In Pari Delicto Doctrine in Bankruptcy In Pari Delicto Doctrine in - PowerPoint PPT Presentation

Presenting a live 90 ‐ minute webinar with interactive Q&A In Pari Delicto Doctrine in Bankruptcy In Pari Delicto Doctrine in Bankruptcy Litigation: Anticipating or Raising the Defense Strategies for Trustee and Creditors' Committee Lawsuits Against Third ‐ Party Professionals THURSDAY, NOVEMBER 4, 2010 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: T d ’ f l f Phil C. Appenzeller, S hareholder, Munsch Hardt Kopf & Harr , Dallas . Wissner-Gross, Partner, Brown & Rudnick , New Y S igmund S ork The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .

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IN PARI DELICTO DOCTRINE IN BANKRUPTCY LITIGATION IN BANKRUPTCY LITIGATION by Phil C. Appenzeller, Jr 214 855 7542 214.855.7542 pappenzeller@munsch.com

INTRODUCTION  What does it mean? - In Equal Fault  The doctrine of In Pari Delicto is based on the principle that a party cannot sue others for its own wrong doing. For example, a common issue is whether a corporation can sue third parties for helping it commit wrongs.  In Pari Delicto is not the same as comparative fault or contributory negligence. f Rather, it is an affirmative defense that acts as a complete bar to recovery.  The analysis includes, e.g., whether the plaintiff’s fault is substantial or equal to the third party’s fault and whether the third party acted in good faith in its the third party s fault, and whether the third party acted in good faith in its dealings with the plaintiff.  Early cases analyzed the doctrine by applying a standing analysis. More recently, however, courts have moved away from whether or not the plaintiff h has standing to bring the claims and now view In Pari Delicto as an affirmative t di t b i th l i d i I P i D li t ffi ti defense or an equitable defense to the plaintiff’s claims. 5

STANDING This change in application was important in the bankruptcy context because if the trustee or the creditors’ committee lacks standing to bring the claims it is “game over ” bring the claims it is game over. Why It is not a standing issue:   “Standing consists of both a case on controversy requirement Standing consists of both a case on controversy requirement stemming from Article III; Section 2 of the Constitution and Sub- constitutional prudential element.” Off. Comm. Of Unsecured Creditors vs. R. F. Lafferty & Co., Inc., 267 F.3d 340, 346 (3d Cir. 2001)  The focus of standing is whether the plaintiff has been injured. It is not whether a party who has been injured is barred from recovery by an equitable defense such as In Pari Delicto .  In drafting a plan of reorganization, much care must be given to preservation of pre-petition claims and proper assignment of those claims to a trustee or creditors’ committee so standing is not an issue. 6

What claims are affected by In Pari Delicto ? by In Pari Delicto ? Two typical fact scenarios: Two typical fact scenarios: Scenario 1  Company operating as a fraud or Ponzi scheme  At center of fraud is CEO  Bad guy cloaks company with air of legitimacy (boards, officers, counsel, accountants, etc.)  Eventually, the company crumbles  Trustee or receiver discovers massive fraud, self-dealing by bad guy, accountants/lawyers are complicit, negligent, or found to have been t t /l li it li t f d t h b acting in bad faith. 7

Scenario 1 Claims: Director and Officer claims: Breach of fiduciary duties, corporate 1. waste, self dealing, fraudulent transfers. Usually easy to overcome business judgment rule, but this is fact-dependent. Problem: If there is director and officer coverage, likely to bar coverage on many claims. ff Third-party claims: 2. A A. Accountants Accountants B. Law firms C. Brokers/ Distributors, etc. Issue: Were the third parties complicit, negligent, or acting in bad faith? 8

Scenario 1 If Complicit or acting in bad faith:  Look at acts of management - Was management acting adversely to Look at acts of management Was management acting adversely to corporation so that it would be improper to impute their acts to the corporation (adverse-interest exception)?  If the answer is “yes,” then the trustee must distance himself from acts of management and adverse-interest bars application of In Pari Delicto . f t d d i t t b li ti f I P i D li t  Potential Obstacles:  If the corporation actually benefitted from management’s acts, then it is likely that the adverse-interest exception may not apply then it is likely that the adverse-interest exception may not apply.  If “sole actor” exception applies, defendant may be able to defeat adverse-interest exception on an alter ego-type theory.  Risks to trustee when he pleads bad acts of management: how to plead Risks to trustee when he pleads bad acts of management: how to plead or how not to plead.  Real life example: ETS Payphones case. 9

Scenario 2  Legitimate company with “legitimate management.”  Management overstates revenue or manipulates revenue recognition (intentionally or negligently).  Did the acts actually benefit the company?  Auditors fail to catch overstatement or lack of internal controls.  Company fails and a trustee is appointed. The trustee then sues auditors. di  Auditors file motion to dismiss and raise In Pari Delicto .  Sh Should the Auditor be held liable when it was negligent (versus grossly ld th A dit b h ld li bl h it li t ( l negligent) but not necessarily complicit or acting in bad faith? 10

Pleading Considerations  Will have to pick your claims carefully.  If trustee sues management for wrongdoing, potential use of those claims by third-party defendants in support of In Pari Delicto defense.  If trustee chooses not to sue management more likely to survive a If trustee chooses not to sue management, more likely to survive a motion to dismiss as the In Pari Delicto defense will require discovery.  Must consider assets and ability to collect in performing this analysis (director and officer insurance policy exceptions erosion rate of (director and officer insurance policy, exceptions, erosion rate of policy, ownership of policy proceeds, solvency of individual defendants, etc.)   Real life example Real life example. 11

The IN PARI DELICTO DOCTRINE in The IN PARI DELICTO DOCTRINE in BANKRUPTCY LITIGATION Allegheny Health, Education and Research Foundation (“AHERF”) A Case Study presented by Sigmund S. Wissner-Gross Brown Rudnick LLP Brown Rudnick LLP swissnergross@brownrudnick.com 212.209.4930 www.brownrudnick.com an international law firm

Background Facts  Allegheny Health, Education and Research Foundation (“AHERF”)  Pennsylvania not-for-profit corporation that provided healthcare services including operating hundreds of physicians’ practices 14 services, including operating hundreds of physicians practices, 14 hospitals, and 2 medical schools.  Beginning in the mid-1980s, AHERF pursued an aggressive “integrated delivery system” model by acquiring hospitals and physicians’ practices that were generally losing money. physicians practices that were generally losing money.  AHERF’s implementation of the model failed.  By 1996, AHERF was suffering substantial operating losses.  AHERF filed a Chapter 11 bankruptcy petition in 1998. www.brownrudnick.com an international law firm 13

Background Facts  A group of AHERF officers was alleged to have knowingly misstated the company’s financials that were provided to PWC, AHERF’s outside auditor for the company’s 1996 and 1997 audits AHERF s outside auditor, for the company s 1996 and 1997 audits, in order to make it appear that the company was successful.  The Official Committee of Unsecured Creditors of AHERF brought claims against PWC for breach of contract, professional negligence, and aiding and abetting breach of fiduciary duty and aiding and abetting breach of fiduciary duty.  The Committee argued that PWC should have brought the misstatements to light, but that PWC instead knowingly issued a “clean” audit opinion for each of those two years, causing injury to “ l ” dit i i f h f th t i i j t AHERF. www.brownrudnick.com an international law firm 14