MERRIMACK COLLEGE vs. KPMG LLP.
SJC-12434
Supreme Judicial Court of Massachusetts
September 27, 2018
Suffolk. May 8, 2018. - September 27, 2018. Present: Gants, C.J., Lenk, Gaziano, Lowy, Budd, & Cypher, JJ.
NOTICE: All slip opinions and orders are subject to formal revision and are superseded by the advance sheets and bound volumes of the Official Reports. If you find a typographical error or other formal error, please notify the Reporter of Decisions, Supreme Judicial Court, John Adams Courthouse, 1 Pemberton Square, Suite 2500, Boston, MA, 02108-1750; (617) 557-1030; SJCReporter@sjc.state.ma.us
Agency, Agent‘s knowledge. Practice, Civil, Answer, Amendment, Affirmative defense.
Civil action commenced in the Superior Court Department on June 30, 2014.
A motion for leave to file an amended answer was heard by Kenneth W. Salinger, J., and the case was heard by him on a motion for summary judgment.
The Supreme Judicial Court granted an application for direct appellate review.
Elizabeth N. Mulvey for the plaintiff.
Ian D. Roffman (George A. Salter also present) for the defendant.
The following submitted briefs for amici curiae:
Matthew P. Bosher, of the District of Columbia, & Elbert Lin for American Institute of Certified Public Accountants & another.
Jeffrey J. Nolan for Massachusetts Academy of Trial Attorneys.
GANTS, C.J. “The doctrine of in pari delicto bars a plaintiff who has participated in wrongdoing from recovering damages for loss resulting from the wrongdoing.” Choquette v. Isacoff, 65 Mass. App. Ct. 1, 3 (2005). The main issue presented in this civil case is whether, where the plaintiff is an organization acting through its agents, we should follow the traditional principles of agency law and impute the wrongdoing of those agents to the plaintiff organization when determining whether it should be barred from recovery under the in pari delicto doctrine. We hold that, for purposes of measuring fault under the in pari delicto doctrine, we impute only the conduct of senior management to the plaintiff organization. Because the judge here granted summary judgment to the defendant under the in pari delicto doctrine after imputing to the plaintiff college the wrongdoing of an employee who was not a member of senior management, we vacate the order allowing summary judgment and remand the case to the Superior Court.1
Background. Merrimack College (Merrimack) is a small private college incorporated under the laws of Massachusetts. From 1998 to 2004, Merrimack engaged KPMG LLP (KPMG), a large multinational accounting firm, as its independent auditor. Pursuant to this engagement, KPMG conducted annual audits of Merrimack‘s financial statements. Because Merrimack received substantial Federal funds in the form of student financial aid, KPMG also conducted audits pursuant to the United States Office of Management and Budget Circular A-133 (A-133 audits) to evaluate Merrimack‘s compliance with relevant Federal requirements.
In conducting these audits, KPMG reviewed the operations of Merrimack‘s financial aid office, which was responsible for administering various grant and loan programs, including Federal programs such as the Perkins Loan Program.2 On several occasions KPMG noted issues with the financial aid office, including
What KPMG‘s audits failed to reveal was that, during this time period, Merrimack‘s financial aid director, Christine Mordach, was engaged in a fraudulent scheme whereby she regularly replaced grants and scholarships that had previously been awarded to students with Perkins loans, often without the students’ knowledge or consent and in some cases creating false paperwork with false names and false Social Security numbers. One consequence of Mordach‘s fraud was that it made the financial aid office‘s budget appear more balanced, because grants and scholarships reduce tuition revenue, whereas Perkins loans, because they are expected to be repaid in the future, are recorded as an asset on Merrimack‘s balance sheet. Another consequence of her fraud was that many students ended up shouldering student debt they had not sought and did not even know they had. Mordach did not tell anyone else at Merrimack that she was issuing fraudulent loans.
Mordach‘s fraud went undetected until 2011, when Merrimack instituted a new system for keeping track of its student borrowers and many students started to receive billing statements for Perkins loans they never knew they had. As the number of complaints increased, Merrimack hired a forensic accounting team, unrelated to KPMG, to investigate the financial aid office. This investigation revealed more than 1,200 “irregular” student loans that were either invalid or potentially uncollectible because of Mordach‘s activities.
In 2014, Mordach pleaded guilty to Federal criminal charges of
Once Mordach‘s activities were discovered, Merrimack wrote off the fraudulent loans and repaid students who had already made payments on them. According to Merrimack, the total cost of these write-offs and repayments, along with investigation and administrative fees, amounted to more than $6 million.
In an effort to recover some of these losses, Merrimack commenced an action against KPMG in the Superior Court, alleging professional malpractice, breach of contract, negligence, negligent misrepresentation, and violation of
The Superior Court judge allowed KPMG‘s motion for summary judgment, concluding that Merrimack‘s claims were barred under the doctrine of in pari delicto. The judge‘s analysis proceeded in three steps. First, the judge considered whether Mordach‘s fraudulent conduct should be imputed to Merrimack. In doing so, the judge relied on traditional principles of agency law, concluding that “[the] same ‘agency-based imputation rules’ for deciding whether an employer will be held vicariously liable for its employee‘s wrongdoing” under a theory of respondeat superior “appl[ied] with full force in this case, because they also determine whether an employee‘s misconduct is imputed to the employer when applying the in pari delicto doctrine” (citation omitted). The judge then applied the familiar three-pronged test for determining vicarious liability under a theory of respondeat superior, concluding that, because Mordach‘s conduct was “of the kind [she was] employed to perform,” “occur[red] substantially within the authorized time and space limits,” and “[was] motivated, at least in part, by a purpose to serve the employer,” it was “within the scope of [her] employment” and should be imputed to Merrimack. Wang Lab., Inc. v. Business Incentives, Inc., 398 Mass. 854, 859 (1986).
Second, the judge weighed the seriousness of the imputed misconduct against KPMG‘s failure to detect it. Because Merrimack had admitted to facts indicating that Mordach‘s conduct was deliberate, the judge concluded that Mordach‘s intentional fraud -- now imputed to Merrimack -- was “far more serious” than KPMG‘s alleged negligence in failing to uncover Mordach‘s fraud, and that Merrimack therefore could not recover from
Third, the judge considered whether he should, on public policy grounds, make an exception to the in pari delicto doctrine for cases like this one, where an auditor through alleged negligence failed to discover fraud committed by a client‘s employee. The judge recognized that, because “[the in pari delicto] doctrine is equitable in nature, considerations of public policy are always relevant.” But the judge declined to make an exception, reasoning that such an exception would be inconsistent with Massachusetts law, which, in the analogous context of legal malpractice claims, bars clients who engaged in wrongdoing from suing their attorneys for joining in the wrongdoing. See Choquette, 65 Mass. App. Ct. at 7-8. The judge also noted that the majority of courts that have considered the issue have “declined to create a blanket ‘auditor exception’ to the doctrine of in pari delicto.” See, e.g., Stewart v. Wilmington Trust SP Servs., Inc., 112 A.3d 271, 315-318 (Del. Ch.), aff‘d, 126 A.3d 1115 (Del. 2015); Kirschner v. KPMG LLP, 15 N.Y.3d 446, 476-477 (2010); Official Comm. of Unsecured Creditors of Allegheny Health Educ. & Research Found. v. PriceWaterhouseCoopers, LLP, 605 Pa. 269, 305 (2010).
Having concluded that Merrimack‘s claims were barred under the in pari delicto doctrine, the judge dismissed the claims with prejudice, without addressing KPMG‘s other grounds for summary judgment. The judge also allowed KPMG‘s motion for leave to amend its answer to add an affirmative defense of release. Merrimack appealed from these decisions, and we granted its application for direct appellate review.
Discussion. 1. Motion for summary judgment. We review a grant of summary judgment de novo. See Federal Nat‘l Mtge. Ass‘n v. Hendricks, 463 Mass. 635, 637 (2012). In granting summary judgment to KPMG, the judge relied on two separate legal doctrines: the agency-based doctrine of imputation, and the equitable doctrine of in pari delicto. To determine whether Merrimack‘s claims are indeed barred as a matter of law, we must first examine these two legal doctrines and the relationship between them.
a. Imputation. The law of agency establishes a set of rules for determining when, in relation to third parties, an agent‘s conduct or knowledge should be imputed to his or her principal. See Restatement (Third) of Agency §§ 2.01-2.04, 5.03 (2006). For example, in transactions with third parties, an agent‘s conduct
The result of imputation is that the principal bears the legal consequences of the agent‘s conduct. Thus, if an agent with actual or apparent authority enters into a contract with a third party, the principal will be bound by that contract. See, e.g., Linkage Corp. v. Trustees of Boston Univ., 425 Mass. 1, 4, 17 (1997), cert. denied, 522 U.S. 1015 (1997) (university bound by agreement signed by vice-president where vice-president had apparent authority). And if an agent negligently injures a third party while acting within the scope of the agency, the principal will be held vicariously liable for that negligence. See, e.g., Dias v. Brigham Med. Assocs., Inc., 438 Mass. 317, 323 (2002) (corporation could be held vicariously liable for alleged medical malpractice of its physician-employee).
Imputation serves various functions. It creates incentives for principals to choose their agents wisely. See Restatement (Third) of Agency, supra at § 5.03 comment b, at 360. It also encourages principals to supervise their agents and to share information with them. Id. The ultimate purpose behind these rules of imputation, however, is to fairly allocate risks between principals and innocent third parties. As we explained in Kansallis Fin. Ltd. v. Fern, 421 Mass. 659, 664-665 (1996) (Kansallis):
“Standing behind [the] diverse concepts of vicarious liability is a principle that helps to rationalize them. This is the principle that as between two innocent parties -- the principal-master and the third party -- the principal-master who for his own purposes places another in a position to do harm to a third party should bear the loss. A principal who requires
an agent to transact his business, and can only get that business done if third parties deal with the agent as if with the principal, cannot complain if the innocent third party suffers loss by reason of the agent‘s act. Similarly, the master who must put an instrument into his servant‘s hands in order to get his business done . . . must also bear the loss if the servant causes harm to a stranger in the use of that instrument as the business is transacted.” (Citations omitted.)
See also Dias, 438 Mass. at 320 (“The doctrine of respondeat superior in the Commonwealth . . . evolved to place the burden of liability on the party better able to bear that burden“); GTE Prods. Corp. v. Broadway Elec. Supply Co., 42 Mass. App. Ct. 293, 300 (1997) (“The rationale for imputing an agent‘s knowledge to his principal . . . [is] to do justice to an innocent third party . . . .“); Restatement (Third) of Agency, supra at § 5.04 comment b, at 392 (“imputation protects innocent third parties“).
Because the rules of imputation are designed to protect innocent third parties, they are typically applied in situations where a third party sues a principal, for example to enforce a contract entered into by an agent or to recover for injuries caused by the agent‘s tortious conduct. Imputation can also provide a defense to a third party, for example where a principal seeks to enforce a contract that a third party executed because of the fraudulent inducement of the agent. See, e.g., Jewett v. Carter, 132 Mass. 335, 337 (1882) (principal cannot enforce contract that third party entered into based on agent‘s false representations). See also Restatement (Third) of Agency, supra at § 6.11 & comment c.
Importantly, the purpose of imputation is not to adjudicate fault. As we have consistently recognized, imputing the wrongful actions of an agent to a principal does not mean that the principal itself has acted wrongfully. See Elias v. Unisys Corp., 410 Mass. 479, 481 (1991) (“[T]he principles of vicarious liability apply where . . . [t]he principal is without fault. The liability of the principal arises simply by the operation of law and is only derivative of the wrongful act of the agent” [emphasis added]). See also Karcher v. Burbank, 303 Mass. 303, 305 (1939) (“if the [principal] is chargeable with the negligence of the [agent], it is only because his negligence is imputed to it by a rule of law“). The rules of imputation are legal rules, not equitable principles, that are designed to allocate risk, not blame.
b. In pari delicto. In contrast, the doctrine of in pari delicto is an equitable one, focused squarely on the moral blame of the
In Massachusetts, the doctrine has generally operated to bar recovery where the parties have engaged in joint wrongdoing. Where a plaintiff engages in intentional wrongdoing and seeks to recover from a defendant who was a coconspirator or accomplice in the plaintiff‘s wrongdoing, the doctrine will generally bar recovery. See Baena v. KPMG LLP, 453 F.3d 1, 6 (1st Cir. 2006); Scattaretico v. Puglisi, 60 Mass. App. Ct. 138, 140 n.6 (2003) (“one in tortious league with another is generally without remedy against the other“). See also, e.g., Duane v. Merchants Legal Stamp Co., 231 Mass. 113, 118, 119 (1918), cert. denied, 249 U.S. 613 (1919) (minority shareholder who participated in corporation‘s anticompetitive scheme barred from recovering profits from that scheme); Choquette, 65 Mass. App. Ct. at 7-8 (plaintiff who committed perjury barred from recovering from attorney who participated in perjury). Similarly, where the parties have entered into an illegal contract, courts will generally decline to enforce the contract. See Berman v. Coakley, 243 Mass. 348, 350 (1923) (“courts will not aid in the enforcement, nor afford relief against the evil consequences, of an illegal or immoral contract“). See also, e.g., Arcidi v. National Ass‘n of Gov‘t Employees, Inc., 447 Mass. 616, 619-622 (2006) (plaintiff barred from recovering payment made under contract where contract violated statute); Patterson v. Clark, 126 Mass. 531, 532-533 (1879) (plaintiff barred from recovering payment made under illegal gambling contract); Atwood v. Fisk, 101 Mass. 363, 363-364 (1869) (plaintiff barred from seeking cancellation of notes executed in exchange for illegal promise to suppress prosecution).
Because the doctrine is equitable in nature, however, it is not to
“Another exception involves ‘cases where the public interest requires that [the courts] should, for the promotion of public policy, interpose, and the relief in such cases is given to the public through the party.‘” Choquette, 65 Mass. App. Ct. at 4, quoting Council, 303 Mass. at 354-355. See, e.g., Broussard v. Melong, 322 Mass. 560, 562 (1948) (worker who contracted to work longer hours than permitted by statute could recover overtime wages from employer where statute was enacted to protect workers); Council, supra (homeowner who granted mortgage in violation of statute could recover interest paid to mortgagee where statute was enacted to protect homeowners). See generally Story, supra at 400 (“there may be on the part of the court itself a necessity of supporting the public interests or public policy in many cases, however reprehensible the acts of the parties may be“).
Thus, in Bateman, 472 U.S. at 301-305, the United States Supreme Court concluded that the in pari delicto doctrine did not bar investors who purchased securities based on inside information (tippees) from bringing an action under Federal securities laws against the insiders who provided them with the information to recover their subsequent trading losses when the inside information turned out to be false. The Court concluded that a private action for damages may be barred under the in pari delicto doctrine “on the grounds of the plaintiff‘s own culpability only where (1) as a direct result of his own actions, the plaintiff bears at least substantially equal responsibility for the violations he seeks to
As to the first element, the Court determined that a tippee who trades on inside information is not as blameworthy as a corporate insider or broker-dealer who discloses the inside information for personal gain. See id. at 312-314. As to the second, the Court determined that “denying the in pari delicto defense in such circumstances will best promote the primary objective of the federal securities laws -- protection of the investing public and the national economy through the promotion of ‘a high standard of business ethics . . . in every facet of the securities industry.‘” Id. at 315, quoting Securities & Exch. Comm‘n v. Capital Gains Research Bur., Inc., 375 U.S. 180, 186-187 (1963). The Court reasoned that barring private actions in these types of cases because of the in pari delicto doctrine “would inexorably result in a number of alleged fraudulent practices going undetected by the authorities and unremedied,” Bateman, supra, and that allowing tippees to bring such cases against corporate insiders and broker-dealers would maximize the deterrence of insider trading. See id. at 316.
We note that the doctrine of in pari delicto is separate and distinct from comparative negligence, codified in
But where the parties are organizations that can act only through their agents, as here, the task becomes more complicated. The question then arises: how do we determine the moral culpability of each party? If we apply the traditional rules of imputation that determine legal responsibility with respect to third parties and impute Mordach‘s intentional misconduct to Merrimack, the in pari delicto doctrine may bar recovery. But if we do not impute Mordach‘s intentional misconduct to Merrimack, then the worst that can be alleged here based on the evidence is that Merrimack was negligent in its retention or supervision of Mordach, in which case Merrimack‘s recovery will be governed by the principles of comparative negligence, not in pari delicto.
The judge cited two cases in support of his decision to apply traditional principles of agency law and impute Mordach‘s fraudulent conduct to Merrimack. One was a decision from the New York Court of Appeals, Kirschner, 15 N.Y.3d at 446, applying New York law. See id. at 465 (“Traditional agency principles play an important role in an in pari delicto analysis“). The other was a decision from the United States Court of Appeals for the First Circuit, Baena, 453 F.3d at 1, applying Massachusetts law.
In Baena, the First Circuit held that the in pari delicto doctrine barred a trustee, acting on behalf of a bankrupt corporation, from recovering from the corporation‘s former accountants for their failure to prevent the fraudulent conduct of the corporation‘s senior managers. Id. at 6. In imputing the senior managers’ conduct to the corporation, the First Circuit explicitly recognized the possibility that
“Massachusetts might take a narrow view of imputation in the context of in pari delicto.” Id. at 7. It also noted that “[w]hether or not application of the in pari delicto doctrine should depend on imputation rules borrowed from agency law is debatable.” Id. at 8. Nevertheless, absent clear guidance from Massachusetts appellate courts, the First Circuit limited itself to
And indeed, that job is ours. See O‘Melveny & Myers v. Federal Deposit Ins. Corp., 512 U.S. 79, 83-85 (1994) (rules governing imputation are matter of State law). We recognize that, in at least one case, we have barred a plaintiff from recovery under the in pari delicto doctrine because of the misdeeds of the plaintiff‘s agent. In Arcidi, 447 Mass. at 619-622, we held that a union that had entered into an illegal contract could not recover the payments it had made under that contract. In doing so, we rejected the union‘s argument that the union itself was not at fault because it was the decision of the union president, acting on behalf of the union, to enter into the illegal contract. Id. at 618, 622. We reasoned that, “because an organization can only act through agents,” separating the conduct of an organization from its agents in this context “would make it too easy for organizations to reap the benefits of illegal contracts when it is convenient, while deflecting the consequences onto agents and third parties when it is not.” Id. at 622. Thus, in Arcidi we effectively imputed the union president‘s conduct to the union to bar recovery under the in pari delicto doctrine. We did not, however, consider whether the doctrine is always governed by traditional rules of imputation under Massachusetts common law, and we are not aware of any decision from this court or the Appeals Court — nor has one been cited to us — that squarely confronts the issue. In deciding this issue, we therefore write on what is essentially a clean slate of Massachusetts law.
We note first that the traditional rules of imputation, although
The traditional rules of imputation are similarly inapplicable where the aim is to assign blame rather than risk. Thus, where an employee has engaged in misconduct, and where a person harmed by that misconduct seeks punitive damages against the employer, that misconduct will not necessarily be imputed to the employer. See Gyulakian v. Lexus of Watertown, Inc., 475 Mass. 290, 298-299 (2016). Rather, in awarding punitive damages, “it is the actions of the employer, not the actions of that employee, that are the appropriate focus, and . . . it is the employer‘s conduct that must be found to be outrageous or egregious.” Id. at 299 n.14. And, in determining whether the employer engaged in outrageous or egregious conduct, we look to whether “members of senior
For similar reasons, we conclude that, under our common law, a principal acting through an agent may not be barred from recovery under the doctrine of in pari delicto unless the principal itself is found to be morally blameworthy, and conduct by an agent that is sufficient to hold a principal vicariously liable to third parties will not always be sufficient, on its own, to support that finding. Where the plaintiff is an organization that can only act through its employees, its moral responsibility is measured by the conduct of those who lead the organization. Thus, where the plaintiff is a corporation, as here, we look to the conduct of senior management — that is, the officers primarily responsible for managing the corporation, the directors, and the controlling shareholders, if any. Only their intentional misconduct may be imputed to the plaintiff under the doctrine of in pari delicto and, only then, will a court need to consider whether application of the doctrine would comport with public policy.6
Because the judge granted summary judgment to KPMG on the sole ground that Merrimack‘s claims were barred under the doctrine of in pari delicto, we vacate the order granting summary judgment and remand the case to the Superior Court for consideration of KPMG‘s three other grounds for summary judgment. We decline to address these grounds where the judge did not address them, and where the parties did not brief them on appeal. On remand, the judge will therefore have to consider whether summary judgment is warranted on alternative grounds.
Having so found, we need not consider whether, as a matter of public policy, we would carve out an exception to the in pari delicto doctrine in cases where an organization seeks to recover damages from its auditor for the auditor‘s negligence in failing to detect fraud committed by members of senior management.7 We decline to consider whether to adopt such an exception under our
the “plaintiff or other party, individual, or entity has been found to have acted fraudulently in the pending action or in another action or proceeding involving similar parties, individuals, entities and claims” and “the fraud was related to the performance of the duties of the . . . firm,” “the trier of fact shall determine: (a) the total amount of the plaintiff‘s damages, (b) the percentage of fault attributable to the fraudulent conduct of the plaintiff or other party, individual or entity contributing to the plaintiff‘s damages, and (c) the percentage of fault of the . . . firm . . . in contributing to the plaintiff‘s damages.”8 Under this statute, if a plaintiff suffered damages of $1 million, and seventy per cent of those damages is attributable to the plaintiff‘s own fraudulent conduct while only thirty per cent is attributable to the negligence of the defendant accounting firm, the defendant shall not be required to pay more than $300,000.9
The parties and the judge did not cite
2. Motion for leave to amend answer. On appeal, Merrimack also challenges the Superior Court judge‘s decision to allow KPMG‘s motion for leave to amend its answer to add an affirmative defense of release, which we review for abuse of discretion. Johnston v. Box, 453 Mass. 569, 582 (2009).
“It is well established that the defense of a release must be raised as an affirmative defense and that the omission of an affirmative defense from an answer generally constitutes a waiver of that defense.” Sharon v. Newton, 437 Mass. 99, 102 (2002), citing
Conclusion. For the reasons stated, the order allowing KPMG‘s motion for summary judgment is vacated, the order allowing KPMG‘s motion for leave to amend its answer is affirmed, and the case is remanded to the Superior Court. On remand, the Superior Court judge will determine whether summary judgment
So ordered.
Notes
“When an individual or firm licensed to practice public accountancy under [§] 87B or 87B 1/2 is held liable for damages in a civil action arising from or related to its provision of services involving the practice of public accountancy, in which action a claim or defense of fraud is raised against the plaintiff or another party, individual or entity, and that plaintiff or other party, individual, or entity has been found to have acted fraudulently in the pending action or in another action or proceeding involving similar parties, individuals, entities and claims, and the fraud was related to the performance of the duties of the individual or firm licensed to practice public accountancy, the trier of fact shall determine: (a) the total amount of the plaintiff‘s damages, (b) the percentage of fault attributable to the fraudulent conduct of the plaintiff or other party, individual or entity contributing to the plaintiff‘s damages, and (c) the percentage of fault of the individual or firm in the practice of public accountancy in contributing to the plaintiff‘s damages. Under the circumstances set forth in this section, individuals or firms in the practice of public accountancy shall not be required to pay damages in an amount greater than the percentage of fault attributable only to their services as so determined. This section shall not apply where a finding is made that the acts of the individual or firm in the practice of public accountancy were willful and knowing. In such an action involving the practice of public accountancy in which a claim or defense of fraud is raised, if there is pending a separate action or proceeding in which the alleged fraudulent conduct of the same party, individuals or entity against whom the claim or defense is raised is to be adjudicated or determined, the court may stay, on its own or by motion, the action involving the practice of public accountancy until the other action or proceeding is concluded or the issue of fraudulent conduct is determined in that other action.”