267 F.3d 340 (3rd Cir. 2001), 00-1157, Off'l Comm. Unsecured Creditors v R.F. Lafferty & Co.

Docket Nº:00-1157
Citation:267 F.3d 340
Case Date:October 09, 2001
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit

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267 F.3d 340 (3rd Cir. 2001)




No. 00-1157

United States Court of Appeals, Third Circuit

October 9, 2001

Argued on May 31, 2001


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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

Before: Sloviter, Fuentes, and Cowen, Circuit Judges


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

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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 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.


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 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

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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.

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]instigation 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 --

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based upon 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.


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

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