Cathy Vance, Resident Guru, Calls Expansive Invocation of the In Pari Delicto Defense a "Jurisprudential House of Cards"

Whatever you may think about the fact that Refco's outside corporate counsel, Joe Collins, was convicted on 5 criminal counts and sentenced today to 7 years in prison, one has to wonder how the system got so turned upside down on the civil side that while the law firm's lead lawyer is torched in criminal court, his firm is summarily dismissed from a civil case for precisely the same conduct on a simple motion to dismiss (based on a theory that the Refco trustee lacked standing to bring suit to recover for damages arising from a fraudulent scheme devised and carried out by Refco's own senior management).  One could argue that this result is unique to the Second Circuit (and the Seventh) because of the Wagoner decision and its progeny (which are not followed in the First, Third, Fifth, Eighth, or Eleventh Circuits).  Even in those circuits, however, management's wrongful conduct has been imputed to the corporation under the in pari delicto doctrine to just as effectively knock the props out from civil actions involving some of the most spectacular commercial frauds of the century.  Of course, all this may change if the NY Court of Appeals has an epiphany and, in response to the Second Circuit's 8 question-long certification of 12/28/09 in the Refco trustee's appeal, completely rewrites the Wagoner rule (and the in pari delicto doctrine too).

DSI's Cathy Vance has long been this blog's resident guru.  In her first post, she unlocked the mystery behind the origin of BAPCPA's section 1102(b)(3).  On BAPCPA's second birthday, she surveyed BAPCPA's unruly landscape as it entered its terrible two's and drove record numbers of readers here.  The next year, on the third anniversary of BAPCPA's passage, as anger and frustration turned to resignation, she untangled the purpose and application of the new Bankruptcy Rule 6003

Recently, Cathy has turned her attention to understanding how the in pari delicto defense morphed into one of the more powerful and complete defenses to professionals that are complicit--through their negligence--in a company's wrongdoing.  In last November's issue of the ABI Journal, Cathy wrote an article entitled, In Pari Delicto, Reconsidered, in which she posited--as none had before--that the in pari delicto doctrine is being inappropriately used by federal courts to supplant traditional tort law defenses that derive from state, not federal, law.

Cathy has graciously expanded upon the theme of her ABI article and written exclusively for this blog a follow up piece entitled In Pari Delicto and a Jurisprudential House of Cards, for which I am very grateful.  So without further ado, heeeeeeerrrrrreeee's Cathy! ........

© Steve Jakubowski 2010

 

In Pari Delicto and a Jurisprudential House of Cards

Catherine E. Vance

January 14, 2010

In a recent article I wrote, In Pari Delicto, Reconsidered,  (published in the November 2009 ABI Journal), I posited, among other things, that in the federal courts the in pari delicto doctrine is supplanting traditional tort law defenses, which derive from state, not federal, law. Within a few weeks, the Third Circuit issued its decision in OHC Liquidating Trust v. Credit Suisse (In re Oakwood Homes Corp.), 2009 U.S. App. LEXIS 27631, 2009 WL 4829835, (3d Cir. Dec. 14, 2009) (pdf), and that decision rather nicely proves my point.  

The facts, in a nutshell: Oakwood Homes, which made and sold manufactured homes, used securitizations to finance its operations. The company hit the skids in 1999 and contacted Credit Suisse regarding a financing transaction intended to provide the company with needed liquidity. An internal memo was prepared within Credit Suisse recommending against the transaction and that transaction never materialized, but two others were negotiated between Credit Suisse and Oakwood Homes in 2000 and 2001. After it sought bankruptcy protection in 2002, Oakwood Homes wanted to continue its securitization financing model with Credit Suisse. 

The plaintiff, OHC Liquidating Trust, was born in the Oakwood Homes bankruptcy. The Trust objected to Credit Suisse’s proof of claim and counterclaimed for common law negligence, breach of fiduciary duty and breah of implied contract. Credit Suisse filed a motion for summary judgment, arguing that none of these allegations could stand because the Trust, as successor to Oakwood Homes, was in pari delicto with Credit Suisse, i.e., Oakwood Homes was at least as blameworthy for entering into what the Trust called “value destroying” transactions with Credit Suisse. The district court, where the matter was heard, sided with Credit Suisse and granted the motion. 

Affirming, the Third Circuit stated, rather definitively, that in pari delicto “is recognized as a defense under New York common law” and cites a number of New York cases to support this proposition.

Back to my prior article for a moment. Here’s what I said then: 

The way that we’ve been thinking about in pari delicto in bankruptcy cases is quite at odds with the comparative negligence regime, irrespective of the variances among the states. Not only does the in pari delicto analysis precede, rather than follow, a merits-based determination on the elements of negligence, it may be resulting in the dismissal of cases that, under state law, would allow the plaintiff to recover.

 

This is precisely what happened in Oakwood Homes. Like most states, New York dropped contributory negligence, which barred recovery if the plaintiff bore any responsibility, in favor of a rule based on comparative negligence. What’s more, New York is a pure comparative negligence state.  

[T]he culpable conduct attributable to the claimant or to the decedent, including contributory negligence or assumption of risk, shall not bar recovery, but the amount of damages otherwise recoverable shall be diminished in the proportion which the culpable conduct attributable to the claimant or decedent bears to the culpable conduct which caused the damages.

 

N.Y. C.L.S. C.P.L.R. § 1411. This means, generally speaking, that the plaintiff can recover unless the plaintiff is solely and entirely to blame for the harm it suffered. Now, based on the facts set out in the district and appellate courts’ decisions, it’s likely that the Oakwood Homes Trust would have lost upon proper application of the comparative negligence standard but that does not diminish the fundamental legal error both courts made. The in pari delicto analysis is flatly inconsistent with a pure comparative negligence regime because the latter allows recovery that is forbidden by the former. By interposing in pari delicto and its consequent search for equal or mutual fault, these courts have, quite literally, judicially altered New York’s comparative negligence statute.

Compounding the problem, the Third Circuit cites New York cases to justify its application of in pari delicto that don’t provide much at all in the way of actual authority for the stated proposition.

One of the cited cases is Abright v. Shapiro, 214 A.D.2d 496, 626 N.Y.S.2d 73, (N.Y. App. Div. 1st Dep’t 1995), which presents the classic in pari delicto scenario and is woefully off point. Abright involved rent-controlled property, where the landlord permitted tenants to rent the properties for use as professional office space and the tenants were required to indemnify the landlord for any damages resulting from that use. The court stated that it disagreed with the lower court’s determination that the indemnification provision was insufficient to encompass the landlord’s legal fees, but it nevertheless affirmed the lower court’s ruling – because both landlord and tenant were parties to an illegal contract and were, therefore, in pari delicto.

So, Abright is both factually and legally beside the point. In Oakwood Homes, there was no assertion that the company and Credit Suisse had entered into an illegal contract (indeed, in pari delicto was used to cut off inquiry into whether there even was, as the Trust alleged, an implied contract). Abright also falls well short as authority that in pari delicto “is recognized as a defense under New York common law,” as the Third Circuit has claimed because it wasn’t asserted as a defense at all. Rather, the appellate court invoked the doctrine sua sponte, refusing to allow either party “to enlist the aid of the courts in the enforcement of their unlawful bargain.”

The Third Circuit also relies on Jackson v. Assoc. Dry Goods Corp., 13 N.Y.2d 112, 192 N.E.2d 167 (1963) and D’Ambrosio v. City of New York, 55 N.Y.2d 454,450 N.Y.S.2d 149, 435 N.E.2d 366 (1982). Neither of these cases, however, has anything to do with measuring the relative fault of a plaintiff against that of a defendant, or the relevance of in pari delicto against allegations of negligence, implied contract or breach of fiduciary duty. Instead, both have at issue the rules of indemnification and contribution among joint tortfeasors. Moreover, as the Third Circuit correctly notes (sort of), D’Ambrosio makes clear that Jackson is no longer good law, but of the two, only Jackson incorporates notions of in pari delicto into the analysis.

A bit of explanation is in order, which D’Ambrosio provides for us. At one time, New York law did not allow contribution among joint tortfeasors based on “the belief that the courts should not participate in adjusting the relative rights of wrongdoers.” Given the harsh results this rule sometimes led to, a rule of indemnification evolved that depended on whether a joint tortfeasor’s negligence was “active” or “passive.” As explained by the D’Ambrosio court: 

Thus, one who was cast in damages for negligence could, if his negligence were merely "passive", nevertheless shift his liability to the tort-feasor whose negligence was considered "active" … One who was himself actively negligent could not, of course, receive the benefit of this doctrine; it was available only to shift full liability from the secondary to the primary wrongdoer, and its availability depended upon the level of culpability of the one seeking indemnity. The inquiry became primarily a question of the degree of fault, or the factual disparity between the delinquency of the several tort-feasors.

 

D’Ambrosio 55 N.Y.2d at 461, 450 N.Y.S.2d at 152, 435 N.E.2d at 369. (internal quotations and citations omitted).

Jackson was decided under the active/passive regime, which explains its reference to the in pari delicto doctrine and invokes the strict rule against contribution. In other words, if two or more joint-tortfeasors are actively negligent, the then-prevailing rule that “the courts should not participate in adjusting the relative rights of wrongdoers” kicks in. 

After Jackson but before D’Ambrosio came the decision in Dole v. Dow Chemical Company, 30 N.Y.2d 143 (1972). Dole eliminated the active/passive negligence test and “adopted the more realistic approach of holding joint tort-feasors liable according to their respective degrees of fault.” D’Ambrosio at 462, 152, 369. The consequence of Dole is to render irrelevant the application of in pari delicto in the context of joint tortfeasors because the very point of the law as it now stands is the allocation of blame.

On the whole, the cases cited by the Third Circuit, combined with New York’s adoption of its comparative negligence statute, indicate a trend away from the Third Circuit’s statement that in pari delicto “is recognized as a defense” in the negligence context under New York law. Whether between plaintiff and defendant or among those jointly responsible for harm, New York has evolved toward apportionment of fault without a threshold that relieves minor or passive participants or notions that where responsibility for negligence and resulting harm is shared, the court should leave all parties where it finds them. 

The Oakwood Homes decision, then, is premised on a jurisprudential house of cards. What’s more, the dispute between the Trust and Credit Suisse isn’t at all proper for invoking the in pari delicto doctrine. As the brief summary of the facts set out above and in the decisions show, the case is really about what brought harm to Oakwood Homes and who caused it. In other words, did some breach of a duty owed by Credit Suisse cause Oakwood Homes to enter into transactions that were “value destroying” to its business?

In answering this question in the negative, both the district and appellate courts reviewed the active participation of Oakwood Homes’ board and management in pursuing its securitization model, even after the bankruptcy. As the Third Circuit put it:  “To the extent the financing decisions were blameworthy, Oakwood was at least as culpable as Credit Suisse: Oakwood routinely approved the ‘value-destroying’ transactions as an appropriate way to raise liquidity when the company was in financial turmoil. The in pari delicto doctrine bars the claims.” Oakwood Homes, 2009 U.S. App. LEXIS 27631 at *11-12, 2009 WL 4829835 at *3.

Well, no, in pari delicto shouldn’t bar the claims because they aren’t of the kind that the doctrine was intended to address. The doctrine has the furtherance of sound public policy as its goal, denying access to the judicial system to persons engaged in conduct that is wrongful or illegal, like the parties in the Abright decision cited by the Third Circuit.

By contrast, Oakwood Homes is about failed business strategy and where, by all appearances, all hands are clean. As the district and appellate courts tell us, the company wasn’t hoodwinked or coerced by Credit Suisse, but, rather, was active in determining what course of action it would take to resolve its liquidity problems and restore the company to health. 

That active participation should have caused the Trust to lose, not because Oakwood Homes was blameworthy or culpable, and therefore in pari delicto, but because there was no proximate cause between anything negligent Credit Suisse may have done and the harm Oakwood Homes suffered. Oddly enough, the Third Circuit did rely on the lack of proximate cause in discussing the breach of fiduciary duty claim, stating explicitly that in pari delicto didn’t apply to that allegation, and then applying the exact same reasoning as it did in its discussion of negligence and in pari delicto.

In closing, I’ll admit to feeling like a voice in the wilderness on the subject of in pari delicto (save for some supportive messages I received on In Pari Delicto, Reconsidered) as it has been interpreted and applied over the last 20 years or so. But decisions like Oakwood Homes compel me to press on because the doctrine truly is overused and too often misapplied. Oakwood Homes is a perfect example of the doctrine being applied where the facts don’t warrant it, the law doesn’t support it and public policy isn’t subverted without it.

 
© 2010 by Steve Jakubowski (except for article, which is © 2010 by Cathy Vance)

Written By:Disability Insurance On March 2, 2010 1:50 PM

Thanks for sharing this with us. Sounds like a real interesting case. The in pari delicto argument was interesting to learn more about.

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