Peterson v. McGladrey & Pullen, LLP
67 Collier Bankr. Cas. 2d 418
7th Cir.2012Background
- Ronald Peterson, as Chapter 7 trustee for the Lancelot investment funds, sues auditor McGladrey & Pullen for negligence related to its 2006-2007 audits.
- The Funds operated a Ponzi scheme run by Petters; Thousand Lakes purportedly financed inventory to operating businesses, but no real customers existed.
- Petters used new investments to pay earlier debts; Bell, head of the Funds’ management, allegedly knew or should have known the fraud, with Bell later pleading guilty in 2009.
- The Funds collapsed in 2008; about 60% of invested money disappeared; the Funds’ assets were in bankruptcy, with Peterson as estate trustee.
- District court dismissed the complaint under in pari delicto, holding the Funds could not sue their auditor because Bell’s fraud tainted the Funds’ claims.
- The Seventh Circuit rejects dismissal, holding that federal bankruptcy law does not override state-law pari delicto defenses unless displaced, and remands for further proceedings.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether in pari delicto applies to a bankruptcy estate’s claim against an auditor. | Peterson argues federal bankruptcy law should override state law to bar pari delicto defenses. | McGladrey argues Illinois in pari delicto applies and bars recovery when client/ insiders were culpable. | Pari delicto defense applies if the jurisdiction allows it, and state-law limits remain in bankruptcy. |
| Whether federal bankruptcy principles permit overcoming state-law defenses against an auditor's liability. | Estate should recover despite state defenses to deter gatekeepers and maximize estate recovery. | Butner framework preserves state-law property rights absent Code displacement. | Federal law does not displace state-law pari delicto absent a Code provision. |
| Whether Bell’s post-hoc criminal culpability affects the viability of Trustee’s claims against McGladrey. | Bell’s knowledge and intent could have supported earlier exposure of the fraud and liability of McGladrey. | Criminal culpability in 2008 does not compel dismissal of pre-2006/2007 audits absent pleadings showing Bell’s knowledge then. | Pleadings permit alternative theories; not dismissed on this basis. |
| Whether the exculpatory clause in McGladrey’s engagement letter negates the complaint. | Clause should not foreclose pleading of the estate’s claims; misrepresentations must be established to trigger defense. | Clause protects if material misrepresentations by client affected auditor's duties. | Clause is not a fatal admission; complaint cannot be dismissed for lack of pleading on this defense at this stage. |
Key Cases Cited
- Butner v. United States, 440 U.S. 48 (1979) (state law defines property in bankruptcy absent code displacement)
- Raleigh v. Illinois Department of Revenue, 530 U.S. 15 (2000) (basic federal rule: state law governs substance of claims)
- Cenco Inc. v. Seidman & Seidman, 686 F.2d 449 (7th Cir. 1982) (managers' fraud imputed to corporation; auditor liability limits)
- Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995) (fraudulent transfers; cannot generalize to override state defenses in bankruptcy)
- Official Committee of Unsecured Creditors v. Edwards, 437 F.3d 1145 (11th Cir. 2006) (paric delicto defense applicability in bankruptcy context)
- Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) (pario delicto defense in bankruptcy)