CONWAY, IN PARI DELICTO, AND THE ADVERSE INTEREST EXCEPTION: BORROWING FROM THE ENGLISH

Two recent scandals spotlighted corporate fraud: the recent Wirecard scandal, which revealed €1.9 billion of missing corporate cash, and FTX’s bankruptcy scandal. Those incidents raised questions about the blameworthiness of professional third parties—lawyers, auditors, and banks, among others—who repeatedly fail to protect large public corporations from corporate fraud and misconduct. Professional third parties often are not held accountable because they can rely on the in pari delicto defense, completely shielding them from liability. Under in pari delicto, which disallows a wrongdoer from benefiting from their own wrongdoing, a corporate officer or director’s fraud or corporate misconduct is imputed to the corporation. Thus, the corporation—including shareholders, liquidators, trustees, or others standing in the corporation’s shoes—cannot recover from professional third parties.

The adverse interest exception mitigates in pari delicto’s harshness, but it is traditionally narrow: It only applies when an agent has “totally abandoned” a principal’s interest. Yet a recent New York Appellate Division decision, Conway v. Marcum & Kliegman, signals increased judicial receptiveness to relax in pari delicto. This relaxation opens the door to holding professional third parties responsible and liable for failing to prevent the very conduct they were hired to monitor.

This Note compares in pari delicto to the analogous English doctrine of illegality. It argues that English doctrine better encourages adherence to the gatekeeping duties owed by professional third parties. It finally recommends incorporating the English approach into in pari delicto case law by expanding the well-known fiduciary duty exception under in pari delicto to professional third parties.

The full text of this Note can be found by clicking the PDF link to the left.

* J.D. Candidate 2023, Columbia Law School. I would like to thank Professor Ronald Mann for his guidance and encouragement. Special thanks also to Alexandra Nickerson and Magdalene Lam for their insightful reads and feedback as well as the staff of the Columbia Law Review for their tireless work and thoughtful edits. Finally, I am grateful to my friends and family, especially my parents Kuppuswamy Srinivasan Bhaskar and Paul Manjula, for their unwavering support throughout the entire process.

Introduction

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.” 1 Ryan Browne, ‘The Enron of Germany’: Wirecard Scandal Casts a Shadow on Corporate Governance, CNBC (June 29, 2020), https://www.cnbc.com/2020/06/29/
enron-of-germany-wirecard-scandal-casts-a-shadow-on-governance.html [https://perma.cc/
5X7D-5DCW]. More recently, FTX’s bankruptcy has sparked public interest in the failure of the company’s auditors and lawyers to prevent its collapse. 2 See Stephen Foley, FTX Collapse Puts Its Auditors in the Spotlight, Fin. Times (Nov. 13, 2022), https://www.ft.com/content/930c6cea-5457-4dfa-9d47-666c0698c335 (on file with the Columbia Law Review) (“The collapse of FTX has thrown a spotlight on two US accounting firms that the cryptocurrency exchange said it had used to audit its books.”); Justin Wise, FTX Bankruptcy Law Firm Is Wrong Fit for Role, Senators Say (1), Bloomberg L. (Jan. 10, 2023), https://news.bloomberglaw.com/business-and-practice/ftx-bankruptcy-law-firm-is-wrong-fit-for-role-four-senators-say (on file with the Columbia Law Review) (noting Senators John Hickenlooper, Thom Tillis, Elizabeth Warren, and Cynthia Lummis’s concerns over “‘significant questions about [FTX’s counsel Sullivan & Cromwell’s] involvement,’ including whether [the firm] suspected fraud at FTX,” in their letter to the judge overseeing FTX’s bankruptcy). These scandals have reminded the world of the infamous WorldCom and Enron bankruptcies plaguing the 2000s. 3 See Browne, supra note 1 (remembering that “Siemens was hit by a corruption scandal in the late 2000s, while Volkswagen’s reputation was significantly damaged by the so-called ‘Dieselgate’ emissions scandal in 2015”). WorldCom’s and Enron’s bankruptcies were among the most notorious. See, e.g., Jonathan Witmer-Rich & Mark Herrmann, Corporate Complicity Claims: Why There Is No Innocent Decision-Maker Exception to Imputing an Officer’s Wrongdoing to a Bankrupt Corporation, 74 Tenn. L. Rev. 47, 47 (2006) (describing the Enron and WorldCom bankruptcies and convictions of high-level Enron and WorldCom officers on securities and accounting fraud charges). 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. 4 See Paula Schaefer, In Pari Delicto Deconstructed: Dismantling the Doctrine that Protects the Business Entity’s Lawyer From Malpractice Liability, 90 St. John’s L. Rev. 1003, 1049 (2016) (pointing out that “lawyers shared a measure of the blame” for Enron and other scandals but “were not held accountable” and that lawyers are still not held accountable as of 2016); see also Dan Ackman, Enron’s Lawyers: Eyes Wide Shut?, Forbes (Jan. 28, 2002), http://www.forbes.com/2002/01/28/0128veenron.html (on file with the Columbia Law Review) (asserting that Enron attorneys Vinson & Elkins “asked few real questions, failed to talk to obvious key witnesses and then blessed Enron’s treatment of controversial partnerships”); Ashby Jones, Where Were the Lawyers?, Wall St. J. (Jan. 2, 2007), http://blogs.wsj.com/law/2007/01/02/where-were-the-lawyers (on file with the Columbia Law Review) (stating that implicit in the “[w]here were the lawyers?” question in the Enron era is the “assumption that . . . lawyers could have done more to keep their companies out of hot water”). Despite failing to guard against corporate misconduct, professional third parties often are not held accountable. 5 See Schaefer, supra note 3, at 1049–50; see also Julie Hilden, Scummery Judgment: Why Enron’s Sleazy Lawyers Walked While Their Accountants Fried, Slate (June 21, 2002), http://www.slate.com/articles/news_and_politics/jurisprudence/2002/06/
scummery_judgment.html [https://perma.cc/UB3U-PMP3] (“[Y]ou would think Vinson & Elkins should be accountable because it was the firm retained by Enron to investigate Sherron Watkins’ internal complaints. The law firm’s investigation was inarguably a disaster for the company. But in the end, Enron got what they paid for . . . .”). More recently, the Volkswagen scandal on cheating diesel emissions tests similarly attracted scrutiny of its lawyers walking away. See Paul Lippe, Volkswagen: Where Were the Lawyers?, ABA J. (Oct. 13, 2015), https://www.abajournal.com/legalrebels/article/volkswagen_where_were_the_
lawyers (on file with the Columbia Law Review) (asking whether Volkswagen’s lawyers knew of its engineers manipulating tests to avoid emissions standards and arguing that there should be a duty to know “what’s going on”); Alice Woolley, The Volkswagen Scandal: When We Ask “Where Were the Lawyers?” Do We Ask the Wrong Question?, Slaw (Sept. 30, 2015), https://www.slaw.ca/2015/09/30/the-volkswagen-scandal-when-we-ask-where-were-the-lawyers-do-we-ask-the-wrong-question/ [https://perma.cc/AD95-YWBA] (“[The ‘where were the lawyers’ question] rests on the premise . . . that . . . lawyers can prevent unlawful things from happening.”). The scandals bring again into sharp focus the role of professional third parties in protecting against company fraud. 6 See Olaf Storbeck, EY Audit Failings on Wirecard Laid Bare in ‘Dynamite’ Report, Fin. Times (May 21, 2021), https://ft.com/content/68c699dc-7427-4c24-a57e-0980fb1371ec (on file with the Columbia Law Review) (pointing out that a German parliamentary special investigative report found that EY audits suffered from “serious shortcomings”). At a time when public appetite has resurged in demanding accountability against these parties, 7 See id. (discussing the demands by German Members of Parliament to release the special investigative report on EY’s failures). A recent securities fraud class action lawsuit filed in the Eastern District of Pennsylvania demanded accountability from EY for “fail[ing] to audit Wirecard in accordance with applicable auditing principles” such that statements “about Wirecard’s business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times.” See Complaint at 19, Brown v. Wirecard AG, No. 2:20-cv-03326-AB (E.D. Pa. July 7, 2020), 2020 WL 3816192. 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. 8 See Christine M. Shepard, Note, Corporate Wrongdoing and the In Pari Delicto Defense in Auditor Malpractice Cases: A New Approach, 69 Wash. & Lee L. Rev. 275, 277 (2012) (sketching the “not-uncommon scenario” involving “creditors and shareholders of [a company whose stock price plummets and which eventually goes bankrupt] want[ing] to recover their losses from . . . the auditor who negligently performed [the company’s] audit”); cf. Schaefer, supra note 3, at 1035 (arguing that “[i]f lawyers are never held accountable to their clients for failing to [act competently and loyally,] there is little incentive to perform this difficult job”).

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.” 9 Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990) (citing In Pari Delicto Potior Est Conditio Possidentis, [Defendentis], Black’s Law Dictionary (4th ed. 1968)); see also Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306 (1985) (“In a case of equal or mutual fault . . . the position of the [defending] party . . . is the better one.” (alterations in original) (quoting In Pari Delicto Potior Est Conditio Possidentis [Defenditis], Black’s Law Dictionary (5th ed. 1979))). A wrongdoer—namely, the corporation to whom its corporate officers’ misconduct is imputed—cannot “seek[] redress against another alleged wrongdoer.” 10 Shepard, supra note 7, at 278. 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.” 11 Ross, 904 F.2d at 824. 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. 12 See Schaefer, supra note 3, at 1004 (noting, in the context of suits against attorneys, that “[w]hen the client sues the lawyer for legal malpractice based on the lawyer’s negligent advice, the lawyer can have the case dismissed based on in pari delicto” (emphasis omitted)). Numerous exceptions, however, mitigate its harshness, the most pervasive among these being the traditionally narrow “adverse interest” exception. 13 See id. at 1006 (describing the adverse interest exception, “an exception to imputation when the agents acted adverse to the company’s interests,” as a “narrow one inapplicable when agents engaged in misconduct for the company’s benefit”). The adverse interest exception, however, only applies when the agent has “totally abandoned [the] principal’s interest.” 14 Kirschner v. KPMG LLP, 938 N.E.2d 941, 952 (N.Y. 2010) (emphasis added by the New York Court of Appeals) (quoting Center v. Hampton Affiliates, Inc., 488 N.E.2d 828, 830 (N.Y. 1985)). Hence, the exception has been criticized for providing too little respite to shareholders and creditors. 15 See, e.g., Schaefer, supra note 3, at 1027 (describing it as “absurd that the adverse-interest exception protects lawyers from liability in the very situation that should trigger lawyer liability”); Shepard, supra note 7, at 286 (suggesting that “reliance on the adverse interest exception by those attempting to defeat the in pari delicto defense is misplaced” (emphasis omitted)). Interestholders in succession, 16 The phrase “interestholders in succession” refers to those parties standing in a corporation’s shoes when bringing an action against professional third parties. The interestholders include shareholders, creditors, liquidators, or trustees. 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.” 17 NCP Litig. Tr. v. KPMG LLP, 901 A.2d 871, 886 (N.J. 2006); see also infra section II.A.3.

Numerous suggestions have been put forth to address in pari delicto’s harshness 18 See, e.g., Kevin H. Michels, The Corporate Attorney as “Internal” Gatekeeper and the In Pari Delicto Defense: A Proposed New Standard, 4 St. Mary’s J. on Legal Malpractice & Ethics 318, 363 (2014) (proposing a gatekeeper imputation exception providing for no imputation of corporate manager misconduct to a corporation if attorneys expressly or impliedly undertook an obligation to investigate or monitor the corporation); Schaefer, supra note 3, at 1056 (proposing an alignment of in pari delicto with attorney fiduciary duty); Shepard, supra note 7, at 327 (suggesting a solution that involves measuring corporate fault through information gathering and reporting systems in place to deter and detect fraud). but with little uptake from courts. 19 See Schaefer, supra note 3, at 1054 (noting how courts are “too rigid in following in pari delicto precedent” (emphasis omitted)). The recent New York Appellate Division decision of Conway v. Marcum & Kliegman LLP, 20 110 N.Y.S.3d 695 (App. Div. 2019). however, signals increased judicial receptivity to better align in pari delicto with the gatekeeping duties professional third parties undertake. 21 See infra section II.A.4.

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. 22 See, e.g., Singularis Holdings Ltd. v. Daiwa Cap. Mkts. Eur. Ltd. [2019] UKSC 50, [2]–[9], [2020] AC 1189, 1197–98 (appeal taken from Eng.) (concerning a suit against a bank for breaching its duty not to pay out funds where it had reasonable grounds to believe that a fraud was being carried out when the bank had complied with the company’s director’s instructions); Stone & Rolls v. Moore Stephens [2009] UKHL 39, [1]–[2], [2009] 1 AC 1391, 1398 (appeal taken from Eng.) (concerning a suit against an auditor for negligently failing to detect a corporate director’s dishonest activities using the corporation, closely resembling Singularis). 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”; 23 Revill v. Newbery [1996] QB 567 at 576 (appeal taken from Eng.). “[n]o Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act.” 24 Holman v. Johnson (1775) 98 Eng. Rep. 1120, 1121; 1 Cowp. 341, 343 (Eng.). 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.” 25 Lincoln Caylor & Martin S. Kenney, In Pari Delicto and Ex Turpi Causa: The Defence of Illegality—Approaches Taken in England and Wales, Canada and the US, 18 Bus. L. Int’l 259, 260 (2017).

Since 2016, English law has departed starkly from prior approaches, adopting the revolutionary and flexible “trio of considerations” approach to illegality. 26 See Patel v. Mirza [2016] UKSC 42, [101], [2017] AC 467, 499–500 (appeal taken from Eng.) (noting the three factors—the underlying purpose of prohibiting the claim, the effect that denying a claim would have on the effectiveness of other public policies, and the possibility of overkill—to be considered). 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.” 27 Caylor & Kenney, supra note 24, at 259. 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. 28 See infra sections III.C–.D.

Part I first provides an overview of in pari delicto and the adverse interest exception in the United States. 29 See infra section I.A. It illustrates traditional in pari delicto using New York as an example 30 See infra section I.A. and then discusses three shortcomings of traditional in pari delicto. 31 See infra section I.B. 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. 32 See infra sections II.A.1–.3. 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. 33 See infra section II.A.4. It also illustrates Conway’s limitations in not providing guidance on how the adverse interest exception applies beyond Conway’s facts. 34 See infra section II.A.4. Section II.B then compares in pari delicto against illegality doctrine in England and Wales. After a brief discussion of prior approaches, 35 See infra sections II.B.1–.2. it discusses the emergence of the trio of considerations approach in Patel v. Mirza. 36 [2016] UKSC 42, [2017] AC 467 (appeal taken from Eng.); see also infra section II.B.3. 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. 37 [2019] UKSC 50, [2020] AC 1189 (appeal taken from Eng.); see also infra section II.C. 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. 38 See infra section II.C. 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.