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Broad application of in pari delicto defense results in summary judgments for Grant Thornton in Parmalat case

November 2009

Overview

 

An old defense to claims brought by clients and former clients has been renewed and given broad application to end litigation against affiliates of the former client's auditors.  U.S. District Judge for the Southern District of New York Lewis Kaplan ruled, on September 18, 2009, that all claims brought by the plaintiffs, Dr. Enrico Bondi, ("Bondi"), the Extraordinary Commissioner of Parmalat Finanziaria, S.p.A., Parmalat S.p.A., and their affiliates (jointly "Parmalat") in Italian reorganization proceedings, and Parmalat Capital Finance Limited, a subsidiary of Parmalat ("PCFL"), against defendants Grant Thornton International ("GTI") and Grant Thornton LLP ("GT-US") were barred under the in pari delicto defense.  As a result, Judge Kaplan granted summary judgments to both GTI and GT-US and dismissed all claims with prejudice. The importance of the Parmalat decision is that it represents a clear articulation of a simple rule – an accountant's client cannot benefit from its own fraud through a lawsuit against its accountant.

 

Background

 

Parmalat was an Italian dairy conglomerate that had grown into a diversified multinational food company by 1990.  Beginning in the late 1980s, Parmalat experienced significant financial difficulties, requiring constant infusions of cash to cover losses and service massive debt.  To obtain the necessary funding, Parmalat, with the aid of its outside Italian auditors, Grant Thornton – Italy ("GT-Italy"), falsified its financial statements for more than a decade to create the appearance of financial health.  In 2003, the scheme, which was massive, became "unsustainable."  In early December 2003, Parmalat failed to pay certain maturing bonds, and its stock had lost half its value.  Italian regulators suspended trading.  On December 19, Parmalat announced that a bank account supposedly holding $4.9 billion did not exist.  Parmalat declared bankruptcy in Italy on December 24 and was declared insolvent three days later.

 

Soon thereafter, Italian authorities indicted a number of Parmalat executives and two GT-Italy partners.  GTI and GT-US severed all relationship with GT-Italy.  In the lawsuit against GT-US and GTI, Bondi's amended complaint asserted claims for professional malpractice, fraud, aiding and abetting fraud, constructive fraud, negligent misrepresentation, aiding and abetting breach of fiduciary duty, theft and diversion of corporate assets, conversion, unjust enrichment, aiding and abetting fraudulent transfer, deepening insolvency, and unlawful civil conspiracy.  The suit claimed damages of $10 billion.  The claims were based upon the alleged activities of GT-Italy, acting in conjunction with Parmalat insiders, to loot Parmalat.  The claims against GT-US and GTI were based primarily upon allegations that GT-US and GTI were vicariously liable for the actions of their former affililiate, GT-Italy.

 

Decision

 

Judge Kaplan initially denied the Grant Thornton motions to dismiss the first amended complaint because of the allegations that the Parmalat insiders acted solely for their own benefit. In June 2006, the court entered a default judgment against GT-Italy on liability because it had filed no responsive pleadings.  GTI and GT-US followed with motions for summary judgment on the ground that plaintiffs were in pari delicto with GT-Italy and thus barred from asserting any claims.1  In ruling on Grant Thornton's summary judgment motions, Judge Kaplan applied controlling Illinois state law, but the legal issue in question is much the same throughout the United States.

 

The in pari delicto defense prevents a party from suing others for a wrong in which the party itself participated.  Since corporations can only act through their officers and agents, the acts performed and the knowledge obtained by corporate officers or agents within the scope of their employment are imputed to the corporation, and by law become the act of the corporation.  Thus, if an officer acting within the scope of his employment participates in fraudulent conduct of others, his actions bar a lawsuit by the corporation related to that fraud, unless an exception to the defense applies.  When a corporation is the plaintiff, any change in control of the entity – i.e., new management taking over for those involved in the misconduct – is immaterial to the applicability of the in pari delicto defense.  ("In short, there is no innocent successor exception that would prevent application of in pari delicto to PCFL here."  Opinion at p. 20.)

 

Issues

 

Judge Kaplan found that Parmalat and PCFL's officers and agents were acting within the scope of their employment when they engaged in their "massive fraud," and thus their knowledge and actions should be imputed to the corporations unless some exception to the rule bars the imputation.  The preponderance of the opinion deals with the plaintiffs' attempts to avoid the in pari delicto defense by finding an applicable exception.  The court's key holdings are:

 

  • The Adverse Interest Exception, where an agent acts adversely to the principal, does not apply unless the agent totally abandons his employer's interests and acts solely for his own interest.  If the agent acts even in part for the benefit of the employer, his actions and knowledge are imputed to the corporate employer and bar any claims under the in pari delicto defense.  The court found that the Parmalat and PCFL officers did not abandon totally the corporate interests.
  • An agent's intent to benefit only himself is not the controlling standard to determine whether the in pari delicto defense applies; to allow the agent's intent to overcome the fact that the corporation also benefited would gut the in pari delicto defense.
  • The fact that the corporation is ultimately destroyed by the agent's fraud does not change the application of the defense because a corporation can be destroyed by fraud on its behalf just as when agents commit fraud against it.  Once it is established that the agents acted in part for the benefit of the corporation, it is immaterial whether and to what extent they also stole or embezzled from the corporations.
  • The in pari delicto defense would not bar recovery from defendants for anything the corporate officers stole from the corporations with the culpable assistance of the defendants.  However, the plaintiffs presented no evidence to sustain their allegation.
  • The in pari delicto defense is applicable to all of the causes of action pleaded by plaintiffs.  "The nature of the defense is that, where it applies, 'the law will not aid either party, but will leave them without remedy as against each other.'"  Opinion at p. 41.
  • The in pari delicto defense is not precluded by the "audit interference doctrine" from applying to a claim for accounting malpractice.  Illinois allows an auditor to assert the client's own negligence as a defense to a malpractice claim only where the negligence interferes with the auditor's performance of his engagement.  This defense has nothing to do with the separate in pari delicto defense, which operates as an absolute bar to a claim based upon equally wrongful acts of both parties.
  • The primary purpose of the in pari delicto defense is to prevent courts from getting involved in suits among co-conspirators and others who are jointly at fault.  As a result, it must be applied to aiding and abetting fraud or fiduciary breaches, or to civil conspiracy claims.

 

Comment

 

An accountant's client cannot avoid the consequences of its officers' or agents' fraudulent actions or the officers' knowledge about a fraud that benefited the corporation, even though those agents also benefited personally from the fraud, so long as the agents were acting within the scope of their employment.  As applied by the Parmalat court, the in pari delicto defense is broader than other traditional defenses such as loss causation, reliance, and proportional responsibility, which are not elements of, or defenses to, all the causes of action that are most frequently pleaded.

 

To view a copy of the opinion in this case, please click here.

 

For more information, please contact Thomas R. Manisero at thomas.manisero@wilsonelser.com or 212.490.3000, Peter J. Larkin at peter.larkin@wilsonelser.com or 914.323.7000, or Robert W. Coleman at robert.coleman@wilsonelser.com or 214.698.8048.



1) PCFL also sued GTI in a separate complaint alleging that certain of its officers worked with GT-Italy to loot PCFL and that it had $1 billion in damages as a result.  Its claims against GTI were based solely on theories of vicarious liability for the acts of GT-Italy.  GTI moved for summary judgment on PCFL's causes of action for negligent misrepresentation, aiding and abetting breaches of fiduciary duty and accounting malpractice on in pari delicto grounds.

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