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An unsecured creditors committee charged with pursuing claims for a pair of debtor companies could not maintain its action against a securities underwriter that helped deepen the companies’ insolvency because the underwriters successfully argued that the debtors’ management was equally at fault, the 3rd U.S. Circuit Court of Appeals ruled on Oct. 9. Official Committee of Unsecured Creditors v. R.F. Lafferty & Co. Inc., No. 00-1157. The committee had sued the underwriter and an accounting firm, alleging that they had falsely certified the financial condition of the debtors — Walnut Equipment Leasing Co. and its subsidiary, the Equipment Leasing Corp. of America — to induce creditors to buy debt instruments that the companies could never honor. The action against the accountant settled, but the underwriter, R.F. Lafferty & Co., raised the defense of “in pari delicto,” stating, in effect, that the debtors were equally guilty. Citing bankruptcy code Section 541, the circuit court said the in pari delicto defense must be evaluated as of the date of the bankruptcy filing, without consideration of post-petition events. One such event was the trustee’s appointment of the committee to pursue claims on the debtors’ behalf. Imputing the corporate officers’ conduct to the debtor companies, the court noted that the committee was acting for the debtors in its pursuit of R.F. Lafferty, and ruled it was barred from doing so by the in pari delicto defense. Though in the absence of controlling Pennsylvania precedent the 3rd Circuit recognized a debtors’ cause of action for deepening insolvency, it rejected the committee’s argument that, as an innocent successor to the wrongdoing management, it should be allowed to pursue the claim on the companies’ behalf. Stuart Melnick, of counsel to New York City’s Tanner Propp, represented R.F. Lafferty & Co. He found part of the dissenting opinion “compelling.” In that dissenting opinion, Judge Robert E. Cowen wrote that the lower court had “inexplicably failed to explain” why it had dismissed the claims against the outside professionals, but not the claims against corporate insiders. Moreover, Cowen opined, under the majority’s logic, all defendants could assert in pari delicto with equal force. Melnick said that while this conclusion was not binding, it could be useful for the remaining defendants. The committee’s lawyer, Barbara Mather, a partner with Philadelphia’s Pepper Hamilton, said, “This case has narrow implications because the court only interpreted Pennsylvania law. The 7th Circuit and 9th Circuit have permitted similar claims in Illinois and California. The 3rd Circuit distinguishes those cases because they involved receivers, not trustees, but the same bankruptcy code language applies to both.” Besides, Mather said, creditors could still sue wrongdoers for their own injuries by bringing a class action. The creditors did so, hiring Philadelphia’s Innelli and Molder to represent them in a class action against R.F. Lafferty and others involved in the scheme. Attorney Michael Molder said that case was settled for $5.8 million last March.

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