Earlier this week we looked at Lateral Inv. Mgt., LLC v Marcum, LLP 2024 NY Slip Op 33865(U) October 29, 2024 Supreme Court, New York County Docket Number: Index No. 154273/2023 Judge: Joel M. Cohen for a discussion of the statute of limitations for accounting malpractice claims. Today we look at the in pari delicto argument and the Court’s decision.
“According to the Complaint, the factual allegations of which are assumed to be true for purposes of this motion, Marcum was FTE’s “long-standing auditor[]” (NYSCEF 47 iJiJ 5, 60). The relationship was far reaching, and “had impacts on their relationship with several other of [Marcum’s] significant institutional clients” due to their relationship with a former Board Member of FTE, Luisa Ingargiola (id ,i,i 64, 66). Plaintiffs allege that these relationships motivated Marcum and Markowitz to engage effectively in a cover-up of misconduct by FTE’s CEO and CFO (id ,i 67). The Complaint states that “Ingargiola was one of-if not the onlyBoard member who had any idea” about an improper scheme by Lethem and Palleschi to issue undisclosed convertible notes (id ,i,i 56, 70). Furthermore, Plaintiffs allege “Defendants directly participated in Palleschi and Lethem’s embezzlement and conversion of Company funds as Palleschi and Lethem would convey trips, gifts and other perks to Markowitz in exchange for his willingness to participate in the fraud against FTE” (id ,i 145). In July 2015, in contemplation of a financing arrangement with FTE, plaintiffs Lateral Investment Management, LLC (“Lateral Investment”), Lateral JusCom Feeder, LLC (“JusCom”), and Lateral Recovery, LLC (“Lateral Recovery”) (collectively, “Lateral”) sought to review Marcum’s files on FTE for fiscal year 2014 (NYSCEF 47 iJiJ 49, 368). Marcum agreed to provide access to their work papers (NYSCEF 35). On October 28, 2015, Lateral entered into a Credit Agreement under which Lateral would provide more than $50 million in financing to FTE over time, in part relying on the work papers (NYSCEF 47 iJiJ 44, 51). The Credit Agreement was secured by an interest in FTE’ s assets (id). From 2016 to 2018, Lethem and Palleschi purportedly “embezzled millions of corporate funds for personal use and enjoyment through a variety of schemes” (id ,i 83). Plaintiffs claim “[t]his conduct was completely outside the scope” of their employment and that they “had totally abandoned the interests of the Company” (id ,i 84). The two also “fraudulently inflated FTE’s revenue” between 2016 and 2018, reporting more than $12 million for non-existent work (id ,i,i 104; 216-19). Despite “identify[ing] this revenue as being wholly unsupported,” Marcum and Markowitz purportedly “performed no further investigations … and rubber-stamped FTE’s filings during the relevant years” (id ,i 107). With reference to the absence of documentation of these revenues, Markowitz noted in an email to Palleschi that “I am the only one keeping you out of jail” (id ,i 229; NYSCEF 50). (Defendants, not surprisingly, strongly disagree with the adverse inferences Plaintiffs draw from this communication, but that dispute cannot be resolved on a motion to dismiss.) Marcum purportedly obtained “actual evidence of undisclosed or improperly disclosed related party transactions involving Palleschi,” and “helped conceal and/or turned a blind eye to” any evidence of misconduct (NYSCEF 47 iJiJ 86-87). Defendants “issued unqualified opinions and approved FTE’ s public filings” over that period and “wholly omitted any information” about the various schemes perpetrated by the FTE’s former executives (id ,i,i 93, 95, 107; 220-28).”
“The doctrine of in pari delicto “mandates that the courts will not intercede to resolve a dispute between two wrongdoers” (Kirschner v KPMG LLP, 15 NY3d 446, 464 [2010]). “Traditional agency principles play an important role in an in pari delicto analysis” (id at 465). Presumptively, “[a] corporation must … be responsible for the acts of its authorized agents even if particular acts were unauthorized” (id). However, under the “adverse interest” exception, where the agent has “‘totally abandoned his principal’s interests and … act[ed] entirely for his own or another’s purposes,” such acts are not imputed to the corporation (id at 466 [quoting Center v Hampton Affiliates, 66 NY2d 782, 784-85 [1985]]). Thus, in the corporate context, in pari delicto does not operate to bar a claim by the corporation if the corporate wrongdoers had totally abandoned the corporation’s interests (see id). In these scenarios, the “fraud is committed against a corporation rather than on its behalf’ (id at 467). In other words, applying the adverse interest exception requires that “the scheme that benefitted the insider operated at the corporation’s expense” (id 467-68). In applying Kirschner, the First Department has held that “the mere continuation of a corporate entity does not per se constitute a benefit that precludes application of the adverse interest exception” (Conway v Marcum & Kliegman LLP, 176 AD3d 477, 477-78 [l st Dept 2019]). The First Department elaborated: Moreover, reliance on speculation about the benefits to be derived from the continued existence of an entity is inconsistent with the analysis of the adverse interest exception in Kirschner. It may be possible in every case to construct a hypothetical scenario where the company teetering on the brink of insolvency because of its agent’s fraud meets with an opportune circumstance that allows it to resume legitimate business operations. Permitting such speculation would render the adverse interest exception meaningless. Further, an ongoing fraud and a continued corporate existence may harm a corporate entity: The agent may prolong the company’s legal existence so that he can continue to loot from it, as appears to have been the case here. (Id. at 478.) Giving Plaintiffs the benefit of all reasonable inferences, the Court cannot conclude that Defendants have conclusively established an in pari delicto defense based solely on the pleadings. Plaintiffs have pleaded sufficient allegations to support an inference that Lethem and Palleschi totally abandoned FTE’ s interests and kept the entity alive merely to pilfer it. The purposes for which the alleged funds were used included “deferred salaries to [Lethem and Palleschi],” “personal expenses, ranging from private jet trips and personal warehouse leases,” and “engaging in related party transactions that sent millions of FTE common stock shares … to entities Palleschi and Lethem controlled” (id ,i 440).”
“In short, Plaintiffs have adequately alleged that the fraud underlying this case was so pervasive and thorough that FTE may have merely been the vehicle for Lethem and Palleschi to carry out their fraud and not an entity which benefited from the fraud. Of course, this ruling does not preclude Defendants from seeking to establish an in pari delicto defense based on the evidence adduced at summary judgment or trial.”