In the face of corporate fraud and deceit, it is not uncommon for the defrauded entity to turn on its professionals. The inevitable issue becomes who is responsible for overseeing the enterprise: the business entity or the independent professional? Perhaps both. The in pari delicto affirmative defense can be an effective tool for professionals to shield themselves from liability arising from alleged wrongdoing of their underlying client. For example, we previously posted a victory for an accountant who successfully asserted the defense here. But, how and when to assert the defense is tricky as evidenced by a recent Pennsylvania District Court decision.
In the recent decision of Neblett v. Clairmont Paciello & Co., P.C., the Middle District of Pennsylvania bucked the recent trend emerging in the Second Circuit favoring dismissal of auditor’s malpractice claims at the motion to dismiss stage. In Neblett, the District Court decided whether accountants for a technology company were liable for failing to detect or prevent the company’s apparent fraud scheme conducted by its principals. The shareholders seek 50 million in damages. In its 61-page decision, the Court found that the facts alleged did indeed “satisfy the plausibility standard” required for such accounting negligence, refused to apply in pari delicto, and denied the motions to dismiss.
As is often the case in this scenario, the shareholders of the defunct company allege that had their independent auditor exercised reasonable care and due diligence, it would have revealed the existence of the scheme. Allegedly, the auditor failed to carry out its professional obligations as prescribed by PCAOB and GAAP, despite having an obligation to “obtain reasonable assurance about whether the financial statements are free of material misstatements.”
The auditor moved for dismissal based upon the in pari delicto doctrine: i.e. “when both parties are guilty, the court will leave them where it finds them.” The court concluded that the defense was premature because the court could not conclusively determine whether the plaintiff benefited from the alleged fraud. The court held that it was required to take the plaintiff’s averments as true that the company was a mere vehicle as to the fraudulent behavior in question, and not an ultimate beneficiary of the fraud. The court accepted the plaintiff’s argument that the complaint raised questions as to whether a fraudulent scheme that ultimately led the company to file for bankruptcy could be construed as having “benefited” the company in any fashion.
This is an interesting decision for all professionals considering the in pari dilecto defense. Often, it is difficult to ascertain who/what benefited from the alleged fraud yet that it is a key element of the defense. Given that this decision was reached at the pleading stage, it remains a possibility that following discovery the auditor will have a clearer picture of in pari delicto and may have an opportunity to move for summary judgment.