The Institute in the Courts
by Aron Goldschneider, Case Citations Director
The Pennsylvania Supreme Court was recently presented with questions of first impression centering on the availability of an imputation-based in pari delicto defense in an auditor-liability scenario, and adopted positions on the matter consistent with the approach taken by Restatement Third, Agency §§ 5.03 and 5.04. The suit at issue, brought by a committee of unsecured creditors of a nonprofit corporate debtor in liquidation against the successor to debtor’s auditor, arose from allegations that auditor colluded with high-level officers of debtor, including its CEO and CFO, to fraudulently misstate debtor’s finances, thus concealing debtor’s deepening insolvency and thwarting remedial intervention by the board of trustees.
On appeal from the federal district court, which granted summary judgment for defendant, the United States Court of Appeals for the Third Circuit certified questions to the Pennsylvania Supreme Court seeking guidance as to (1) what the proper test was under Pennsylvania law for determining whether an agent’s fraud should be imputed to the principal when it was an allegedly noninnocent third party that sought to invoke the law of imputation in order to shield itself from liability and (2) whether the doctrine of in pari delicto prevented a corporation from recovering against its accountants for a breach of contract, professional negligence, or aiding and abetting a breach of fiduciary duty, if those accountants conspired with officers of the corporation to misstate the corporation’s finances to its ultimate detriment.
In answering the questions, the Pennsylvania court held that, while defensive imputation could extend to scenarios involving auditor negligence, subject to an adverse-interest exception, it did not apply where the defendant materially had not dealt in good faith with the principal; thus, an in pari delicto defense was foreclosed in a scenario involving secretive collusion between officers and auditors to misstate corporate finances to the corporation’s ultimate detriment. The court quoted at length from Restatement Third, Agency’s § 5.04, Comment c, in support of its conclusion, including language that “[a] principal should not be held to assume the risk that an agent may act wrongfully in dealing with a third party who colludes with the agent in an action that is adverse to the principal. That is, the third party should not benefit from imputing the agent’s knowledge to the principal when the third party has acted wrongfully or otherwise in bad faith.”
While the court recognized that the defense of in pari delicto could be available in some cases arising in the corporate auditing context, it stressed that, under Pennsylvania law, a policy of “incentivizing internal corporate monitoring” through a stronger application of the defense did not trump the “objectives of the traditional schemes governing liability in contract and in tort, including fair compensation and deterrence of wrongdoing.” In this regard, the court pointed to the “special and crucial role assumed by independent auditors as a check against potential management abuses.” Official Committee of Unsecured Creditors of Allegheny Health Educ. and Research Foundation v. PricewaterhouseCoopers, LLP, 989 A.2d 313 (Pa. 2010).