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First Impressions Are Lasting: New Defense Available in Delaware for Auditors and Other Third Parties in Corporate Misconduct Claims

Case Study

First Impressions Are Lasting: New Defense Available in Delaware for Auditors and Other Third Parties in Corporate Misconduct Claims

In a case of first impression before the Delaware Chancery Court, the defense of in pari delicto was applied in favor of an auditor to defeat claims brought by the receiver of several insolvent insurance entities. This decision sets important and favorable precedent for the defense of accounting firms and other third parties when they become implicated in cases alleging corporate wrongdoing on the part of other defendants.

In the dispute, the Insurance Commissioner for the State of Delaware, in her capacity as receiver, alleged that an officer of four captive insurance cells had orchestrated a $5 million fraud, aided and abetted by other officers and directors, by an outside management company, and by two CPA audit firms. Malpractice claims were also asserted against the auditors.

The auditor defendants and management company moved to dismiss, arguing in part that the perpetrating officer’s wrongdoing should be imputed to the captive cells, and that the equitable doctrine of in pari delicto (“of equal fault”) should bar the receiver from asserting the malpractice claims. In pari delicto is an equitable doctrine that prevents courts from adjudicating disputes amongst wrongdoers.

The defense presented novelty in this case on two fronts. First, no Delaware state court had applied in pari delicto as a bar to malpractice claims against an auditor. Second, even if in pari delicto were a valid defense, it was unclear whether it applied in the context of a receivership. The receiver contended that her role was not analogous to that of a trustee in bankruptcy, and that she did not stand in the shoes of the liquidated captives.

In its March 26, 2015 decision, the court held that third parties, like auditors, “who are implicated in the alleged misconduct of the corporation’s directors and officers,” may assert in pari delicto as a defense to malpractice claims under Delaware law. The court also concluded that in pari delicto applies with equal force in the insurance receivership context.

This important decision allows for a potential knockout defense — as early as at the pleading stage — when auditors and other third parties, such as lawyers, outside managers, and advisors, are implicated in corporate misconduct under Delaware law.

Jonathan S. Ziss and Seth L. Laver, partners in Goldberg Segalla’s Professional Liability Practice Group, represented one of the auditor defendants in this case.