A federal appeals court ruled against PricewaterhouseCoopers in a long-running bankruptcy case that could now examine whether the firm acted in good faith as the auditor for a defunct hospital system.

The case involved the Allegheny Health, Education and Research Foundation, a Pittsburgh-based nonprofit hospital system that filed for bankruptcy in July 1998 with approximately $1.3 billion in debt, according to Reuters. Coopers & Lybrand had been AHERF’s auditing firm before merging with Price Waterhouse in 1998. A committee of unsecured creditors accused the firm of giving a clean opinion in its 1996 and 1997 audits of AHERF despite the precarious state of the hospital system’s finances.

The committee, on behalf of AHERF, asserted three causes of action against PwC: breach of contract, professional negligence, and aiding and abetting a breach of fiduciary duty. PwC moved for summary judgment on numerous grounds, and in January 2007, a U.S. District Court granted summary judgment in favor of PwC because of the doctrine of “in pari delicto,” essentially saying that AHERF was at equal fault because its executive officers misstated the company’s finances.

However, the Third Circuit requested guidance from the Pennsylvania Supreme Court on several questions regarding the auditor’s liability. The court concluded that an auditor could be liable if the firm had not dealt materially in good faith with the client, and that the “in pari delicto” defense could not be applied in “scenarios involving secretive collusion between officers and auditors to misstate corporate finances to the corporation's ultimate detriment.”

Relying on their guidance, last Friday, Judge Thomas Ambro, writing for the Third Circuit, ruled against PwC and ordered an inquiry into whether the firm had dealt in good faith with AHERF.