Chancery Provides Guidance on Agency and Joint Venture Theories of Vicarious Liability

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Otto Candies, LLC v. KPMG, LLP, C.A. No. 2018-0435-MTZ (Del. Ch. Aug. 21, 2020)

The Court of Chancery dismissed a complaint filed by creditors and former business affiliates of a defunct Latin American offshore oil service company for failing to establish, under agency or joint venture theories, a basis for finding KPMG US vicariously liable for audits performed by KPMG Mexico. 

Prior to its collapse, the oil service company engaged in fraud by submitting forged and sham invoices to Citigroup, Inc. for work never performed in exchange for cash draws from a line of credit established by one of the oil service company’s clients. The oil services company landed in bankruptcy after Citigroup and the Mexican government exposed the fraud. KPMG Mexico audited the oil service company’s books and records while it engaged in its cash fraud scheme. In their complaint, plaintiffs alleged that if KPMG Mexico had complied with certain audit standards, the cash advance fraud would have been detected and prevented. According to plaintiffs, KPMG US was vicariously liable, under both direct agency and sub-agency theories, for KPMG Mexico’s negligent misrepresentation in the oil service company’s audit opinions. The plaintiffs’ sub-agency theory of liability rested on allegations that KPMG US is a principal to KPMG International and KPMG International is a principal to KPMG Mexico.   

Vice Chancellor Morgan T. Zurn first determined that Delaware law would govern her analysis because there was no material difference in the laws of Delaware, New York and Mexico for vicarious liability. The Vice Chancellor concluded that, under Delaware law, “to hold one entity vicariously liable for the tort of another via agency principals, the plaintiff must plead the principal had control over the wrongdoing at issue.”  Under the agency theory of vicarious liability, the court focuses on the arrangement between the entities, the authority given under such an arrangement and the relevance of that arrangement to the claims at issue. Accordingly, Delaware law requires “plaintiffs seeking to hold a purported principal liable for wrongful acts of the agent to plead control over that specific wrongful act.” 

With respect to the plaintiffs’ direct agency claims, the Court concluded that allegations concerning KPMG Mexico’s audit work for U.S. companies and the potential overlap with KPMG US’ audit work for Citigroup were insufficient to establish that KPMG US “wielded the necessary control over the content of” KPMG Mexico’s audit opinions of the oil service company. 

The Court also found the plaintiffs’ sub-agency claims were inadequate. That KPMG US was a founding member of KMPG International, constituted nearly one-third of its revenues and its personnel made up 40% of KPMG International’s management team failed to establish that KPMG US exercised control over KPMG International in relation to KPMG Mexico’s audit of the oil service company. In addition, even if KPMG International could control KPMG Mexico, that would not establish that KPMG International in fact exercised control over KPMG Mexico with respect to the audit opinions in question. The Court also rejected the plaintiffs’ claim that KPMG Mexico acted with KPMG International’s implied actual authority regarding the allegedly fraudulently misrepresented audit opinions because the plaintiffs still could not tether the relationship between KPMG International and KPMG Mexico to the audits, as required to demonstrate a sub-agency relationship based upon implied actual authority.     

The Court also was not persuaded by the plaintiffs’ attempt to hold KPMG US vicariously liable for KPMG Mexico’s actions under joint venture theory of liability, because the complaint failed to establish a relationship or agreement, express or implied, to perform a common purpose among KPMG US, KPMG Mexico, and KPMG International. Statements in KPMG International’s governing statutes that the entities shared profits, losses and risks were insufficient to establish a joint venture under Delaware law.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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