NY COURT OF APPEALS DECLINES TO EXPAND LIABILITIES FOR ACCOUNTANTS, LAWYERS, BANKERS & OTHER PROFESS

In an opinion issued October 21, 2010, the New York Court of Appeals aEURoedecline[d] to alter our precedent ... to bring about the expansion of third-party liability.aEUR? This decision could offer significant protections to myriad professionals, including auditors, accountants, lawyers, investment bankers, financial advisers and others, as well as the insurers of directors and officers, professional liability, fidelity and other risks. Although there is no limit to Plaintiffs creativity in looking for deep-pocked sources to pay for losses when investments are in trouble, this decision could provide a useful weapon to shield third-party professionals from liability. The New York high-courtaEUR(TM)s decision in Kirschner v. KPMG, et al. involved two cases brought by creditors or shareholders of companies whose executives allegedly committed fraud.

The Professional Liability Lawsuits Certified to the Court of Appeals The first case was brought by the Liquidation Trustee of Refco on behalf of certain unsecured creditors, suing the investment banks that underwrote RefcoaEUR(TM)s leveraged buyout and IPOs, RefcoaEUR(TM)s lawyers, two of RefcoaEUR(TM)s accounting firms, and several other defendants. A federal District Court in New York dismissed the claims on the basis that the wayward executivesaEUR(TM) conduct was imputed to the company without exception and, therefore, a bankruptcy rule akin to the in pari delicto doctrine barred the TrusteeaEUR(TM)s claims. On appeal, the Second Circuit certified several questions to the New York Court of Appeals, including whether the aEURoeadverse interestaEUR? exception to the imputation doctrine could apply to certain situations.

The second case involved a shareholder derivative lawsuit that arose from the AIG accounting scandal of 2005 which allegedly cost shareholders $3.5 billion in equity. There, shareholders of AIG attempted to sue derivatively PricewaterhouseCoopers, AIGaEUR(TM)s independent auditors, for failing to uncover the alleged accounting fraud then being perpetrated by AIGaEUR(TM)s senior management. When PwC moved to dismiss, the Delaware Court of Chancery held that the executivesaEUR(TM) conduct must be imputed to the company without exception and, on that basis, the in pari delicto rule barred the shareholders from attempting to pursue the auditors. Those plaintiffs appealed and the Delaware Supreme Court certified a question to the New York Court of Appeals as to whether the in pari delicto doctrine would, under New York law, apply to bar a derivative claim against outside auditors where the auditors were not alleged to have been active, but negligent, in the purported accounting fraud.

In Pari Delicto, Imputation, and the Adverse Interest Exception There were three legal principles at issue in the questions certified to the Court, including: 1) in pari delicto; 2) imputation, and; 3) the adverse interest exception to imputation. As succinctly put by the Court, aEURoeThe doctrine of in pari delicto mandates that the courts will not intercede to resolve a dispute between two wrongdoers.aEUR? (Opinion, at 12). The doctrine of imputation recognizes that aEURoethe acts of agents, and the knowledge they acquire while acting within the scope of their authority are presumptively imputed to their principals.aEUR? (Id. at 14). And the adverse interest exception is a narrow exemption to the imputation doctrine and will apply only where the agent has aEURoetotally abandoned his principalaEUR(TM)s interests and [is] acting entirely for his own or anotheraEUR(TM)s purposes.aEUR? (Id. at 17) (emphasis in original). In both of the cases underlying this appeal, the motion courts determined that imputation applied, that the adverse interest exception did not exempt imputation, and that in pari delicto prevented the plaintiffs (now standing on the same footing as the company and the allegedly wayward executives) from recovering against the companyaEUR(TM)s third-party professionals.

The Court of Appeals' Decision The Refco Trustee and AIG derivative plaintiffs chiefly challenged application of imputation and in pari delicto doctrines on public policy grounds, in order to aEURoerecompense the innocent and make outside professionals (especially accountants) responsible for their negligence and misconduct in cases of corporate fraud.aEUR? (Op. at 22). To do so, they offered several arguments, each of which the Court rejected.

First, the appellants argued that application of the adverse interest exception should take into account the agentaEUR(TM)s intent in order to determine whether the agent of the company totally abandoned the companyaEUR(TM)s interests. The Court ruled, however, that this reading of the exception would make it so broad that it would aEURoeexplodeaEUR? the exception and make it a aEURoenearly impermeable rule barring imputation in every case.aEUR? (Op. at 24). Second, the appellants asked the Court to adopt what the appellants viewed as carve-outs to the exception as fashioned by two other decisions in New Jersey and Pennsylvania. But the Court declined that invitation, noting that those decisions rendered the adverse interest exception aEURoebeside the point,aEUR? (Id. at 25), because those statesaEUR(TM) decisions called for factual inquiries into the relative faults of the parties before imputation could be decided. Third, the appellants asserted that the existence of New YorkaEUR(TM)s comparative negligence rules show in pari delicto is or should be abolished, but the Court held otherwise and found that interpreting the comparative fault rules as absolutely controlling would be to aEURoemarginalize the adverse interest exception.aEUR? (Op. at 30). Fourth, the appellants urged the Court to expand the third-party professionalsaEUR(TM) liability over the imputation and in pari delicto doctrines on pure public policy grounds. The Court, though, noted that the appellants aEURoeboth stand in the shoes of corporate malefactorsaEUR? and that there was no reason to put their interests ahead of aEURoethose of innocent stakeholders of the outside professionals.aEUR? (Id. at 31). In declining to expand third-party liabilities as advocated by the appellants, the Court reasoned:

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