Equity Turned on Its Head: The Applicability of in pari delicto to a Bankruptcy Trustee

By: Phil C. Appenzeller, Jr. (Co-speaker) and Ross H. Parker (Co-speaker)
Presented at the 26th Annual Jay L. Westbrook Bankruptcy Conference
November 15-16, 2007

The Latin phrase in pari delicto refers to a plaintiff's participation in the same wrongdoing as the defendant.1 The equitable defense of in pari delicto prevents wrongdoers from recovering damages resulting from their own wrongful conduct. A line of cases has recently emerged regarding the applicability of the in pari delicto defense to bankruptcy trustees. Defendants, such as accounting firms and other professionals, are now trying to use this defense to prevent plaintiffs from recovering for the defendants' own wrongdoing. Unfortunately, some courts have blessed this perverted use of the defense, stripping trustees and creditor's committees of valuable claims and leaving aggrieved parties with little practical redress.

To reach this result, some courts have improperly conflated the in pari delicto defense with the concept of standing, while others have applied a restrictive construction of the Bankruptcy Code. In fact, an affirmative defense like in pari delicto has nothing to do with standing, and the Bankruptcy Code (itself a body of equitable principles) does not in our opinion require the application of the in pari delicto defense as called for by these courts. This line of cases is wrongly decided, as the growing rumblings of bankruptcy experts across the country condemning this trend in the case law portend.2

This article first addresses the standing argument. Second, and more substantively, the article analyzes imputation. Finally, this article provides what the authors believe is the correct interpretation of section 541 of the Bankruptcy Code as it applies to personal defenses such as in pari delicto.

¹The doctrine of in pari delicto has its root in the Latin phrase, in pari delicto potior est conditio defendentis, which translates to mean, "in the case of equal or mutual fault, the position of the defending party is the better one." Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306, 105 S. Ct. 2622, 2626 (1985).
²See Jeffrey Davis, Ending the Nonsense: The in pari delicto Doctrine Has Nothing to Do with What is § 541 Property of the Bankruptcy Estate, 21 EMORY BANKR. DEV J. 519 (Summer 2005); Tanvir Alam, Fraudulent Advisors Exploit Confusion in the Bankruptcy Code: How in pari delicto Has Been Perverted to Prevent Recovery for Innocent Creditors, 77 AM. BANKR. L.J. 305 (Summer 2003); Gerald L. Baldwin, in pari delicto Should Not Bar a Trustee's Recovery, 23 AM. BANKR. INST. J. 8 (Oct. 2004); Making Sense of the in pari delicto Defense: "Who's Zoomin' Who?" 23 No. 11 BANKR. LAW LETTER 1 (Nov. 2003) Robert T. Kugler, The Role of Imputation and in pari delicto in Barring Claims Against Third Parties, 1 No. 14 ANDREWS BANKR. LIT. REP. 13 (2004).

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