KAPLAN, District Judge.
The plaintiff in this case was the purchasing vehicle in a 1994 management buyout of ICD, Inc. ("ICD"), a large international dealer in petrochemical based commodities. It brings this action against Alfred M. Frankel and Jacques Leviant, who sold the ICD shares to plaintiff, and Richard A. Eisner & Co. ("Eisner"), certified public accountants who prepared certain materials contemplated by the purchase agreement for use in determining the price. All defendants move to dismiss the complaint.
This is the second action concerning this transaction, the first having occasioned three opinions by this Court that set out the pertinent aspects of the purchase agreement and the nature of the dispute between the buyer and the sellers.
The Prior Action
In brief summary, the plaintiff in this case, ICD Holdings S.A. ("Holdings"), purchased all of the shares of ICD from Frankel and Leviant for (1) $5 million in promissory notes, and (2) cash equal to the Book Value, as defined by the purchase agreement, less $5.9 million. The notes were guaranteed by Holdings' two shareholders, Messrs. deGeus and Löffelhardt. The overall purchase price was subject to a post-closing adjustment in which the buyer or the sellers, as the case might be, would pay to the other any amount necessary to adjust the consideration transferred at the closing to an amount equal to the adjusted purchase price.
The prior action was commenced not by the filing of a complaint, but by the service of a motion for summary judgment in lieu of complaint as permitted in such cases by Section 3213 of the New York Civil Practice Law and Rules. As there was no complaint, Holdings, deGeus and Löffelhardt filed no answer.
In Frankel I, this Court held that Holdings, by the terms of the notes it had signed, waived the defense of fraud in the inducement of the notes.
The structure of this buyout transaction was complex. The purchase agreement, which is the document that obliged deGeus and Löffelhardt to execute their guarantees at the closing, conditioned their obligation to do so (as well as the obligation of Holdings to proceed with the purchase) on the receipt of a preliminary balance sheet showing the Estimated Cash Purchase Price — the Book Value as defined less $5.9 million — to be within ten percent of $67.8 million.
In order to defeat the buyers' motion for summary judgment on the guarantees, Frankel I held, deGeus and Löffelhardt were obliged to adduce evidence sufficient to raise a genuine issue of fact as to the existence of a material overstatement of the Estimated Cash Purchase Price.
DeGeus and Löffelhardt sought relief from the judgment under Rule 60(b)(2), relying on additional accounting evidence in support of their position that there had been a material overstatement. Among the evidence proffered was an opinion of a Price Waterhouse
The Complaint in this Action
This action was commenced during the pendency of the prior action.
I. Former Adjudication
Frankel and Leviant move to dismiss the entire complaint on the grounds that all of Holdings' claims are barred by both issue and claim preclusion, often referred to as collateral estoppel and res judicata, respectively. Eisner contends that Holdings' fraud, aiding and abetting and negligent misrepresentation claims must be dismissed on the basis of issue preclusion.
A. Issue Preclusion
The fraud claims asserted here depend upon the allegation that the defendants made six misrepresentations to Holdings: that (1) Eisner would act independently, (2) Eisner would prepare the balance sheet in accordance with U.S. generally accepted accounting principles ("GAAP"), (3) Eisner would perform an audit or special procedures with respect to ICD and the retained subsidiaries, (4) the Estimated Book Value, as of September 30, 1993, was $70,573,766, (5) the Estimated Cash Purchase Price was $64,933,450, and (6) the 1992 financial statements were materially correct.
All of the defendants contend that the Court's rulings in Frankel I decided these issues against Holdings and that these claims therefore must be dismissed. In addition, Frankel and Leviant argue that the breach of contract claims against them are based on one of two theories: either (1) there was a misrepresentation of the book value of the businesses on the balance sheet or (2) there was a breach of the purchase agreement in failing to account for the transaction in accordance with its terms. The rejection of the fraud defense asserted in Frankel I, they contend, precludes Holdings from establishing either theory and requires dismissal of the contract claims as well.
Litigants who have had a full and fair opportunity to litigate ordinarily will not be heard to relitigate an issue actually, finally and necessarily decided against them in a prior action. In order for this doctrine of issue preclusion to apply, four requirements must be satisfied:
It therefore is essential to determine at the outset exactly what Frankel I actually and necessarily decided.
1. Actually and Necessarily Decided
As described, the prior action, insofar as it dealt with the fraud defense on its merits, was a suit by Frankel and Leviant against deGeus and Löffelhardt on their guarantees. As a matter of law, deGeus and Löffelhardt could have avoided the guarantees only if they had raised a genuine issue of fact as to the existence of an overstatement of the Estimated Cash Purchase Price of sufficient magnitude that disclosure of the truth would have given them the right to decline to execute the guarantees of the $5 million in notes at the Closing.
Frankel and Leviant argue that the Court previously determined that there were no material misrepresentations in connection with the purchase agreement. They place great emphasis on the Court's statement in Frankel I that "[t]he evidence is insufficient to permit the inference that properly prepared balance sheets as at September 30, 1993 would vary materially from those Eisner prepared."
In ordinary circumstances, the test of materiality, broadly speaking, is whether an alleged misstatement or omission would have been important to a reasonable buyer or seller.
2. Identity of Issues
Holdings would have the Court go further. It contends that the prior judgment can have no issue preclusive effect because the requisite identity of issues is absent.
To begin with, the alleged overstatement of the Estimated Cash Purchase Price and the Book Value are one and the same. The Estimated Cash Purchase Price was defined in the purchase agreement as the purchase price less the $5 million in notes.
The differences between the elements of the contract and negligent misrepresentation claims in this case and the fraud defense on the guarantees is of no greater help to Holdings. Differences there certainly are. To the extent, however, that Holdings claims that the Book Value and Estimated Cash Purchase Price were overstated by $7.5 million, proof of an overstatement in excess of $6.78 million is essential to Holdings' complete success and, to the extent the claim exceeds that amount, identical to the issue in the prior action.
Holdings' contention that there can be no issue preclusion because of the allegedly higher standard of proof it claims applied in the prior action fares no better. New York, to be sure, requires that one seeking recovery for fraud prove his or her case by clear and convincing evidence.
First, the prior action was litigated without regard to the allegedly higher burden of proof of fraud. Neither party asserted that the defense of fraud in the inducement of the guarantees was governed by the clear and convincing evidence standard, and the Court decided the case on the basis that no reasonable trier of fact could have inferred, by a preponderance of the evidence, that there was an overstatement of the purchase price of more than $6.78 million. While the Court's assumption as to the standard of proof, in consequence of the parties' silence, may or may not have reflected accurately the law of New York, that in fact was the basis of the decision.
Second, even if the prior action were regarded as establishing only that deGeus and Löffelhardt had failed to establish fraud by clear and convincing evidence, that same clear and convincing standard clearly applies to their fourth and seventh causes of action in this case and at least arguably applies to their other causes of action which incorporate the allegations of fraud.
3. Actually Litigated
Finally, Holdings contends that this Court did not reach the merits of Holdings' fraud claim in the prior action because it concluded that Holdings waived the defense of fraud in the promissory notes. In substance, the argument is that the prior determination may bind deGeus and Löffelhardt, but not Holdings.
Holdings raises no other objections to the issue preclusive effect of the prior judgment. In consequence, the Court holds that the decision in the prior action precludes Holdings from asserting that the Estimated Cash Purchase Price or the Book Value of ICD was overstated by more than $6.78 million. As that was the only determination necessary to support the prior decision, the prior decision has no broader issue preclusive effect.
B. Claim Preclusion
Frankel and Leviant briefly assert that Holdings' fraud claims are barred by the doctrine of claim preclusion.
Under established principles, a final judgment on the merits "prevents litigation of all grounds for, or defenses to, recovery that were previously available to the parties, regardless of whether they were asserted or determined in the prior proceeding."
The prior action, as noted above, was a suit on the promissory notes and the guarantees, not on the purchase agreement. Fraud in the inducement was a defense only to the extent that Holdings, deGeus and Löffelhardt were entitled and able to show that they would not have executed those instruments but for the alleged fraud. Holdings, the Court held, waived the defense entirely. DeGeus and Löffelhardt did not, but they were unable to raise a genuine issue as to whether there was an overstatement of the Estimated Cash Purchase Price sufficiently large to have relieved them of their obligation under the purchase agreement, which they signed before any fraud allegedly occurred, to execute and deliver the guarantees. Claims of fraudulent overstatement of the Estimated Cash Purchase Price in any lesser amount would not have been legally sufficient defenses to the action. Hence, the judgment determining that there was no overstatement of sufficient magnitude to avoid the guarantees does not bar a claim of overstatement in a smaller amount.
II. Performance by Holdings of its Contractual Obligations to Frankel and Leviant
Frankel and Leviant next seek dismissal of Holdings' contract claims. They assert that a plaintiffs own performance of a contract is a prerequisite to its recovery for breach by the defendant. Holdings, they assert, has not and cannot allege due performance
Due performance by the plaintiff is an element of a claim for breach of contract under New York law.
Some district court decisions have held that a breach of contract plaintiff must make some allegation of its own performance.
The essence of the position taken by Frankel and Leviant here is that Holdings cannot allege its own due performance because it has not paid the $5 million in notes which it gave for a comparatively small part of the purchase price. This action, however, is for breach of the purchase agreement. While Frankel and Leviant suggest that payment of the notes was among Holdings' obligations under the purchase agreement, their argument is unpersuasive.
Given that the complaint, generously construed as it must be, makes out a claim for relief and that Frankel and Leviant have advanced no substantial reason for believing that there has been any material failure of performance of Holdings' obligations under the purchase agreement, the Court declines to elevate form over substance. Insofar as Frankel and Leviant seek dismissal on the ground that there is no broader allegation of due performance by Holdings, the motion is denied.
III. The Alleged Breach of the Implied Covenant of Good Faith and Fair Dealing
The second claim for relief alleges that Frankel and Leviant breached the covenant of good faith and fair dealing implied in every contract and therefore in the purchase agreement. The claim rests entirely on the breaches of the purchase agreement alleged in the first claim for relief.
A claim for breach of the implied covenant "will be dismissed as redundant where the conduct allegedly violating the implied
IV. The Fraud and Related Claims Against Eisner
The fourth and seventh claims for relief charge Eisner with common law fraud and with aiding and abetting the alleged fraud by Frankel and Leviant, respectively. The fifth accuses it of negligent misrepresentation. The tenth seeks relief on a theory of breach of fiduciary duty. All four claims are based on the common theme that Eisner acted in concert with or aided and abetted Frankel and Leviant in making six alleged misrepresentations.
Eisner seeks dismissal of all of them on the ground that they fail to allege fraud with the particularity required by Rule 9(b) in three respects. According to Eisner, they do not allege facts giving rise to a strong inference of scienter, rest on allegations made only on information and belief, and do not plead the alleged overstatements of the Estimated Cash Purchase Price and the Book Value with particularity.
The pleading alleges that Frankel and Leviant knew or were chargeable with knowledge that the Book Value of ICD was sufficiently low that its accurate disclosure would have given Holdings the right to walk away from the deal.
Many of these allegations are made "on information and belief." Moreover, the complaint contains no suggestion as to why Eisner would have engaged in such duplicitous behavior apart from the fact that it previously had been responsible for auditing ICD's financial statements and is said to have had a "long-standing relationship with Frankel and Leviant."
Rule 9(b) of the Federal Rules of Civil Procedure requires that averments of fraud be made with particularity in order to protect a defendant's reputation from "improvident charges of wrongdoing," discourage strike suits, and provide fair notice of the basis for such claims.
There are two theories on which a plaintiff may seek to establish the necessary inference of fraud: "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness."
Here there is precious little basis in the amended complaint for inferring conscious misbehavior or recklessness. Although the complaint contains the conclusory assertion that Eisner knew or recklessly disregarded the fact that its own statement was inaccurate, there is no suggestion that Eisner knew what the Book Value and Estimated Cash Purchase Price actually were. Nor is there any substantial allegation that it knowingly or recklessly failed to carry out its task properly or disregarded discrepancies. The allegations that it failed to conduct or have conducted an on-site review of the books of
Accordingly, the Court holds that the fraud allegations against Eisner fail to state a claim upon which relief may be granted. The fourth, fifth, seventh and tenth claims for relief therefore will be dismissed as against Eisner.
V. The Breach of Contract and Malpractice Claims Against Eisner
The eighth and ninth claims for relief allege breach of contract and professional malpractice by Eisner. The theory of both is that Holdings, together with Frankel and Leviant, jointly retained Eisner and that the alleged overstatement of the Book Value and Estimated Cash Purchase Price was the product of malpractice and breach of Eisner's contractual duties, said to have been set forth in the purchase agreement, to Holdings.
A. Standing and the Scope of the Engagement
The complaint alleges that "ICD Holdings, together with Frankel and Leviant pursuant to a retention agreement, jointly retained Eisner to perform certain accounting functions ..."
Very much the same point disposes of Eisner's contention that the scope of its engagement was set forth in its March 28 and May 31, 1995 letters rather than in the purchase agreement. The amended complaint asserts that Eisner was retained by Holdings and the other defendants to prepare "an accurate statement [of] Book Value in accordance with U.S. GAAP and ... an accurate statement of the Estimated Cash Purchase and Final Cash Purchase Prices,"
B. Compliance with the Purchase Agreement
1. AOZT and Hisparus
As explained in Frankel I and Frankel II, the core of this dispute is whether AOZT Versus and Hisparus, two Russian subsidiaries of ICD, had negative equity values as of September 30, 1993, the amounts of any such negative equity values, and whether any such negative values were required to be included in the Book Value reflected in the preliminary balance sheet.
Eisner contends that Exhibit 6.03(4) to the purchase agreement makes clear that the parties intended that AOZT Versus and Hisparus were not to be included in the preliminary or closing balance sheets, but were among the items that would be accounted for, if necessary, by a post-closing additional contingent purchase price payment. There is substantial force to the argument, both from the terms of Exhibit 6.03(4) and from the fact that evidently neither side in the transaction had up-to-date financial statements for either subsidiary. Nevertheless, Holdings' position is not clearly wrong, at least on the face of the documents. AOZT Versus and Hisparus were "Retained Businesses" as that term was defined in the purchase agreement.
As the foregoing demonstrates, there manifestly is a material issue of fact as to whether the purchase agreement required the equity values of these entities to be included.
2. ICD Paris
Holdings contends that Section 6.11 of the purchase agreement required that any negative book value of ICD Group S.A., referred to as ICD Paris, which was sold separately to Holdings, be credited against the purchase price for ICD, that in fact ICD Paris had a negative book value, and that Eisner failed properly to reflect that negative value in the preliminary and closing balance sheets.
Section 6.11 of the purchase agreement provides:
Holdings responds that ICD Paris was sold at the same time as ICD and that the purchase agreement required that the purchase price for ICD be adjusted downward to reflect the negative equity.
Assuming the accuracy of Eisner's contention that Holdings got the benefit of the contemplated credit for the negative equity value of ICD Paris, albeit in the ICD Paris rather than the ICD acquisition, it would appear that Holdings got all that it was entitled to. Nevertheless, this is a motion to dismiss. The assertion that the credit was given on the ICD Paris transaction first was made in Eisner's reply memorandum and in any case is outside the pleadings. As the Court is obliged to accept as true the allegations of the complaint, and as there is no admissible evidence outside the pleadings that could be taken into account on this point under Rule 12(b), this aspect of Eisner's motion also must be denied.
3. The Consolidation Eliminations
It is common ground among the parties that the statements prepared by Eisner incorrectly overstated Book Value by $1.5 million by failing to make required consolidation eliminations and that Frankel and Leviant refunded that amount promptly. Holdings concedes that it therefore has no direct damages as a result of this error. It nevertheless contends that it suffered consequential damages as a result of the error.
The prompt repayment of the $1.5 million overpayment eliminates any direct damages to Holdings. Its claim of consequential damages does not appear in the amended complaint. In consequence, this aspect of the amended complaint will be dismissed, albeit with leave to amend to assert this damage theory.
VI. The Breach of Fiduciary Duty Claim Against Eisner
Eisner moves to dismiss the tenth claim for relief, which asserts breach of fiduciary duty, on the ground that it owed no fiduciary duty to Holdings. It contends that Holdings was not its client, and, in any case, that accountants do not owe even their clients fiduciary obligations.
In view of the Court's holding that the complaint adequately alleges that Holdings was a client of Eisner, Eisner's motion cannot succeed on this ground. "While it is true that the `[c]ourts do not generally regard the accountant-client relationship as a fiduciary one', where the allegations include knowledge and concealment of illegal acts and diversions of funds and failure to withdraw in the face of a conflict of interest ... such a cause of action against an accountant will be permitted to stand."
For the foregoing reasons, defendants' motions to dismiss the amended complaint are granted to the extent that:
The motions to dismiss are denied in all other respects.