The debtor’s owner was running a Ponzi scheme and created and used the debtor to facilitate the scheme. When investors gave money to the debtor, the owner diverted the funds to himself or others in the scheme via the debtor’s accounts with the bank. Following the collapse of the scheme, the debtor pleaded guilty to wire fraud and several conspiracy charges and was placed in a receivership where a receiver was then appointed. With the court’s authorization, the receiver filed for bankruptcy on behalf of the debtor, and the bankruptcy court then appointed the receiver as the trustee of the bankruptcy estate. The trustee filed an adversary proceeding in bankruptcy court against the bank, alleging that the bank aided and abetted the scheme and, in effect, breach of financial duty. Specifically, the trustee claimed the bank knew of the scheme and gave the debtor special treatment to help the debtor’s account avoid detection by ignoring money-laundering alerts and excessive overdrafts on the debtor’s accounts. The bank moved for summary judgment, arguing under the doctrine of in pari delicto, the debtor was barred from recovery because the debtor was a party to the scheme with equal or greater fault. The bankruptcy and district court both ruled the in pari delicto defense was unavailable to the bank because, under Minnesota law, the “new” receivership entity did not assume the wrongdoing of the debtor’s previous officers, or, in the alternative, questions of material fact remained regarding the fault of the parties. After the bank was denied from advancing the in pari delicto defense, the jury found the bank liable, and the bank appealed. The Eighth Circuit reviewed the district court’s denial of the defense for abuse of discretion.
In Kelley v. BMO Harris Bank N.A., 115 F.4th 901 (8th Cir. 2024), the Eighth Circuit reversed the district court’s denial of the bank’s in pari delicto defense. The court explained that a trustee “stands in the shoes of [a] debtor,” meaning the in pari delicto defense is available in a proceeding brought by a bankruptcy trustee if the defense could have been raised against the debtor. Additionally, the court noted that if the debtor itself had sued the bank in Minnesota, the bank would have been allowed to raise its in pari delicto defense so that the defense would have been available against the debtor. The issue facing the court was how Minnesota receivership law changed the availability of the defense because the trustee argued that he was not bringing the action in the “shoes” of the debtor but rather the “cleansed” receivership. State law governs a receiver’s rights in a state-law matter, even if the receiver was federally appointed as it was here. Minnesota law states that a receiver “is not bound by the fraudulent acts of a former officer of the corporation,” allowing the receiver to sue for fraud committed against the former entity’s creditors, even though a defense, like in pari delicto, might have been available against the entity itself. Magnusson v. Am. Allied Ins., 189 N.W.2d 28 (Minn. 1971). The court disagrees with the trustee that this law should be interpreted as “cleansing” the entity, as the conversion to a receivership did not change the debtor, only the management. The court clarifies that while serving as the receiver, the receiver could have pursued causes of action in Minnesota as a party free from the previous act of the debtor’s officers, but rather, he only brought actions after taking over as the trustee. The change from receiver to trustee was a second change in management in which all the debtor’s assets, including causes of action, were transferred from the receiver to the trustee and became part of the bankruptcy estate – so the receiver-trustee could no longer bring claims as the receiver with the benefit of freedom from previous fraudulent acts. The court emphasizes that the receivership is not a party here, the debtor is, and the debtor’s claims would have been subject to the in pari delicto defense if they brought the claims itself, so the trustee, acting on behalf of the debtor, is also subject to the defense. In its decision, the Eight Circuit pointed to a similar proceeding from the Second Circuit. There, the Second Circuit held that the trustee, as an innocent party, acts are representative of the debtor, and therefore, all the debtor’s misconduct is assigned to the trustee. Picard v. JPMorgan Chase & Co. (In re Bernard L. Madoff Inv. Sec. LLC), 721 F.3d 54 (2d Cir. 2013). The court concluded that the district court made a legal error in ruling that the bank’s defense was unavailable and, as such, abused its discretion. Finding that the bank could in no situation be found to be more culpable than the debtor, whose sole purpose of existing was to facilitate the Ponzi scheme, the court held the bank’s in pari delicto defense barred the trustee’s claims and remanded the case with instructions to enter judgment for the bank.
By Taylor O’Brien: [email protected]
Edited By Kristin Meurer: [email protected]