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Two Wrongs Make a Right to Dismissal: At-Fault Feeder Funds’ Claims Dismissed Under In Pari Delicto

This week’s Latin lesson: in pari delicto potior est conditio defendentis means that if both parties are in the wrong, then the defendant’s position is stronger.  This centuries-old legal doctrine (in pari delicto, for short) provides that if the wrongdoing of the plaintiff and the defendant is at least equal, then the plaintiff will not prevail against the defendant.[1]  The Appellate Division, First Department applied this doctrine recently in the “never ending saga of Bernard L. Madoff’s Ponzi scheme.”[2]  In an opinion by Presiding Justice Peter Tom, the First Department in the case of New Greenwich Litig. Trustee, LLC v. Citco Fund Servs. (Europe) B.V. affirmed a Commercial Division order dismissing claims asserted by feeder funds because the funds had engaged in their own wrongdoing.[3]  Most striking is how the wrongdoing came to the court’s attention: i.e., through the funds’ own court filings.

The case began when limited partners of two feeder funds—Greenwich Sentry, L.P. and Greenwich Sentry Partners, L.P. (the “Funds”)—filed derivative complaints on the Funds’ behalf.  The complaints alleged that the Funds’ management, as well as outside accountants, auditors, and administrators, had failed to conduct due diligence on Madoff’s firm, and had collected enormous fees on fictitious assets.  They further alleged that the Funds’ own general partner “participated in, approved, or permitted the wrongs . . . .”[4]

When the Funds declared bankruptcy, a trustee, who substituted for the derivative plaintiffs, filed amended complaints.  In contrast with the original derivative complaints, the amended complaints alleged that the Funds were not culpable participants in the Ponzi scheme, and did not know about the scheme until it came to light in December 2008.[5]

Justice Marcy S. Friedman of the Commercial Division applied in pari delicto and dismissed the Funds’ claims because the original derivative complaints had alleged wrongdoing on the part of the Funds which was at least equal to the defendants’ wrongdoing.  The Commercial Division held that the allegations were judicial admissions that left no room for a jury to decide the parties’ relative culpability.[6]

The First Department affirmed.  “While a claim of in pari delicto sometimes requires factual development and is therefore not amenable to dismissal at the pleading stage,” the court found no need for such factual development here because the original derivative complaints “pleaded extensive wrongdoing on the part of the funds’ management,” including issuing highly-inflated earnings reports and failing to perform minimal due diligence.[7]  The First Department agreed with the Commercial Division that these allegations were judicial admissions that bound the Funds, and constituted “documentary evidence” that the court could consider on the defendants’ motion to dismiss.[8] 

The Funds argued that the derivative allegations were not judicial admissions because they were made “upon information and belief.”[9]  The First Department disagreed.  According to Justice Tom, the derivative allegations were not fairly characterized as “information and belief” allegations because they were “factual in nature, highly detailed, and . . . not consistent with the lack of direct knowledge . . . ordinarily found in allegations that are truly made on information and belief.”[10]

The lesson here—apart from the Latin—is that if a corporation’s wrongdoing is on par with the wrongdoing of an outside defendant (e.g., an accountant or auditor), it may give rise to an in pari delicto defense.  The more “highly detailed” the allegations of wrongdoing, the more likely that an in pari delicto defense will succeed on a motion to dismiss.[11]

By Eric B. LaPre and Muhammad U. Faridi

[1] See New Greenwich Litig. Trustee, LLC v. Citco Fund Servs. (Europe) B.V., Nos. 600498/09 and 600469/09, 2016 N.Y. App. Div. LEXIS 6702, at *15 (N.Y. App. Div. Oct. 18, 2016).

[2] Id. at *2.

[3] Id. at *21.

[4] Id. at *13.

[5] Id. at *5-6.

[6] Walker, Truesdell, Roth & Assocs., Inc., Trustee of Greenwich Sentry, L.P. Litig. Trust v. Globeop Fin. Servs. LLC, No. 600469/09, 2013 N.Y. Misc. LEXIS 6561, at *33-39 (N.Y. Sup. Ct. May 27, 2013).

[7] New Greenwich Litig. Trustee, LLC, 2016 N.Y. App. Div. LEXIS 6702, at *12-13.

[8] Id. at *13-14.

[9] Id. at *15-16.

[10] Id. at *16.

[11] See id. at *16.