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In a case that could have a broad impact on whether and when accounting firms can be held liable in the wake of corporate scandals, a federal appeals court has asked the Pennsylvania Supreme Court to answer two questions relating to the doctrine of in pari delicto. At issue in the case is whether the creditors’ committee in the massive Allegheny Health, Education and Research Foundation hospital bankruptcy has the right to bring claims against PricewaterhouseCoopers for allegedly conspiring with AHERF’s corporate officers to hide the company’s desperate financial condition prior to its spectacular collapse in July 1998. Reluctant to predict the answers to state law questions, the 3rd U.S. Circuit Court of Appeals has certified two questions to the Pennsylvania Supreme Court. The wording of the second question illustrates how broad the impact of the case could be. It reads: “Does the doctrine of in pari delicto prevent a corporation from recovering against its accountants for breach of contract, professional negligence, or aiding and abetting a breach of fiduciary duty, if those accountants conspired with officers of the corporation to misstate the corporation’s finances to the corporation’s ultimate detriment?” In the lower court, PwC won the first round of the litigation when a federal judge in Pittsburgh dismissed the claims, finding that the doctrine of in pari delicto barred AHERF from casting blame on PwC because of AHERF’s own culpability. The doctrine of in pari delicto, which is Latin for “in equal fault,” provides that a plaintiff may not assert a claim against a defendant if the plaintiff bears fault for the claim. It is derived from the maxim, in pari delicto potior est conditio defendentis, meaning: “in a case of equal or mutual fault, the position of the defending party is the better one.” In a January 2007 decision, U.S. District Judge David S. Cercone of the Western District of Pennsylvania found that the defense of in pari delicto is “limited to situations where the plaintiff bore at least substantially equal responsibility for his injury, and where the parties’ culpability arose out of the same illegal act.” Cercone concluded that the defense was a silver bullet for PwC because the misconduct of AHERF’s corporate officers should be imputed to the corporation, and because the creditors’ committee in the AHERF bankruptcy stands in the shoes of the corporation. But when the case was argued before the 3rd Circuit, a three-judge panel unanimously concluded that it was unable to decide the case without guidance from the Pennsylvania Supreme Court. “In pari delicto is a murky area of law. It is an ill-defined group of doctrines that prevents courts from becoming involved in disputes in which the adverse parties are equally at fault,” 3rd Circuit Judge Thomas L. Ambro wrote in a 15-page order in Official Committee of Unsecured Creditors of Allegheny Health, Education and Research Foundation v. PricewaterhouseCoopers. “Courts in Pennsylvania have not been of one mind as to whether the doctrine is legal or equitable,” Ambro found, and “it is not clear from the few Pennsylvania cases invoking it how the doctrine applies to the causes of action at issue here: professional negligence, breach of contract, and aiding and abetting a breach of fiduciary duty.” Ambro’s order was joined by 3rd Circuit Judge Kent A. Jordan and visiting Judge Paul R. Michel, the chief judge of the Court of Appeals for the Federal Circuit. The creditors’ committee, Ambro said, argued that the doctrine of in pari delicto, like unclean hands, should not apply against a party that has not personally engaged in inequitable conduct, but rather has that conduct imputed through agency law. But lawyers for PwC argued that the 3rd Circuit has already held in Official Committee of Unsecured Creditors v. R.F. Lafferty & Co. that it is proper to apply the doctrine on the basis of imputed conduct. Ambro found that the competing arguments pointed to a gap in Pennsylvania law. “The contours of in pari delicto in Pennsylvania law are not clear, and the committee has raised a serious argument, albeit one that Lafferty seems to foreclose,” Ambro wrote. But Ambro also noted that “ Lafferty‘s view of in pari delicto is a minority one,” and that other courts have rejected its reasoning. Guidance from Pennsylvania’s high court is necessary, Ambro said, because “we are unsure whether the three causes of action presented here — professional negligence, breach of contract, and aiding and abetting a breach of fiduciary duty — are subject to in pari delicto in the same way.” Some of Ambro’s discussion of the issue suggests that the 3rd Circuit was leaning in favor of a ruling that would revive the claims against PwC, but was reluctant to do so without the endorsement of Pennsylvania’s high court. “Extending in pari delicto to a breach-of-fiduciary-duty action without guidance from the Supreme Court of Pennsylvania gives us pause,” Ambro wrote. The doctrine “is generally not a valid defense for corporate directors alleged to have breached their fiduciary duties. The reason is obvious: if directors were allowed to have their misconduct imputed to the corporation for purposes of avoiding liability for breaching their duties to the corporation, shareholders and other corporate stakeholders would have little recourse against disloyal and careless corporate managers.” Quoting the Delaware Chancery Court, Ambro found that “such a result would be … ‘transparently silly.’” Ambro concluded that, under Pennsylvania law, there is an “open question” as to “whether it would make sense to allow in pari delicto to shield persons alleged to have knowingly aided and abetted this sort of misconduct.” And since the 3rd Circuit’s own rulings on the issue have been rejected by other courts, Ambro found that it was time to seek guidance from the state court. “Given the questions surrounding the Lafferty holding, the need for clarification of the in pari delicto doctrine under Pennsylvania law, and the presence of the aiding and abetting cause of action, we believe that the best course is to request that the Pennsylvania Supreme Court clarify the contours of in pari delicto under Pennsylvania law,” Ambro wrote. In the final paragraph of the order, Ambro framed the issues into two questions to be certified to the Pennsylvania Supreme Court: “What is the proper test under Pennsylvania law for determining whether an agent’s fraud should be imputed to the principal when it is an allegedly non-innocent third-party that seeks to invoke the law of imputation in order to shield itself from liability?” And “Does the doctrine of in pari delicto prevent a corporation from recovering against its accountants for breach of contract, professional negligence, or aiding and abetting a breach of fiduciary duty, if those accountants conspired with officers of the corporation to misstate the corporation’s finances to the corporation’s ultimate detriment?” The creditors’ committee is represented in the appeal by attorney Patrick F. McCartan of Jones Day in Cleveland. Attorney Thomas G. Rafferty of Cravath Swaine & Moore in New York argued the case for PwC.

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