[IMGCAP(1)]In a case of first impression before the Delaware Chancery Court, the defense of in pari delicto was applied in favor of an auditor/accounting firm to defeat claims brought by the receiver of several insolvent insurance companies.

The decision sets important and favorable precedent for the defense of accounting firms and other third parties when they become implicated in cases alleging corporate wrongdoing on the part of other defendants.

In pari delicto” is an equitable doctrine that prevents courts from adjudicating disputes among wrongdoers.

In the dispute, the Insurance Commissioner for the State of Delaware, in her capacity as receiver, alleged that an officer of four captive insurance cells had orchestrated a $5 million fraud, aided and abetted by other officers and directors, by Wilmington Trust, an outside management company, and by two outside CPA audit firms, Johnson Lambert & Co., and McSoley McCoy & Co.

“The CPA firms were sued on the theory that either they were complicit in what went wrong, or they failed to catch it,” said Jonathan Ziss, a partner in Goldberg Segalla’s Professional Liability Practice Group, who represented one of the auditor defendants. “We filed a motion to dismiss the complaint, raising a number of defenses. In essence, we asserted that the case was one of corrupt managers, who were claiming that the accountants either ‘helped us be bad, or failed to prevent us from being bad.’ This goes to the defense of in pari delicto [in equal fault], which recognizes that it’s not the function of the court to decide between wrongdoers.”

As the court explained, “in pari delicto bars the court from intervening to adjudicate claims between wrongdoers.”

“I conclude that in pari delicto does apply in this case, and that it effectively would bar the relevant claims against the moving defendants, unless I found applicable one of the exceptions urged by the receiver,” the court stated. “In the circumstances of this case, the well-known ‘adverse interest’ exception does not apply.”

“This was a case of first impression,” said Ziss. “Surprisingly, despite its role as a corporate nexus, Delaware has never had the occasion to consider the applicability of in pari delicto to a claim of wrongdoing by an auditor. The receiver-plaintiff [the Insurance Commissioner] urged the court to accept an auditor exception that in pari delicto should not protect an auditor.”

“The court, in a well-reasoned decision, concluded that there is no auditor exception, nor should there be an auditor exception under Delaware law,” said Ziss. “In pari delicto is available on an appropriate set of facts for an auditor to assert as a defense.”

“The court also noted that auditors are not fiduciaries,” said Ziss. “The term is sometimes slung around loosely in asserting that auditors have breached their fiduciary duty. That’s the thrust of the decision, that the court was asked to recognize an auditor exception and chose not to. It should be a viable defense for auditors.”

The decision allows a potential knockout defense—as early as the pleading stage—when auditors and other third parties are implicated in corporate misconduct under Delaware law.

“Not all Delaware audits are subject to Delaware law, but an engagement can be contractually worded to make it so.” Ziss noted. “The receiver has filed a motion seeking permission to appeal this decision on a hurry-up basis. It’s up to the judge if he will allow it to be appealed at this time, or wait until the case is over. We will know in a couple of weeks whether the decision is going up on appeal to the Delaware Supreme Court.”

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