The in pari delicto doctrine states that “[i]n a case of equal or mutual fault … the position of the [defending] party … is the better one.” This doctrine is guided by the premise that it is not within the purview of the court to resolve disputes among wrongdoers, and that denial of judicial relief in these instances effectively deters illegal activity. Within the bankruptcy context, “every Circuit to have considered the question has held that in pari delicto can be asserted against a trustee bringing a claim on behalf of a debtor in bankruptcy.”
Under Section 541(a)(1) of title 11 of the United States Code (the “Bankruptcy Code”), the debtor’s bankruptcy estate is comprised of “all legal or equitable interests of the debtor in property as of the commencement of the case.” Courts have looked to the plain meaning of this language to determine that where a debtor’s claim would have been subject to in pari delicto as of the commencement of the bankruptcy, then the trustee, by asserting the same claim, is also subject to in pari delicto. Moreover, the legislative history to Section 541 supports this interpretation by stating that Section 541(a)(1) “is not intended to expand the debtor’s rights against others more than they exist at the commencement of the case.”
Although all circuits agree that in pari delicto is a part of a debtor’s estate under Section 541(a), only a majority of the circuits have held that in pari delicto is an affirmative defense. In contrast, the Second Circuit has concluded that it is an issue of a trustee’s standing. This memorandum explores the contours of these two views in order to determine when trustees may avoid being held in pari delicto. Part I analyzes the elements that establish the affirmative defense of in pari delicto. Part II examines the exceptions a trustee may argue in order to defeat a proper claim of the defense. Part III explains the Second Circuit’s minority rule that in pari delicto is an issue of the trustee’s standing rather than an affirmative defense.