May 28, 2010 / 8:12 PM / 9 years ago

UPDATE 1-PwC loses ruling on big Pa. healthcare bankruptcy

* Lower court ruling favoring PwC thrown out

* Pittsburgh’s AHERF went bankrupt in 1998

* AHERF was largest U.S. nonprofit health care collapse

(Adds comments, details)

By Jonathan Stempel

NEW YORK, May 28 (Reuters) - PricewaterhouseCoopers LLP suffered a defeat on Friday when a federal appeals court ordered an inquiry into whether the auditor dealt in good faith with a large Pennsylvania hospital system that went bankrupt.

The Third Circuit Court of Appeals in Philadelphia threw out a January 2007 ruling dismissing claims against PwC by a committee of unsecured creditors of behalf of the now defunct Allegheny Health, Education and Research Foundation.

These creditors accused Coopers & Lybrand LLP, one of PwC’s predecessor companies, of conspiring with AHERF officials in the 1996 and 1997 fiscal years to hide the increasingly dire financial health of the Pittsburgh-based system.

AHERF ultimately sought Chapter 11 protection in July 1998, with about $1.3 billion of debt, in the largest U.S. nonprofit healthcare collapse. The system once ran 14 hospitals and two medical schools and employed an estimated 31,000 people.

It is not clear whether Friday’s ruling will result in more litigation or prompt the parties to pursue a settlement.

PwC spokesman Steven Silber said company officials could not be reached for comment. James Jones, a Pittsburgh-based lawyer for the creditors, declined immediate comment.

In his 2007 ruling, U.S. District Judge David Cercone said the creditors could not recover on AHERF’s behalf under a legal doctrine governing cases of equal fault, concluding AHERF was at least as much at fault as PwC.

But the Third Circuit asked the Pennsylvania Supreme Court for guidance on that state’s law, including whether an auditor such as PwC could be held liable for breach of contract, negligence or aiding and abetting a breach of fiduciary duty.

Writing for a unanimous three-judge panel of the Third Circuit, Judge Thomas Ambro adopted the Pennsylvania court’s conclusion that an auditor could be held liable if it had “not dealt materially in good faith with the client-principal.”

This effectively barred the equal fault defense in cases of “secretive collusion between officers and auditors to misstate corporate finances to the corporation’s ultimate detriment.”

Ambro also directed the district court to reconsider its finding that misstated financials could have been a short-term “benefit” to AHERF.

He said that, as a matter of law, “a knowing, secretive, fraudulent misstatement of corporate financial information” cannot benefit a company.

The AHERF bankruptcy generated much litigation and regulatory activity. In 2007, the bond insurer MBIA Inc (MBI.N) agreed to pay $75 million to settle regulatory fraud charges over a reinsurance transaction involving defaulted AHERF debt.

The case is Official Committee of Unsecured Creditors of Allegheny Health, Education and Research Foundation v. PricewaterhouseCoopers LLP, U.S. Third Circuit Court of Appeals, No. 07-1397. (Reporting by Jonathan Stempel; editing by Steve Orlofsky and Andre Grenon)

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