In Re: Lehr Construction Corp.
MEMORANDUM OPINION AND ORDER: Appellant Jonathan Flaxer, chapter 11 Trustee (the "Trustee") for Lehr Construction Corporation ("Lehr"), appeals from the Bankruptcy Court's order granting defendant Peter Gifford's motio n to dismiss the Trustee's faithless servant claim against him on the grounds that it is barred by the in pari delicto doctrine. For the foregoing reasons, the decision of the Bankruptcy Court is AFFIRMED. The Clerk of Court is instructed to enter judgment accordingly and to close the case. (As further set forth in this Order.) (Signed by Judge Gregory H. Woods on 1/12/2016) (kko)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
In re LEHR CONSTRUCTION CORP.,
JONATHAN L. FLAXER, not individually but
solely in his capacity as Chapter 11 trustee for Lehr :
DOC #: _________________
DATE FILED: 1/12/2016
GREGORY H. WOODS, United States District Judge:
Appellant Jonathan Flaxer, chapter 11 Trustee (the “Trustee”) for Lehr Construction
Corporation (“Lehr”), appeals from the Bankruptcy Court’s order granting defendant Peter
Gifford’s motion to dismiss the Trustee’s faithless servant claim against him on the grounds that it is
barred by the in pari delicto doctrine. For the reasons that follow, I AFFIRM the Bankruptcy Court’s
decision dismissing the Trustee’s claim.
Lehr was a large construction company that planned, designed, and oversaw interior
construction projects in and around New York City. S.D.N.Y. Bankr. No. 13-01256
Dkt. 1. (“Compl.”) ¶¶ 14-28.2 Lehr competed for construction jobs by submitting bids, and if Lehr
was hired, it, in turn, would hire subcontractors to complete the project. Compl. ¶¶ 15-16. Lehr’s
The facts included in this section are undisputed, and are limited to those necessary to decide this appeal.
As noted in the parties’ briefs, the Trustee filed an amended complaint after Gifford’s motion to dismiss was fully
briefed and argued. Appellee’s Br. 3 n.1. Because that amendment did not change the allegations against Gifford, and
because the Bankruptcy Court followed the original complaint’s paragraph numbering in its decision, I will do the same
for ease of reference.
purchasing department negotiated the costs of construction services with subcontractors, and was
responsible for entering into purchase orders with subcontractors. Compl. ¶¶ 20, 38. Gifford
worked in the purchasing department, and was supervised by Mark Martino, the head of the
department. Compl. ¶¶ 37-38.
Sometime between early 2000 and August 1, 2004, Lehr began purposely including
superfluous work on bid packages, so that customers were billed for more construction services than
were ultimately performed. Compl. ¶¶ 33, 35-36. Rather than returning money for unperformed
work to customers, Jeffrey Lazar, one of Lehr’s senior officers, oversaw a scheme in which Lehr and
its subcontractors conspired to keep money customers paid for services that were never provided.
Compl. ¶ 35. Steven Wasserman, the head of the estimating department, was responsible for
ensuring that bid packages contained services, and costs for such services, beyond those actually
needed. The purchasing department, headed by Martino, would issue the inflated purchase orders
and then negotiate with the subcontractors to agree on the lower, actual cost of the project. Compl.
¶¶ 37-38. The subcontractor would be paid the inflated purchase price, and Martino then
maintained records listing those overpaid funds and money “owed” to Lehr by subcontractors.
Compl. ¶¶ 39, 42. Lehr would recoup the funds through future bids with the same subcontractors;
Martino’s department would keep track of the debits and credits between Lehr and the
subcontractors. Compl. ¶¶ 41-42.
Gifford, along with two other employees in the purchasing department, participated in the
scheme by negotiating with subcontractors to agree upon an actual cost of a bid project as compared
to the inflated bid package amount and by keeping track of the credits and debits between Lehr and
the co-conspirator subcontractors. Compl. ¶¶ 38, 46.
In early 2010, the Manhattan District Attorney began investigating construction companies,
including Lehr. Compl. ¶ 48. After a widely publicized raid at Lehr’s office on March 10, 2010,
some customers cancelled existing contracts with Lehr and others excluded Lehr from bidding for
future work. Compl. ¶¶ 50-51, 53. Lehr filed for protection under Chapter 11 of the Bankruptcy
Code in February 2011. Compl. ¶¶ 54-55.
In May 2011, Lehr—along with several now-former employees—was indicted. Bankruptcy
Court Opinion (“Op.”) at 7. Lehr was convicted on thirteen counts including one count of
enterprise corruption, one count of a scheme to defraud, nine counts of grand larceny, and two
counts of money laundering in the first degree. Bankr. Dkt. 15-6. Lazar was indicted and convicted
of a scheme to defraud in the first degree and sentenced to serve a prison term. Bankr. Dkt. 15-7.
Wasserman was also indicted and convicted of grand larceny in the fourth degree and sentenced to
probation. Bankr. Dkt. 15-8. Gifford was not indicted or convicted for any criminal activity relating
to Lehr’s criminal scheme, although he did enter into a cooperation agreement with the Manhattan
District Attorney’s Office. Compl. ¶ 61.
In February 2013, the Trustee filed the complaint seeking to recover “all sums paid to or on
behalf of Gifford as compensation” as well as “legal fees” associated with the criminal investigation
because Gifford was a “faithless servant.” Compl. ¶ 68. 3 Gifford moved to dismiss the complaint,
arguing (1) that Lehr had waived its claim against him because an employee is not disloyal when his
employer knows of and tolerates his conduct, and (2) that the claim was barred by the in pari delicto
doctrine. Bankr. Dkt. 15-10. The Bankruptcy Court dismissed the Trustee’s claim based on the in
pari delicto doctrine, Flaxer v. Gifford (In re Lehr Constr. Corp.), 528 B.R. 598 (Bankr. S.D.N.Y. 2015),
and this appeal followed.
Standard of Review
A district court reviews a bankruptcy court’s findings of fact for clear error and its
conclusions of law de novo. In re Bayshore Wine Prods. Corp., 209 F.3d 100, 103 (2d Cir. 2000). Because
The complaint named multiple defendants, and the Trustee has since settled all claims except the faithless servant claim
against Gifford, see Appellant’s Br. at 1 n.2.
this is an appeal from a decision on a motion to dismiss, only conclusions of law are at issue and my
review is de novo.
A motion for judgment on the pleadings under Federal Rule of Civil Procedure 12(c) is
evaluated under the same standard as a motion to dismiss under Rule 12(b)(6).4 In re Thelen LLB,
736 F.3d 213, 218 (2d Cir. 2013). When deciding a motion to dismiss, a court accepts “all factual
allegations in the complaint as true and draw[s] all reasonable inferences in plaintiff’s favor.” In re
Thelen, 736 F.3d at 218 (quoting Hayden v. Paterson, 594 F.3d 150, 160 (2d Cir. 2010)). “To survive a
Rule 12(c) motion . . . [a] ‘complaint must contain sufficient factual matter, accepted as true, to state
a claim for relief that is plausible on its face.’” Id. at 218-19 (quoting Johnson v. Rowley, 569 F.3d 40,
43 (2d Cir. 2009)). The in pari delicto doctrine may be applied at the pleadings stage where the
outcome is plain on the face of the pleadings. In re Bernard L. Madoff Inv. Sec. LLC, 721 F.3d 54, 65
(2d Cir. 2013) (citing Kirschner v. KPMG LLP, 15 N.Y.3d 446, 459 n.3 (2010)).
In considering Gifford’s motion, the Bankruptcy Court took judicial notice of several
documents related to the outcome of the criminal proceedings involving Lehr, Lazar, and
Wasserman. Op. at 10-11; see Bankr. Dkt. No. 15-1. On appeal, “matters judicially noticed by the
District Court are not considered matters outside the pleadings.” In re Thelen, 736 F.3d at 219
(quoting Staehr v. Hartford Fin. Servs. Grp., Inc., 547 F.3d 406, 426 (2d Cir. 2008)). Accordingly, I will
consider here the facts of which the Bankruptcy Court took judicial notice.
Faithless Servant Doctrine
“Under New York law, an agent is obligated ‘to be loyal to his employer and is prohibited
from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise
the utmost good faith and loyalty in the performance of his duties.’” Phansalkar v. Andersen Weinroth
Federal Rule of Civil Procedure 12(c) applies in adversary proceedings in bankruptcy pursuant to Federal Rule of
Bankruptcy Procedure 7012(b).
& Co., L.P., 344 F.3d 184, 200 (2d Cir. 2003) (quoting Western Elec. Co. v. Brenner, 41 N.Y.2d 291, 295
(N.Y. 1977) (internal quotation marks omitted)). “A faithless servant forfeits all compensation
earned during the period of his disloyalty even if his services benefitted the principal in some part.”
Tyco Intern., Ltd. v. Kozlowski, 756 F. Supp. 2d 553, 562 (S.D.N.Y. 2010) (citing Phansalkar, 344 F.3d at
“New York courts have used two different standards to determine whether an employee’s
misbehavior warrants forfeiture.” Phansalkar, 344 F.3d at 201. The first, and more stringent,
standard—the Turner standard—requires “substantial” disloyalty on the part of the employee.
Phansalkar, 344 F.3d at 201 (citing Turner v. Kouwenhoven, 100 N.Y. 115, 119 (1885)). Where the
disloyalty consists of a single act or where the employer knew of and tolerated the behavior, courts
have found the disloyalty not to be “substantial.” Id. at 202 (citing Bravin v. Fashion Week, Inc., 73
Misc. 2d 974 (1973) (finding no substantial violation of contract of service where employer
continued employment of a person who was allegedly insubordinate)). The second standard, first
suggested in Murray v. Beard, 102 N.Y. 505, 508 (1886), and confirmed by the New York Court of
Appeals in Lamdin v. Broadway Surface Advertising Corp., requires only “a breach of a duty of loyalty or
good faith,” without inquiring into the severity of the breach. Id. (citing Lamdin, 272 N.Y. 133, 138
The tension between these two standards—whether any breach of a duty of loyalty or good
faith warrants forfeiture, or whether such a breach must constitute “substantial” disloyalty—has not
been resolved. See Phansalkar, 344 F.3d at 202. Because, as explained below, I uphold the
Bankruptcy Court’s ruling that the Trustee’s claim against Lehr is barred by the in pari delicto doctrine,
I need not decide which standard applies here.
In Pari Delicto
“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 N.Y.3d 446, 464 (N.Y. 2010). The
doctrine serves two public policy purposes. “First, denying judicial relief to an admitted wrongdoer
deters illegality. Second, in pari delicto avoids entangling courts in disputes between wrongdoers.” Id.
[N]o court should be required to serve as paymaster of the wages of crime, or referee
between thieves. Therefore, the law will not extend its aid to either of the parties or
listen to their complaints against each other, but will leave them where their own acts
have placed them.
Id. (quoting Stone v. Freeman, 298 NY 268, 271 (1948)).
“The doctrine of in pari delicto bars a party that has been injured as a result of its own
intentional wrongdoing from recovering for those injuries from another party whose equal or lesser
fault contributed to the loss.” Rosenbach v. Diversified Group, Inc., 85 A.D.3d 569, 570 (N.Y. App. Div.
2011). “The defense requires intentional conduct on the part of the plaintiff or its agents.” Sacher v.
Beacon Assocs. Mgmt. Corp., 980 N.Y.S.2d 121, 124 (N.Y. App. Div. 2014) (citing Kirschner, 15 N.Y.3d
“Traditional agency principles play an important role in an in pari delicto analysis . . . namely,
the acts of agents, and the knowledge they acquire while acting within the scope of their authority
are presumptively imputed to their principles.” Kirschner, 15 N.Y.3d at 465 (citing Henry v. Allen, 151
NY 1, 9 (1896)). Imputation is presumed “even where the agent acts less than admirably, exhibits
poor business judgment, or commits fraud.” Id. (citing Price v. Keyes, 62 N.Y. 378, 384-85 (1875)).
“Like a natural person, a corporation must bear the consequences when it commits fraud.” Id.
(citing Wight v. BankAmerica Corp., 219 F.3d 79, 86-87 (2d Cir. 2000)). The presumption of
imputation “fosters an incentive for a principal to select honest agents and delegate duties with
care.” Id. at 466.
There is a narrow exception to the presumption of imputation, the adverse interest
exception, which is not at issue here.5 See Kirschner, 15 N.Y.3d at 466. The adverse interest
exception applies only when the agent has “totally abandoned his principal’s interests” and is “acting
See Appellant’s Reply Br. 8 (stating that the Trustee is not invoking the adverse interest or innocent insider exception).
entirely for his own or another’s purposes,” but does not apply where there is a benefit to both the
employee and the corporation. Id. at 466 (citing Center v. Hampton Affiliates, 66 N.Y.2d 782, 784-85
The Bankruptcy Court described an additional exception to the presumption of imputation,
which I do not believe is supported by New York law. The Bankruptcy Court held that “corporate
insiders cannot rely on the in pari delicto defense” because their acts are not properly imputed to the
corporation, citing to a number of federal district court and bankruptcy court decisions. Op. at 15.
I will refer to this as “the bankruptcy insider’s exception”—described in certain bankruptcy cases to
preserve a bankruptcy trustee’s ability to sue the debtor’s insiders, despite the fact that their
wrongdoing is imputed to the bankrupt corporation. See Teras Int’l Corp. v. Gimbel, No. 13-cv-6788VEC, 2014 WL 7177972, at *10 (S.D.N.Y. Dec. 17, 2014) (“Claims against insiders for their acts as
corporate fiduciaries are not barred by in pari delicto, because it would be absurd to allow a
wrongdoing insider to rely on the imputation of his own conduct to the corporation as a defense.”)
(internal quotations marks and citation omitted).
I do not see a foundation for the “insider” exception to imputation for purposes of the in
pari delicto defense as it exists under New York law. In Kirschner, the Court of Appeals sought to
“remove any lingering confusion” regarding “the principles of in pari delicto and imputation, with
its narrow adverse interest exception . . . .” Kirschner, 15 N.Y.3d at 477. Kirschner also included a
clear warning regarding the distinction between the federal Wagoner doctrine and New York’s in pari
delicto defense. Id. at 459 n.3. I linger on the point here because I am concerned that the Bankruptcy
Court’s description of an additional exception to imputation under New York law signals a
resurgence of the confusion that Kirschner sought to eliminate. As described below, I think that any
“insider exception” arises under the Wagoner doctrine, not the imputation rules applicable to the in
pari delicto defense under New York law.
First, I note that the in pari delicto defense exists as a matter of federal common law, as well as
under the laws of the various states. This decision involves the application of New York’s law
regarding in pari delicto. New York’s version of the in pari delicto defense is not the same as that of all
other jurisdictions. The Court of Appeals made that point quite clear in Kirschner, when it rejected
proposals to “water down” New York’s in pari delicto doctrine by making it more consistent with the
defense as it existed in New Jersey and Pennsylvania. Kirschner v. KPMG LLP, 15 N.Y.3d 446, 470477 (2010). In pari delicto is not a restatement principle, to be applied as if it existed uniformly in all
jurisdictions. Here, I apply New York law.
As articulated by the Court of Appeals in Kirschner, the presumption of imputation under
New York law, “governs in every case, except where the corporation is actually the agent’s intended
victim . . . .” Kirschner, 15 N.Y.3d at 466. New York law reserves only one exception to the broad
presumption of imputation—the adverse interest exception described above—“this most narrow of
exceptions.” Id. In Kirschner, the Court of Appeals wrote “because the [adverse interest] exception
requires adversity, it cannot apply unless the scheme that benefited the insider operated at the
corporation’s expense.” Id. at 467. The Court of Appeals rejected the proposition that the acts of
an insider would be exempted from imputation in situations where the adverse interest exception
did not apply. See id. (“[T]his rule avoids ambiguity where there is a benefit to both the insider and
the corporation . . . .”). Thus, under New York law, the acts of insiders are imputed to the
corporation unless the adverse interest exception applies. Kirschner does not support the Bankruptcy
Court’s conclusion that New York law provides for a broad “insider” exception to the presumption
What, then, is the source of the insider exception described by the Bankruptcy Court? As
noted above, the Bankruptcy Court cited to a series of federal and federal bankruptcy court cases as
support for its holding on that point. Op. at 15. The special master’s decision for In re Refco Inc. Sec.
Litig., 2010 WL 6549830 (S.D.N.Y. Dec. 6, 2010), aff’d in part, 779 F. Supp. 2d 372 (S.D.N.Y. 2011),
seems to have been particularly influential; it was cited directly by the Bankruptcy Court, and many
of the other cases relied on by the Bankruptcy Court cited to it in turn.
I believe that the special master’s opinion in In re Refco is written in a way that makes it easy
for cases relying on that decision to conflate the federal Wagoner doctrine with New York state law.
The Second Circuit’s Wagoner rule, established in Shearson Lehman Hutton v. Wagoner, 944 F.2d 114,
118 (2d Cir. 1991), is a prudential limitation on standing under federal bankruptcy law. The Wagoner
rule provides that that trustees do “not have standing to seek recovery from third parties where
corporate insiders engaged in the wrongdoing that caused the damages.” In re Refco, 2010 WL
6549830, at *3. Rather, “[a] claim against a third party for defrauding a corporation with the
cooperation of management accrues to creditors, not to the guilty corporation.” Wagoner, 944 F.2d
The special master In Re Refco treated New York in pari delicto doctrine and Wagoner as
substantively identical for purposes of his report and recommendation. In re Refco, 2010 WL
6549830, at *6. He recognized that the New York Court of Appeals had stated expressly that the
Wagoner doctrine was not the same as the state law defense of in pari delicto, but concluded that
“[w]hile the New York court’s analysis may suggest some conceptual divergence between Wagoner
and the in pari delicto doctrine, there is no in fact difference as a practical matter as applied in these
cases.” Id. (emphasis added). The special master observed that in Kirschner v. KPMG LLP, 626 F.3d
673 (2d. Cir. 2010), the Second Circuit had applied the Court of Appeals’ rulings on New York law
in Kirschner without reservation with respect to the Wagoner. Id. The special master also noted that
the Second Circuit did not “even remark about the New York Court of Appeals’ conceptual
differentiation of in pari delicto and Wagoner.” Id. Having concluded that the analysis of Wagoner and
in pari delicto was substantively the same in that particular case, the special master proceeded to
As the Bankruptcy Court noted, this case does not present the typical fact pattern in which the Wagoner rule is typically
invoked, Op. 18 n.5, and the parties have not argued that it applies here.
discuss what he termed “in pari delicto/Wagoner” as an undifferentiated aggregate concept throughout
Nearly all of the cases cited by the Bankruptcy Court’s in support of its conclusion that an
“insider” exception to imputation exists under New York law, rely ultimately on In Re Refco. What In
Re Refco, actually states, however, is that
The Wagoner doctrine is inapplicable to claims by or on behalf of the corporation against
insiders for damages caused by their misconduct as corporate insiders. The reasoning is that
it would be absurd to allow a wrongdoing insider to rely on the imputation of his own
conduct to the corporation as a defense. None of the Defendants disagree with the basic
proposition that claims against insiders for their acts as corporate fiduciaries are not barred
by in pari delicto/Wagoner. . . . The case law does not support the broad proposition that every
breach of fiduciary claim escapes in pari delicto/Wagoner. Such a broad rule would be
inconsistent with the rationale for imputation—which is that the corporation is responsible
for the acts of its agents. . . . That is why the case law is narrower—it provides that in pari
delicto/Wagoner does not apply to the actions of fiduciaries who are insiders in the sense that
they either are on the board or in management, or in some other way control the
In Re Refco at *11.
From this extensive quotation, it is apparent that the “insider” exception discussed by the
special master was first framed as an exception to the Wagoner doctrine—the special master states
that “it would be absurd to allow a wrongdoing insider to rely on the imputation of his own
conduct” to explain the insider exception to the Wagoner rule, not an exception to imputation under
New York law for purposes of the in pari delicto defense. “[T]he Wagoner rule is not part of New
York law except as it reflects the in pari delicto principle,” Kirschner, 15 N.Y.3d at 459 n.3, but
because In Re Refco analyzed both concepts collectively (“in pari delicto/Wagoner”), the decision has
been cited for the proposition that an “insider” exception also exists for purposes of imputation
under New York law in addition to the adverse interest exception. I do not believe that the cases
cited by In Re Refco support that broad conclusion.7
The discussion in In Re Refco, involved a discussion of the availability of in pari delicto in the context of claims for breach
of fiduciary duty against insiders on behalf of a corporation. That nuance has been lost in many cases citing to In Re
While federal courts may refer to the in pari delicto principle to guide our analysis of the
Wagoner doctrine, I do not think that it is a two-way ratchet. Federal courts cannot “water down”
the clear imputation rules established under New York law in Kirschner by reference to Wagoner, on
the assumption that the doctrines are substantively the same for all purposes.
I am not taking the position that In Re Refco was wrongly decided. The special master’s
decision—in the context of his report and recommendation—to treat Wagoner and in pari delicto as
substantive equivalents, and his resulting use of the aggregated term “in pari delicto/Wagoner” made
perfect sense in the context of that specific decision. But the decision should not be read to support
the proposition that the two doctrines are substantively identical under all circumstances. In my
view, the special master’s report, as affirmed in part by the District Court, does not provide a
foundation for the Bankruptcy Court’s holding that a broad insider exception to imputation, and,
thus, in pari delicto, exists under New York law. To understand the exceptions to imputation under
New York law, I look instead to the Court of Appeals decision in Kirschner, which provides only for
the adverse interest exception.
Application of In Pari Delicto Defense to the Trustee’s Faithless Servant Claim
As discussed above, “[t]he traditional principle that a corporation is liable for the acts of its
agents and employees applies with full force to the in pari delicto analysis.” In re MF Global Holdings
Ltd. Inv. Litig., 998 F.Supp.2d 157, 189 (S.D.N.Y. 2014) (citing Kirschner, 15 N.Y.S.3d at 464-66).
The Trustee argues (1) that in pari delicto cannot, and should not be, permitted as a defense to
faithless servant claims, and (2) that even if in pari delicto can apply to faithless servant claims it does
not apply to Gifford because he is an insider.
Refco as establishing a broad exception to in pari delicto. This case does not involve a claim for breach of fiduciary duty by
the corporation against Mr. Gifford.
The first argument is foreclosed by New York case law. As the Court of Appeals stated, in
pari delicto “applies even in difficult cases and should not be ‘weakened by exceptions.’” Kirschner, 15
N.Y.3d at 464 (citing McConnell v. Commonwealth Pictures Corp., 7 N.Y.2d 465, 470 (1960)). New York
courts have not recognized an exception for faithless servant claims. Indeed, the Appellate Division,
on facts quite similar to this case, recently upheld the Supreme Court’s ruling that in pari delicto barred
a faithless servant claim. Teneyck, Inc. v. Rosenberg, 957 N.Y.S.2d 845 (N.Y. Sup. Ct.), aff’d, 975
N.Y.S.2d 335 (N.Y. App. Div. 2013). There, as here, the plaintiff corporation had been convicted
for the criminal scheme that formed the basis of its faithless servant claim. Id. at 847. Unlike
Gifford, in Teneyck the defendant-employee had also been convicted for his conduct in the criminal
scheme; in fact, the corporation and defendant pleaded guilty to identical charges. Id. The
Appellate Division held that where the parties were guilty of misconduct stemming from the same
criminal scheme the action was barred by in pari delicto. 975 N.Y.S.2d 335.
The Trustee can cite no case supporting his assertion that in pari delicto cannot bar faithless
servant claims. Neither of the cases the Trustee relies upon, Sansum v. Fioratti, 8 N.Y.S.3d 311 (N.Y.
App. Div. 2015) and Mosionzhnik v. Chowaiki, 972 N.Y.S.2d 814 (N.Y. Sup. Ct. 2013), are to the
In his brief, the Trustee cites Sansum for the general proposition that in pari delicto is
inapplicable in faithless servant claims, but, as he admitted at oral argument, this is an overstatement.
In Sansum, an employee who had embezzled funds from his former employer sued the former
employer for breaches of fiduciary duty, and the employer counter-claimed under the faithless
servant doctrine. 8 N.Y.S.3d 311, 313 (N.Y. App. Div. 2015). The Appellate Division held that the
employer was entitled to summary judgment on its faithless servant claim, notwithstanding the
employee’s argument that the employer had originally obtained the (later embezzled) funds
unlawfully and so its claims were barred by in pari delicto. Id. This makes sense because the employer
was not an “active, voluntary participant in the unlawful activity”—the embezzlement—that was at
issue in its faithless servant claim. The facts of Sansum did not justify the application of in pari delicto,
but the decision does not support the broad proposition that in pari delicto never applies to any
faithless servant claim as the Trustee maintains.
The Trustee also relies on Mosionzhnik v. Chowaiki in support of his argument, but misreads
the case. Mosionzhnik involved a former employee of an art gallery, who had committed various bad
acts, including stealing money from the gallery and using clients’ art as collateral for loans without
the clients’ consent. 972 N.Y.S.2d 814, 826 (N.Y. Sup. Ct. 2013). The Court determined that Ms.
Mosionzhnik had to return the $500,000 she had stolen to the gallery, but that “[r]ecovery on the
remaining improprieties . . . is barred by the doctrine of in pari delicto” because her bad acts that
benefited the gallery were imputed to the gallery. Id. at 830. As the Trustee stresses, the Court also
determined that Mosionzhnik could not claim any additional compensation from the gallery. Id.
Again, this particular case in no way renders in pari delicto categorically inapplicable to faithless
servant claims; Mosionzhnik, unlike Gifford, had harmed the company by stealing money from it,
providing a separate basis for forfeiting compensation that was not imputed to the gallery.
Considered together, Teneyck, Sansum, and Mosionzhnik demonstrate that in pari delicto can
apply to faithless servant claims; courts must consider the individual facts of each case to determine
whether it does apply. Here, as in Teneyck, the in pari delicto doctrine bars the faithless servant claim.
Lehr is a wrongdoer that was ultimately convicted for the unlawful activity that is the subject of the
Trustee’s faithless servant claim, and Lehr was more culpable than Gifford—Gifford was only one
of at least half a dozen Lehr employees involved, and the others included two department heads,
Wasserman and Martino (Gifford’s supervisor), and Lazar, a senior executive, all of whose conduct
is imputed to Lehr.
Lacking support in case law for his position, the Trustee resorts to public policy arguments.
Appellant’s Br. 10-11, 18-20. But the Trustee does not represent the public; he stands in the shoes
of the debtor, a wrongdoer. Moreover, it is not true, as the Trustee claims, that the application of in
pari delicto to faithless servant claims will eliminate the faithless servant doctrine. Corporations will
still be able to recover against the prototypical faithless servant—the employee who steals from the
company for his own benefit—because that employee’s conduct will not be imputed to the
corporation. Kirschner, 15 N.Y.3d at 466-67. Moreover, the Court’s conclusion today does not
compel the conclusion that a corporation will never be able to withhold or recover compensation
from an employee whose bad acts benefit both the employee and corporation. As Mosionzhnik
demonstrates, even where some of an employee’s misconduct benefits a corporation, if the
employee is also simultaneously acting against the corporation’s interests the corporation will have a
claim. But here there is no allegation that the interests advanced by the employee’s misconduct were
ever unaligned with those of the corporation. As a result, his conduct is imputed to the corporation
and the in pari delicto defense applies.
Having determined that the in pari delicto doctrine is applicable, I next consider the Trustee’s
argument that the “bankruptcy insider exception” prevents the doctrine from applying to Gifford.
As discussed in depth above, it is not clear to me that bankruptcy law can or does create a special
“bankruptcy” exception to the New York state law. Nonetheless, for the sake of completeness, I
evaluate the argument assuming that such an exception exists.8 Because this exception, as framed in
the cases cited by the Trustee is limited “to the actions of fiduciaries who are insiders in the sense
that they either are on the board or in management, or in some other way control the corporation,”
I conclude that any such exception would not apply. Teras Int’l Corp., 2014 WL at *10 (quoting In re
Optimal U.S. Litig., 813 F.Supp.2d 383, 400 (S.D.N.Y. 2011). Gifford was not an officer or director,
nor did he exert control over Lehr such that he could be considered an insider. 9
8 Alternatively, if Mr. Gifford had framed his argument as an argument that the Trustee lacked standing under the
Wagoner rule this analysis would apply.
9 The Bankruptcy Court noted that two recent New York state court decisions— Mosionzhnik and Teneyck—allowed
defendants, who were clearly insiders, to utilize the in pari delicto defense. Op. 16 n.4. This is consistent with my
conclusion that there is no broad insider exception to imputation under New York state law.
The Trustee tries to circumvent this roadblock by asserting that all employees of a
corporation are “insiders” for the purposes of in pari delicto analysis and so all come within the
“bankruptcy insider exception.” The Trustee’s position, as articulated at oral argument, that “a
corporate insider” is any employee of a corporation because all employees are insider the
corporation is frivolous. He seeks precedential support for this assertion by misreading the Court of
Appeals statement in Kirschner that:
A corporate insider’s personal interests—as an officer, employee, or shareholder of
the company—are often deliberately aligned with the corporation’s interests by way
of, for example, stock options or bonuses, the value of which depends on the
corporation’s financial performance.
15 N.Y.3d at 467. The Trustee argues that this statement demonstrates that the Court of Appeals
considers every employee—and presumably every shareholder—of a company to be an insider for
the purposes of analyzing the bankruptcy insider exception to in pari delicto. I disagree. The only
reasonable reading of this sentence is as a simple acknowledgement that a CEO or CFO, for
example, who may well be an officer, and employee, and a shareholder of their company, will have a
personal stake in the company’s financial success. If courts were to adopt the Trustee’s theory, in
pari delicto could never apply to situations in which an employee’s fraud on behalf of a corporation
leads to bankruptcy, a result clearly contrary to the Court of Appeals’ holding in Kirschner. Id. at 464466.
Finally, the Trustee’s contention is not supported by the cases he cites. See Teras Int’l Corp.,
2014 WL at *10 (two defendants who were corporate directors were insiders, three directors who
were not directors and did not control corporation were not); In re Granite Partners, L.P., 194 B.R.
318, 331 (Bankr. S.D.N.Y. 1996) (insider was corporation’s sole decision maker, sole general partner,
and only person acting on corporation’s behalf); Kirschner, 15 N.Y.3d at 458 (categorizing
corporation’s president, CEO, and “other owners and senior management” as insiders).
Because Gifford was not an insider the “bankruptcy insider exception” does not apply, and I
affirm the Bankruptcy Court’s ruling that the Trustee’s claim against Gifford in barred by in pari
D. Leave to Amend
The Trustee asks that the Court grant leave to amend the complaint, in the event that the
Court finds that the in pari delicto doctrine applies, so that he may re-plead.10 Although a district
court “should freely give leave” to amend “when justice so requires,” Federal Rule of Civil
Procedure 15(a)(2), it has “discretion to deny leave for good reason, including futility . . . .”
McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 200 (2d Cir. 2007). Lehr was convicted of thirteen
counts of criminal activity, including enterprise corruption, a scheme to defraud, grand larceny in the
second degree, and money laundering in the first degree. Bankr. Dkt. No. 15-6. Because Lehr
participated in and was at the very least Gifford’s equal in fault, any amendment would be futile, and
leave to amend the complaint is denied.
For the foregoing reasons, the decision of the Bankruptcy Court is AFFIRMED. The Clerk
of Court is instructed to enter judgment accordingly and to close the case.
Dated: January 12, 2016
New York, New York
GREGORY H. WOODS
United States District Judge
10 The Trustee argues that he can add allegations that Lehr’s owners and most senior executives were unaware of the
criminal scheme, and had they known would have put a stop to it. Setting aside the fact that this argument contradicts
all of the Trustee’s arguments regarding imputation, it is also foreclosed by Kirschner. 15 N.Y.3d at 466 (“Where the
agent is defrauding someone else on the corporation’s behalf, the presumption of full communication [between agents
and principals] remains in full force and effect.”).
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