Commercial Litigation and Arbitration

Nevada Would Follow New York’s Strict Application of In Pari Delicto — Erie Prediction — Pennsylvania’s More Liberal Rule Questioned

From USCAM Liquidating Trust v. Deloitte & Touche, LLP, 2011 U.S. Dist. LEXIS 16123 (D. Nev. Feb. 16, 2011):

Under Nevada law, the knowledge of an officer or agent is imputed to the corporation when the agent obtains the knowledge "while acting in the course of his employment and within the scope of his authority, and the corporation is charged with such knowledge even though the officer or agent does not in fact communicate his knowledge to the corporation." ***

Further, a corporation is "responsible for the acts of its authorized agents even if particular acts were unauthorized," because the "risk of loss from the unauthorized acts of a dishonest agent falls on the principal that selected the agent." Kirschner v. KPMG LLP, 938 N.E.2d 941, 950-51 (N.Y. 2010) (quotation omitted). ***

However, an agent's knowledge will not be imputed to the corporation when the agent is acting on his own behalf and not on behalf of the corporation. *** This is commonly referred to as the "adverse interest" exception to the usual rule that an officer's or director's acts and knowledge are imputed to the corporation.

Nevada has not indicated whether an agent's interest must be completely adverse to its principal to invoke the adverse interest exception. "Where the state's highest court has not decided an issue, the task of the federal courts is to predict how the state high court would resolve it." *** "In answering that question, this court looks for 'guidance' to decisions by intermediate appellate courts of the state and by courts in other jurisdictions." ***

Other jurisdictions would require an agent to completely abandon the principal's interests and act entirely for his own purposes. See, e.g., In re CBI Holding Co., Inc., 529 F.3d 432, 448 (2d Cir. 2008); In re Bennett Funding Group, Inc., 336 F.3d 94, 100 (2d Cir. 2003) (indicating adverse interest exception applies only when the agent has "totally abandoned" the principal's interests); In re Crazy Eddie Secs. Litig., 802 F. Supp. 804, 817 (E.D.N.Y. 1992) (stating that when the agent acts both for himself and for the principal, the agent's knowledge is imputed to the principal even if the agent's primary interest is inimical to the principal). According to Fletcher's Cyclopedia of the Law of Private Corporations, the agent's relations to the subject matter must be "so adverse as practically to destroy the relation of agency." 3 Fletcher Cyclopedia of Private Corp. § 789. Courts generally require total abandonment to invoke the adverse interest exception because "[t]his rule avoids ambiguity where there is a benefit to both the insider and the corporation, and reserves this most narrow of exceptions for those cases-outright theft or looting or embezzlement-where the insider's misconduct benefits only himself or a third party . . . ." Kirschner, 938 N.E.2d at 952. Based on these authorities, the Court concludes, as it has previously, that Nevada would adopt a similar rule. ***

In sum, Nevada recognizes the well-accepted rule that an agent's knowledge and acts are imputed to his principal, unless the agent acts adversely to his principal. The Court concludes that Nevada would require the agent to totally abandon his principal's interest for the adverse interest exception to apply, and that an agent most clearly does so when he loots or steals or embezzles from his principal. The Court further concludes that Nevada would adopt the recognized and uncontroversial proposition that even where agents act adversely to their principal, their knowledge and acts still will be imputed to the principal if they are the sole relevant actors. Finally, the Court concludes that to the extent Nevada would adopt an innocent decision maker exception, it would do so as a corollary to the sole actor rule and not as an independent exception to imputation. Rather, assuming without deciding that Nevada would find the presence of innocent decision makers relevant, Nevada would inquire whether any innocent insider existed who could and would have exercised actual corporate authority to stop the fraud such that there is no unity between the wrongdoing agents and their corporate principal. ***

[T]he Trust argues the Court should conclude that Nevada would follow a recent decision by the Pennsylvania Supreme Court and hold that an outside auditor cannot rely on imputation where the auditor does not act in good faith. In Official Committee of Unsecured Creditors of Allegheny Health Education and Research Foundation v. PriceWaterhouseCoopers, LLP, the Pennsylvania Supreme Court noted that because imputation rules "justly operate to protect third parties on account of their reliance on an agent's actual or apparent authority," imputation should not apply "where both the agent and the third party know very well that the agent's conduct goes unsanctioned by one or more of the tiers of corporate governance." 989 A.2d 313, 336 (Pa. 2010). That court considered it "ill-advised, if not perverse" to charge the principal corporation "with knowledge as against a third party whose agents actively and intentionally prevented those in [the corporation's] governing structure who were non-participants in the fraud from acquiring such knowledge." Id. Thus, where an outside auditor engages in "secretive, collusive conduct" with corporate agents, Pennsylvania denies the colluding auditor the ability to rely on an imputation defense. Id.

Nevada has not addressed whether it would adopt such a rule. Even if Nevada were inclined to follow the Pennsylvania Supreme Court, that court indicated that such a rule would not apply where the wrongdoing agent with whom the auditor colluded is the sole actor:

Were the action between a corporation controlled by a single individual and a sole-proprietor auditor, there would be a good case to be made that in pari delicto should apply to negate all causes of action arising out of intentional auditor misrepresentations made at the behest of the owner, and thus, with full corporate complicity. At the very least, in the absence of some countervailing social policy at stake, the business can be deemed to have exposed itself to a just, judicial determination whether or not to simply leave the equally culpable parties in the condition in which they are found.

Id. at 331 (quotation and alteration omitted). Because the sole actor rule applies here, and any intentional misrepresentations made by Deloitte would have been made with USACM's full complicity through Hantges and Milanowski, imputation still would be an available defense for Deloitte, even if Nevada followed the Pennsylvania Supreme Court.

Footnote 3. Further the Pennsylvania Supreme Court's requirement that the auditor act in good faith creates a double standard. USACM's innocent stakeholders would be able to avoid having the bad faith conduct of USACM's agents imputed to USACM, but Deloitte's innocent stakeholders would have no such opportunity.

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