here parties are equally at fault, the defending party is in the stronger position.”
A wrongdoer—namely, the corporation to whom its corporate officers’ misconduct is imputed—cannot “seek redress against another alleged wrongdoer.”
Instead, “the plaintiff should not . . . recover, and parties should be left where they are [because of] . . . the principle that to grant plaintiff relief would contravene the public good by aiding one to profit from [their] own wrong.”
For example, the wrongdoing of Enron’s officers—who are agents of the corporation—would be imputed to Enron. Enron itself would thus be deemed to have wronged. In pari delicto would hence disallow claims by Enron—or Enron’s shareholders or bankruptcy representatives standing in its shoes—against Enron’s lawyers for failing to protect against Enron’s officers’ corporate misconduct.
In pari delicto is an absolute bar to otherwise good claims, completely shielding professional third parties from liability.
Numerous exceptions, however, mitigate its harshness, the most pervasive among these being the traditionally narrow “adverse interest” exception.
The adverse interest exception, however, only applies when the agent has “totally abandoned [the] principal’s interest.”
Hence, the exception has been criticized for providing too little respite to shareholders and creditors.
Interestholders in succession,
like shareholders and creditors, are often in a far worse position than attorneys, auditors, or banks to supervise the conduct of a corporation’s officers. Indeed, “the nature of today’s corporations makes it increasingly unlikely that shareholders of large corporations have the ability to effectively monitor the actions of corporate officials.”
Numerous suggestions have been put forth to address in pari delicto’s harshness
but with little uptake from courts.
The recent New York Appellate Division decision of Conway v. Marcum & Kliegman LLP,
however, signals increased judicial receptivity to better align in pari delicto with the gatekeeping duties professional third parties undertake.
Juxtaposed against the American approach lies the English approach. In England and Wales, courts confronted with analogous corporate misconduct cases involving professional third parties rely on the illegality doctrine.
Illegality is also known as the Latin maxim ex turpi causa non oritur actio : “[N]o cause of action may be founded upon an immoral or illegal act”;
“[n]o Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act.”
The fundamental motivation behind ex turpi causa resembles U.S. courts’ justification for in pari delicto: “[A] plaintiff should not be permitted to recover damages that arise from his or her own illegal or immoral conduct.”
Since 2016, English law has departed starkly from prior approaches, adopting the revolutionary and flexible “trio of considerations” approach to illegality.
When deciding whether the illegality defense applies, English law seeks to “preserve the integrity of the justice system[,] . . . tak[ing] into account the impact that a successful application of the illegality defence will have on the ‘true victim’ of the wrongdoing.”
This Note argues that Conway presents, in American law, an analogous pivotal moment. With increased judicial receptiveness, in pari delicto too can transform to align itself with the gatekeeping owed by professional third parties and promote compliance with those duties.
This Note demonstrates that the English approach better promotes professional third parties’ compliance with their professional duties than predominant American approaches. It recommends incorporating the English approach into in pari delicto case law by expanding the well-known fiduciary duty exception to encompass professional third parties.
Part I first provides an overview of in pari delicto and the adverse interest exception in the United States.
It illustrates traditional in pari delicto using New York as an example
and then discusses three shortcomings of traditional in pari delicto.
Part II explores a range of alternative approaches to corporate misconduct by professional third parties. First, in section II.A, it presents three divergent approaches by leading jurisdictions seeking to address the difficulties with traditional in pari delicto—Delaware, Pennsylvania, and New Jersey.
It also discusses their limitations. Next, section II.A discusses how Conway’s expansion of the adverse interest exception showcases increased judicial receptivity to align gatekeeping duties with in pari delicto.
It also illustrates Conway’s limitations in not providing guidance on how the adverse interest exception applies beyond Conway’s facts.
Section II.B then compares in pari delicto against illegality doctrine in England and Wales. After a brief discussion of prior approaches,
it discusses the emergence of the trio of considerations approach in Patel v. Mirza.
Finally, section II.C illustrates the English trio of considerations approach’s application in corporate misconduct cases in Singularis Holdings Ltd. v. Daiwa Cap. Mkts. Europe Ltd.
It shows how the trio of considerations approach, by aligning illegality with professional third parties’ gatekeeping duties to protect against corporate misconduct, reflects the advantages professional third parties enjoy in monitoring corporate agents as against shareholders and creditors.
Part III illustrates how the English approach emerges superior to American approaches to in pari delicto by explicitly aligning liability of professional third parties to the gatekeeping duties they undertake explicitly or impliedly in monitoring and guarding against corporate misconduct. It then argues that the fiduciary duty exception—which allows corporations to sue their fraudulent or negligent corporate officers—should be expanded to include professional third parties.