Court Analyzes Adverse Interest Exception to in Pari Delicto Defense

On October 10, 2019, the First Department issued a decision in Conway v. Marcum & Kliegman LLP, 2019 NY Slip Op. 07338, analyzing the adverse interest exception to the in pari delicto defense:

In this accounting malpractice action, plaintiffs, the liquidators of several hedge funds, allege that defendants failed to uncover fraudulent activity by the funds' investment managers. The issue before us is whether the adverse interest exception to the equitable defense of in pari delicto bars the defense in this case. We find that plaintiffs raised issues of fact as to the adverse nature of their interests vis-a-vis those of their agents, the funds' investment managers, that preclude summary dismissal of the complaint on the ground of the in pari delicto defense.

To come within the exception, the agent must have totally abandoned his principal's interests and be acting entirely for his own or another's purposes. The exception is applied only where the fraud is committed against a corporation rather than on its behalf. So long as the corporate wrongdoer's fraudulent conduct enables the business to survive — to attract investors and customers and raise funds for corporate purposes — this test is not met. Thus, we conclude that the mere continuation of a corporate entity does not per se constitute a benefit that precludes application of the adverse interest exception.

We note that in a prior appeal, this Court upheld plaintiffs' assertion of the adverse interest exception in opposition to defendants' motion to dismiss the original complaint on the pleadings. The original complaint alleged that the funds' liquidation did not begin until years after the 2007 audits conducted by defendants were completed. This alleged fact was not sufficient to warrant dismissal then, and is not sufficient to warrant dismissal now under CPLR 3212.

Moreover, reliance on speculation about the benefits to be derived from the continued existence of an entity is inconsistent with the analysis of the adverse interest exception in Kirschner. It may be possible in every case to construct a hypothetical scenario where the company teetering on the brink of insolvency because of its agent's fraud meets with an opportune circumstance that allows it to resume legitimate business operations. Permitting such speculation would render the adverse interest exception meaningless. Further, an ongoing fraud and a continued corporate existence may harm a corporate entity: The agent may prolong the company's legal existence so that he can continue to loot from it, as appears to have been the case here.

The other purported benefits cited by defendants are also insufficient to show that the adverse interest exception is inapplicable, as there exist factual questions as to whether the funds were beneficiaries, rather than victims, of the investment managers' fraud. Further, any purported benefit flowing to plaintiffs must be tied to wrongful conduct by defendants.

(Internal quotations and citations omitted).

We both bring and defend professional malpractice claims and other claims relating to the duties of professionals such as lawyers, accountants and architects to their clients. Contact Schlam Stone & Dolan partner Erik Groothuis at egroothuis@schlamstone.com if you have questions regarding such claims or appeals of such claims.