Official Comm. Of Unsecured Creditors Of Allegheny Health v. Pricewaterhousecoopers

• Decision Date: 28 May 2010
• Docket Number: No. 07-1397.,07-1397.
• Citation: Official Comm. of Unsecured Creditors of Allegheny Health, Educ. & Research Found. v. Pricewaterhousecoopers, LLP, 607 F.3d 346 (3rd Cir. 2010)
• Parties: OFFICIAL COMMITTEE OF UNSECURED Creditors OF ALLEGHENY HEALTH, EDUCATION AND RESEARCH FOUNDATION, Appellantv.PRICEWATERHOUSECOOPERS, LLP.
• Court: U.S. Court of Appeals — Third Circuit

607 F.3d 346

OFFICIAL COMMITTEE OF UNSECURED Creditors OF ALLEGHENY HEALTH, EDUCATION AND RESEARCH FOUNDATION, Appellantv.PRICEWATERHOUSECOOPERS, LLP.

No. 07-1397.

United States Court of Appeals Third Circuit.

Argued April 15, 2008.

Filed: May 28, 2010.

Beth Heifetz, Esquire, Jones Day, Washington, DC, James M. Jones, Esquire, Jones Day, Pittsburgh, PA, Patrick F. McCartan, Esquire(Argued), Richard B. Whitney, Esquire, Jones Day, Cleveland, OH, for Appellant.

Joseph F. McDonough, Esquire, Manion, McDonough & Lucas, Pittsburgh, PA, Thomas G. Rafferty, Esquire(Argued), Antony L. Ryan, EsquireCravath, Swaine & Moore, New York, NY, for Appellee.

Before: AMBRO, JORDAN, and MICHEL,^* Circuit Judges.

OPINION OF THE COURT

AMBRO, Circuit Judge.

We deal with a much-debated question of Pennsylvania law-if a third party(here, an auditor) colludes with agents to defraud their principal, do we impute to the principal the agents' misconduct and, if so, does that preclude recovery by another standing in the principal's place?With the benefit of a much-appreciated clarifying opinion from the Supreme Court of Pennsylvania, we now hold that Pennsylvania law requires an inquiry into whether the third party dealt with the principal in good faith.Because the District Court did not have the benefit of this clarifying opinion and did not conduct such an inquiry, we remand for further proceedings.

I.Facts and Procedural BackgroundA.The Debtor's Growth

The debtor is the Allegheny Health, Education, and Research Foundation (“AHERF”), a Pennsylvania non-profit corporation that, prior to its liquidation, provided a wide range of healthcare services, including operating hundreds of physicians' practices, 14 hospitals, and two medical schools.

From the mid-1980s, AHERF, under the leadership of CEO Sherif Abdelhak, tried to build a region-wide “integrated delivery system” through an aggressive program of acquisitions.According to the then-popular theory, a health system could make money by building a network of hospitals, physician practices, and medical schools.The schools would staff the hospitals with residents; the physician practices would, through referrals, provide the hospitals with patients; and the hospitals would bring in substantial net income through the provision of high-dollar specialty care.Industry publications and news articles from the 1990s discussing the integrated-delivery-system model indicate that it was, at least for a time, the business model du jour for large healthcare providers.¹

AHERF pursued the integrated-delivery-system model by acquiring hospitals and physician practices.When acquired, these entities generally were losing money.The hospitals, some thought, could be rehabilitated through better management, operational efficiencies, price reductions from mass contracts with vendors, and other economies of scale.The physician practices, on the other hand, would perform better, but would primarily serve as “loss leaders” to generate patients for the hospitals' high-dollar specialist care.

AHERF's implementation of the integrated-delivery-system model failed.By 1996, the company was suffering substantial operating losses.Cost savings and efficiency gains were not being realized, and cash was running out.

B. PwC's 1996 and 1997 Audits of AHERF

AHERF had for some time employed the services of Coopers and Lybrand, now PricewaterhouseCoopers, LLP(“PwC”), to audit its financial statements.Specifically, PwC was engaged to provide an opinion on AHERF's financial statements to its board of trustees.PwC could either provide a “clean” opinion, which would indicate that the statements were accurate and complied with generally accepted accounting principles (“GAAP”) and generally accepted auditing standards (“GAAS”), or an “adverse” opinion, which would identify deficiencies in the statements.

A group of high-level AHERF officers, led by David McConnell(AHERF's chief financial officer) and operating with Abdelhak's approval, is alleged to have knowingly misstated AHERF's finances in the figures they provided PwC for the 1996 audit of AHERF.These misstatements were designed to conceal how precarious AHERF's financial position was, and to make it look as though the integrated-delivery-system model was beginning to pay dividends in the form of cost savings and increased net income.As alleged by the Official Committee of Unsecured Creditors(the “Committee”), standing in the shoes of AHERF, PwC's audit should have brought these misstatements to light, but, rather than issuing an adverse opinion as GAAP and GAAS required, PwC knowingly assisted in the officers' misconduct by issuing a “clean” opinion.According to the Committee, the officers and PwC repeated this misconduct in 1997.

The result of these misdeeds, according to the Committee, was that the AHERF board was under the false impression that the company was in relatively good financial shape.Thus, the board did not intervene in management's business strategy, and instead allowed Abdelhak to continue making acquisitions.

C.Bankruptcy

By the spring of 1998, Abdelhak and McConnell were unable to prevent board members from perceiving that AHERF's financial position was dire.Suppliers began complaining directly to board members about not being paid, and doctors threatened to quit over Allegheny General Hospital's lack of resources.As AHERF's financial condition leaked out, board members became less confident in Abdelhak's leadership, and in early June 1998they removed him as President and CEO.They also removed McConnell as CFO.Soon thereafter, they terminated PwC and issued warnings that their 1997 financial statements were not reliable.

AHERF's corrective measures came too late, and in July 1998 it filed for relief under Chapter 11 of the Bankruptcy Code.

D.This Action

In this adversary proceeding, the Committee, on behalf of AHERF, asserted three causes of action against PwC: (1) breach of contract, (2) professional negligence, and (3) aiding and abetting a breach of fiduciary duty.PwC moved for summary judgment on numerous grounds.

On January 17, 2007, the District Court granted summary judgment in favor of PwC.Official Comm. of Unsecured Creditors of Allegheny Health, Educ. & Research Found. v. Pricewaterhouse Coopers, LLP (Allegheny I),No. 2:00cv684, 2007 WL 141059(W.D.Pa.Jan.17, 2007).Although PwC asserted seven arguments in favor of granting summary judgment to it, the District Court granted it on the sole ground that AHERF was in pari delicto² with PwC, and thus the Committee could not recover.Put another way, the Court found that the wrongdoing of AHERF's senior management must be imputed to AHERF, and that the doctrine of in pari delicto applies to bar the Committee's claims, as AHERF was at least as much at fault as PwC.Id. at *6.

On the issue of imputation, the District Court looked to our decision in Lafferty, Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340(3d Cir.2001), and applied a two-part test to determine whether fraud of an officer is imputed to a corporation.It found both prongs (course of employment and benefit to the corporation) satisfied and imputed the officers' conduct to AHERF.Allegheny I,2007 WL 141059, at *9-13.In particular, it set a low bar for benefit to the corporation: “the question is a relatively simple one-whether any benefit accrued to AHERF.”Id. at *10(emphasis in original).Although it noted that there were “many factual issues that are disputed,”the District Court determined that “AHERF management was acting within the scope of their employment in submitting the [false] financial statements and that such misconduct enabled further acquisitions that, in the short term, was a benefit to AHERF.”Id. at *11.

On the issue of in pari delicto,the District Court found that even though the auditor was alleged to have improperly colluded with management, the “mutual fault” of the corporation (as a result of imputation) barred its (and thereby, the Committee's) claims.Id. at *13.The Court also rejected the “innocent and independent decision-maker” argument ³ adopted by some courts to bar in pari delicto defenses in the auditor-liability context.Id. at *14.

This timely appeal followed.

E.Certification to the Supreme Court of Pennsylvania

Although we normally resolve issues of state law without certifying questions to a state Supreme Court, this case includes a dimension not previously considered in the Pennsylvania cases cited to us.After reading the briefs and submissions of the parties, hearing oral argument, and reviewing applicable Pennsylvania law, we certified two questions to the Supreme Court of Pennsylvania to clarify important and unresolved questions concerning the interaction between the in pari delicto doctrine and the imputation of an agent's fraud to his principal under Pennsylvania law.Official Comm. of Unsecured Creditors of Allegheny Health, Educ. & Research Found. v. PricewaterhouseCoopers, LLP (Allegheny II),No. 07-1397, 2008 WL 3895559, at *6(3d Cir.July 1, 2008).

The Pennsylvania Supreme Court unanimously answered the certified questions and returned the matter to us.Official Comm. of Unsecured Creditors of Allegheny Health Educ. & Research Found. v. PriceWaterhouseCoopers, LLP (Allegheny III),989 A.2d 313(Pa.2010).It conducted a comprehensive analysis of the certified questions, for which we are most grateful, and we proceed with the benefit of that opinion.

II.Jurisdiction and Standard of Review

The District Court had jurisdiction over this matter pursuant to 28 U.S.C. § 1334(b).We have jurisdiction pursuant to 28 U.S.C. § 1291.

We exercise plenary review over an appeal from a grant of summary judgment.Revell v. Port Auth. of N.Y., N.J.,598 F.3d 128, 134(3d Cir.2010).Summary judgment is appropriate if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law.Id.

III.Discussion

As...