Ponzi Scheme Trustee Has Standing to Pursue Recovery Claims, and Is Not Barred by in Pari Delicto Doctrine, in Sixth Circuit, Which Joins Third, Eighth and Eleventh Circuits in Declining to Follow Second Circuit’s Wagoner Rule
In 1991, the Second Circuit, in Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir. 1991), held that the trustee cannot bring action on behalf of the company that is the subject of a Ponzi scheme, pursuant to the doctrine of in pari delicto, because the company was a participant in the fraud. Since then, the Second Circuit and New York District Courts have barred similar actions, including those brought by the trustee in the Madoff Ponzi scheme, pursuant to what has become known as the Wagoner Rule. The Third, Eighth and Eleventh Circuits, however, have declined to adopt that Rule, determining that a trustee of a company that perpetrated a Ponzi scheme is not barred by the doctrine of in pari delicto from bringing recovery actions on behalf of the estate.
Last month, the Sixth Circuit joined the ranks of those Wagoner dissenters in In re Fair Finance Company (Bash v. Textron Financial Corp.), Case No. 5:12-cv-00987, (Aug. 23, 2016), reviving a bankruptcy trustee’s claims, including civil conspiracy, against a lender based on assisting to conceal and perpetuate the Ponzi scheme. Citing Eighth, Eleventh and Third Circuit decisions, the Bash Court (the Honorable Andre M. Davis, Senior Circuit Judge for the U.S. Court of Appeals for the Fourth Circuit, sitting by designation) explained that “the Second Circuit’s decision in Wagoner appears to conflate the affirmative in pari delicto defense with the issue of standing.” Id. (omitting footnote) (citing Moratzka v. Morris (In re Senior Cottages of Am., LLC), 482 F.3d 997, 1003 (8th Cir. 2007) (collecting cases in which “other circuits have declined to conflate the constitutional standing doctrine with the in pari delicto defense”); Official Comm. of Unsecured Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145, 1149–50 (11th Cir. 2006) (explaining that, while a debtor’s wrongdoing was material to the ultimate success of a trustee’s claim against an alleged accomplice in the debtor’s Ponzi scheme, the debtor’s wrongdoing did not bear on the trustee’s standing “because ‘[a]n analysis of standing does not include an analysis of equitable defenses, such as in pari delicto’” (alteration in original) (quoting Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 346 (3d Cir. 2001))); R.F. Lafferty, 267 F.3d at 346 (“In general, [s]tanding consists of both a case and controversy requirement stemming from Article III, Section 2 of the Constitution, and a subconstitutional prudential element. An analysis of standing does not include an analysis of equitable defenses, such as in pari delicto.” (alteration in original) (internal citations and quotation marks omitted)).
The Sixth Circuit reasoned that while the doctrine of in pari delicto does not deprive a trustee of standing to pursue recovery claims, the doctrine is likely to bar such claims unless there is an applicable exception. The trustee argued that the innocent insider exception applied to preserve his civil conspiracy claim, but the lender countered that the complaint failed to allege such exception. The Court held that the trustee was not required to plead facts in anticipation of the lender’s potential in pari delicto affirmative defense to survive a motion to dismiss. Therefore, the Court reversed the district court’s dismissal of the trustee’s civil conspiracy claim, among other claims.