board of directors and every owner of its common stock.
1. Delaware Law Claim — Aiding and Abetting Breach of Fiduciary
Duty. While there is little Delaware case law on point, Coopers cites a
case, applying Delaware law for standing purposes, which holds that the
trustee of Granite Partners L.P., a Delaware partnership, lacked standing
to bring claims against third party brokers who aided and abetted
Granite's insiders in their misconduct. In re Granite Partners, L.P.
(Goldin v. Primavera Familienstiftung), 194 B.R. 318, 322, 325, 328-30
(Bankr.S.D.N.Y. 1996); see also Primavera Familienstiftung v. Askin, 95
Civ. 8905, 1996 WL 494904, at *11-12 (S.D.N.Y. Aug. 30, 1996) (discussing
Granite Partners). Granite Partners expressly follows New York case law
on standing to support its holding. There are no Delaware cases that have
been decided contrary to New York law. Thus, it appears that there is no
conflict between New York and Delaware law.
Under the New York law cited in Granite Partners, an action which
consists of claims against a third party for defrauding a corporation
with the cooperation of management "accrues to creditors, not to the
guilty corporation." Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114,
120 (2d Cir. 1991) (the "Wagoner Rule"). Further, "[i]t is well-settled
that a bankruptcy trustee has no standing generally to sue third parties
on behalf of the estate's creditors, but may only assert claims held by
the bankrupt corporation itself." Id. at 118 (citing Caplin v. Marine
Midland Grace Trust Co. of New York, 406 U.S. 416, 434 (1972)). Thus,
under the Wagoner Rule, a bankrupt corporation's trustee or committee of
unsecured creditors lacks standing to bring a claim against a third party
for defrauding or misleading the corporation with the cooperation of the
Although Wagoner involved a sole shareholder who orchestrated the
fraud, and whose conduct was thus clearly attributable to the corporation
under the "sole actor" exception to the adverse interest doctrine of
agency law, see Mediators, Inc. v. Manney (In re Mediators, Inc.),
105 F.3d 822, 827 (2d Cir. 1997), subsequent cases have recognized that
the Wagoner rule is also applicable outside the sole actor context if
"all relevant shareholders and/or decisionmakers" were involved in the
wrongful conduct, Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld,
L.L.P., 212 B.R. 34, 36 (S.D.N.Y. 1997), or if there is otherwise
sufficient "unity" between the corporation and defendant to implicate the
corporation itself, rather than just its agents, in the alleged
wrongdoing. Lippe v. Bairnco Corp., 218 B.R. 294, 302 (S.D.N.Y. 1998);
Securities Investor Protection Corp. v. BDO Seidman, LLP,
49 F. Supp.2d 644, 651 (S.D.N Y 1999).
As set forth in Wechsler, in cases involving more than one corporate
actor, the plaintiff may avoid dismissal for lack of standing by alleging
the existence of "an innocent member of . . . management who would have
been able to prevent the fraud had he known about it." Wechsler, 212
B.R. at 36; see also BDO Seidman, 49 F. Supp.2d at 651 (resting decision
on the absence of any allegation in the complaint that a member of the
corporation's management was innocent of the fraud and could have stopped
it). In Wechsler, the trustee of Towers Financial Corporation sued
Towers' law firm for its involvement in a Ponzi scheme carried out by
corporate insiders. The amended complaint identified two members of the
Towers board who were ignorant, despite an ongoing SEC investigation, of
the accounting fraud being perpetrated at Towers. Wechsler v. Squadron,
Ellenoff, Plesent & Sheinfeld, LLP, 994 F. Supp. 202, 208 (S.D.N.Y.
1998). The two directors had asked about the accounting practices of
Towers and were given false assurances that there were no problems. Id.
The Wechsler court found that the trustee had sufficiently alleged that
the two directors were innocent and unaware of Tower's wrongdoing such
the other corporate agents' knowledge of the fraud was not imputed to the
The Committee vigorously argues that the Management Directors were
similarly innocent of the detrimental aspects of the 1993 Transaction.
But as alleged in the Complaint, the Management Directors voted in favor
of the 1993 Transaction, partly out of their own self-interest in keeping
their jobs with the company, even though they knew that the 1993
Transaction was adverse to Color Tile's interests in that "the purchase
price was grossly excessive, the projections supporting the 1993
Transaction were unrealistic and exaggerated, and the 1993 Transaction
would impose an imprudent and unmanageable debt structure on Color Tile."
(Compl. ¶ 80.) Thus, they were not ignorant of the wrongdoing.
The Committee also argues that the allegations that the Management
Directors would have indirectly caused the 1993 Transaction to collapse
by taking the accurate information to the banks renders them "innocent"
and thus protects the Committee from loss of standing under the Wagoner
Rule. In Federal Deposit Ins. Corp. v. Ernst & Young, 967 F.2d 166 (5th
Cir. 1992), an analogous case, the FDIC, as an assignee of the insolvent
Western Savings Association ("Western"), made the same causation argument
in a suit against a third party accountant. The Fifth Circuit rejected
This argument is flawed because it is not an
appropriate argument for Western, or its assignee, to
make. Western cannot claim it should recover from [the
outside accountants] for not being rescued by a third
party for something Western was already aware of and
chose to ignore.
Ernst & Young, 967 F.2d at 171. The Complaint also fails to allege that
the Management Directors would not have had any choice other than to turn
Coopers' conclusions over to Bear Sterns and the banks. Thus, the
Complaint does not allege any basis for treating the Management Directors
as innocent with respect the 1993 Transaction.
Because the Complaint alleges that each of the directors on Color
Tile's board of directors knew of the negative aspects of the 1993
Transaction and nevertheless approved it, and because a Delaware
corporation is managed by its board of directors, Del. Code Ann. tit. 8,
§ 141(a) (1998), and because all the common shareholders of Color
Tile are alleged to have acted as a unified group in forcing the 1993
Transaction on Color Tile, the Committee's claim against Coopers for
aiding and abetting breach of fiduciary duty is dismissed for lack of
standing under the Wagoner Rule. See Granite Partners, 194 B.R. at 322,
325, 328-30; Wechsler, 994 F. Supp. at 208.
2. Texas law claims — breach of fiduciary duty and breach of
contract. The Fifth Circuit has held that, under Texas law, collaboration
by a debtor's representatives would constitute a valid affirmative
defense to the debtor's claim against a third party defendant such as
Coopers but would not deprive the debtor of standing to bring the claim.
In re Educators Group Health Trust (Schertz-Cibolo-Universal City,
Indep. School Dist. v. Wright), 25 F.3d 1281, 1286 (5th Cir. 1994). A
footnote in Educators suggests that if management collaboration with the
third party defendant were established on the face of the complaint
(which was not the case in Educators), dismissal of the complaint for
pleading the defendant's affirmative defense would be appropriate. Id. at
1286 n. 7.
The parties are in agreement that the affirmative defense to which the
Fifth Circuit refers in Educators is the equitable defense of in pari
delicto. See 34 Tex. Jur. 3d Equity § 31 (discussing doctrines of
"unclean hands" and "in pari delicto"). The Texas law claims, which the
Committee has standing to pursue, are subject to any state law defense
that Coopers may have. O'Melveny & Myers v. Federal Deposit Ins. Corp.,
512 U.S. 79, 83-85
(1994). The defense of in pari delicto "is rooted in the common-law
notion that a plaintiff's recovery may be barred by his own wrongful
conduct." Pinter v. Dahl, 486 U.S. 622, 632 (1988). The defense,
traditionally limited to situations where the plaintiff bore at least
substantially equal responsibility for his injury, has been expanded by
contemporary courts to cover situations "more closely analogous to those
encompassed by the `unclean hands' doctrine, where the plaintiff has
participated `in some of the same sort of wrongdoing' as the defendant."
Id. "In the case of equal or mutual fault [between two parties] the
condition of the party . . . [defending] is the better one." In re
Granite Partners, L.P. (Goldin v. Primavera Familienstiftung),
194 B.R. 318, 328 (Bankr.S.D.N.Y. 1996) (citing Black's Law Dictionary
791 (6th ed. 1990)). "The doctrine is based on two premises: courts
should not mediate disputes between wrongdoers, and denying judicial
relief to a wrongdoer deters illegal conduct." Id. (citing Bateman
Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306 (1985)).
As Coopers observes, unlike the complaint in Educators, the Complaint
in this case affirmatively alleges that the entire 1993 Color Tile board
of directors approved the 1993 Transaction knowing that it was based on
grossly inflated and exaggerated projections of revenue growth. It also
alleges that the Investcorp Group, which owned all of Color Tile's common
stock and acted as a sole shareholder, forced the 1993 Transaction on
Color Tile against warnings from Color Tile's management. These
allegations are adequate to support a determination that the 1993
directors and the Investcorp Group bear at least substantially equal
responsibility with Coopers for permitting the 1993 Transaction to go
forward on the basis of inflated projections.
Texas law governs the imputation of the board's and shareholders'
knowledge to the corporation. O'Melveny & Myers v. Federal Deposit
Insurance Corp., 512 U.S. 79, 84-85 (1994). It provides that where the
persons dominating and controlling the corporation orchestrated the
fraudulent conduct, their knowledge is imputed to the corporation as
principal. Federal Deposit Insurance Corp. v. Ernst & Young, 967 F.2d 166,
171 (5th Cir. 1992); Mays v. First State Bank of Keller, 247 S.W. 845,
846 (Tex. Comm'n App. 1923); cf. Mediators, Inc. v. Manney (In re
Mediators, Inc.), 105 F.3d 822, 827 (2d Cir. 1997) (discussing the "sole
actor" rule under New York law); Wechsler v. Squadron, Ellenoff, Plesent
& Sheinfeld, L.L.P., 212 B.R. 34, 36, 43-45 (S.D.N.Y. 1997) (same).
Thus, the Committee has pleaded the affirmative defense of in pari
delicto to its claims of breach of fiduciary duty and breach of
contract. Because all the facts that give rise to the defense are alleged
in the Complaint, it is proper to dismiss on that ground under 12(b)(6).
Ghartey v. St. John's Queens Hosp., 869 F.2d 160, 162 (2d Cir. 1989); 5
Charles A. Wright & Arthur R. Miller, Federal Practice and Procedure
§ 1277 (1990 & Supp. 1999). These claims are accordingly dismissed
for failure to state a claim on which relief may be granted.
C. Negligence in the 1994 and 1995 Audits
Federal Rule of Civil Procedure 8(a) requires that "[a] pleading which
sets forth a claim for relief . . . shall contain . . . (2) a short and
plain statement of the claim showing that the pleader is entitled to
relief." When stating a claim, a plaintiff "enjoy[s] all favorable
inferences from facts that have been pleaded" but may not assert
"conclusory statements to substitute for minimally sufficient factual
allegations." Furlong v. Long Island College Hosp., 710 F.2d 922, 927 (2d
The Committee's statement of its negligence claims against Coopers based
on Coopers' audits and certifications of Color Tile's 1993 and 1994
fails to "show that the pleader is entitled to relief" as required by
Rule 8(a)(2). The Complaint alleges that Coopers "was negligent and
breached its duty of care" by failing to qualify Color Tile's financial
statements, failing to value Color Tile on a liquidation basis, and
failing to write down or write off Color Tile's goodwill when auditing
and certifying Color Tile's 1993 and 1994 financial statements. (Compl.
¶¶ 185, 189.) However, the only allegation that Coopers' negligence
proximately caused injury to Color Tile is that Color Tile "could have
taken steps that would have preserved whatever value of the company was
salvageable" had Coopers exercised reasonable care. (Id. ¶¶ 186,
190.) (emphasis added).
Such an allegation is plainly insufficient to show that the Committee
is entitled to relief. In order to prove that Coopers' negligence
proximately caused Color Tile's injury, the Committee must show that Color
Tile not only "could" have taken steps to salvage itself but that it
would have done so if Coopers had exercised reasonable care. The
Complaint alleges no facts from which it can be inferred that Color
Tile's directors would have taken such steps had Coopers performed its
duties appropriately. Apart from its allegations concerning the 1993
Transaction, the Complaint delicately avoids any description of the
complete composition of Color Tile's board at any time. Without even
alleging that Color Tile's board included a majority of "innocent"
directors who would have acted in Color Tile's interest, the Complaint
fails to show that Color Tile could have taken a different course, let
alone that it would have. Accordingly, the Committee's negligence claims
against Coopers concerning the 1994 and 1995 audits must be dismissed.
See Yucyco, Ltd. v. Republic of Slovenia, 984 F. Supp. 209, 219
(S.D.N.Y. 1997) (dismissing claims pursuant to Rule 8(a) because "a mere
assertion that the defendant `may' be necessary under a speculative
scenario for relief is insufficient to justify its continued presence in
For the foregoing reasons, Coopers' motion to dismiss Counts Thirteen
through Eighteen for breach of fiduciary duty, aiding and abetting breach
of fiduciary duty, breach of contract, and negligence is granted.