Posted by Kathy Bazoian Phelps
Once again, the defense of in pari delicto has saved a defendant from a claim of professional negligence in a Ponzi scheme case. This time the case is Peterson v. Winston & Strawn, LLP, 2012 U.S. Dist. LEXIS 147653 (N.D. Ill. Oct. 10, 2012). Ronald Peterson is the trustee of two hedge funds, Lancelot Investors Fund, Ltd. and Colossus Capital Fund, Ltd. (the “Funds”), which invested in entities run by Thomas Petters. As we know, the Petters’ entities turned out to be massive Ponzi schemes. Winston & Strawn had been the Funds’ lawyers.
In his complaint, Peterson first alleged that the law firm failed in its duty to disclose to the Funds that their manager, Greg Bell, was not complying with the investment restrictions set forth in a Confidential Information Memorandum (“CIM”) that the Funds had published to investors. According to the complaint, Bell had told the law firm shortly after it was retained in August 2005 that he was not complying with the CIM. Specifically, Bell stated that Petters would not allow him to verify the inventory and that the Funds did not have any lock-box arrangements with any of Petters’ businesses.
Peterson’s complaint further alleged that the law firm drafted an amended CIM in March 2006, which had the same investment restrictions, giving the “false impression” that Bell was complying with those restrictions.
Finally, the complaint stated that Bell became suspicious of Petters in December 2007 and that he expressed those concerns to the law firm in January 2008 when he sought individual representation from the law firm. Peterson alleged that the law firm again failed in its to duty to disclose this to the Funds and to address potential harm to them.
The law firm responded to the suit with a motion to dismiss based on in pari delicto, and the court granted the motion. The court relied heavily on the Seventh Circuit’s decision applying in pari delicto in another malpractice lawsuit that Peterson had filed against the Fund’s auditors. Peterson v. McGladrey & Pullen, LLP, 676 F.3d 594 (7th Cir. 2012). In that case the court held that the in pari delicto defense did apply to Peterson’s claims to the extent they arose after Bell joined in Petters' fraud in April 2008. In the court’s view, “The Funds knew what Bell knew . . .”, and because Peterson stood in the Funds’ shoes, in pari delicto barred the claims that arose after April 2008. However, the court made a crucial distinction. It held that Peterson could maintain the claims that arose before April 2008 because the complaint did not allege that Bell knew of Petters’ fraud before then.
In its decision on Peterson’s claim against the law firm, however, the court refused to apply the Seventh Circuit’s distinction on the grounds that everything that the law firm learned about the funds came from Bell:
In the present case, however, Peterson's claims against Winston & Strawn rest entirely on facts that the firm only learned through Bell’s disclosures. Specifically, Peterson contends that Winston & Strawn breached its duties of disclosure and due care in failing to notify and advise the Funds regarding Bell’s stated failure to comply with the investment restrictions in the CIMs. As indicated above, Bell’s actions are imputed to the Funds. Thus the Funds cannot sue Winston & Strawn for failing to advise them of facts that they already knew through Bell.
The court then concluded that because Peterson alleged only that the law firm was negligent and Peterson admitted that Bell was negligent, “Peterson, standing in the shoes of the Funds, is thus equal in culpability to Winston & Strawn and, therefore, the Court finds that in pari delicto bars Peterson’s claims.”
As in every case in which the in pari delicto doctrine is invoked to dismiss a trustee’s claims in a Ponzi scheme case, the result here is that innocent victims are denied a potential source of recovery. Obviously, these victims would argue that this result is both inequitable to them and ineffective in deterring the defendant’s wrongful conduct. On the other hand, proponents of the doctrine argue that this result is required by Butner v. United States, 440 U.S. 48 (1979), and 11 U.S.C. § 541. And in the case law at this time, that is certainly the prevailing argument.
For more on Peterson v. McGladrey & Pullen, LLP, see my blog of April 9, 2012, The "In Pari Delicto" Battle in Ponzi Cases Rages On.
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