Court Dismisses Law Firm’s “In Pari Delicto” Defense as Premature at Motion to Dismiss Stage
September 22, 2022, US Bankruptcy Court for Nevada – The Nevada Bankruptcy Court denied dismissal of the bankruptcy Trustee’s suit against a law firm under Federal Rule of Civil Procedure 12(b)(6). The Trustee’s complaint alleged “professional malpractice”, “breach of fiduciary duty”, and other claims against the law firm and the Court denied the use of in pari delicto defense under the California Civil Code to dismiss the complaint.
Christina Lovato, chapter 7 trustee (Trustee) for the bankruptcy estates of Double Jump, Inc., et al. (Debtors), sued Nixon Peabody LLP (law firm) for the law firm’s alleged involvement in the Debtors’ operation of an alleged “Ponzi Scheme”. The Trustee alleged that the Debtors’ founder and executive Jeff Carpoff employed the Debtors to allegedly perpetrate an alleged “Ponzi Scheme”.
Between 2010 and 2018, the law firm provided legal advice and assisted the Debtors with the “tax-advantaged” transactions. The Trustee sought to recover the benefits accrued to the law firm due to its alleged involvement in the alleged “Ponzi Scheme”. In its motion to dismiss, the law firm claimed that the Trustee stood in the shoes of the Debtors and allegedly could not recover from the law firm for its alleged role in Carpoff’s alleged “Ponzi Scheme”.
The doctrine of in pari delicto provides that “when a participant in illegal, fraudulent, or inequitable conduct seeks to recover from another participant in that conduct, the parties are deemed in pari delicto, and the law will aid neither, but rather, will leave them where it finds them”.
The Court found that the complaint sufficiently alleged that Carpoff’s actions were adverse to the interests of the Debtors since his actions allegedly led to the insolvency of the Debtors. The Court held that this allegation barred Carpoff’s “fraudulent” actions to be imputed to the Debtors. The Court concluded that the application of the in pari delicto defense requires an in-depth examination and weighing of the facts of the case and that its application was premature in the present case. Therefore, the Court dismissed the law firm’s motion to dismiss the Trustee’s complaint. The Court however ruled out the Trustee’s argument that pre-petition changes in the management of the Debtors would absolve the Debtors of their role in the alleged “Ponzi Scheme”.
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