                                                                                                                           Opinions of the United
2001 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


10-9-2001

Official Committee v. RF Lafferty & Co Inc
Precedential or Non-Precedential:

Docket 00-1157




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Filed October 9, 2001

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

No. 00-1157

OFFICIAL COMMITTEE of UNSECURED CREDITORS,
       Appellant

v.

R.F. LAFFERTY & CO., INC.;
*COGEN SKLAR, L.L.P.

*(Dismissed Pursuant to Court's February 14, 2001 Order)

ON APPEAL FROM THE ORDER
OF THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA

(D.C. Civ. No: 00-cv-00519)
District Court Judge: The Honorable Edmund V. Ludwig

Argued on May 31, 2001

Before: SLOVITER, FUENTES, and COWEN, Circuit Judges

(Opinion Filed: October 9, 2001)
       Barbara W. Mather (argued)
       Francis J. Lawall
       Matthew J. Hamilton
       Pepper Hamilton LLP
       3000 Two Logan Square
       18th and Arch Streets
       Philadelphia, PA 1903-2799

       Attorney for Appellant

       Stuart L. Melnick (argued)
       Tanner Propp LLP
       99 Park Avenue
       New York, New York 10016

       Attorney for Appellee

OPINION OF THE COURT

FUENTES, Circuit Judge:

This matter arises out of the bankruptcy of two lease
financing corporations, which were allegedly operated as a
"Ponzi scheme."1 Like all such schemes, this one collapsed,
leaving numerous investors with significant losses. To
operate the scheme, William Shapiro, aided by others,
allegedly caused the corporations to issue fraudulent debt
certificates, which were then sold to individual investors.
When the corporations lost any reasonable prospect of
repaying the outstanding debt, they filed for bankruptcy.

A Committee of Creditors, appointed by a bankruptcy
trustee, brought claims in the District Court on behalf of
the two debtor corporations alleging that third-parties had
fraudulently induced the corporations to issue the debt
securities, thereby deepening their insolvency and forcing
them into bankruptcy. These third-parties allegedly
conspired with the debtors' management, who were also the
_________________________________________________________________

1. A "Ponzi scheme" is "[a] fraudulent investment scheme in which
money contributed by later investors generates artificially high dividends
for the original investors, whose example attracts even larger
investments." Black's Law Dictionary 1180 (7th ed. 1999).

                                2
debtors' sole shareholders, in engineering the Ponzi
scheme. On these allegations, the District Court concluded
that it could not rule out the possibility of a cognizable
injury. Nevertheless, the District Court held that the
Committee lacked standing to assert its claims against the
third-parties because of the doctrine of in pari delicto. The
Committee appeals.

We conclude that "deepening insolvency" constitutes a
valid cause of action under Pennsylvania state law and that
the Committee therefore has standing to bring this action.
However, evaluating the Committee's claims "as of the
commencement" of the bankruptcy, we hold that because
the Committee, standing in the shoes of the debtors, was in
pari delicto with the third parties it is suing, its claims were
properly dismissed. Accordingly, we will affirm the
judgment of the District Court.

I.

The following allegations are taken from the Amended
Complaint of the appellant, the Official Committee of
Unsecured Creditors ("the Committee"), which was
appointed by the bankruptcy trustee and which was
authorized by stipulation to assert claims on behalf of the
debtor corporations. The essence of the Committee's
allegations is that the Shapiro family (or "the Shapiros"),
with the assistance of other defendants, including third-
party professionals,2 operated Walnut Equipment Leasing
Company, Inc., ("Walnut"), and its wholly owned subsidiary,
Equipment Leasing Corporation of America ("ELCOA"), as a
Ponzi scheme.

The scheme originated with Walnut, which was owned by
defendant Walnut Associates, Inc., and which, in turn, was
owned by William Shapiro. In 1986, Walnut was
_________________________________________________________________

2. The sixteen defendants in the original case before the District Court
are as follows: (1) William Shapiro, (2) Kenneth Shapiro, (3) DelJean
Shapiro, (4) Lester Shapiro, (5) Nathan Tattar, (6) Adam Varrenti, Jr.,
(7)
John Orr, (8) Philip Bagley, (9) Walnut Associates, Inc., (10) Welco,
Inc.,
(11) The Law Offices of William Shapiro, Esq., P.C., (12) Financial Data,
Inc., (13) Kenner Collection Agency, Inc., (14) Cogen, Sklar, L.L.P., (15)
R.F. Lafferty & Co., Inc., and (16) Liss Financial Services, Inc.

                               3
experiencing financial difficulties. As a result, Walnut could
not raise sufficient capital through the sale of debt
securities. In a purported effort to secure more capital for
Walnut, the Shapiro family organized ELCOA as "a limited
purpose financing subsidiary," wholly owned by Walnut, to
provide a platform to sell debt securities through a new
company with a clean financial picture.

According to the Amended Complaint, ELCOA was
fraudulently marketed as an independent business entity,
even though its only function was to acquire leases from
Walnut and to sell debt certificates to raise money. In
reality, Walnut and ELCOA were part of a network of
businesses owned and operated by the Shapiro family. This
network included defendants Welco, Inc., The Law Offices
of William Shapiro, Esq., P.C., Walnut Associates, Inc.,
Financial Data, Inc., and Kenner Collection Agency, Inc. As
part of the scheme to keep this network afloat, the Shapiros
allegedly misstated Walnut and ELCOA's financial position
in order to induce these companies to register, offer, and
sell additional debt certificates to raise capital. Numerous
investors purchased the ELCOA debt securities, and the
Committee claims that the Shapiros funneled those monies
into Walnut. At the same time, the Shapiros and their co-
conspirators continued receiving salaries and fees from
Walnut and ELCOA. Moreover, the issuance of debt
securities allegedly deepened the insolvency of Walnut and
ELCOA, and put them on the path to bankruptcy.

The Amended Complaint states that certain third-party
professionals were essential to the Shapiro family's
operation, namely, their counsel, defendant William
Shapiro, Esq. P.C., their accountant, defendant Cogen
Sklar, L.L.P. ("Cogen"), and their qualified independent
underwriters, defendant R.F. Lafferty & Co., Inc. ("Lafferty"),
and defendant Liss Financial Services, Inc. ("Liss"). Each of
these parties was responsible for professional opinions that
served as prerequisites for the registration of each public
offering and sale of ELCOA's debt securities. Each allegedly
conspired with the Shapiro family to render opinions
replete with multiple fraudulent misstatements and
material omissions concerning Walnut and ELCOA's
financial statements. The parties allegedly lacked any
foundation for their conclusions.

                               4
Ultimately, the artifice collapsed, leading to the
bankruptcies of Walnut and ELCOA, which became the
debtor corporations (or "the Debtors"). The companies filed
Chapter 11 petitions, and the Debtors' management, which
included members of the Shapiro family and their co-
conspirators, were removed. The Bankruptcy Court then
appointed a bankruptcy trustee. Thereafter, the trustee,
pursuant to section 1102 of the Bankruptcy Code, 11
U.S.C. S 1102, appointed the Committee to represent the
claims of unsecured creditors in connection with the
bankruptcy proceedings. The Committee is comprised
entirely of creditors; no member of the Debtors' former
management is present.

On January 19, 1999, the Bankruptcy Court approved a
Stipulation between the Committee and the Debtors
authorizing, among other things, "the Committee to
commence and prosecute . . . [l]itigation on behalf of the
Debtors' estates." Stipulation Among the Debtors and the
Official Committee of Unsecured Creditors of the Debtors
Authorizing the Committee to Commence Litigation on Behalf
of the Debtors' Estates, Bankr. No. 97-19699-DWS, at *2
(Bankr. E.D. Pa. Jan. 19, 1999). Under the Stipulation, the
Committee effectively acquired all the attributes of a
bankruptcy trustee for purposes of this case. See In re The
Mediators, Inc., 105 F.3d 822, 826 (2d Cir. 1997) ("[T]he
Committee, while not a trustee in bankruptcy, is in a
position analogous to a trustee because it is suing on
behalf of the debtor.").

On February 1, 1999, the Committee, on behalf of the
Debtors' estates, commenced a civil action in the District
Court for the Eastern District of Pennsylvania against the
Debtors' officers, directors, affiliated companies (the
Shapiro family and their network of companies), and
outside professionals (Cogen and Lafferty) on the ground
that the defendants, through their mismanagement of the
Debtors and their participation in a fraudulent scheme, had
"wrongfully expanded the [D]ebtors' debt out of all
proportion of their ability to repay and ultimately forced the
[D]ebtors to seek bankruptcy protection." The Committee
brought claims against the Shapiros and their alleged co-
conspirators -- including Cogen and Lafferty -- based upon

                               5
violations of federal securities laws, as well as common law
fraud and negligent misrepresentation, mismanagement
and breach of fiduciary duty, breach of contract,
professional malpractice, and aiding and abetting breach of
fiduciary duty. In addition, the Committee brought claims
against some defendants -- DelJean Shapiro, Lester
Shapiro, Adam Varrenti, Jr., John Orr, and Philip Bagley --
in their capacity as directors of either Walnut or ELCOA or
both, asserting that they had mismanaged and breached
their fiduciary duties to the Debtors by allegedly failing to
supervise and oversee the Debtors' affairs.

All defendants (except Liss, who failed to appear) moved
to dismiss the Committee's Amended Complaint or,
alternatively, for summary judgment. On September 8,
1999, the District Court dismissed the claims against
Cogen and Lafferty, reasoning that, "[s]ince it is pleaded
that the [D]ebtors, acting through the Shapiros, perpetrated
the Ponzi scheme . . . the doctrine of in pari delicto . . . bars
[the Committee] from suing these defendants for claims
arising out of the fraud." Official Committee of Unsecured
Creditors v. William Shapiro, et al., No. 99-526, slip op. at
11 (E.D. Pa. Sept. 8, 1999). At the same time, however, the
District Court denied the motion to dismiss as to the other
defendants on the ground that in pari delicto did not
preclude claims against corporate insiders. Id. at 12.
Thereafter, the court severed the Committee's claims
against Cogen and Lafferty, and the Committee appealed
the dismissal of those claims. Cogen has settled with the
Committee, leaving Lafferty as the only appellee.

II.

The District Court had subject matter jurisdiction over
the case under 28 U.S.C. SS 1331 and 1334(b). We have
jurisdiction to hear the appeal under 28 U.S.C.S 1291.

We have plenary review over the District Court's
dismissal of the Committee's claims against Lafferty. See
Maio v. Aetna, Inc., 221 F.3d 472, 481-82 (3d Cir. 2000).
We apply the same standard used by the District Court,
namely, we must determine whether, under any reasonable
reading of the pleadings, the Committee may be entitled to

                                6
relief, accepting as true all well pleaded allegations in the
Amended Complaint and drawing all reasonable inferences
in favor of the Committee. Nami v. Fauver, 82 F.3d 63, 65
(3d Cir. 1996). The District Court's order granting the
motion to dismiss will be affirmed only if it appears that the
Committee can prove no set of facts that would entitle it to
relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

III.

As a preliminary matter, we believe that the District
Court's conception of the standing issue in this case was
somewhat flawed. The District Court stated that both
cognizable injury and the doctrine of in pari delicto were
elements of the standing analysis. Official Committee of
Unsecured Creditors, No. 99-526, slip op. at 6. This
formulation, however, was incorrect. In general,"[s]tanding
consists of both a `case or controversy' requirement
stemming from Article III, Section 2 of the Constitution, and
a subconstitutional `prudential' element." See The Pitt News
v. Fisher, 215 F.3d 354, 359 (3d Cir. 2000). An analysis of
standing does not include an analysis of equitable defenses,
such as in pari delicto. Whether a party has standing to
bring claims and whether a party's claims are barred by an
equitable defense are two separate questions, to be
addressed on their own terms. See In re Dublin Secs., Inc.,
133 F.3d 377, 380 (6th Cir. 1997) (analyzing in pari delicto
separately from standing).

That said, we will address both doctrines because,
together, they formed the basis of the District Court's
judgment. As a threshold requirement, standing demands
our initial attention. See Valley Forge Christian College v.
Americans United for Separation of Church & State, Inc.,
454 U.S. 464, 471-74 (1982) (discussing the fundamental
requirement of standing). Citing Warth v. Seldin , 422 U.S.
490, 501 (1975), for the proposition that standing requires
a "distinct and palpable injury," Lafferty argues that the
Committee lacks standing because the Debtors have not
sustained a "cognizable injury" separate and apart from any
injury sustained by investors who had purchased the
Debtors' debt securities. As such, Lafferty maintains that
the Committee may not bring those claims under the

                               7
Supreme Court's decision in Caplin v. Marine Midland
Grace Trust Co., in which the Court held that a bankruptcy
trustee has no standing to assert claims on behalf of an
estate's creditors. See 406 U.S. 416, 434 (1972).

Lafferty made the same argument to the District Court,
which rejected it on the ground that, at the motion to
dismiss stage, the court could not foreclose the existence of
a separately cognizable injury to the Debtors
distinguishable from the injuries suffered by purchasers of
the Debtors' certificates:

       Here, the Committee is suing on behalf of the bankrupt
       debtor corporations [Walnut and ELCOA] -- not on
       behalf of the creditors themselves. The injury alleged is
       that "the debtors were fraudulently induced to register,
       offer and sell certificates when insolvent and thus
       without ability to repay their obligations to investors.
       As a result, the debtors' outstanding debt was
       continually expanded out of all proportion with their
       ability to repay, forcing them into bankruptcy." Compl.
       PP 1, 77.

        . . . .

       Defendants Cogen [ ] and Lafferty maintain that the
       alleged Ponzi scheme claims belong exclusively to the
       creditors, citing Hirsch v. Arthur Anderson & Co., 72
       F.3d 1085 (2d Cir. 1995). [However, I believe that,
       w]hile the most obvious damages were those sustained
       by the creditors who purchased certificates [and
       securities], the possibility of a distinct and separate
       injury to the debtor corporations cannot be eliminated at
       this stage. See In re Plaza Mortg. and Fin. Corp., 187
       B.R. 37, 41 (N.D. Ga. 1995) (denying motion to dismiss
       trustee's claims against accountants who participated
       in Ponzi scheme and distinguishing Hirsch where only
       allegation of injury was "unpaid obligations of the
       debtor to the creditors").

Official Committee of Unsecured Creditors, No. 99-526, slip.
op. at 5, 7 (emphasis added).

We agree with the District Court's evaluation. With the
exception of a single federal securities law claim, the

                                8
Committee brought only state common law claims on behalf
of the Debtors. According to the Amended Complaint, the
defendants (including Lafferty), through their alleged fraud
and participation in the scheme, injured the Debtors by
"wrongfully expand[ing] the [D]ebtors' debt out of all
proportion of their ability to repay and ultimately forc[ing]
the [D]ebtors to seek bankruptcy protection." In other
words, the Committee alleges an injury to the Debtors'
corporate property from the fraudulent expansion of
corporate debt and prolongation of corporate life. This type
of injury has been referred to as "deepening insolvency."
See, e.g., ALI-ABA Course of Study, Proximate Cause,
Foreseeability, and Deepening Insolvency in Accountants'
Liability Litigation, C994 ALI-ABA 201, 203 (1995).

As far as the state law claims are concerned, it is clear
that, to the extent Pennsylvania law recognizes a cause of
action for the Debtors against Lafferty, the Committee can
demonstrate the injury required for standing to sue in
federal court. Given Lafferty's arguments, the standing
analysis then consists of three inquiries: (1) whether the
Committee is merely asserting claims belonging to the
creditors, (2) whether "deepening insolvency" is a valid
theory giving rise to a cognizable injury under Pennsylvania
state law, and (3) whether, as Lafferty contends, the injury
is merely illusory.

A. Whether the Committee is merely asserting claims
belonging to creditors

Whether a right of action belongs to the debtor or to
individual creditors is a question of state law. Hirsch v.
Arthur Andersen & Co., 72 F.3d 1085, 1093 (2d Cir. 1995).
In Pennsylvania, as in almost every other state,"a
corporation is a distinct and separate entity, irrespective of
the persons who own all its stock." Barium Steel Corp. v.
Wiley, 108 A.2d 336, 341 (Pa. 1954) (citations omitted);
accord In re Erie Drug Co., 204 A.2d 256, 257 (Pa. 1964).
From this principle arises a distinction between the
property of a corporation and that of others. For example,
with respect to shareholders,

       [t]he fact that one person owns all of the stock does not
       make him and the corporation one and the same

                               9
       person, nor does he thereby become the owner of all
       the property of the corporation. The shares of stock of
       a corporation are essentially distinct and different from
       the corporate property.

Barium Steel, 108 A.2d at 341 (citations omitted); see also
Meitner v. State Real Estate Comm'n, 275 A.2d 417, 419
(Pa. Commw. Ct. 1971) (stating that "officers of
corporations are not deemed to be the owners of corporate
property even to the extent that they are shareholders").

The legal fiction of corporate existence corresponds with
the view that an injury to the corporate body is legally
distinct from an injury to another person. Thus, it is well
established, under Pennsylvania law, that where fraud,
mismanagement, or other wrong damages a corporation's
assets, a shareholder does not have a direct cause of
action. Burdon v. Erskine, 401 A.2d 369, 370-71 (Pa.
Super. Ct. 1979) (citation omitted). Rather, it is the
corporate body that suffers the primary wrong and,
consequently, it is the corporate body that possesses the
right to sue. John L. Motley Assoc., Inc. v. Rumbaugh, 104
B.R. 683, 686-87 (E.D. Pa. 1989) (citations omitted)
(describing Pennsylvania law). Thus, "an action to redress
injuries to the corporation cannot be maintained by an
individual shareholder, but must be brought as a derivative
action in the name of the corporation." Id. (citations
omitted) (describing Pennsylvania law); see also 12
Summary of Pennsylvania Jurisprudence Business
Relationships S 7:90 (2d ed. 1993) ("creditors claiming a
beneficial interest in the corporation . . . may not[even]
maintain a derivative action").

It follows from this discussion that a corporation can
suffer an injury unto itself, and any claim it asserts to
recover for that injury is independent and separate from the
claims of shareholders, creditors, and others. We think it is
irrelevant that, in bankruptcy, a successfully prosecuted
cause of action leads to an inflow of money to the estate
that will immediately flow out again to repay creditors:

       The . . . assertion that this action will benefit creditors
       is not an admission that this action is being brought
       on their behalf. In a liquidation case, it is

                               10
       commonplace for a trustee to pursue an action on
       behalf of the debtor in order to obtain a recovery
       thereon for the estate. If the trustee is successful in the
       action, the recovery which he obtains becomes property
       of the estate and is then distributed pursuant to the
       scheme established by S 726(a). Simply because the
       creditors of a[n] estate may be the primary or even the
       only beneficiaries of such a recovery does not
       transform the action into a suit by the creditors.
       Otherwise, whenever a lawsuit constituted property of
       an estate which has insufficient funds to pay all
       creditors, the lawsuit would be worthless since under
       Caplin it could not be pursued by the trustee.

In re: Jack Greenberg, Inc., 240 B.R. 486, 506 (Bankr. E.D.
Pa. 1999); accord Scholes v. Lehmann, 56 F.3d 750, 754
(7th Cir. 1995) ("That the return would benefit the limited
partners is just to say that anything that helps a
corporation helps those who have claims against its
assets.").

In the instant case, the Committee sought recovery of
damage to the Debtors' property from "deepening
insolvency." We see no indication that the Committee is
attempting to recover for injuries to the creditors. Cf.
Caplin, 406 U.S. at 434 (holding that a trustee may not
assert claims on behalf of creditors). Therefore, accepting
the allegations as true and drawing all reasonable
inferences in favor of the Committee, we conclude that the
claims here belong to the Debtors, rather than to the
creditors.

B. Whether "deepening insolvency" is a valid theory that
       gives rise to a cognizable injury under state law

Having established that the Committee brought claims on
behalf of the Debtors, rather than the creditors, we must
now determine whether the alleged theory of injury--
"deepening insolvency" -- is cognizable under Pennsylvania
law. Neither the Pennsylvania Supreme Court nor any
intermediate Pennsylvania court has directly addressed this
issue. In the absence of an opinion from the state's highest
tribunal, we must don the soothsayer's garb and predict
how that court would rule if it were presented with the

                               11
question. See Wiley v. State Farm Fire & Casualty Co., 995
F.2d 457, 459 (3d Cir. 1993). Indeed, because no state or
federal courts have interpreted Pennsylvania law on this
subject, we will rely predominantly on decisions
interpreting the law of other jurisdictions and on the policy
underlying Pennsylvania tort law to make this prediction.
See Gruber v. Owens-Illinois, Inc., 899 F.2d 1366, 1369-70
(3d Cir. 1990) (noting possible sources of authority for
making a prediction).

Drawing guidance from these authorities, we conclude
that, if faced with the issue, the Pennsylvania Supreme
Court would determine that "deepening insolvency" may
give rise to a cognizable injury. First and foremost, the
theory is essentially sound. Under federal bankruptcy law,
insolvency is a financial condition in which a corporation's
debts exceed the fair market value of its assets. 11 U.S.C.
S 101(32). Even when a corporation is insolvent, its
corporate property may have value. The fraudulent and
concealed incurrence of debt can damage that value in
several ways. For example, to the extent that bankruptcy is
not already a certainty, the incurrence of debt can force an
insolvent corporation into bankruptcy, thus inflicting legal
and administrative costs on the corporation. See Richard A.
Brealey & Stewart C. Myers, Principles of Corporate Finance
487 (5th ed. 1996) ("[B]y issuing risky debt,[a corporation]
give[s] lawyers and the court system a claim on the firm if
it defaults."). When brought on by unwieldy debt,
bankruptcy also creates operational limitations which hurt
a corporation's ability to run its business in a profitable
manner. See id. at 488-89. Aside from causing actual
bankruptcy, deepening insolvency can undermine a
corporation's relationships with its customers, suppliers,
and employees. The very threat of bankruptcy, brought
about through fraudulent debt, can shake the confidence of
parties dealing with the corporation, calling into question
its ability to perform, thereby damaging the corporation's
assets, the value of which often depends on the
performance of other parties. See Michael S. Knoll, Taxing
Prometheus: How the Corporate Interest Deduction
Discourages Innovation and Risk-Taking, 38 Vill. L. Rev.
1461, 1479-80 (1993). In addition, prolonging an insolvent

                               12
corporation's life through bad debt may simply cause the
dissipation of corporate assets.

These harms can be averted, and the value within an
insolvent corporation salvaged, if the corporation is
dissolved in a timely manner, rather than kept afloat with
spurious debt. As the Seventh Circuit explained in Schacht
v. Brown:

       [C]ases [that oppose "deepening insolvency"] rest[ ]
       upon a seriously flawed assumption, i.e., that the
       fraudulent prolongation of a corporation's life beyond
       insolvency is automatically to be considered a benefit
       to the corporation's interests. This premise collides
       with common sense, for the corporate body is
       ineluctably damaged by the deepening of its insolvency,
       through increased exposure to creditor liability. Indeed,
       in most cases, it would be crucial that the insolvency of
       the corporation be disclosed, so that shareholders may
       exercise their right to dissolve the corporation in order to
       cut their losses. Thus, acceptance of a rule which
       would bar a corporation from recovering damages due
       to the hiding of information concerning its insolvency
       would create perverse incentives for wrong-doing
       officers and directors to conceal the true financial
       condition of the corporation from the corporate body as
       long as possible.

711 F.2d 1343, 1350 (7th Cir. 1983) (citations omitted)
(emphasis added).

Growing acceptance of the deepening insolvency theory
confirms its soundness. In recent years, a number of
federal courts have held that "deepening insolvency" may
give rise to a cognizable injury to corporate debtors. See,
e.g., id. (applying Illinois law and holding that, where a
debtor corporation was fraudulently continued in business
past the point of insolvency, the liquidator had standing to
maintain a civil action under racketeering law); Hannover
Corp. of America v. Beckner, 211 B.R. 849, 854-55 (M.D.
La. 1997) (applying Louisiana law and stating that"a
corporation can suffer injury from fraudulently extended
life, dissipation of assets, or increased insolvency"); Allard
v. Arthur Andersen & Co., 924 F. Supp. 488, 494 (S.D.N.Y.

                                13
1996) (applying New York law and stating that, as to suit
brought by bankruptcy trustee, "[b]ecause courts have
permitted recovery under the `deepening insolvency' theory,
[defendant] is not entitled to summary judgment as to
whatever portion of the claim for relief represents damages
flowing from indebtedness to trade creditors"); In re Gouiran
Holdings, Inc., 165 B.R. 104, 107 (E.D.N.Y. 1994) (applying
New York law, and refusing to dismiss claims brought by a
creditors' committee because it was possible that,"under
some set of facts two years of negligently prepared financial
statements could have been a substantial cause of[the
debtor] incurring unmanageable debt and filing for
bankruptcy protection"); Feltman v. Prudential Bache
Securities, 122 B.R. 466, 473 (S.D. Fla. 1990) (stating that
an " `artificial and fraudulently prolonged life . . . and . . .
consequent dissipation of assets' constitutes a recognized
injury for which a corporation can sue under certain
conditions", but concluding that there was no injury on the
facts). Some state courts have also recognized the
deepening insolvency theory. See, e.g., Herbert H. Post &
Co. v. Sidney Bitterman, Inc., 219 A.D. 2d 214 (N.Y. App.
Div. 1st Dep't 1996) (applying New York law and allowing a
malpractice claim for failing to detect embezzlement that
weakened a company, which already was operating at a
loss, thereby causing default on loans and forcing
liquidation); Corcoran v. Frank B. Hall & Co. , 149 A.D. 2d
165, 175 (N.Y. App. Div. 1st Dep't 1989) (applying New York
law and allowing claims for causing a company to"assume
additional risks and thereby increase the extent of its
exposure to creditors").

Significantly, one of the most venerable principles in
Pennsylvania jurisprudence, and in most common law
jurisdictions for that matter, is that, where there is an
injury, the law provides a remedy. See 37 Pennsylvania
Law Encyclopedia, Torts S 4, at 120 (1961) ("For every legal
wrong there must be a correlative legal right.") (citation
omitted). Thus, an identifiable and compensable injury is
essential to the existence of tort liability, Schweitzer v.
Consolidated Rail Corp., 758 F.2d 936, 942 (3d Cir. 1985),
but once an injury has occurred, "tort law attempts to place
the injured party in the same position he occupied before
the injury," Hahn v. Atlantic Richfield Co. , 625 F.2d 1095,

                               14
1104 (3d Cir. 1980) (construing Pennsylvania tort policy).
Similarly, where a contractual "breach occurs, contract law
seeks to give to the nonbreaching party the benefit of his or
her bargain, to put him or her in the position he or she
would have been in had there been no breach." 1 Summary
of Pennsylvania Jurisprudence Torts S 1.1 (2d ed. 1999).
Thus, where "deepening insolvency" causes damage to
corporate property, we believe that the Pennsylvania
Supreme Court would provide a remedy by recognizing a
cause of action for that injury.

Lafferty challenges the strong rationales for recognizing
an injury here, citing a few cases that it claims reject
"deepening insolvency." In our view, the majority of these
cases do not address "deepening insolvency," but rather,
simply apply the Supreme Court's holding in Caplin that a
bankruptcy trustee has no standing to assert claims on
behalf of creditors. See, e.g., Hirsch v. Arthur Andersen &
Co., 72 F.3d 1085, 1093-94 (2d Cir. 1995); E.F. Hutton &
Co. v. Hadley, 901 F.2d 979, 986-87 (11th Cir. 1990);
Williams v. California 1st Bank, 859 F.2d 664, 666-67 (9th
Cir. 1988). These decisions are not relevant to the present
case because, as we explained earlier, the Committee is
proceeding on behalf of the Debtors, not the creditors.
Moreover, to the extent that either the cases cited by
Lafferty or other cases suggest that a corporation may
never sue to recover damages resulting from the fraudulent
prolongation of its life past solvency, we believe, under the
same analysis conducted by the Seventh Circuit in Schacht,
that Pennsylvania courts would reject them.

We pause here to consider the 19th century case of
Patterson v. Franklin, 35 A. 205 (Pa. 1896), an arguably
applicable decision of the Pennsylvania Supreme Court. In
Patterson, an assignee standing in the shoes of an insolvent
corporation brought suit against the incorporators, claiming
that they had allegedly made false representations in the
statement of incorporation. Id. at 206. Apparently, the false
representations had allowed the corporation to contract
more debts. Id. On these allegations, the Pennsylvania
Supreme Court affirmed the dismissal of the assignee's
claims, reasoning that, because the assignee had alleged
that the corporation had benefitted from the
representations, there was no viable cause of action. Id.

                               15
In our view, Patterson is not controlling here. The
Patterson court never expressly considered the"deepening
insolvency" theory, as the opinion does not indicate that the
assignee presented any version of that argument to the
court. In fact, it seems that the assignee in Patterson had
not even alleged an injury to the corporation at all:

       The fraud was perpetrated for its benefit. It was a
       gainer, not a loser because of it. It was given a
       considerable credit by the statement to which, as it is
       alleged, it had no claim whatever.

Id. (emphasis added). Thus, given the allegations in the
case, it was perfectly reasonable for the court in Patterson
to affirm the dismissal. See also Kinter v. Connolly, 81 A.
905, 905 (Pa. 1911) (rejecting receiver's claim on behalf of
the corporation against the directors for fraudulent
statements that induced parties to do business with the
corporation because "there [was] no averment that any act
or omission of those of the defendants who demur caused
loss or injury to the [corporation].").

Our reading of Patterson is informed in part by its age. In
the hundred-plus years between that decision and the
present, the business practices of corporations in the
United States have changed quite dramatically. Likewise,
society's understanding of corporate theory has grown. See
William W. Bratton, Jr., The New Economic Theory of the
Firm: Critical Perspectives from History, 41 Stan. L. Rev.
1471, 1482-1501 (1989) (describing the evolution of
corporations over the last two centuries); see also Henry
Hansmann & Reinier Kraakman, The End of History for
Corporate Law, 89 Geo. L.J. 439, 440-49 (2001) (describing
the history of models for corporate structure and
governance). Therefore, we decline to draw any broad
principle from Patterson, a decision which did not directly
address "deepening insolvency."

In sum, we believe that the soundness of the theory, its
growing acceptance among courts, and the remedial theme
in Pennsylvania law would persuade the Pennsylvania
Supreme Court to recognize "deepening insolvency" as
giving rise to a cognizable injury in the proper
circumstances. We now apply this conclusion to the
allegations presented in this case.

                               16
C. Whether, as Lafferty contends, the injury is merely
       illusory

At oral argument, Lafferty observed that, under the Ponzi
scheme alleged in the Committee's Amended Complaint,
any fraudulent debt certificates issued by the Debtors
would have created a capital flow into the Debtors, allowing
them to pay the perpetrators of the fraud, the Shapiros,
who were at the top of the pyramid. Stated in slightly
different terms, we understand Lafferty to be saying that
any injury to the Debtors caused by deepening insolvency
might be considered illusory because that injury passed
directly to the sole shareholders and wrongdoers, the
Shapiro family. See, e.g., Feltman, 122 B.R. at 473-74
(accepting "deepening insolvency" but concluding that,
because a corporation was fictitious, any injury to it was
illusory). As we discussed earlier, so long as the corporate
form is respected, the alleged "deepening insolvency" injury
to the property of the Debtors cannot be regarded as
equivalent to the Shapiro family's shareholder interest. See
Barium Steel, 108 A.2d at 341 (corporate property is
distinct from shareholder property); John L. Motley Assoc.,
104 B.R. at 686-87 (causes of action for damage to
corporate property belong to the corporation). Thus, we
think that Lafferty is essentially asking us to disregard the
corporate existence of Walnut, whose status separates the
Debtors' property, and hence, the alleged injury from the
Shapiro family's shareholder interest.3

As a result, Lafferty's argument implicitly invokes the
"piercing the corporate veil" doctrine, which treats a
corporation and its shareholders as identical for purposes
of suit, thereby imposing personal liability on shareholders.
See Kiehl v. Action Mfg. Co., 535 A.2d 571, 574 (Pa. 1987).
We doubt that the Pennsylvania Supreme Court would
apply any form of the doctrine here. The present issue, after
all, involves the defendant Lafferty invoking the doctrine to
demonstrate the lack of injury to the Debtors, whereas in
the standard scenario the plaintiff invokes the"piercing the
_________________________________________________________________

3. The corporate existence of ELCOA is irrelevant to this inquiry because
ELCOA was wholly owned by Walnut. It is Walnut's corporate existence
that provides the legal fiction separating the Debtors from the Shapiros.

                               17
corporate veil" doctrine to impose liability on shareholders.
Even assuming, for argument's sake, that the Pennsylvania
Supreme Court would consider the merits of the corporate
veil doctrine here, we think that, given the pleadings, the
court would not disregard Walnut's corporate form and
would not find the alleged injury to the Debtors to be
illusory.

In Pennsylvania, "courts will disregard the corporate
entity only in limited circumstances when [the form is] used
to defeat public convenience, justify wrong, protect fraud or
defend crime." Kiehl, 535 A.2d at 574. This is a stringent
inquiry. "[C]ourt[s] must start from the general rule that the
corporate entity should be recognized and upheld, unless
specific, unusual circumstances call for an exception. . . .
Care should be taken on all occasions to avoid making the
entire theory of the corporate entity useless." Wedner v.
Unemployment Compensation Bd. of Review, 296 A.2d 792,
795 (Pa. 1972) (quoting Zubik v. Zubik, 384 F.2d 267, 273
(3d Cir. 1967)) (internal quotations omitted).

The narrow circumstances in which Pennsylvania courts
will disregard the corporate form are demonstrated by the
number of cases, outside traditional attempts to impose
liability on shareholders, that reject such arguments. See,
e.g., Kiehl, 535 A.2d at 574-75 (refusing to disregard the
corporate form between parents and subsidiaries when
applying workmen's compensation laws); Wedner , 296 A.2d
at 794-96 (reversing the determination of a board of
unemployment compensation to ignore the corporate form
to deny benefits to an employee shareholder); Shared
Communications Servs. of 1800-80 JFK Boulevard, Inc. v.
Bell Atlantic Props., Inc., 692 A.2d 570, 573-74 (Pa. Super.
Ct. 1997) (refusing, on a common law conspiracy claim, to
ignore the legal corporate form between parents and wholly
owned subsidiaries).

We conclude, on the allegations presented here, that the
circumstances for ignoring Walnut's corporate form do not
exist with certainty. Although the Committee alleged in the
Amended Complaint that the Shapiro family had made
misrepresentations through Walnut, it did not allege that
Walnut was a fictional or sham corporation. Cf. Feltman,
122 B.R. at 473-74 (concluding that a deepening insolvency

                               18
injury was illusory because the debtor corporations were
fictitious with no corporate identity separate from their sole
shareholder). The Committee merely identified Walnut as
an equipment leasing company, with no indication that
Walnut's business activities, apart from its debt certificates,
were anything but legitimate and real. Moreover, the record
does not support a finding that corporate formalities were
ignored. Although the Shapiros used Walnut to commit a
fraud, the Committee has not alleged that Walnut lacked a
corporate identity separate from the Shapiro family.

Thus, accepting all of the Committee's allegations as true
and reading them in the light most favorable to the
Committee, we cannot state with certainty that Walnut's
corporate existence should be disregarded such that any
deepening insolvency injury was illusory. See Weston v.
Commw. of Pennsylvania, 251 F.3d 420, 425 (3d Cir. 2001)
("We will affirm a dismissal only if it appears certain that a
plaintiff will be unable to support his claim."). We therefore
agree with the District Court that the possibility of a
distinct and separate injury to the Debtors cannot be ruled
out at the motion to dismiss stage.

Up until this point in our analysis of standing, we have
spoken only in terms of the Committee's state law claims
under Pennsylvania law. With regard to the Committee's
single federal securities claim, we are confident that the
principles we have elucidated are so well accepted that the
analysis of that claim is the same. That is, insofar as
alleged securities misrepresentations induced the Debtors
to incur excessive debt which damaged corporate property,
we think that the claim belongs to the Debtors, not to the
creditors. Cf. Caplin, 406 U.S. at 434. Furthermore, for the
reasons noted earlier, we believe "deepening insolvency" is
generally a valid theory for federal law claims. See Schacht,
711 F.2d at 1350.

Thus, because the Committee properly asserts the claims
of the Debtors, rather than the creditors, and because we
recognize deepening insolvency as a valid theory giving rise
to a claim under Pennsylvania law, we hold that the District
Court did not err in concluding that the Committee had
standing to bring the Debtors' claims against Lafferty.

                               19
IV.

Having determined that the Committee has standing to
bring the Debtors' claims, we now address Lafferty's
assertion of the doctrine of in pari delicto as an affirmative
defense against those claims. The doctrine of in pari delicto
provides that a plaintiff may not assert a claim against a
defendant if the plaintiff bears fault for the claim. See Feld
and Sons, Inc. v. Pechner, Dorfman, Wolfee, Rounick and
Cabot, 458 A.2d 545, 548-49 (Pa. Super. Ct. 1983); see also
American Trade Partners, L.P. v. A-1 International Importing
Enterprises, Ltd., 770 F. Supp. 273, 276 (E.D. Pa. 1991)
(under the in pari delicto doctrine, "a party is barred from
recovering damages if his losses are substantially caused
by activities the law forbade him to engage in"). Under
Pennsylvania law (as well as federal law), in pari delicto is
a doctrine of equity. See Peyton v. Margiotti , 156 A.2d 865,
868 (Pa. 1959); Reynolds v. Boland, 52 A. 19, 21 (Pa. 1902).
More generally, the broad idea captured by the doctrine
may involve a number of different defenses, depending on
whether a contract, tort, or other claim is asserted. We
nevertheless can legitimately speak of one doctrine, in pari
delicto, across the different claims because the analysis
under the various causes of action will typically be the
same. Judge Posner made this point in Cenco, Inc. v.
Seidman & Seidman:

       The challenged [jury] instructions relate to the question
       whether Seidman was entitled to use the wrongdoing of
       Cenco's managers as a defense against the charges of
       breach of contract, negligence, and fraud [which] when
       committed by auditors, are a single form of wrongdoing
       under different names. . . . Because these theories of
       auditors' misconduct are so alike, the defenses based
       on misconduct of the audited firm or its employees are
       also alike, though verbalized differently. A breach of
       contract is excused if the promisee's hindrance or
       failure to cooperate prevented the promisor from
       performing the contract. The corresponding defense in
       the case of negligence is, of course, contributory
       negligence. . . . [And, in the fraud context, a]
       participant in a fraud cannot also be a victim entitled
       to recover damages, for he cannot have relied on the

                               20
       truth of the fraudulent representations, and such
       reliance is an essential element in a case of fraud.

686 F.2d 449, 453-54 (7th Cir. 1982) (citation omitted).

Whether the in pari delicto doctrine applies here depends
on whether the Shapiro family's conduct can be imputed to
the Debtors and hence to the Committee, which, under
bankruptcy law, stands in the shoes of the Debtors.
Imputation refers to the attribution of one person's
wrongdoing to another person. For example, in the present
case, the rules of imputation determine whether or not the
Debtors will be deemed to have participated in wrongdoing
because of the acts of the Debtors' management. If
wrongdoing is imputed, then the in pari delicto doctrine
comes into play and bars a suit.

In the present case, the District Court imputed the
Shapiro family's wrongdoing to the Debtors and held that
the Committee, standing in the shoes of the Debtors, was
barred from bringing claims under the doctrine of in pari
delicto. On appeal, the Committee argues that the District
Court erred in discounting the Committee's status as an
innocent successor when applying the in pari delicto
defense. For support, the Committee relies primarily on In
re: Jack Greenberg, Inc., 240 B.R. 486 (Bankr. E.D. Pa.
1999). The crux of its argument is that, under Pennsylvania
law, courts may disallow the in pari delicto defense when its
invocation would produce an inequitable result. See id. at
504. According to the Committee, the fact of bankruptcy
and the resulting removal of the Shapiro family and their
co-conspirators from management prevents bad actors from
benefitting from a recovery to the Debtors. Because only
innocent creditors would now benefit from this suit, the
Committee argues that the imputation of the Shapiro
family's wrongdoing to the Debtors and the consequent
application of the in pari delicto doctrine are unwarranted.

The Committee's argument requires us to resolve two
related questions. First, we must decide whether, when
evaluating a claim brought by a bankruptcy trustee, a court
of law may consider post-petition events that may affect an
equitable defense, such as in pari delicto. Second, we must
decide whether, in light of our answer to the first question,

                               21
the Shapiro family's conduct should in fact be imputed to
the Debtors such that the doctrine of in pari delicto bars
the Committee's claims.

A.

The first question is whether post-petition events may be
considered when evaluating a claim in bankruptcy. At the
outset, we note that the application of the in pari delicto
doctrine is affected by the rules governing bankruptcies.
The bankruptcy trustee -- or in this case the Committee --
is the representative of the bankruptcy estate. See 11
U.S.C. S 323(a); In re Mediators, Inc., 105 F.3d 822, 826 (2d
Cir. 1997) (suggesting that, when a committee bring claims
on behalf of a debtor, it takes on the characteristics of a
trustee). Therefore, in this case, the bankruptcy laws
authorize the Committee to "commence and prosecute any
action or proceeding in behalf of the estate before any
tribunal." Fed. R. Bankr. P. 6009; cf. 11 U.S.C. SS 1207,
1306. "Such actions . . . fall into two categories: (1) those
brought by the trustee as successor to the debtor's interest
included in the estate under Section 541, and (2) those
brought under one or more of the trustee's avoiding
powers." 3 Collier on Bankruptcy P 323.03[2] (15th rev. ed.
2001). The trustee's "avoiding" powers are not implicated
here, as they relate to the trustee's power to resist pre-
bankruptcy transfers of property.

Instead, the Committee brings claims against Lafferty as
a successor to Walnut and ELCOA's interest. Section 541
covers such claims. Under section 541, the bankruptcy
estate includes "all legal or equitable interests of the debtor
in property as of the commencement" of bankruptcy. 11
U.S.C. S 541(a) (emphasis added); see also O'Dowd v.
Trueger, 233 F.3d 197, 202 (3d Cir. 2000). These legal and
equitable interests include causes of action. 3 Collier on
Bankruptcy P 323.02[1]; accord O'Dowd, 233 F.3d at 202-
03. Given these provisions, we have held that "in actions
brought by the trustee as successor to the debtor's interest
under section 541, the `trustee stands in the shoes of the
debtor and can only assert those causes of action
possessed by the debtor. [Conversely,] [t]he trustee is, of
course, subject to the same defenses as could have been

                                22
asserted by the defendant had the action been instituted by
the debtor.' " Hays & Co. v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 885 F.2d 1149, 1154 (3d Cir. 1989) (quoting
Collier on Bankruptcy P 323.02[4]).

As these authorities demonstrate, the explicit language of
section 541 directs courts to evaluate defenses as they
existed at the commencement of the bankruptcy. This
direction is entirely consistent with the legislative history.
The Senate Report to the Bankruptcy Reform Act of 1978
made clear that the appropriate frame of reference for
section 541 is the state of the debtor as of the
commencement of the bankruptcy:

       Though [section 541] will include choses in action and
       claims by the debtor against others, it is not intended
       to expand the debtor's rights against others more than
       they exist at the commencement of the case. For
       example, if the debtor has a claim that is barred at the
       time of the commencement of the case by the statute
       of limitations, then the trustee would not be able to
       pursue that claim, because he too would be barred. He
       could take no greater rights than the debtor himself
       had.

S. Rep. No. 95-989, at 82 (1978), reprinted in 1978
U.S.C.C.A.N. 5787, 5868 (capitals in the original omitted).
The House Report contains identical language. See H.R.
Rep. No. 95-595, at 367-68 (1977), reprinted in 1978
U.S.C.C.A.N. 5963, 6323.

The answer to our first question should now be apparent.
The Committee asks us to consider post-petition events,
namely, the removal of the Shapiro family and their co-
conspirators from the Debtors' management, as well as the
Committee's status as an innocent successor, when
weighing the equities of the in pari delicto defense. The
plain language of section 541, however, prevents courts
from taking into account events that occur after the
commencement of the bankruptcy case. As a result, we
must evaluate the in pari delicto defense without regard to
whether the Committee is an innocent successor. See Bank
of Marin v. England, 385 U.S. 99, 101 (1966) ("The trustee
succeeds only to such rights as the bankrupt possessed;

                               23
and the trustee is subject to all claims and defenses which
might have been asserted against the bankruptcy but for
the filing of the petition."); Integrated Solutions, Inc. v. Serv.
Support Specialties, Inc., 124 F.3d 487, 495 (3d Cir. 1997)
(stating that it is a "fundamental principle that the estate
succeeds only to the nature and the rights of the property
interest that the debtor possessed pre-petition").

We thus agree with the analysis of the Tenth Circuit in In
re: Hedged-Investments Assocs., Inc., 84 F.3d 1281 (10th
Cir. 1996), which employed section 541 in applying the in
pari delicto doctrine to bar a bankruptcy trustee's suit
against a third-party. In Hedged-Investments, an individual
ran a Ponzi scheme through a solely owned corporation and
three limited partnerships. After the scheme collapsed, the
corporation and the partnerships went into bankruptcy. A
bankruptcy trustee was appointed over the four entities,
and the trustee subsequently brought suit on behalf of the
debtors against third-party investors who had profited from
the Ponzi scheme. See id. at 1282. The district court
applied the in pari delicto defense and dismissed the suit.
See id.

The trustee argued before the Tenth Circuit, as the
Committee does here, that his status as a bankruptcy
trustee prevented the application of the in pari delicto
defense. In support, he cited Scholes v. Lehmann , a case in
which the Seventh Circuit refused to apply the defense to
bar a receiver from bringing fraudulent conveyance actions
on behalf of the debtor corporations against third-parties
and others who had received funds from the corporations.
See 56 F.3d at 754-55. The Scholes court's holding rested
on the rationale that the appointment of the innocent
receiver had removed the wrongdoer from the scene and
changed the equities such that the in pari delicto doctrine
"los[t] its sting." Id. (citations omitted).

The Tenth Circuit rejected the trustee's argument and
held that the trustee could not bring suit against the third-
party investors because "one who has himself participated
in a violation of law cannot be permitted to assert . . . any
right founded upon . . . the illegal transaction." Hedged-
Investments, 84 F.3d at 1284 (internal quotations and
citations omitted). It reasoned that, while the Seventh

                               24
Circuit's reasoning in Scholes might be preferable from a
public policy perspective, it did not comport with the plain
language of section 541, which explicitly provided that the
bankruptcy estate "is comprised of . . . all legal or equitable
interests of the debtor in property as of the commencement
of the case." Id. at 1285. The court explained the
significance of that language:

       We emphasize [that] S 541(a)(1) limits estate property to
       the debtor's interests "as of the commencement of the
       case." This phrase places both temporal and qualitative
       limitations on the reach of the bankruptcy estate. In a
       temporal sense, it establishes a clear-cut date after
       which property acquired by the debtor will normally
       not become property of the bankruptcy estate. In a
       qualitative sense, the phrase establishes the estate's
       rights as no stronger than they were when actually
       held by the debtor. Congress intended the trustee to
       stand in the shoes of the debtor and "take no greater
       rights than the debtor himself had." Therefore, to the
       extent [that the trustee] must rely on 11 U.S.C. S 541
       for his standing in this case, he may not use his status
       as trustee to insulate the partnership from . . .
       wrongdoing . . .

        . . . .

       Neither the text of the [Bankruptcy] Code nor its
       legislative history suggests any exceptions to the
       principle that the strength of an estate's cause of
       action is measured by how it stood "as of
       commencement of the case."

Id. at 1285-86 (citations omitted).

We note that the Tenth Circuit is not alone. Both the
Second and Sixth Circuits have also applied the in pari
delicto doctrine to bar claims of a bankruptcy trustee,
standing in the shoes of a debtor, against third-parties,
without regard to the trustee's status as an innocent
successor. See Dublin Secs., 133 F.3d at 380 (applying Ohio
law); Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093-
94 (2d Cir. 1995) (applying Connecticut law); Shearson
Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir.
1991) (applying New York law); see also The Mediators, 105

                               25
F.3d at 825-27 (summarizing Hirsch and Wagoner and
applying New York law to find that a bankruptcy trustee
has no standing to assert claims against third-parties for
cooperating in the very misconduct that the debtor had
initiated). Our research reveals no courts that hold
otherwise in the bankruptcy context.

We certainly acknowledge that, in the receivership
context, several courts have declined to apply in pari delicto
to bar the receiver from asserting the claims of an insolvent
corporation on the ground that application of the doctrine
to an innocent successor would be inequitable. These
courts have thought it proper to consider events arising
after a corporation enters into receivership. See, e.g., FDIC
v. O'Melveny & Myers, 61 F.3d 17, 19 (9th Cir. 1995)
("While a party may itself be denied a right or defense on
account of its misdeeds, there is little reason to impose the
same punishment on . . . [an] innocent entity that steps
into the party's shoes pursuant to court order or operation
of law."); Scholes, 56 F.3d at 754 (stating that "the defense
of in pari delicto loses its sting when the person who is in
pari delicto is eliminated"). These cases are easily
distinguishable, however; unlike bankruptcy trustees,
receivers are not subject to the limits of section 541.

B.

The second question we must answer is whether, viewing
the Committee as if it had brought its claims as of the
commencement of the bankruptcy, as section 541
commands, the Shapiro family's conduct should, in fact, be
imputed to the Debtors such that the doctrine of in pari
delicto bars the Committee's claims. While bankruptcy law
mandates that the trustee step into the shoes of the debtor
when asserting causes of action, state law generally
provides the substantive law governing imputation for state
law claims. See O'Melveny & Myers v. FDIC, 512 U.S. 79,
84, 85, 87-89 (1994) (holding, in the FDIC receivership
context, that, without an "explicit federal statutory
provision" or special federal interest, state law"governs the
imputation of knowledge to corporate victims of alleged
negligence").

                                26
Under the law of imputation, courts impute the fraud of
an officer to a corporation when the officer commits the
fraud (1) in the course of his employment, and (2) for the
benefit of the corporation. See Waslow v. Grant Thornton (In
re Jack Greenberg, Inc.), 212 B.R. 76, 83 (Bankr. E.D. Pa.
1997) (citing Rochez Bros., Inc. v. Rhoades, 527 F.2d 880,
884 (3d Cir. 1975), and deriving a federal rule that is
consistent with Pennsylvania law); see also Nat'l Bank of
Shamokin v. Waynseboro Knitting Co., 172 A. 131, 134 (Pa.
1934) (describing Pennsylvania agency law).

The allegations in the Amended Complaint leave no doubt
that the first part of the imputation test is satisfied -- the
fraud allegedly perpetrated by the Shapiro family took place
in the course of their employment for the Debtors. As the
District Court explained:

       William Shapiro is the sole shareholder of Walnut
       Associates, Inc, which in turn owns debtor Walnut,
       which owns debtor ELCOA. William Shapiro is
       president and a director of the debtors. Kenneth
       Shapiro is debtors' vice-president and a director.
       Defendants Walnut Associates, William Shapiro, P.C.,
       Welco, Financial Data, and Kenner Collection Agency,
       which are owned by William Shapiro, are alleged to
       have played a role in the fraudulent certificate
       offerings. The debtor corporations are alleged to have
       been part of the Shapiro Organization -- i.e. , owned
       and controlled by the Shapiros.

Official Committee of Unsecured Creditors, No. 99-526, slip.
op. at 10 (citations omitted). The Committee's central
allegation, that the Shapiros "were able to perpetuate their
fraudulent scheme for years through the assistance of
several `affiliated' companies, including Walnut[and]
ELCOA," demonstrates the relationship described by the
District Court.

The second part of the imputation test -- whether
fraudulent conduct was perpetrated for the benefit of the
debtor corporation -- is often analyzed under the"adverse
interest exception." Under this exception, fraudulent
conduct will not be imputed if the officer's interests were
adverse to the corporation and "not for the benefit of the

                               27
corporation." See Waslow, 212 B.R. at 84 (citing Resolution
Trust Corp. v. Farmer, 865 F. Supp. 1143, 1155-56 (E.D.
Pa. 1994)); see also Solomon v. Gibson, 615 A.2d 367 (Pa.
Super. Ct. 1992) (same).

The Committee argues that the Shapiro family's fraud
was adverse to the interests of the Debtors, and indeed,
caused damage to them through "deepening insolvency."
Thus, the Committee maintains that the Shapiros did not
act for the benefit of the Debtors and their fraudulent
conduct cannot be imputed to those corporations. However,
even assuming that the Shapiros' interests were adverse to
the Debtors' interests, the Committee cannot prevail
because the "adverse interest exception" is itself subject to
an exception -- the "sole actor" exception. The general
principle of the "sole actor" exception provides that, if an
agent is the sole representative of a principal, then that
agent's fraudulent conduct is imputable to the principal
regardless of whether the agent's conduct was adverse to
the principal's interests. See Waslow, 212 B.R. at 86. The
rationale for this rule is that the sole agent has no one to
whom he can impart his knowledge, or from whom he can
conceal it, and that the corporation must bear the
responsibility for allowing an agent to act without
accountability. See id. (citing First National Bank of Cicero
v. Lewco Secs. Corp., 860 F.2d 1407, 1417-18 (7th Cir.
1988) and William M. Fletcher et al., Fletcher Cyclopedia of
the Law of Private Corporations S 827.10, at 160 (perm. ed.
rev. vol. 1994)). Pennsylvania has recognized the"sole
actor" exception. See Gordon v. Continental Cas. Co., 181 A.
574, 577 (Pa. 1935).

The "sole actor" exception has been applied to cases in
which the agent who committed the fraud was also the sole
shareholder of the corporation. See, e.g., In re Mediators,
105 F.3d at 827. Courts have additionally applied the
exception to cases in which the agent "dominated" the
corporation. See, e.g., PNC Bank v. Hous. Mortgage Corp.,
899 F. Supp. 1399, 1405-06 (W.D. Pa. 1994) (dismissing
corporation's claims against accountants because sole
shareholders and officers of corporation participated in
alleged fraud).

                               28
In the present case, the Shapiros clearly dominated
Walnut and ELCOA. They were the sole representatives in
the alleged fraud with Lafferty. Additionally, William
Shapiro was the sole shareholder. And, according to the
Amended Complaint, the Shapiros dominated the
ownership and control of Walnut and ELCOA. Thus, the
"sole actor" exception applies. Further, we reject the
Committee's argument that the exception should not apply
because several of the Debtors' directors merely acted
negligently and did not perpetrate the fraud. The possible
existence of any innocent independent directors does not
alter the fact that the Shapiros controlled and dominated
the Debtors. See Vail Nat'l Bank v. Finkelman , 800 P.2d
1342, 1345 (Colo. Ct. App. 1990) (acknowledging that
domination justifies invocation of the "sole actor"
exception); FDIC v. Nat'l Surety Corp., 281 N.W.2d 816, 821
(Iowa 1979) (doctrine applies to board of directors or
corporation subject to agent's control).

In sum, we will impute the fraudulent conduct of the
Shapiros to the Debtors because the Shapiros perpetrated
the alleged fraud in the course of their employment, and
because, although the Shapiros may have acted adversely
to the interests of the Debtors, they were the sole actors
engaged in the alleged fraudulent conduct. Viewing the
claim as of the commencement of bankruptcy, we find that
the in pari delicto doctrine bars the Committee, standing in
the shoes of the Debtors, from bringing its claims against
Lafferty.

V.

For the reasons stated, we will affirm the judgment of the
District Court.

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COWEN, Circuit Judge, dissenting:

In this case we confront a regrettably common scenario.
Using a type of Ponzi scheme, William and Kenneth Shapiro
along with others fraudulently induced the appellant to
invest in the Shapiros' companies long past the point where
those companies could repay the funds. In the ensuing
bankruptcy, the appellant formed a creditors' committee
and, acting as the equivalent of a bankruptcy trustee,
sought to recover some of its losses by pursuing claims that
the debtor corporations have against various professionals,
such as accountants and underwriters, who allegedly
facilitated the Shapiros' fraud. The majority holds that
these creditors -- and indeed any creditors in a case like
this -- are barred from obtaining relief in bankruptcy from
the professionals. I believe the majority's reasoning rests on
a mistaken interpretation of the bankruptcy code,
needlessly thwarts recovery for innocent creditors, and
insulates from civil liability those who help perpetrate
fraud. Under the majority's reasoning, no matter how
egregious the conduct is of a professional who facilitated a
fraudulent sale of securities, creditors cannot recover from
that professional in the likely event that the corporation
winds up in bankruptcy.

Despite my disagreement with the outcome reached by
the majority, I agree with much of the majority's reasoning.
In particular, I agree with the majority that the creditors'
committee has standing to sue. The creditors' committee
received an assignment of the debtor corporations' claims,
and it is well settled that an "assignee of a claim has
standing to assert the injury in fact suffered by the
assignor." Vermont Agency of Natural Resources v. United
States ex rel. Stevens, 529 U.S. 765, 774, 120 S.Ct. 1858,
1863 (2000). The question then reverts to whether the
debtor corporations have standing. As the majority points
out, a corporation has a distinct legal existence from its
officers and owners, and economic losses wrongfully
suffered by a corporation are sufficient injuries to confer
standing. See, e.g., Barlow v. Collins , 397 U.S. 159, 90
S.Ct. 832 (1970); Hardin v. Kentucky Utils. Co. , 390 U.S. 1,
88 S.Ct. 651 (1968); FCC v. Sanders Bros. Radio Station,
309 U.S. 470, 60 S.Ct. 693 (1940). The only reason to

                               30
suppose that a corporation lacks standing in a case like
this one is that there is an allegedly valid affirmative
defense available against the corporation's claims. But as a
general matter, the ultimate merits of an affirmative
defense do not raise questions about a plaintiff 's standing,
or else the moment the court was poised to rule in favor of
the defendant on the affirmative defense, the court would
lose jurisdiction and there would be no binding judgment.
Moreover, as I explain below, I think the defense fails in
this case.

Like the majority, I agree that in evaluating the
affirmative defense at issue here -- the in pari delicto
doctrine -- we apply state law for the plaintiffs' state causes
of action, see O'Melveny & Meyers v. FDIC, 512 U.S. 79,
83-85, 114 S.Ct. 2048, 2052-53 (1994), and federal law for
federal causes of action. Id. (citing Schact v. Brown, 711
F.2d 1343, 1347 (7th Cir. 1983)). And I also agree with the
majority that, regardless of whether federal or state (in this
case Pennsylvania) law is applied, the in pari delicto
doctrine is best understood as a broad equitable principle
that encompasses a variety of different, more specific legal
rules and defenses drawn from torts, contracts, or other
areas of law depending on the underlying cause of action at
issue. See Cenco Inc. v. Seidman & Seidman, 686 F.2d 449,
453-54 (7th Cir. 1982). Broadly, the idea behind in pari
delicto is that "a plaintiff who has participated in
wrongdoing may not recover damages resulting from the
wrongdoing." Black's Law Dictionary 794 (7th ed. 1999).

Because the wrongdoers here were officers of the debtor
corporations, a special case of the in pari delicto doctrine
comes into play -- the standards covering when to impute
the acts of a corporation's officers to the corporation itself.
If those officers remain in control of the corporation or
stand to benefit from any recovery, then the officers'
conduct plainly would be imputed to the corporation. See,
e.g., Cenco, 686 F.2d at 455-56; Rochez Bros., Inc. v.
Rhoades, 527 F.2d 880, 884 (3d Cir. 1975).

But, as Judge Posner has explained, the equitable
principles underlying the doctrines of imputing misconduct
and in pari delicto lead to a different result when the
miscreant officers are removed and no wrongdoer will

                                31
receive the benefit of recovery. See Scholes v. Lehman, 56
F.3d 750, 753-55 (7th Cir. 1995) (citing McCandless v.
Furland, 296 U.S. 140, 160, 56 S.Ct. 41, 47 (1935)
(Cardozo, J.)). No longer will it be true that, as Black's
definition puts it, one "who has participated in wrongdoing
[will] . . . recover damages resulting from the wrongdoing."
Instead, allowing the corporation to impose liability on
professionals who wrongfully facilitated the fraud will both
help deter that professional misconduct and help
compensate victims who may otherwise go away empty-
handed. The Ninth Circuit has recognized this point as well
and refused to apply in pari delicto when the recovery would
not benefit the wrongdoers. FDIC v. O'Melveny & Myers, 61
F.3d 17, 18, (9th Cir. 1995). Nothing suggests that
Pennsylvania would interpret in pari delicto and the rules of
imputation differently than the Seventh and Ninth Circuits
have.

As I understand the majority, they accept that if the
wrongdoers within a corporation are removed and the
benefit of the recovery will ultimately help victims of the
fraud, then the corporation can proceed with its claims.
The reason the majority concludes nevertheless that the
creditors' committee is barred from recovery is that at the
moment the bankruptcy petition was filed, the majority
maintains that the wrongdoers had not actually been
removed yet. The majority's argument tracks a Tenth
Circuit decision, In re Hedge-Investments Assoc., Inc., 84
F.3d 1281 (10th Cir. 196). That case refused to follow
Scholes and the Ninth Circuit's decision in O'Melveny,
which both involved receiverships, because the Tenth
Circuit thought that a contrary result was compelled by a
provision in the bankruptcy code, 11 U.S.C. S 541(a). The
court explained that under S 541(a) the debtor's estate is
formed at the time the bankruptcy petition is filed. Since
the bad corporate officers were only removed post-petition,
the court reasoned that S 541(a) dictates that the removal
cannot be considered. That is, because the officers were
still in control at the moment the petition was filed, in pari
delicto still erected a bar at that moment. 84 F.3d at 1285.

There are a number of problems with this reasoning. The
first and most obvious is that, whatever the inflexibility is

                               32
of the bankruptcy code, an equitable doctrine like in pari
delicto is highly sensitive to the facts and readily adapted to
achieve equitable results. What is sufficient to satisfy the
doctrine, in other words, need not be parsed like a statute.
Even if we assume that we can look no further than the
filing of the bankruptcy petition, it can scarcely be denied
that as soon as the Shapiros' companies were placed in
bankruptcy, the Shapiros lost any ability to benefit further
from their Ponzi scheme. The bankruptcy court would not
have allowed itself to become an instrument of their fraud.
Some time, of course, would elapse before the full process
of bankruptcy proceedings took their course, but there is
nothing in the equitable doctrine of in pari delicto that
insists those formalities must be completed before the
doctrine is triggered.

The point of equitable doctrines is to avoid injustice
caused by overly inflexible rules: equity is "[t]he recourse to
principles of justice to correct or supplement the law as
applied to particular circumstances." Black's Law
Dictionary 560 (7th ed. 1999). Here the majority injects a
pointless technicality into an equitable doctrine. For
example, one court has distinguished the Tenth Circuit's
decision that the majority follows by noting that if the
debtor corporation is placed in receivership prior to the
filing of the bankruptcy petition, there is no in pari delicto
bar on an action by the corporation. See, e.g. , Hanover
Corp. of America v. Beckner, 221 B.R. 849, 859 (M.D. La.
1997). It is difficult to understand what is accomplished by
forcing future plaintiffs to take that extra step or denying
these plaintiffs relief because they failed to take it. Equity
does not turn on that kind of empty technicality.

A second problem with the majority's reasoning is that,
while it is certainly true that a trustee (or a creditor's
committee acting as trustee) assumes the same causes of
action and is subject to the same defenses as the debtor,
see Bank of Marin v. England, 385 U.S. 99, 101, 87 S.Ct.
274, 276 (1966); Integrated Solutions, Inc. v. Serv. Support
Specialities, Inc., 124 F.3d 487, 495 (3d Cir. 1997), that
rule does not mandate that in evaluating a trustee's claims
on behalf of an estate, post-petition events can never be
considered. Segal v. Rochell, 382 U.S. 375, 86 S.Ct. 511

                               33
(1966). The rule that the trustee must be restricted to the
debtor's causes of action and is subject to the same
defenses as the debtor does not mandate that post-petition
events are never considered in evaluating those causes of
action and defenses inherited by the trustee.

In Segal, the question before the Court was whether a
trustee could claim as property of the estate a tax loss-
carryback refund for a taxable year that ended post-
petition. Significantly, even though under the Internal
Revenue Code the refund could not be claimed until the
end of the taxable year, which occurred after the petition
date, the Supreme Court agreed with the trustee that the
refund was property of the estate. The refund was
"sufficiently rooted in the pre-bankruptcy past and so little
entangled with the bankrupt's ability to make an
unencumbered fresh start that it should be regarded as
"property." 382 U.S. at 380, 86 S.Ct. at 514.

So too in this case the losses suffered by the debtor
corporation all took place before the bankruptcy and the
only obstacle to the corporations' recovery is the removal of
the Shapiros, an event as inevitable as that completion of
the taxable year in Segal. More important, since our case
involves corporations, there is no concern about the
competing fresh-start policy for individuals that the
Supreme Court had to weigh in Segal. Corporations do not
get fresh starts.

One last point is worth noting parenthetically. Under the
majority's logic, the claims brought by the creditors'
committee against the Shapiros themselves and other
corporate insiders should be barred as well as the claims
against the outside professionals. After all, the corporations
and the insiders were as much in pari delicto as the
corporation and the outside professionals. The District
Court did not dismiss the claims against the insiders, but
inexplicably failed to explain why those creditors' claims,
which apparently were also on behalf of the corporation,
were not subject to the same reasoning that the court
applied in dismissing the claims against Lafferty. Although
the claims against the insiders are not properly before us,
having been severed below to create a final judgment, it is

                               34
especially disturbing that the majority's reasoning applies
with equal force to them.

In short, the majority's position retards the normal goals
of tort law, misinterprets equitable doctrine, and reads the
bankruptcy code too narrowly. I dissent.

A True Copy:
Teste:

       Clerk of the United States Court of Appeals
       for the Third Circuit

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