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Chelsea Housing Authority v. McLaughlin

Supreme Judicial Court of Massachusetts, Suffolk

July 9, 2019

CHELSEA HOUSING AUTHORITY
v.
MICHAEL E. McLAUGHLIN & others.[1]

          Heard: March 5, 2019.

         The case was heard by Timothy Q. Feeley, J., on motions for summary judgment, and entry of separate and final judgment was ordered by him.

         The Supreme Judicial Court granted an application for direct appellate review.

          Ronaldo Rauseo-Ricupero (Richard C. Pedone also present) for the plaintiff.

          William L. Boesch for Martin J. Scafidi, P.C. Nancy M. Reimer (Eric A. Martignetti also present) for John Marotto.

          Maura Healey, Attorney General, & Roberta L. Rubin, Special Assistant Attorney General, for Department of Housing and Community Development, amicus curiae, submitted a brief.

          Matthew P. Bosher & Matthew S. Brooker, of the District of Columbia, & Nicholas D. Stellakis, for American Institute of Certified Public Accountants & another, amici curiae, submitted a brief.

          Present: Gants, C.J., Lenk, Gaziano, Lowy, Budd, Cypher, & Kafker, JJ.

          GANTS, C.J.

         Under the equitable common-law doctrine of in pari delicto, a plaintiff who has committed fraud cannot recover damages resulting from the negligence of an accountant in failing to detect the plaintiff's fraud, unless such relief is required as a matter of public policy. See Merrimack College v. KPMG LLP, 480 Mass. 614, 625 (2018). In Merrimack College, we held that, where the plaintiff is a corporation, it is barred under the doctrine from recovering damages for the negligence of its accounting firm in failing to detect the corporation's fraudulent conduct only if the fraud was committed by someone in its "senior management -- that is, the officers primarily responsible for managing the corporation, the directors, and the controlling shareholders." Id. at 628. But because the parties did not raise the issue, we did not decide in that case whether the Legislature by enacting G. L. c. 112, § 87A 3/4 -- which applies to conduct occurring after February 23, 2003, see St. 2001, c. 147, § 2 -- replaced the common-law doctrine of in pari delicto "in 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." Merrimack College, supra at 631.[2]

         Here, the plaintiff, the Chelsea Housing Authority (CHA), has commenced this suit in the Superior Court against, among others, its former accountants, John Marotto and Martin J. Scafidi, P.C. (collectively, accountants), seeking to recover the losses it incurred from their alleged negligent failure to detect the fraudulent conduct of its former executive director, Michael E. McLaughlin, [3] and former finance director, Vitus Shum, among others. A Superior Court judge granted the accountants' motions for summary judgment solely on the ground that CHA's claim of negligence against them is barred by the common-law doctrine of in pari delicto -- due to the intentional misconduct of McLaughlin and Shum -- without addressing the applicability of § 87A 3/4. Because the accountants' alleged negligent conduct occurred after the effective date of § 87A 3/4, CHA's appeal from that judgment now requires us to decide the issue left unanswered in Merrimack College: whether the Legislature intended to preempt the common-law doctrine of in pari delicto in cases where an accountant is sued for failing to detect fraud committed by a client.

         After careful examination of the language of that statute, viewed in the context of its legislative history, we conclude that the Legislature intended that, where a plaintiff sues an accountant for negligently failing to detect the fraudulent conduct of the plaintiff, the plaintiff may recover damages from the accountant, but only for the percentage of fault attributed to the accountant (as compared to the fault of all others whose fraudulent conduct contributed to causing the plaintiff's damages). In so doing, by necessary implication, the Legislature has preempted the common-law doctrine of in pari delicto doctrine as it applies to the negligent conduct of accountants and auditors in failing to detect fraud. We therefore vacate the grant of summary judgment and remand the case to the Superior Court for further proceedings consistent with this opinion.[4]'[5]

         Background.

         We summarize the relevant facts recited by the judge in granting the accountants' motions for summary judgment. Ng Bros. Constr., Inc. v. Cranney, 436 Mass. 638, 639 (2002) . From 2000 until 2011, McLaughlin served as the executive director of CHA, which is the agency responsible for the administration of Chelsea's low income housing programs. His employment agreements -- which were executed between McLaughlin and CHA's five-member board of commissioners (board) -- established his annual salary, which began at $107, 000 for the 2001 fiscal year. CHA was required to submit annual budget reports to the Department of Housing and Community Development (DHCD) for approval, subject to regulatory limits on the amount by which a housing authority could increase administrative salaries.

         However, McLaughlin quickly sought and obtained board approval for salary increases vastly higher than those permitted by the regulatory limits imposed by DHCD. By 2004, McLaughlin's board-approved salary had risen to $180, 000; in 2008, he earned $267, 199; and in 2011, his final year at CHA, the board approved a salary of $291, 975. In order to avoid scrutiny from DHCD for these raises, McLaughlin stopped submitting his employment agreements to DHCD, and instead prepared and filed budget reports with deliberately falsified salary figures that fell within State regulatory guidelines. For example, McLaughlin incorrectly reported salaries of $135, 000 in 2004, $151, 945 in 2008, and $160, 415 in 2011. These budget reports were submitted to DHCD with the knowledge and approval of the CHA board.[6]

         At McLaughlin's direction, CHA "misallocated and misused" Federal funds granted to CHA by the United States Department of Housing and Urban Development (HUD) under its capital funds program. Some of these Federal funds were diverted to pay McLaughlin the difference between his actual salary and the falsified figures reported to DHCD. Eventually, HUD investigators uncovered McLaughlin's excessive compensation and the misuse of Federal funds. HUD has since demanded the recapture from CHA of $2.7 million: $500, 000 of excessive compensation paid to McLaughlin and $2.2 million of misused capital funds program monies.

         In July 2013, McLaughlin pleaded guilty in the United States District Court for the District of Massachusetts to four counts of falsifying a record in a matter pertaining to a Federal agency, in violation of 18 U.S.C. § 1519. Each count pertained to a different fiscal year and charged McLaughlin with knowingly and falsely understating the amount of his budgeted annual salary in CHA budgets that HUD required to be submitted to State regulatory authorities.[7]'[8]

         In the Superior Court action, CHA moved for summary judgment against the accountants, claiming that, based on the undisputed facts, they committed professional malpractice by failing to detect the fraud perpetrated by McLaughlin and Shum, and their negligence caused CHA to suffer substantial losses. The accountants opposed CHA's motion, asserting that there is a material dispute of fact whether they were negligent in the performance of their duties. They also cross-moved for summary judgment, claiming that -- even if they were negligent -- they are entitled to judgment under the doctrine of in pari delicto because the fraudulent conduct of McLaughlin and Shum is imputed to CHA, and an entity that committed fraud cannot recover judgment against its accountants for failing to detect that fraud.

         As noted, the motion judge granted the accountants' motions for summary judgment, concluding that the doctrine of in pari delicto barred CHA from recovering damages against them even if they were negligent. The judge found that CHA was "by far the greater wrongdoer" based on the intentional misconduct of McLaughlin and Shum, whose actions, the judge held, must be imputed to CHA because those actions were committed within the scope of their employment. The judge further noted that, if CHA's claims were not barred by the doctrine of in pari delicto, he would have denied the motions for summary judgment because the other arguments raised were "more appropriately dealt with at trial." The judge did not cite or make reference to G. L. c. 112, § 87A 3/4.

         CHA timely appealed from the grant of summary judgment, and we allowed an application for direct appellate review.

         Discussion.

         On appeal, CHA contends that, where, as here, the alleged negligence of the accountants occurred after February 23, 2003, the common-law doctrine of in pari delicto is preempted by the statutory allocation of damages for an accountant's liability established by G. L. c. 112, § 87A 3/4. In Merrimack College, 480 Mass. at 631, we noted that "the Legislature appears to have replaced the common-law doctrine of in pari delicto in 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." ...


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