O\u27Melveny Meyers v. FDIC: Imputation of Fraud and Optimal Monitoring

The imputation-of-fraud rule bars recovery by a corporation from its outside professionals who fail to uncover fraud against third parties committed by the corporation\u27s management. In O\u27Melveny & Meyers v FDIC, the Supreme Court refused to adopt a federal common law exception to that rule for transactions undertaken while the corporation was insolvent. This article explains why that exception is justified under traditional standards of state corporate law. Under those traditional standards, creditors become the beneficial owners of the corporation after insolvency. Their aversion to corporate risktaking-such as the commission of fraud against third parties-requires an exception to the ordinary imputation-of-fraud rule in order to induce outside professionals to monitor fraud by the corporation. Enlisting outside professionals to monitor for fraud will curb excessive risktaking by the corporation, thereby minimizing the corporations\u27 cost of credit