On September 12, 2024, the United States Court of Appeals for the Eighth Circuit reversed a trial court decision that had rejected a bank's assertion of the in pari delicto defense to aiding and abetting claims brought by the bankruptcy trustee for a debtor that had allegedly perpetrated a Ponzi scheme. Kelley v. BMO Harris Bank Nat'l Ass'n, 2024 WL 4158179 (8th Cir. Sept. 12, 2024). The trustee alleged various claims under Minnesota law against the bank, including a claim for aiding and abetting breach of fiduciary duty, alleging that employees of the bank's predecessor-in-interest knew about the Ponzi scheme, ignored money‑laundering alerts, and allowed the company to overdraft more money than permitted under bank policy. The trial court held that the in pari delicto defense was unavailable because the company had previously been placed in receivership before filing for bankruptcy; the jury then found the bank liable and awarded more than $550 million in compensatory and punitive damages. The Eighth Circuit reversed, holding that the bankruptcy trustee stood in the shoes of the debtor, including with respect to the in pari delicto defense, even if under Minnesota law the defense could not have been asserted against a receiver while the company was in receivership.
The Court first observed that, under Minnesota law, the in pari delicto defense operates as a bar to recovery when the plaintiff's "fraud was no less than that of" the defendant, id. at *2, and that the defense can be raised against a bankruptcy trustee if it could have been raised against the debtor, because bankruptcy trustees stand in the debtor's shoes. Id. Plaintiff nevertheless argued that the defense was inapplicable because he had served as receiver for the company before being appointed as bankruptcy trustee, and the Minnesota Supreme Court has held that receivers are "not bound by the fraudulent acts of a former officer of the corporation" and may bring litigation "even though the defense set up might be valid as against the corporation itself." Id. at *3. Thus, according to plaintiff, the bankrupt entity was "cleansed" when placed in receivership such that in pari delicto could not be asserted against him even after he was appointed as bankruptcy trustee. Id.
The Court disagreed, noting that plaintiff was bringing suit as a bankruptcy trustee, not as a receiver. Accordingly, federal bankruptcy law governed plaintiff's powers and defined the property of the bankruptcy estate. At the time the company filed for bankruptcy, it possessed a claim that was subject to the in pari delicto defense due to the company's own wrongdoing, and that wrongdoing was never "cleansed" even if under Minnesota law the defense could not have been asserted against the receiver while the company was in receivership. Id. at *4. As the Court explained, receivership constituted a change in management, not a cleansing of the entity or its claims. Id. at *3.
The Court noted that this result was consistent with a decision of the Second Circuit in another case involving a large Ponzi scheme, which applied the in pari delicto doctrine to bar a trustee's claims, reasoning that "[t]he debtor's misconduct is imputed to the trustee because, innocent as he may be, he acts as the debtor's representative." Id. at *4 (citing Picard v. JPMorgan Chase & Co. (In re Bernard L. Madoff Inv. Sec. LLC), 721 F.3d 54, 63 (2d Cir. 2013)). While plaintiff argued that the Madoff case was inapposite because the rule in New York was supposedly different from Minnesota's rule, the Court determined that New York courts similarly do not allow the in pari delicto defense against non-bankruptcy trustees or receivers but apply the defense in the bankruptcy context. Id.
The Court concluded that it was not necessary to remand the case for the trial court to further consider the availability of the in pari delicto defense. The Court explained that, even if the allegations against the bank were true, the company itself was "created solely to operate the Ponzi scheme," and the bank "cannot be more culpable than the entity that orchestrated the scheme." Id. at *5. Therefore, the Court directed the trial court to enter judgment in favor of defendant.
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