National City Bank v. Coopers & Lybrand

• Decision Date: 21 July 1987
• Docket Number: No. C1-86-2224,C1-86-2224
• Parties: NATIONAL CITY BANK, as Indenture Trustee for Holders of Gambles Credit Corporation, etc., Appellants, v. COOPERS & LYBRAND, Respondent.
• Court: Minnesota Court of Appeals

Page 862

409 N.W.2d 862

NATIONAL CITY BANK, as Indenture Trustee for Holders of Gambles Credit Corporation, etc., Appellants, v. COOPERS & LYBRAND, Respondent.

No. C1-86-2224.

Court of Appeals of Minnesota.

July 21, 1987.

Review Denied Oct. 21, 1987.

Syllabus by the Court

1. The trial court did not err in holding that appellant lacks standing and is not the proper plaintiff to bring this action.

2. The trial court did not err in holding that appellant's claims are derivative.

Allen D. Barnard, James C. Daracles, Best & Flanagan, Minneapolis, for appellants.

Robert R. Weinstine, Darron C. Knutson, Steven C. Tourek, Winthrop & Weinstine, St. Paul, for respondent; Hughes, Hubbard & Reed, Washington, D.C., of counsel.

Heard, considered, and decided by RANDALL, P.J., and WOZNIAK and NIERENGARTEN, JJ.

OPINION

WOZNIAK, Judge.

Appellant National City Bank (NCB) appeals from the summary judgment entered in favor of respondent Coopers & Lybrand (C & L). NCB brought this action against C & L as indenture trustee for noteholders of two sets of notes issued by Gambles Credit Corporation (GCC), alleging negligence in C & L's audit of GCC's financial affairs, misrepresentation, and breach of contract as a third party beneficiary. The trial court granted summary judgment against NCB, holding that NCB did not have standing as an indenture trustee to bring the action and was not the proper plaintiff in the case and that NCB had alleged a derivative claim which was precluded by GCC's bankruptcy. We affirm.

FACTS

NCB was the indenture trustee under two indenture agreements governing three separate series of subordinated notes, totaling $66,760,000, issued by GCC in 1977 and 1978 and sold to public investors. Under the indenture agreements, NCB was authorized to act for the noteholders according to the terms of the indentures. As trustee, NCB was to administer the provisions of the indentures for the benefit of the noteholders and was primarily responsible for receiving periodic payments of principal and interest from GCC and redistributing the payments to the registered noteholders, for ensuring that the covenants in the indenture were performed by examining reports and certificates furnished by GCC and outside professionals, and for protecting the trust res in the event of default by enforcing the remedial provisions contained in the indentures. Conversely, the noteholders were not permitted to take any action relating to the indentures, except under special circumstances.

At the time the notes were issued, GCC was a wholly-owned subsidiary of Gamble-Skogmo, Inc. (GSK). GCC was organized to finance the accounts receivable generated by GSK and its retail subsidiaries. GCC purchased from GSK and its retail subsidiaries accounts receivable consisting primarily of charge account debt owed by retail customers. GCC operated as a finance business by borrowing funds from a group of banks and using the public debt obtained from the sale of the notes. The funds were paid to GSK in return for receivables. GCC's only material assets were the accounts receivable which it purchased from GSK and its retail subsidiaries. The receivables provided security for approximately $268,000,000 of debt, including the notes.

In 1980, Wickes Companies, Inc. (Wickes) acquired GSK and its subsidiary GCC. After acquiring GSK and GCC, Wickes retained C & L to audit GCC's financial statements. One of the purposes of the audit was to assist in meeting the reporting requirements under various debt agreements similar to the indentures. C & L issued a report for GCC's January 1981 financial statement, offering its opinion that the statement fairly presented GCC's financial position as of January 1981, "in conformity with generally accepted accounting principles." GCC's financial statements contained direct representations that GCC had purchased the receivables upon which the noteholders depended for payment on the notes. NCB received a copy of C & L's report and GCC's 1981 financial statement.

In 1982, Wickes and most of its subsidiaries, including GSK and GCC, filed petitions in bankruptcy court, seeking reorganization under Chapter 11. Pursuant to the GCC Plan of Reorganization, GCC was merged into GSK, which in turn was merged into Wickes under the Wickes Plan of Reorganization. During the bankruptcy proceedings, an investigation of GCC's books showed that GCC's ownership interest in the receivables purchased from GSK was in doubt. The necessary documentation from GSK showing the transfer of assets was apparently lacking. C & L did not offer an opinion on GCC's financial statement of January 1982 because questions had arisen whether GCC had acquired valid title to the receivables. NCB alleges that C & L's failure to detect the lack of documentation for over $380,000,000 of receivables was the primary defect in the audit.

During the bankruptcy reorganization proceedings, a committee to protect the interests of GCC creditors was formed. The committee commenced an adversary proceeding in bankruptcy court against GSK seeking a declaration that GCC had a valid and enforceable ownership interest in the GSK receivables. The GCC creditors' committee, however, settled their claim against Wickes, GSK, and GCC. Under the settlement agreement, which the bankruptcy court approved, NCB received an unsecured claim against GSK in the amount of $66,760,000, the full principal amount of the notes. In exchange, GCC creditors, including NCB, released all claims against Wickes, GSK, and GCC. The settlement specifically did not release claims against any outside professionals retained by GCC prior to March 1, 1982.

As part of the reorganization, the notes were surrendered for cancellation in return for a distribution under the reorganization plan. Pursuant to the GSK Reorganization Plan, NCB received, on behalf of the noteholders, $44,512,056.47 in cash, $17,644,500 in Wickes notes, and Wickes common stock appraised at $1,559,958, for a total value of $63,716,514.47, or approximately 95% of the principal amount of the notes. At oral argument, counsel for NCB conceded that some noteholders purchased their notes at a discount subsequent to GCC's bankruptcy. The record does not disclose the number of such notes or at what discount they were bought.

In a related proceeding, at the time Wickes was filing for reorganization, eight securities class actions were filed against various Wickes entities, its officers and directors, and its auditors (including C & L) and financial advisers, alleging securities law violations. The defendants in these actions, other than Wickes, filed claims for indemnity and contribution from Wickes. These actions were consolidated under the caption In re Wickes Companies Securities Litigation in federal district court for the Southern District of California.

Prior to court approval of the Wickes Reorganization Plan, Wickes and the other defendants entered into a settlement with the class action plaintiffs. As part of the settlement, Wickes and GSK, into which GCC had merged, entered into a separate agreement with C & L, under which C & L agreed to contribute $1,100,000 to the settlement fund and to withdraw its claims against Wickes for indemnity and contribution. In exchange, Wickes agreed to release C & L from all claims arising from its actions or omissions in its capacity as accountant or auditor for Wickes, which was defined to include GCC. This settlement agreement between Wickes and C & L was expressly conditioned on bankruptcy court approval, and notice of the agreement was given to all creditors. Neither NCB nor the GCC creditor committee objected to the settlement agreement, which was approved by the bankruptcy court and subsequently implemented.

After receiving its bankruptcy distribution, NCB, as trustee for the noteholders, sued C & L seeking to recover $22,000,000 as the difference between the full amount due on the notes and the amount received in the bankruptcy distribution, plus accrued interest from the date of the GCC bankruptcy filing to the date of the distribution. NCB alleged, among other things, that C & L was negligent in conducting its 1981 audit of GCC and that it breached a duty of care to NCB. NCB claimed that if C & L had properly performed its duties as GCC's auditor and disclosed alleged deficiencies in GCC's interest in GSK receivables, NCB would have taken steps to correct those deficiencies. Presumably, by such action GCC's bankruptcy estate would have been worth more and the noteholders would have recovered in full. NCB's complaint also alleged fraud, aiding and abetting breach of a contract, and breach of a third-party beneficiary contract.

C & L moved for judgment on the pleadings or, alternatively, for summary judgment. The trial court granted summary judgment, holding that NCB lacked standing to bring the action as indenture trustee. The court noted that NCB's powers as trustee stemmed solely from the indenture agreements, which authorized it to bring suit on the notes. Since the notes were surrendered by the noteholders under the

bankruptcy reorganization, the court concluded NCB had no standing to represent the noteholders nor was it the proper plaintiff in the case because the noteholders had different interests which could not be protected by one trustee. The court also held that NCB's claims on behalf of the noteholders were derivative in nature, explaining that GCC sustained the direct injury, not the noteholders. The court noted that, as derivative claims, they belonged to GCC and could have been brought derivatively in GCC's name before the bankruptcy proceedings, but could never have been asserted directly by NCB on behalf of the noteholders.

ISSUES

1. Did the trial court err in holding that NCB lacks standing and is not the proper plaintiff to bring this action?

2. Did the trial court err in holding that NCB's claims are derivative?

ANALYSIS

On appeal, the function of a court...