In pari delicto: does the doctrine protect auditors from liability?

• Author: BY EARL WEISS, KIREN DOSANJH ZUCKER AND RAZMIK KAJBERUNI
• Position: Liabilityprotection

if a corporate officer or other employee commits fraud, should the corporation or its shareholders be permitted to successfully sue an auditor for failing to detect die fraud--even if the auditor was negligent? A legal concept dial has Mown below die radar might oiler auditors some cover when facing such claims.

Under the doctrine of in pari delicto ("in equal fault"), an auditor cannot lie held liable for negligently failing lo detect wrongdoing or lor even participating in die wrongdoing if the corporation also participated at least equally. The courts do not permit wrongdoers to profit from their own misconduct.

An auditor's success in using the in pari delicto defense varies significantly, depending on the applicable law of the stale in which die lawsuit is filed.

Imputing Wrongdoing and the Adverse Interest Exception

If a corporation's agents--such as directors, officers or other employees--participate in die wrongdoing, their conduct can be imputed lo die corporation as if the corporation itself had acted wrongfully.

However, a corporation may avoid imputation of its agent's wrongful acts, and the in pari delicto defense, wilh die "adverse interest exception." which relieves the corporation of imputed acts not performed for the benefit of die corporation.

For example: An employee who steals or embezzles from a corporation acts adversely lo die corporation's own interests and. therefore, such wrongdoing cannot be imputed lo the corporation.

On die other hand, if an employee falsifies financial statements to maintain or increase the value of die corporation's stock then, arguably, die corporation derives a benefit from die wrongdoing which can be imputed to it even if the employee also benefits.

Kirschner and Other Jurisdictions

In die last four years, live major court decisions have addressed die auditor's use of in pari delicto lo defend against liability.

In Kirschner v, KPMG, the New York Court of Appeals determined that New York law allows an auditor to assert the defense where a corporation benefitted from iis officer's undetected fraudulent acts. The litigation trustee of a bankrupt company. String on behalf of die company, alleged that KPMG wrongfully failed lo uncover uncollectible debts concealed by the company's president and CEO: For the adverse interest exception to apply and prevent ill pari delicto, the wrongdoing officer would have bad to totally abandon the corporation's best interests and act solely for his own...