Merrimack College v. KPMG LLP , 480 Mass. 614 ( 2018 )

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SJC-12434
MERRIMACK COLLEGE vs. KPMG LLP.
Suffolk. May 8, 2018. - September 27, 2018.
Present: Gants, C.J., Lenk, Gaziano, Lowy, Budd, & Cypher, JJ.
Agency, Agent's knowledge. Practice, Civil, Answer, Amendment,
Affirmative defense.
Civil action commenced in the Superior Court Department on
June 30, 2014.
A motion for leave to file an amended answer was heard by
Kenneth W. Salinger, J., and the case was heard by him on a
motion for summary judgment.
The Supreme Judicial Court granted an application for
direct appellate review.
Elizabeth N. Mulvey for the plaintiff.
Ian D. Roffman (George A. Salter also present) for the
defendant.
The following submitted briefs for amici curiae:
Matthew P. Bosher, of the District of Columbia, & Elbert
Lin for American Institute of Certified Public Accountants &
another.
Susan M. Whalen for Chelsea Housing Authority.
Jeffrey J. Nolan for Massachusetts Academy of Trial
Attorneys.
2
GANTS, C.J. "The doctrine of in pari delicto bars a
plaintiff who has participated in wrongdoing from recovering
damages for loss resulting from the wrongdoing." Choquette v.
Isacoff, 65 Mass. App. Ct. 1, 3 (2005). The main issue
presented in this civil case is whether, where the plaintiff is
an organization acting through its agents, we should follow the
traditional principles of agency law and impute the wrongdoing
of those agents to the plaintiff organization when determining
whether it should be barred from recovery under the in pari
delicto doctrine. We hold that, for purposes of measuring fault
under the in pari delicto doctrine, we impute only the conduct
of senior management to the plaintiff organization. Because the
judge here granted summary judgment to the defendant under the
in pari delicto doctrine after imputing to the plaintiff college
the wrongdoing of an employee who was not a member of senior
management, we vacate the order allowing summary judgment and
remand the case to the Superior Court.1
Background. Merrimack College (Merrimack) is a small
private college incorporated under the laws of Massachusetts.
From 1998 to 2004, Merrimack engaged KPMG LLP (KPMG), a large
multinational accounting firm, as its independent auditor.
1 We acknowledge the amicus briefs submitted by the American
Institute of Certified Public Accountants and the Massachusetts
Society of Certified Public Accountants, by the Chelsea Housing
Authority, and by the Massachusetts Academy of Trial Attorneys.
3
Pursuant to this engagement, KPMG conducted annual audits of
Merrimack's financial statements. Because Merrimack received
substantial Federal funds in the form of student financial aid,
KPMG also conducted audits pursuant to the United States Office
of Management and Budget Circular A-133 (A-133 audits) to
evaluate Merrimack's compliance with relevant Federal
requirements.
In conducting these audits, KPMG reviewed the operations of
Merrimack's financial aid office, which was responsible for
administering various grant and loan programs, including Federal
programs such as the Perkins Loan Program.2 On several occasions
KPMG noted issues with the financial aid office, including
delayed reconciliations, discrepancies between loan amounts
recorded in the billing system and loan amounts recorded on the
ledger, and Perkins loans disbursed without the required
promissory notes. KPMG also noted a lack of formal policies and
procedures relating to the disbursement of grants and loans.
KPMG reported these issues to Merrimack's management and to its
2 The Perkins Loan Program is "designed to assist
institutions of higher education in financing low-interest loans
to financially needy students." De La Mota v. United States
Dep't of Educ., 412 F.3d 71, 74 (2d Cir. 2005). See 20 U.S.C.
§ 1070 (2012). Under this program, the United States Department
of Education provides Federal funds to participating schools,
who in turn make additional capital contributions and disburse
the combined funds as loans to eligible students. The
individual schools are responsible for determining eligibility,
advancing funds, and collecting payments. See De La Mota,
supra.
4
board of trustees. However, for every fiscal year between 1998
and 2004, KPMG issued an unqualified opinion that Merrimack's
financial statements were free from material misrepresentation
and also issued an opinion, based on its A-133 audits, that
Merrimack was in material compliance with Federal program
requirements.
What KPMG's audits failed to reveal was that, during this
time period, Merrimack's financial aid director, Christine
Mordach, was engaged in a fraudulent scheme whereby she
regularly replaced grants and scholarships that had previously
been awarded to students with Perkins loans, often without the
students' knowledge or consent and in some cases creating false
paperwork with false names and false Social Security numbers.
One consequence of Mordach's fraud was that it made the
financial aid office's budget appear more balanced, because
grants and scholarships reduce tuition revenue, whereas Perkins
loans, because they are expected to be repaid in the future, are
recorded as an asset on Merrimack's balance sheet. Another
consequence of her fraud was that many students ended up
shouldering student debt they had not sought and did not even
know they had. Mordach did not tell anyone else at Merrimack
that she was issuing fraudulent loans.
Mordach's fraud went undetected until 2011, when Merrimack
instituted a new system for keeping track of its student
5
borrowers and many students started to receive billing
statements for Perkins loans they never knew they had. As the
number of complaints increased, Merrimack hired a forensic
accounting team, unrelated to KPMG, to investigate the financial
aid office. This investigation revealed more than 1,200
"irregular" student loans that were either invalid or
potentially uncollectible because of Mordach's activities.
In 2014, Mordach pleaded guilty to Federal criminal charges
of mail and wire fraud. She was sentenced to a term in prison
and ordered to pay over $1.5 million in restitution to former
Merrimack students. However, her motivation for committing this
fraud remains unclear. No one at Merrimack ever told Mordach to
issue loans to students without the students' consent. Mordach
did not profit financially from her fraud; in fact, in order to
avoid detection she sometimes used her own funds to pay back the
fraudulent loans. There was evidence that, at least in the
short run, until the fraud was detected, the fraud benefited
Merrimack in that it enabled Merrimack to present a more
favorable view of its financial position in connection with bond
issues and bond ratings. But there was also evidence that
Mordach devised the fraudulent scheme in order to keep her job,
because she was under pressure to balance the financial aid
office's budget, had nearly been fired in 1990 for her poor
6
performance, and continued to have performance issues that
caused Merrimack to place her on probation in 2003.
Once Mordach's activities were discovered, Merrimack wrote
off the fraudulent loans and repaid students who had already
made payments on them. According to Merrimack, the total cost
of these write-offs and repayments, along with investigation and
administrative fees, amounted to more than $6 million.
In an effort to recover some of these losses, Merrimack
commenced an action against KPMG in the Superior Court, alleging
professional malpractice, breach of contract, negligence,
negligent misrepresentation, and violation of G. L. c. 93A.
Following discovery, KPMG moved for summary judgment on four
separate grounds, arguing that Merrimack's claims were barred
under the equitable doctrine of in pari delicto, that Merrimack
had released KPMG from liability under the terms of their
agreements because its management had made false statements to
KPMG,3 that Merrimack's claims were barred by the Massachusetts
3 Pursuant to the terms of its agreements with KPMG LLP
(KPMG), Merrimack College (Merrimack) provided annual management
representation letters to KPMG. In these letters, the
president, the chief financial officer, and the controller of
Merrimack represented "to the best of [their] knowledge and
belief" that, among other things, there were no instances of
fraud involving management or employees with "significant roles
in internal control," no instances of fraud involving others
that could have "a material effect on the financial statements,"
and "no . . . [v]iolations or possible violations of laws or
regulations." Merrimack also provided representation letters in
connection with KPMG's audits conducted pursuant to the United
7
statute of limitations for auditor malpractice claims, and that
Merrimack had failed to establish a claim under c. 93A. KPMG
also filed a motion for leave to file an amended answer, seeking
to add the affirmative defense of release based on false
statements from management.
The Superior Court judge allowed KPMG's motion for summary
judgment, concluding that Merrimack's claims were barred under
the doctrine of in pari delicto. The judge's analysis proceeded
in three steps. First, the judge considered whether Mordach's
fraudulent conduct should be imputed to Merrimack. In doing so,
the judge relied on traditional principles of agency law,
concluding that "[the] same 'agency-based imputation rules' for
deciding whether an employer will be held vicariously liable for
its employee's wrongdoing" under a theory of respondeat superior
"appl[ied] with full force in this case, because they also
determine whether an employee's misconduct is imputed to the
States Office of Management and Budget Circular A-133, in which
members of Merrimack's management -- including in some years
Christine Mordach -- represented, again "to the best of [their]
knowledge and belief," that Merrimack had "complied . . . with
the requirements of laws and regulations." Separately, the
engagement letters setting forth the terms of KPMG's engagement
provided that "[Merrimack] agrees to release KPMG . . . and its
personnel from any claims . . . relating to [KPMG's] services
. . . attributable to any misrepresentations in the
representation letter [from management]." With respect to the
management representation letters not signed by Mordach, the
parties dispute whether there was any "misrepresentation," given
that the representations were only based on "knowledge and
belief." The parties also dispute whether the representation
letters signed by Mordach fall within the scope of the release.
8
employer when applying the in pari delicto doctrine" (citation
omitted). The judge then applied the familiar three-pronged
test for determining vicarious liability under a theory of
respondeat superior, concluding that, because Mordach's conduct
was "of the kind [she was] employed to perform," "occur[red]
substantially within the authorized time and space limits," and
"[was] motivated, at least in part, by a purpose to serve the
employer," it was "within the scope of [her] employment" and
should be imputed to Merrimack. Wang Lab., Inc. v. Business
Incentives, Inc., 398 Mass. 854, 859 (1986).
Second, the judge weighed the seriousness of the imputed
misconduct against KPMG's failure to detect it. Because
Merrimack had admitted to facts indicating that Mordach's
conduct was deliberate, the judge concluded that Mordach's
intentional fraud -- now imputed to Merrimack -- was "far more
serious" than KPMG's alleged negligence in failing to uncover
Mordach's fraud, and that Merrimack therefore could not recover
from KPMG under the doctrine of in pari delicto.
Third, the judge considered whether he should, on public
policy grounds, make an exception to the in pari delicto
doctrine for cases like this one, where an auditor through
alleged negligence failed to discover fraud committed by a
client's employee. The judge recognized that, because "[the in
pari delicto] doctrine is equitable in nature, considerations of
9
public policy are always relevant." But the judge declined to
make an exception, reasoning that such an exception would be
inconsistent with Massachusetts law, which, in the analogous
context of legal malpractice claims, bars clients who engaged in
wrongdoing from suing their attorneys for joining in the
wrongdoing. See Choquette, 65 Mass. App. Ct. at 7-8. The judge
also noted that the majority of courts that have considered the
issue have "declined to create a blanket 'auditor exception' to
the doctrine of in pari delicto." See, e.g., Stewart v.
Wilmington Trust SP Servs., Inc., 112 A.3d 271, 315-318 (Del.
Ch.), aff'd, 126 A.3d 1115 (Del. 2015); Kirschner v. KPMG LLP,
15 N.Y.3d 446, 476-477 (2010); Official Comm. of Unsecured
Creditors of Allegheny Health Educ. & Research Found. v.
PriceWaterhouseCoopers, LLP, 605 Pa. 269, 305 (2010).
Having concluded that Merrimack's claims were barred under
the in pari delicto doctrine, the judge dismissed the claims
with prejudice, without addressing KPMG's other grounds for
summary judgment. The judge also allowed KPMG's motion for
leave to amend its answer to add an affirmative defense of
release. Merrimack appealed from these decisions, and we
granted its application for direct appellate review.
Discussion. 1. Motion for summary judgment. We review a
grant of summary judgment de novo. See Federal Nat'l Mtge.
Ass'n v. Hendricks, 463 Mass. 635, 637 (2012). In granting
10
summary judgment to KPMG, the judge relied on two separate legal
doctrines: the agency-based doctrine of imputation, and the
equitable doctrine of in pari delicto. To determine whether
Merrimack's claims are indeed barred as a matter of law, we must
first examine these two legal doctrines and the relationship
between them.
a. Imputation. The law of agency establishes a set of
rules for determining when, in relation to third parties, an
agent's conduct or knowledge should be imputed to his or her
principal. See Restatement (Third) of Agency §§ 2.01-2.04, 5.03
(2006). For example, in transactions with third parties, an
agent's conduct will be imputed to the principal if the agent
acted with actual or apparent authority, or if the principal
ratified the agent's conduct. See Fergus v. Ross, 477 Mass.
563, 566-568 (2017). See also Restatement (Third) of Agency,
supra at §§ 2.01-2.03, 4.02. In the realm of torts, the
tortious conduct committed by an agent in the scope of his or
her agency will be imputed to the principal under a theory of
respondeat superior. See Lev v. Beverly Enters.-Mass., Inc.,
457 Mass. 234, 238 (2010). See also Restatement (Third) of
Agency, supra at § 2.04. Knowledge that an agent acquires in
the scope of his or her employment can also be imputed to the
principal. See Sunrise Props., Inc. v. Bacon, Wilson, Ratner,
Cohen, Salvage, Fialky & Fitzgerald, P.C., 425 Mass. 63, 66-67
11
(1997). See also Restatement (Third) of Agency, supra at
§ 5.03.
The result of imputation is that the principal bears the
legal consequences of the agent's conduct. Thus, if an agent
with actual or apparent authority enters into a contract with a
third party, the principal will be bound by that contract. See,
e.g., Linkage Corp. v. Trustees of Boston Univ., 425 Mass. 1, 4,
17, cert. denied, 522 U.S. 1015 (1997) (university bound by
agreement signed by vice-president where vice-president had
apparent authority). And if an agent negligently injures a
third party while acting within the scope of the agency, the
principal will be held vicariously liable for that negligence.
See, e.g., Dias v. Brigham Med. Assocs., Inc., 438 Mass. 317,
323 (2002) (corporation could be held vicariously liable for
alleged medical malpractice of its physician-employee).
Imputation serves various functions. It creates incentives
for principals to choose their agents wisely. See Restatement
(Third) of Agency, supra at § 5.03 comment b, at 360. It also
encourages principals to supervise their agents and to share
information with them. Id. The ultimate purpose behind these
rules of imputation, however, is to fairly allocate risks
between principals and innocent third parties. As we explained
in Kansallis Fin. Ltd. v. Fern, 421 Mass. 659, 664-665 (1996)
(Kansallis):
12
"Standing behind [the] diverse concepts of vicarious
liability is a principle that helps to rationalize them.
This is the principle that as between two innocent parties
-- the principal-master and the third party -- the
principal-master who for his own purposes places another in
a position to do harm to a third party should bear the
loss. A principal who requires an agent to transact his
business, and can only get that business done if third
parties deal with the agent as if with the principal,
cannot complain if the innocent third party suffers loss by
reason of the agent's act. Similarly, the master who must
put an instrument into his servant's hands in order to get
his business done . . . must also bear the loss if the
servant causes harm to a stranger in the use of that
instrument as the business is transacted." (Citations
omitted.)
See also Dias, 438 Mass. at 320 ("The doctrine of respondeat
superior in the Commonwealth . . . evolved to place the burden
of liability on the party better able to bear that burden"); GTE
Prods. Corp. v. Broadway Elec. Supply Co., 42 Mass. App. Ct.
293, 300 (1997) ("The rationale for imputing an agent's
knowledge to his principal . . . [is] to do justice to an
innocent third party . . ."); Restatement (Third) of Agency,
supra at § 5.04 comment b, at 392 ("imputation protects innocent
third parties").
Because the rules of imputation are designed to protect
innocent third parties, they are typically applied in situations
where a third party sues a principal, for example to enforce a
contract entered into by an agent or to recover for injuries
caused by the agent's tortious conduct. Imputation can also
provide a defense to a third party, for example where a
13
principal seeks to enforce a contract that a third party
executed because of the fraudulent inducement of the agent.
See, e.g., Jewett v. Carter, 132 Mass. 335, 337 (1882)
(principal cannot enforce contract that third party entered into
based on agent's false representations). See also Restatement
(Third) of Agency, supra at § 6.11 & comment c.
Importantly, the purpose of imputation is not to adjudicate
fault. As we have consistently recognized, imputing the
wrongful actions of an agent to a principal does not mean that
the principal itself has acted wrongfully. See Elias v. Unisys
Corp., 410 Mass. 479, 481 (1991) ("[T]he principles of vicarious
liability apply where . . . [t]he principal is without fault.
The liability of the principal arises simply by the operation of
law and is only derivative of the wrongful act of the agent"
[emphasis added]). See also Karcher v. Burbank, 303 Mass. 303,
305 (1939) ("if the [principal] is chargeable with the
negligence of the [agent], it is only because his negligence is
imputed to it by a rule of law"). The rules of imputation are
legal rules, not equitable principles, that are designed to
allocate risk, not blame.
b. In pari delicto. In contrast, the doctrine of in pari
delicto is an equitable one, focused squarely on the moral blame
14
of the parties. Latin for "in equal fault,"4 the doctrine
provides that a plaintiff who has participated in wrongdoing
cannot recover damages resulting from the wrongdoing. See
Black's Law Dictionary 911 (10th ed. 2014). See also Choquette,
65 Mass. App. Ct. at 3. This long-standing doctrine "is
grounded on two premises: first, that courts should not lend
their good offices to mediating disputes among wrongdoers; and
second, that denying judicial relief to an admitted wrongdoer is
an effective means of deterring illegality" (footnotes omitted).
Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299,
306 (1985) (Bateman).
In Massachusetts, the doctrine has generally operated to
bar recovery where the parties have engaged in joint wrongdoing.
Where a plaintiff engages in intentional wrongdoing and seeks to
recover from a defendant who was a coconspirator or accomplice
in the plaintiff's wrongdoing, the doctrine will generally bar
recovery. See Baena v. KPMG LLP, 453 F.3d 1, 6 (1st Cir. 2006);
Scattaretico v. Puglisi, 60 Mass. App. Ct. 138, 140 n.6 (2003)
("one in tortious league with another is generally without
remedy against the other"). See also, e.g., Duane v. Merchants
Legal Stamp Co., 231 Mass. 113, 118, 119 (1918), cert. denied,
4 The full maxim is "in pari delicto potior est conditio
defendentis," meaning "[i]n a case of equal or mutual fault
. . . the position of the [defending party] . . . is the better
one" (citation omitted). Bateman Eichler, Hill Richards, Inc.
v. Berner, 472 U.S. 299, 306 (1985).
15
249 U.S. 613 (1919) (minority shareholder who participated in
corporation's anticompetitive scheme barred from recovering
profits from that scheme); Choquette, 65 Mass. App. Ct. at 7-8
(plaintiff who committed perjury barred from recovering from
attorney who participated in perjury). Similarly, where the
parties have entered into an illegal contract, courts will
generally decline to enforce the contract. See Berman v.
Coakley, 243 Mass. 348, 350 (1923) ("courts will not aid in the
enforcement, nor afford relief against the evil consequences, of
an illegal or immoral contract"). See also, e.g., Arcidi v.
National Ass'n of Gov't Employees, Inc., 447 Mass. 616, 619-622
(2006) (plaintiff barred from recovering payment made under
contract where contract violated statute); Patterson v. Clark,
126 Mass. 531, 532-533 (1879) (plaintiff barred from recovering
payment made under illegal gambling contract); Atwood v. Fisk,
101 Mass. 363, 363-364 (1869) (plaintiff barred from seeking
cancellation of notes executed in exchange for illegal promise
to suppress prosecution).
Because the doctrine is equitable in nature, however, it is
not to be applied mechanically. "One well established exception
to the doctrine of in pari delicto provides that 'where the
parties are not in equal fault as to the illegal element . . .
and where there are elements of public policy more outraged by
the conduct of one than of the other, then relief in equity may
16
be granted to the less guilty.'" Choquette, 65 Mass. App. Ct.
at 4, quoting Council v. Cohen, 303 Mass. 348, 354 (1939). See,
e.g., Berman, 243 Mass. at 355 (plaintiff who was fraudulently
induced to enter into illegal contract by attorney could recover
from attorney, where attorney's conduct was "far more
reprehensible" than plaintiff's). See generally 1 J. Story,
Commentaries on Equity Jurisprudence § 423, at 399-400 (14th ed.
1918) ("One party may act under circumstances of oppression,
imposition, hardship, undue influence, or great inequality of
condition or age; so that his guilt may be far less in degree
than that of his associate in the offence" [footnote omitted]).
"Another exception involves 'cases where the public
interest requires that [the courts] should, for the promotion of
public policy, interpose, and the relief in such cases is given
to the public through the party.'" Choquette, 65 Mass. App. Ct.
at 4, quoting Council, 303 Mass. at 354-355. See, e.g.,
Broussard v. Melong, 322 Mass. 560, 562 (1948) (worker who
contracted to work longer hours than permitted by statute could
recover overtime wages from employer where statute was enacted
to protect workers); Council, supra (homeowner who granted
mortgage in violation of statute could recover interest paid to
mortgagee where statute was enacted to protect homeowners). See
generally Story, supra at 400 ("there may be on the part of the
court itself a necessity of supporting the public interests or
17
public policy in many cases, however reprehensible the acts of
the parties may be").
Thus, in Bateman, 472 U.S. at 301-305, the United States
Supreme Court concluded that the in pari delicto doctrine did
not bar investors who purchased securities based on inside
information (tippees) from bringing an action under Federal
securities laws against the insiders who provided them with the
information to recover their subsequent trading losses when the
inside information turned out to be false. The Court concluded
that a private action for damages may be barred under the in
pari delicto doctrine "on the grounds of the plaintiff's own
culpability only where (1) as a direct result of his own
actions, the plaintiff bears at least substantially equal
responsibility for the violations he seeks to redress, and (2)
preclusion of suit would not significantly interfere with the
effective enforcement of the securities laws and protection of
the investing public." Id. at 310-311.
As to the first element, the Court determined that a tippee
who trades on inside information is not as blameworthy as a
corporate insider or broker-dealer who discloses the inside
information for personal gain. See id. at 312-314. As to the
second, the Court determined that "denying the in pari delicto
defense in such circumstances will best promote the primary
objective of the federal securities laws -- protection of the
18
investing public and the national economy through the promotion
of 'a high standard of business ethics . . . in every facet of
the securities industry.'" Id. at 315, quoting Securities &
Exch. Comm'n v. Capital Gains Research Bur., Inc., 375 U.S. 180,
186-187 (1963). The Court reasoned that barring private actions
in these types of cases because of the in pari delicto doctrine
"would inexorably result in a number of alleged fraudulent
practices going undetected by the authorities and unremedied,"
Bateman, supra, and that allowing tippees to bring such cases
against corporate insiders and broker-dealers would maximize the
deterrence of insider trading. See id. at 316.
We note that the doctrine of in pari delicto is separate
and distinct from comparative negligence, codified in G. L.
c. 231, § 85. Under the comparative negligence statute, a
plaintiff is barred from recovery only where the plaintiff's
negligence is greater than the defendant's, meaning that it
accounts for more than fifty per cent of the parties' combined
negligence. Where the plaintiff's negligence is less than the
defendant's, the plaintiff is still allowed to recover, although
any damages awarded will be "diminished in proportion to the
amount of negligence attributable" to the plaintiff. Id. Thus,
under the comparative negligence statute, the plaintiff's
relative fault is considered only when apportioning damages and
does not necessarily preclude recovery. But the comparative
19
negligence statute does not apply where the plaintiff has
engaged in intentional wrongdoing; it applies only where the
plaintiff and defendant are both found to be negligent. See
Boyd v. National R.R. Passenger Corp., 446 Mass. 540, 548 n.11
(2006) ("The comparative negligence statute is not applicable to
intentional or wilful, wanton, or reckless conduct"). Where the
plaintiff has engaged in intentional wrongdoing, the in pari
delicto doctrine, if applicable, serves as a complete bar to
recovery.
Where the parties are individuals, application of the in
pari delicto doctrine is relatively straightforward: the moral
culpability of one party is measured against the moral
culpability of the other. Thus, a plaintiff who engages in
intentional wrongdoing is unlikely to recover from a defendant
who is alleged to be merely negligent, unless public policy
dictates otherwise. See Kirschner, 15 N.Y.3d at 464 ("A
criminal who is injured committing a crime cannot sue the police
officer or security guard who failed to stop him; the arsonist
who is singed cannot sue the fire department").
But where the parties are organizations that can act only
through their agents, as here, the task becomes more
complicated. The question then arises: how do we determine the
moral culpability of each party? If we apply the traditional
rules of imputation that determine legal responsibility with
20
respect to third parties and impute Mordach's intentional
misconduct to Merrimack, the in pari delicto doctrine may bar
recovery. But if we do not impute Mordach's intentional
misconduct to Merrimack, then the worst that can be alleged here
based on the evidence is that Merrimack was negligent in its
retention or supervision of Mordach, in which case Merrimack's
recovery will be governed by the principles of comparative
negligence, not in pari delicto.
The judge cited two cases in support of his decision to
apply traditional principles of agency law and impute Mordach's
fraudulent conduct to Merrimack. One was a decision from the
New York Court of Appeals, Kirschner, 15 N.Y.3d at 446, applying
New York law. See id. at 465 ("Traditional agency principles
play an important role in an in pari delicto analysis"). The
other was a decision from the United States Court of Appeals for
the First Circuit, Baena, 453 F.3d at 1, applying Massachusetts
law.
In Baena, the First Circuit held that the in pari delicto
doctrine barred a trustee, acting on behalf of a bankrupt
corporation, from recovering from the corporation's former
accountants for their failure to prevent the fraudulent conduct
of the corporation's senior managers. Id. at 6. In imputing
the senior managers' conduct to the corporation, the First
Circuit explicitly recognized the possibility that
21
"Massachusetts might take a narrow view of imputation in the
context of in pari delicto." Id. at 7. It also noted that
"[w]hether or not application of the in pari delicto doctrine
should depend on imputation rules borrowed from agency law is
debatable." Id. at 8. Nevertheless, absent clear guidance from
Massachusetts appellate courts, the First Circuit limited itself
to the "traditional standards" governing imputation, id. at 7,
writing: "It is not our job to make new law for Massachusetts
. . . ." Id. at 8.5
And indeed, that job is ours. See O'Melveny & Myers v.
Federal Deposit Ins. Corp., 512 U.S. 79, 83-85 (1994) (rules
governing imputation are matter of State law). We recognize
that, in at least one case, we have barred a plaintiff from
recovery under the in pari delicto doctrine because of the
5 The First Circuit concluded that "ordinary agency-based
imputation rules appear to operate in Massachusetts, . . .
whether the issue is primary liability of the company or in pari
delicto." Baena v. KPMG LLP, 453 F.3d 1, 8 (1st Cir. 2006).
However, the only case cited in support of this proposition of
Massachusetts law was Rea v. Checker Taxi Co., 272 Mass. 510
(1930), and this case is simply inapposite. In Rea, we held
only that the doctrine of in pari delicto did not bar a taxicab
passenger who was injured by the driver's negligence from
recovering from the driver's employer, because she was not at
fault. Id. at 514. The only conduct that was imputed in that
case was the conduct of the defendant's agent, the driver, to
the defendant, the driver's employer -- as is typical under a
theory of respondeat superior. Id. at 512. The plaintiff
herself was an individual acting on her own behalf, not a
principal acting through an agent. Thus, this case has no
bearing on whether, where a plaintiff is acting through an
agent, that agent's conduct should be imputed to the plaintiff
for purposes of the in pari delicto doctrine.
22
misdeeds of the plaintiff's agent. In Arcidi, 447 Mass. at 619-
622, we held that a union that had entered into an illegal
contract could not recover the payments it had made under that
contract. In doing so, we rejected the union's argument that
the union itself was not at fault because it was the decision of
the union president, acting on behalf of the union, to enter
into the illegal contract. Id. at 618, 622. We reasoned that,
"because an organization can only act through agents,"
separating the conduct of an organization from its agents in
this context "would make it too easy for organizations to reap
the benefits of illegal contracts when it is convenient, while
deflecting the consequences onto agents and third parties when
it is not." Id. at 622. Thus, in Arcidi we effectively imputed
the union president's conduct to the union to bar recovery under
the in pari delicto doctrine. We did not, however, consider
whether the doctrine is always governed by traditional rules of
imputation under Massachusetts common law, and we are not aware
of any decision from this court or the Appeals Court -- nor has
one been cited to us -- that squarely confronts the issue. In
deciding this issue, we therefore write on what is essentially a
clean slate of Massachusetts law.
We note first that the traditional rules of imputation,
although broad in application, are not without their limits. As
stated, the rules of imputation are premised on the risk-
23
allocation principle that, as between an innocent principal and
an innocent third party, it is the principal -- who is
responsible for selecting and supervising the agent -- who
should bear the loss resulting from an agent's actions. See
Kansallis, 421 Mass. at 664. "This overarching principle" not
only unifies the various rules of imputation but also "suggests
[their] . . . limitations." Id. at 665. Here, for instance, if
a student who had been issued a fraudulent loan sought to
recover damages from Merrimack, there would be little doubt that
Mordach's fraud should be imputed to Merrimack under a theory of
respondeat superior and that Merrimack should be held
vicariously liable to the student. This is because the student
is an innocent third party and, as between Merrimack and the
student, it is Merrimack that should pay for the damage. But if
Merrimack were to then sue Mordach for indemnification, as it
would be entitled to do, see Elias, 410 Mass. at 482, Mordach
may not offer as a defense to the indemnification claim that her
fraud should be imputed to Merrimack, making it equally
culpable, because the rationale for imputation -- the need to
protect innocent third parties -- is absent. See Restatement
(Third) of Agency, supra at § 5.03 comment b ("imputation does
not furnish a basis on which an agent may defend against a claim
by the principal"). Cf. American Int'l Group, Inc. v.
Greenberg, 965 A.2d 763, 828 n.246 (Del. Ch. 2009), aff'd, 11
24
A.3d 228 (Del. 2011) ("[Although] the behavior of faithless
fiduciaries is imputed to the corporation when the corporation
faces liability to innocent third-parties . . . [,] [t]his, of
course, has never prevented the corporation [itself] from
recovering against those faithless fiduciaries in a derivative
suit").
The traditional rules of imputation are similarly
inapplicable where the aim is to assign blame rather than risk.
Thus, where an employee has engaged in misconduct, and where a
person harmed by that misconduct seeks punitive damages against
the employer, that misconduct will not necessarily be imputed to
the employer. See Gyulakian v. Lexus of Watertown, Inc., 475
Mass. 290, 298-299 (2016). Rather, in awarding punitive
damages, "it is the actions of the employer, not the actions of
that employee, that are the appropriate focus, and . . . it is
the employer's conduct that must be found to be outrageous or
egregious." Id. at 299 n.14. And, in determining whether the
employer engaged in outrageous or egregious conduct, we look to
whether "members of senior management" participated in the
misconduct, or acquiesced in it by knowing of the misconduct and
failing to remedy it. See id. at 300-301. The misconduct of
lower-level employees -- even those at the supervisory level --
is insufficient to warrant punitive damages. See id. at 298.
In this context, we depart from the usual rules of imputation
25
because an award of punitive damages requires a moral judgment
that the defendant's conduct is so blameworthy that it
"justifies punishment [rather than] merely compensation."
Haddad v. Wal-Mart Stores, Inc. (No. 1), 455 Mass. 91, 110
(2009). See Pinshaw v. Metropolitan Dist. Comm'n, 402 Mass.
687, 697 (1988), quoting Smith v. Wade, 461 U.S. 30, 52 (1983)
("The award of punitive damages is 'a discretionary moral
judgment' . . ."). Accordingly, conduct by an employee that is
sufficient to hold an employer vicariously liable for
compensatory damages does not necessarily suffice to justify
punitive damages against the employer. To support an award of
punitive damages, a jury must find the employer itself to be
morally blameworthy, and that requires a finding that a member
of the employer's senior management was morally blameworthy.
For similar reasons, we conclude that, under our common
law, a principal acting through an agent may not be barred from
recovery under the doctrine of in pari delicto unless the
principal itself is found to be morally blameworthy, and conduct
by an agent that is sufficient to hold a principal vicariously
liable to third parties will not always be sufficient, on its
own, to support that finding. Where the plaintiff is an
organization that can only act through its employees, its moral
responsibility is measured by the conduct of those who lead the
organization. Thus, where the plaintiff is a corporation, as
26
here, we look to the conduct of senior management -- that is,
the officers primarily responsible for managing the corporation,
the directors, and the controlling shareholders, if any. Only
their intentional misconduct may be imputed to the plaintiff
under the doctrine of in pari delicto and, only then, will a
court need to consider whether application of the doctrine would
comport with public policy.6
Here, viewing the evidence in the light most favorable to
Merrimack, we conclude that Mordach cannot be deemed a member of
senior management whose conduct may be imputed to Merrimack.
Although we recognize that Mordach had substantial
responsibilities as financial aid director, she was not an
officer of Merrimack and, in contrast with its president and
chief financial officer, she was not among the select few who
were primarily responsible for the management of the college.
As a result, Merrimack cannot be deemed because of Mordach's
6 We note that this rule is consistent with the few cases
where courts, applying Massachusetts law, have imputed an
agent's conduct to a plaintiff to bar recovery under the in pari
delicto doctrine. In Arcidi v. National Ass'n of Gov't
Employees, Inc., 447 Mass. 616, 622 (2006), we barred a union
from recovering under an illegal contract based on the actions
of the union's president. Meanwhile, in Baena, 453 F.3d at 3 &
n.1, 6-7, the First Circuit held that the in pari delicto
doctrine barred a claim against a corporation's auditors for
failing to prevent fraud, where the corporation's "top officers
and directors" -- the chairman of the board, the chief executive
officer, the chief financial officer, and the managing director
-- were alleged to have orchestrated the fraud. In both cases,
it was the conduct of senior management that was imputed for
purposes of the in pari delicto doctrine.
27
misconduct to have engaged in intentional wrongdoing that would
bar it from recovering damages against KPMG under the in pari
delicto doctrine. Instead, we must look to the conduct of
Merrimack's senior management, and the evidence, again viewed in
the light most favorable to Merrimack, supports at most a
finding that senior management was negligent in retaining
Mordach as financial aid director or in failing adequately to
supervise her. This conduct may limit Merrimack's recovery
under the comparative negligence statute, but does not rise to
the level that would bar recovery entirely under the doctrine of
in pari delicto.
Because the judge granted summary judgment to KPMG on the
sole ground that Merrimack's claims were barred under the
doctrine of in pari delicto, we vacate the order granting
summary judgment and remand the case to the Superior Court for
consideration of KPMG's three other grounds for summary
judgment. We decline to address these grounds where the judge
did not address them, and where the parties did not brief them
on appeal. On remand, the judge will therefore have to consider
whether summary judgment is warranted on alternative grounds.
Having so found, we need not consider whether, as a matter
of public policy, we would carve out an exception to the in pari
delicto doctrine in cases where an organization seeks to recover
damages from its auditor for the auditor's negligence in failing
28
to detect fraud committed by members of senior management.7 We
decline to consider whether to adopt such an exception under our
common law, not only because it is unnecessary to our decision,
but also because the Legislature in 2001 enacted G. L. c. 112,
§ 87A ¾, which applies to "conduct occurring after its effective
date [February 23, 2003]." St. 2001, § 147, § 2. Section 87A ¾
provides that, where a "firm licensed to practice public
accountancy . . . is held liable for damages in a civil action
arising from or related to its provision of services," and where
7 In NCP Litig. Trust v. KPMG LLP, 187 N.J. 353, 357 (2006)
(NCP), the Supreme Court of New Jersey held that imputation does
not bar corporate shareholders from suing an auditor where the
auditor negligently failed to uncover fraud committed by
corporate officers and directors. In reaching this conclusion,
the court emphasized that "third-party auditors are specifically
retained for the task of monitoring corporate activity," id. at
379, and that allowing an auditor to escape liability where it
fails to do so would "stretch [the imputation doctrine] to its
breaking point," id. at 372. The Superior Court judge in this
case characterized the decision in NCP as creating an "auditor
exception" to the doctrine of in pari delicto, when in fact the
court in NCP did not address the in pari delicto doctrine, and
instead focused only on the related doctrine of estoppel. The
court's holding is better understood as creating an exception to
the traditional rules of imputation for cases involving auditor
negligence. See id. at 372 n.2 (auditor negligence is
considered both "an exception to the imputation doctrine and a
ground for estoppel"). See also Kirschner v. KPMG LLP, 15
N.Y.3d 446, 471 (2010) (New Jersey has "fashioned [a] carve-
out[] from traditional agency law in cases of corporate fraud so
as to deny the in pari delicto defense to negligent or otherwise
culpable auditors"); Official Comm. of Unsecured Creditors of
Allegheny Health Educ. & Research Found. v.
PriceWaterhouseCoopers LLP, 605 Pa. 269, 305 (2010) ("we read
the rationale for the New Jersey Supreme Court's decision in NCP
as effectively negating imputation [and thus barring the in pari
delicto defense] relative to . . . claims of negligence against
auditors").
29
the "plaintiff or other party, individual, or entity has been
found to have acted fraudulently in the pending action or in
another action or proceeding involving similar parties,
individuals, entities and claims" and "the fraud was related to
the performance of the duties of the . . . firm," "the trier of
fact shall determine: (a) the total amount of the plaintiff's
damages, (b) the percentage of fault attributable to the
fraudulent conduct of the plaintiff or other party, individual
or entity contributing to the plaintiff's damages, and (c) the
percentage of fault of the . . . firm . . . in contributing to
the plaintiff's damages."8 Under this statute, if a plaintiff
suffered damages of $1 million, and seventy per cent of those
damages is attributable to the plaintiff's own fraudulent
conduct while only thirty per cent is attributable to the
negligence of the defendant accounting firm, the defendant shall
not be required to pay more than $300,000.9
8 General Laws c. 112, § 87A ¾, does not apply "where a
finding is made that the acts of the individual or firm in the
practice of public accountancy were willful and knowing."
9 The full text of G. L. c. 112, § 87A ¾, is reprinted
below:
"When an individual or firm licensed to practice
public accountancy under [§] 87B or 87B ½ is held liable
for damages in a civil action arising from or related to
its provision of services involving the practice of public
accountancy, in which action a claim or defense of fraud is
raised against the plaintiff or another party, individual
or entity, and that plaintiff or other party, individual,
30
The parties and the judge did not cite § 87A ¾ or make
reference to it, even though there may be relevant conduct that
occurred after its effective date and that may be governed by
it.10,11 By enacting this statute, the Legislature appears to
have replaced the common-law doctrine of in pari delicto in
or entity has been found to have acted fraudulently in the
pending action or in another action or proceeding involving
similar parties, individuals, entities and claims, and the
fraud was related to the performance of the duties of the
individual or firm licensed to practice public accountancy,
the trier of fact shall determine: (a) the total amount of
the plaintiff's damages, (b) the percentage of fault
attributable to the fraudulent conduct of the plaintiff or
other party, individual or entity contributing to the
plaintiff's damages, and (c) the percentage of fault of the
individual or firm in the practice of public accountancy in
contributing to the plaintiff's damages. Under the
circumstances set forth in this section, individuals or
firms in the practice of public accountancy shall not be
required to pay damages in an amount greater than the
percentage of fault attributable only to their services as
so determined. This section shall not apply where a
finding is made that the acts of the individual or firm in
the practice of public accountancy were willful and
knowing. In such an action involving the practice of
public accountancy in which a claim or defense of fraud is
raised, if there is pending a separate action or proceeding
in which the alleged fraudulent conduct of the same party,
individuals or entity against whom the claim or defense is
raised is to be adjudicated or determined, the court may
stay, on its own or by motion, the action involving the
practice of public accountancy until the other action or
proceeding is concluded or the issue of fraudulent conduct
is determined in that other action."
The statute was cited and discussed in the amicus brief
10
submitted by the Chelsea Housing Authority.
Perhaps because there was no discussion of the statute,
11
the record does not reflect whether KPMG is a firm licensed to
practice public accountancy under G. L. c. 112, § 87B ½. One
would expect that it is.
31
cases where an accounting firm is sued for its failure to detect
fraud by a client's employee, with a statutory allocation of
damages akin to, but different from, comparative negligence.12
But we do not endeavor here to interpret § 87A ¾, where the
parties have not discussed it and where we have not found any
appellate court opinion that has interpreted or applied it, or
any legislative history that sheds light on its origin or
purpose. The Superior Court, on remand, may consider the
statute's application to this case, if any.
2. Motion for leave to amend answer. On appeal, Merrimack
also challenges the Superior Court judge's decision to allow
KPMG's motion for leave to amend its answer to add an
affirmative defense of release, which we review for abuse of
discretion. Johnston v. Box, 453 Mass. 569, 582 (2009).
"It is well established that the defense of a release must
be raised as an affirmative defense and that the omission of an
affirmative defense from an answer generally constitutes a
waiver of that defense." Sharon v. Newton, 437 Mass. 99, 102
12One difference is that comparative negligence under G. L.
c. 231, § 85, compares only the negligence attributed to all
parties, but G. L. c. 112, § 87A ¾, compares the damages
attributable to the plaintiff's fraudulent conduct with the
damages attributable to the accounting firm's negligence.
Another difference is that a plaintiff is barred from any
recovery under the comparative negligence statute if its
negligence is greater than the defendant's negligence, whereas a
plaintiff under § 87A ¾ is entitled to recovery even if the
damages attributable to its fault are greater than the damages
attributable to the defendant's fault.
32
(2002), citing Mass. R. Civ. P. 8 (c), 365 Mass. 749 (1974).
"It is equally well settled," however, "that a party may amend
its pleading by leave of court and that such leave 'shall be
freely given where justice so requires.'" Sharon, supra,
quoting Mass. R. Civ. P. 15 (a), 365 Mass. 761 (1974). Like the
plaintiff in Sharon, supra, Merrimack contends that undue delay
should have led the judge to deny KPMG's motion to amend.
"While we have often upheld a judge's discretion to deny leave
to amend based in part on undue delay, such denials have
generally been coupled with consideration of other factors such
as imminence of trial and futility of the claim sought to be
added." Id., citing Leonard v. Brimfield, 423 Mass. 152, 157,
cert. denied, 519 U.S. 1028 (1996); Mathis v. Massachusetts
Elec. Co., 409 Mass. 256, 264 (1991); Castellucci v. United
States Fid. & Guar. Co., 372 Mass. 288, 292 (1977). Here, as in
Sharon, we conclude that where "the amendment . . . did not
raise a new issue on the eve of trial and could not be
considered futile or irrelevant to [KPMG's] defense, the judge
did not abuse [his] discretion in granting the motion to amend
[KPMG's] answer." Sharon, supra at 102-103.
Conclusion. For the reasons stated, the order allowing
KPMG's motion for summary judgment is vacated, the order
allowing KPMG's motion for leave to amend its answer is
affirmed, and the case is remanded to the Superior Court. On
33
remand, the Superior Court judge will determine whether summary
judgment should be granted on any of the alternative grounds
asserted by KPMG, including release.
So ordered.