Under the Bankruptcy Code, a Chapter 7 bankruptcy trustee is fortified with all of the rights that the debtor had as of the petition date, which includes all causes of action the debtor could have brought prepetition.
Creative bankruptcy trustees are increasingly asserting claims for contribution under New York statutory law against third parties such as, banks, accountants and attorneys, on behalf of debtors who engaged in fraudulent behavior, such as a ponzi scheme.
Under this theory, even
though a third-party may not be directly liable to the wronged investors, and
may not owe them a duty of care, the bankruptcy trustee is attempting to seek
contribution from the third party for amounts the trustee pays to creditors in
satisfaction of the wronged investors’ allowed claims.
In that scenario, the duty of care would run
from the third-party alleged tortfeasor (i.e.,
the defendant) to the debtor (which duty was alleged to be breached).
Despite a bankruptcy trustee’s creative
pleading, a claim for contribution will likely not survive dismissal in the
Second Circuit, mainly because of the well-established Wagoner rule.
The Trustee’s Standing – Or Lack Thereof
For the past twenty
years, the Second Circuit has followed a principle known as the Wagoner
rule, which is a variant of New
York’s in pari delicto defense.
delicto is an equitable doctrine and is rooted in the common-law notion
that a plaintiff's recovery may be barred by his own wrongful conduct.
pari delicto doctrine subjects claims to dismissal based on a premise that (i)
courts should not mediate disputes between wrongdoers, and (ii) denying
judicial relief to a wrongdoer is an effective means to deter illegal conduct.
The Second Circuit views
issues of misconduct by a debtor as a matter of standing in the first instance
rather than as an equitable defense such as in
In essence, under Wagoner, a bankruptcy trustee lacks standing to pursue claims
against a third party for defrauding a fraudulent debtor because the trustee
stands in the shoes of that fraudulent debtor.
Further, "[a] claim against a third party for
defrauding a corporation with the cooperation of management accrues to
creditors, not the guilty corporation.”
is a complete bar, rather than a defense, to claims asserted on behalf of a
New York Claim for Contribution
In New York, the
statute governing claims for contribution enables a tortfeasor to sue other
purported tortfeasors for their proportionate share of the claimed damages.
The effect is that a tortfeasor who is forced
to pay more than his share of liability could be made whole.
Specifically, § 1401 provides for
contribution claims among "two or more persons who are subject to liability for
damages for the same personal injury, injury to property or wrongful death.”
"The amount of contribution to which a person
is entitled shall be the excess paid by him over and above his equitable share
of the judgment recovered by the injured party.
. . .The equitable shares shall be determined in accordance with the
relative culpability of each person liable for contribution.”
Accordingly, a claim for contribution rises
and falls based on the existence of separate tortfeasors.
A Bankruptcy Trustee’s
Claim For Contribution
A bankruptcy trustee’s
right to bring a contribution claim is derived from state law, made applicable
by Section 544 of the Bankruptcy Code.
It is necessary to establish which rights
belonged to a debtor at the time of the bankruptcy filing in order to determine
which rights the trustee has standing to assert.
Generally, a bankruptcy trustee’s claim for
contribution is premised on state common law claims, including fraud, aiding
and abetting a fraud, breach of fiduciary duty, negligence and/or
malpractice. Fact patterns that involve bankruptcy
trustees asserting a claim for contribution include, for example, an accounting
or law firm that advised an entity involved in gross mismanagement prior to
when banks held monies on behalf of ponzi scheme perpetrators.
When exploring the viability of a
contribution claim in New York and in the Second Circuit, the overriding issue
is "what effect Wagoner
has on the
Contribution is not, in
and of itself, a basis upon which liability can be imposed. Rather, contribution offers a vehicle for one
tortfeasor to recover from another tortfeasor where: (1) an independent basis
exists to hold the proposed contributor liable; and (2) the injured party has
not made a direct claim against the proposed contributor.
Significantly, "an action for contribution
will not lie unless all the essential elements of a cause of action against the
proposed contributor can be made out.”
Thus, the question becomes whether Wagoner, which generally bars a trustee
from asserting claims of negligence or fraud against third-parties on behalf of
a fraudulent debtor, bars a claim for contribution.
The answer is yes. Specifically, in the event Wagoner bars the underlying claims, the
defendant is not "subject to liability” for fraud and/or negligence and
therefore, a claim for contribution cannot be imposed.
In other words, a bankruptcy trustee must be
able to establish that there is a viable cause of action for which the
defendant would be subject to liability in conjunction with a debtor.
A bankruptcy trustee cannot circumvent his
lack of standing by asserting a claim for contribution. Thus, where dismissal of the underlying claims
are mandated, so too is the claim for contribution.
Moreover, with respect
to any negligence claims against third parties, a claim for contribution should
be based on the breach of a defendant’s duty to the fraudulent debtor, and not
on any tort committed against the investors/creditors directly. A complaint against a defendant that had
dealings with a fraudulent debtor prior to the bankruptcy filing generally will
not survive the pleadings requirement set forth in Achcroft v. Ibqal.
For example, speculative allegations of
negligence in which a trustee asserts that a defendant breached its duty of
care by providing negligent advice which, in turn, managed to defraud thousands
of other people, is simply unavailing. The
harm alleged would have likely occurred whether or not the third party
accountant or attorney gave advice, good or bad.
Likewise, in finding a
proximate cause of the injury, it is mere conjecture that "but for” the
defendant’s alleged negligence, the fraudulent scheme occurred, when in truth,
it was admittedly intended by the debtor by perpetrators such as Nicholas Cosmo
and Bernard Madoff.
Moreover, the claims could not survive
because it is obvious that the victims, i.e.,
the injured parties, to such a scheme are the creditors, and not the fraudulent
debtor. Consequently, since the merits
of the negligence claims would also be subject to dismissal, a claim for contribution
would similarly be subject to dismissal.
Finally, in reality, a
bankruptcy trustee’s obligation to pay creditors for their losses arises only
from the Bankruptcy Code and not based on any adjudication of the debtor’s liability. In fact, establishing a debtor’s liability is
an event that will never occur, and arguably, a trustee’s contribution claim is
At any rate, the assertion that proofs of
claims filed against the estate is a sufficient showing of a debtor’s liability
is erroneous insofar as a debtor is in no danger of being held liable for more
than its fair share, and thus, contribution, as contemplated under New York law
It is not pragmatic to seek recovery from a
third-party defendant to apportion damages to an estate that recovers, for
example, approximately one-third of the amounts outstanding to creditors. Such recovery is simply not in keeping with
the contribution statute.
In the Second Circuit,
a bankruptcy trustee cannot circumvent his lack of standing for his direct
claims by seeking relief under the guise of a contribution claim.
A party that is confronted with a claim of
contribution must be aware that the when standing is divested and an
adjudication of the underlying claims can never be reached, a claim for contribution
is similarly subject to dismissal.
Consequently, the suggested strategy is to immediately seek dismissal of
such claims under the Federal Rules of Bankruptcy Procedure Rule 7012(b)(6).
Hirsch v. Arthur Anderson &
Co., 72 F.3d
1085. 1094 (2d Cir. 1995).
See e.g., Picard v. J.P.Morgan
Chase & Co. , 460 B.R. 84 (S.D.N.Y. 2011), appeal docketed, No. 11-5044 (2d Cir. Dec. 7, 2011); Picard v. HSBC Bank PLC, 454 B.R. 25
(S.D.N.Y. 2011), appeal docketed, No. 11-5207 (2d Cir. Dec. 15, 2011); Silverman v. Meister Seelig & Fein, LLP
(In re Agape World, Inc.), 467 B.R. 556
Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991); see also, e.g., Am. Tissue, Inc. v. Arthur Andersen, L.L.P., 275 F. Supp.2d 398,
404, 406 (S.D.N.Y. 2003) (noting that Wagoner is controlling authority).
Pinter v. Dahl, 486 U.S. 622, 632 (1988).
Goldin v. Primavera Familienstiftung (In re Granite Partners, L.P), 194 B.R. 318, 338 (S.D.N.Y. 1996); Symbol Technologies, Inc. v Deloitte & Touche, LLP, 2008 N.Y. Misc. LEXIS 9586 (Sup. Ct.,
The Wagoner construct is not followed by any other circuit unless New
York law is deemed to control. By
contrast, the in pari delicto defense has been recognized as a valid defense
against bankruptcy trustees asserting claims against third parties in at least
six circuits. Baena v. KPMG LLP, 453 F.3d 1 (1st Cir. 2006); Official Comm. Of Unsecured Creditors v. R.F. Laffert & Co.,
267 F.3d 340 (3d Cir. 2011); Terlecky v.
Hurd (In re Dublin Sec., Inc.), 133 F.3d 377 (6th Cir. 1997); Moratzka v. Morris (In re Senior Cottages of
Am., LLC), 482 F.3d 997 (8th Cir. 2007); Sender v. Buchanan (In re Hedged-Invs. Assocs., Inc.), 84 F.3d 1281
(10th Cir. 1986) and Official Comm. Of
Unsecured Creditors of PSA, Inc. v. Edwards, 437 F.3d 1145 (11th
Wagoner, 944 F.2d 114; see also, e.g.’s Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d 822 (2d
Cir. 1997); Hirsch v. Arthur Anderson
& Co., 72 F.3d 1085, 1094 (2d Cir. 1995); Breeden v. Kirkpatrick & Lockhart, LLP, 268 B.R. 704 (S.D.N.Y.
Id.; see also, e.g., Picard v. J.P.Morgan Chase & Co.,
460 B.R. 84, 91 (S.D.N.Y. 2011) ("there is no doubt that the common law causes
of action in the Amended Complaints, premised on a Ponzi scheme of
unprecedented scope and duration orchestrated by [Madoff], belong to the
creditors, not to [Madoff].”); In re
Granite Partners, L.P), 194 B.R. at 324 (S.D.N.Y. 1996) (the bankruptcy
code does not permit the trustee to assert the personal, direct claims of
creditors for the benefit of the estate or for a particular class of
CPLR § 1402 (McKinney’s
Graphic Arts Mut. Ins. Co. v. Bakers Mut. Ins. Co., 45 N.Y.2d 551,
Civil Practice Law & Rules ("CPLR”) § 1401 (McKinney’s 2013).
CPLR § 1402 (McKinney’s 2013).
AG Capital Funding Partners, L.P.
v. State St. Bank & Trust Co., 5 N.Y.3d 582, 594 (2005) (citations
omitted); see also, United States of America, 2011 U.S.
Dist. LEXIS 51648, *22 ft. 6.
re Granite Partners, L.P), 194 B.R. at 324 (citations omitted).
Silverman v. Meister Seelig & Fein, LLP, 467 B.R. 556.
See e.g., Picard v. J.P.Morgan
Chase & Co., 460 B.R. 84; Picard
v. HSBC Bank PLC, 454 B.R. 25.
CPLR § 1401 (McKinney’s 2013).
Silverman v. Mesiter Seelig & Fein LLP (In re Agape World, Inc.),
467 B.R. 556 (E.D.N.Y. 2012) (citing Calcutti v. SBU, Inc., 273 F. Supp. 2d
488, 497 (S.D.N.Y. 2003).
United States of America v. Staten Island University Hospital, 2011
U.S. Dist. LEXIS 51648, * 17 (2011) (A contrary holding is belied by the
statute itself which was developed in response to the unfairness of allowing
one tortfeasor to be held liable for injuries caused by another tortfeasor).
For example, in Hill v. Day (In re
Today’s Destiny, Inc.), 388 B.R. 737, 753 (S.D. Tex. 2008), a Texas bankruptcy
court did not dismiss a claim for contribution, only after an explicit finding
that in pari delicto does not bar standing to bring the underlying claims in
the Fifth Circuit.
Ashcroft v. Iqbal, 556 U.S. 662 (2009)(holding that under Rule 12(b)(6)
of the Federal Rules a complaint must be dismissed unless it alleges facts that
if accepted as true, state a claim to relief that is plausible on its face.) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)).
For example, Nicholas Cosmo, the
president and sole shareholder of Agape, et al., is the admitted Ponzi scheme
perpetrator in the In re Agape World,
Inc. bankruptcy matter, Case No. 11-9170-reg, United States Bankruptcy
Court, Eastern District of New York. In re Agape Litigation, 681 F.Supp2d 352
(E.D.N.Y. 2010) (Cosmo sentenced to 21 months imprisonment and three years of
supervised release after he pleaded guilty to fraud). Likewise, in Securities Investment Protection Corporation v. Bernard L. Madoff
Investment Securities LLC (In re Madoff Securities), SIPA Liquidation
(substantively consolidated), Adv. Pro. No. 08-01789, the fraudulent scheme was
See e.g., CD Liquidation
Trust v. Martillo (In re CD Liquidation Co., LLC), 462 B.R. 124
Parenthetically, it can be argued that because a proof of claim is
analogous to the commencement of an adversary proceeding, that the filing of
claims satisfies the requirement of the debtor’s liability. See
Nortec Trading Corp. v. Newfield, 311
F.2d 163, 164 (2d Cir. 1962) (the Second Circuit adopting the tenet that the
filing of a proof of claim is analogous to the commencement of an action within
the bankruptcy proceeding).
Devon Mobile Commc’ns Liquidating
Trust v. Adelphia Commc’ns Corp. (In re Adelphia Commc’ns Corp.), 322 B.R.
509, 529 (S.D.N.Y. 2005) ("This standing requirement cannot be circumvented by
the expedient of filing a third-party complaint and denominating the . . .
claims as claims for contribution[.]”).