PwC Prevails in Important Ruling on In Pari Delicto Doctrine

On October 21, 2010, the New York Court of Appeals issued an opinion answering a certified question of law in favor of Cravath client, PricewaterhouseCoopers LLP (“PwC”), in an important ruling on the in pari delicto doctrine in New York. This doctrine prevents one wrongdoer from maintaining a lawsuit against another alleged wrongdoer. It is an important defense for auditors and other professional advisors in actions brought by plaintiffs, such as bankruptcy trustees and shareholder derivative plaintiffs, on behalf of a company whose former management is alleged to have engaged in wrongdoing.

A derivative action, Teachers’ Retirement System of Louisiana v. PricewaterhouseCoopers LLP, was brought in Delaware Chancery Court by shareholders on behalf of AIG against PwC, AIG’s auditor. The action claimed negligence in PwC’s not detecting an alleged fraud perpetuated by AIG’s senior officers, which led AIG in 2005 to restate a number of prior years’ financial statements. In 2009, the Delaware Chancery Court dismissed the claims against PwC, holding that, under New York law, the conduct of AIG’s senior officers was attributed to AIG. As a result, plaintiffs’ claims against PwC were barred by the doctrine of in pari delicto. On appeal, the Delaware Supreme Court certified the following question to the New York Court of Appeals: “Would the doctrine of in pari delicto bar a derivative claim under New York law where a corporation sues its outside auditor for professional malpractice or negligence based on the auditor’s failure to detect fraud committed by the corporation; and, the outside auditor did not knowingly participate in the corporation’s fraud, but instead, failed to satisfy professional standards in its audits of the corporation’s financial statements?”

The Court of Appeals issued a strong opinion upholding the in pari delicto doctrine as an affirmative defense to claims against auditors in cases, such as the AIG action, “where a willful wrongdoer is suing someone who is alleged to be merely negligent,” as well as cases “where both parties acted willfully.” The court limited the adverse-interest exception to the imputation of an insider’s conduct, for purposes of the in pari delicto doctrine, to situations in which this conduct is totally adverse to the company, such as “outright theft or looting or embezzlement.”

The Cravath team included partner Antony L. Ryan, senior attorney Samira Shah, practice area attorney Paul E. Rosenthal and associates Hector J. Valdes, Marc J. Khadpe, Jeffrey G. Paik and Alejandro Cruz.