Office Building Tower 185PricewaterhouseCoopers LLC (PwC) won another victory in the MF Global litigation when the Second Circuit Court of Appeals affirmed the dismissal of claims brought by former commodities customers (the “Customers”) of MF Global Inc. (“MFGI”). This holding is important for its clear affirmation of the in pari delicto doctrine and as a visible limitation on claims by parties not in privity.

The collapse of MF Global Holdings Limited (“MFG Holdings”) spawned vast amounts of litigation, including claims brought by the Customers for the disappearance of $1.6 billion in customer funds. While much of the Customer’s litigation is directed at the directors and officers of MFGI and MFG Holdings, the Customers also brought claims against PwC for negligence and breach of fiduciary duties owed to MFGI. PwC served as the independent auditor of MFGI and MF Global during the 2010-2011-time period.

The district court granted PwC’s motion to dismiss the Customer’s claims. The court first found that, because the Customers did not have a contractual relationship with PwC, the Customers would need to be in “near-privity” with PwC in order for the negligence claim to stand. Under New York law, near-privity requires three elements to be met: (1) PwC must have been aware that the audited reports would be used for a particular purpose; (2) in furtherance of which a known party was intended to rely; and (3) some conduct by PWC “linking” it to the known party. The district court held that the test for near-privity was not satisfied because there was no direct contact between the Customers and PwC.

The district court also agreed with PwC that the Customers’ claim for breach of fiduciary duty was barred by the doctrine of in pari delicto. Distilled to its simplest form, the in pari delicto doctrine bars a court from interceding to resolve a dispute between two wrongdoers. As a result, one party cannot sue another party where the first party was actively participating in the unlawful activity. As applied in the bankruptcy context, a bankruptcy trustee standing in the shoes of the bankrupt corporation is precluded by the in pari delicto doctrine from recovering in tort if the corporation participated in the tort. Here, the Customers’ claim for breach of fiduciary duty was brought derivatively on behalf of MFGI’s liquidating trustee who, by operation of law, stands in the shoes of MFGI. Because MFGI was alleged to be a participant in the wrongdoing underlying the Customers’ claim, the court held that the in pari delicto defense was available for PwC on the face of the pleadings, and dismissed the breach of fiduciary duty claim.

On appeal, the Customers argued that the doctrine of in pari delicto did not apply because (i) PwC was performing a regulatory function, (ii) PwC’s wrongful conduct in preparing negligent audits pre-dated the MFGI wrongdoing, and (iii) it was premature to apply the doctrine because there was no definitive ruling of wrongdoing by MFGI. The Second Circuit disagreed, holding that MFGI’s misuse of customer funds was sufficiently linked to PwC’s alleged auditing failures, and further that the Customers’ case depended on wrongdoing by MFGI, so that the Customers’ third argument was self-defeating. On the claim of breach of fiduciary duty, the Second Circuit agreed that the elements of “near-privity” were not satisfied, and held that the district court had properly dismissed the claim.

On June 5, 2015, the Customers moved for a panel rehearing.  Notwithstanding this challenge, the Second Circuit’s ruling is an important reminder of the power of the in pari delicto defense. This is especially true in the bankruptcy context where the debtor may have participated in the underlying bad acts. Moreover, the Court’s narrow interpretation of “near privity” underscores the attractiveness of directors and officers as litigation targets since claims against the directors and officers are not dependent upon determinations of privity.