Ponzi Scheme
Douglas A. Kelley v. BMO Harris Bank
Date: Sept. 12, 2024
Issue: Whether the district court erred in prohibiting BMO Harris from using the in pari delicto defense in a lawsuit claiming the bank aided and abetted Thomas J. Petters’ multibillion-dollar Ponzi scheme.
Case Summary: In a 3-0 decision, an Eighth Circuit panel reversed a $563 million verdict against BMO Harris Bank, ruling the bank should have been allowed to use the in pari delicto defense in a lawsuit claiming it aided and abetted Thomas J. Petters’ multibillion-dollar Ponzi scheme.
The in pari delicto defense is a legal doctrine that prohibits a plaintiff from recovering damages if they participated in the same wrongdoing as the defendant. The In Pari Delicto defense, which means “in equal fault” in Latin, is based on the idea parties who are equally involved in illegal conduct should not benefit in a legal proceeding.
Petters was convicted and sentenced to 50 years in prison for using a small-business account at M&I Bank to move billions of dollars in victims’ funds. When the scheme collapsed, a federal district court placed one of his companies, Petters Company Inc. (PCI), in a receivership and appointed Douglas Kelley as a receiver. PCI then filed for bankruptcy, and Kelley was appointed trustee of the bankruptcy estate. As trustee, Kelley filed an adversary proceeding in the bankruptcy court against BMO Harris as successor-in-interest to M&I Bank, alleging M&I aided and abetted the Ponzi Scheme. Kelley also alleged M&I employees knew about the Ponzi scheme and gave PCI special treatment which helped the scheme avoid detection.
BMO moved for summary judgment, arguing the doctrine of in pari delicto functions as an equitable defense that prevents a plaintiff from recovering damages if they were also at fault for the wrong. According to BMO, PCI could not recover based on M&I’s alleged wrongdoing because PCI was itself a wrongdoer of equal or greater fault. However, the bankruptcy court ruled under Minnesota law, the in pari delicto defense was unavailable because “PCI had become a receivership entity” and was no longer bound by its officers’ previous fraudulent acts. At trial, Kelley and BMO cross-moved for judgment as a matter of law on BMO’s in pari delicto defense. The district court granted Kelley’s motion, concluding BMO “had no valid factual or legal basis” to advance the defense. The jury found BMO liable for aiding and abetting and awarded Kelley over $563 million in damages.
On appeal, the panel determined the district court erred by denying BMO’s in pari delicto defense. As explained by the panel, a receiver acting on behalf of creditors may not avoid the in pari delicto defense even when the receiver brings a claim belonging to the corporate entity. The court recognized that a receiver has a dual role “representing the creditors as well as the shareholders and holds the property for the benefit of both.” Because a receiver represents the rights of creditors, he is not bound by the fraudulent acts of a former officer of the corporation. However, the panel determined Kelley was acting as a bankruptcy trustee in this case, not as a receiver. The panel opined a bankruptcy trustee steps into the shoes of the debtor and is subject to any defenses that could be raised against the debtor, including the in pari delicto defense.
While Kelley maintained “he stepped into the shoes of a cleansed receivership entity,” who is no longer bound by its prior wrongdoing, the panel declared under Minnesota law the appointment of a receiver does not change the receivership entity as a receivership only changes the corporation’s management. In addition, the panel reasoned once Kelley transferred PCI’s claims to the estate, bankruptcy law governed his ability to bring PCI’s claims as the trustee. As a result, the panel reiterated in bankruptcy, the trustee is “subject to any equitable or legal defenses that could have been raised against the debtor.”
Additionally, the court noted its decision was consistent with the Second Circuit in a comparable proceeding arising from Bernard Madoff’s Ponzi scheme. In Madoff’s case, the court ruled the doctrine of in pari delicto “barred a trustee under the Securities Investor Protection Act — vested with the same powers as a bankruptcy trustee — from asserting claims on behalf of the estate of Madoff’s failed brokerage firm for wrongdoing in which Madoff participated.” Kelley contended Madoff’s case was inapposite because the rule in New York is different from Minnesota law. However, the panel applied precedent to conclude New York law aligns with the decisions from Minnesota, holding “the in pari delicto defense does not apply against an innocent non-bankruptcy trustee or receiver who seeks recovery for investors or creditors, although a bankruptcy trustee is subject to the defense as in Madoff.”
Bottom Line: The Eighth Circuit remanded the case with directions to enter judgment in favor of BMO and dismissed Kelley’s cross-appeal as moot.
Documents: Opinion
