In re Citx Corp., Inc.

• Decision Date: 26 May 2006
• Docket Number: No. 05-2760.,05-2760.
• Citation: 448 F.3d 672
• Parties: In re: CITX CORPORATION, INC., Debtor. Gary Seitz, Chapter 7 Trustee for CitX Corporation, Inc., Appellant v. Detweiler, Hershey and Associates, P.C.; Robert Schoen, C.P.A.
• Court: U.S. Court of Appeals — Third Circuit

448 F.3d 672

In re: CITX CORPORATION, INC., Debtor.

Gary Seitz, Chapter 7 Trustee for CitX Corporation, Inc., Appellant v. Detweiler, Hershey and Associates, P.C.; Robert Schoen, C.P.A.

No. 05-2760.

United States Court of Appeals, Third Circuit.

Argued April 27, 2006.

Filed May 26, 2006.

As Amended June 6, 2006.

COPYRIGHT MATERIAL OMITTED

Neal A. Jacobs, Joshua A. Gelman, Matthew I. Cohen, (Argued), Jacobs Law Group, Philadelphia, PA, for Appellant.

Jonathan K. Hollin, (Argued), Powell, Trachtman, Logan, Carrle & Lombardo, King of Prussia, PA, for Appellee.

Before AMBRO and FUENTES, Circuit Judges, and IRENAS,^* District Judge.

AMBRO, Circuit Judge.

An insolvent internet company involved in an illegal Ponzi scheme used its financial statements, compiled by its accounting firm, to attract investors. After the company spent the investors' money and incurred millions more in debt, it filed for bankruptcy. A bankruptcy trustee was appointed, and he sued the accounting firm, along with the partner responsible for compiling the financial statements, for, among other things, malpractice and "deepening insolvency." The District Court granted summary judgment for the defendants on both claims.

We affirm. The malpractice claim founders on two grounds: the company was not harmed by its accountants' actions, and in any event the affidavit submitted to support the claim was a sham. As for the deepening-insolvency claim, allegations of negligent conduct do not qualify for consideration.

I. Factual Background and Procedural History

A. CitX becomes insolvent

Bernard Roemmele formed CitX Corporation, Inc. in 1996 as an internet company of sorts. Roemmele took immediate opportunity to pillage CitX; for starters, he used its money to license his own intellectual property, to cover one of his debts, and to settle one of his lawsuits.¹

In mid-1999, CitX linked up with Professional Resources Systems International, Inc. (PRSI), ostensibly to create an internet shopping mall for home-based merchants who would pay a fee to be featured. CitX used this PRSI relationship — with the help of a phenomenon called the Internet Bubble — to sell equity in itself. As it happened, PRSI was a fraudulent enterprise, and CitX's stock sales were illegal under federal and Pennsylvania law. PRSI scammed nearly $18,000,000 from would-be online merchants, and CitX received approximately $700,000 of this money. The Florida Attorney General shut down PRSI in January 2000, and a receiver was appointed for it.

PRSI was CitX's only significant client, and at the time PRSI was closed it owed CitX over $2,400,000. In CitX's compiled financials, this was all that was keeping the company theoretically in the black. Because CitX showed a positive balance sheet, it was able to sell more securities for over $1,000,000, which it proceeded to burn through in a year and a half. (CitX apparently spent much of the money in fruitless litigation against PRSI's receiver.)

In July 2001, CitX filed a Chapter 11 petition. The case was later converted to Chapter 7, and Gary Seitz was appointed as trustee.²

B. Schoen and Detweiler compile the financials

The defendants-appellees in this case are Robert Schoen, a certified public accountant, and Detweiler, Hershey and Associates, P.C., Schoen's employer. In 1997, CitX retained Detweiler and Schoen to compile³ its financial statements. Seitz alleges that Detweiler⁴ went beyond its written engagement agreement and that it missed many "red flags" at CitX. These alleged red flags included that CitX's "bookkeeper" was actually Bernard Roemmele's girlfriend, and a high school dropout; CitX was bouncing checks; it was insolvent (i.e., without the PRSI receivable, it had virtually no income); PRSI had been shut down; and yet CitX was selling stock to the public.

Detweiler prepared CitX's financial statements for the period from July 1, 1997, through December 31, 1999. There were two sets of statements, both of which were compilations, as was made plain at the beginning of each statement. The first statement covered the fiscal years ending June 30, 1998, and June 30, 1999; the second covered the six-month period ending December 31, 1999. The second statement included the $2,400,000 PRSI receivable and was accompanied by a note that said in full:

In January 2000, the Company, along with its largest customer and several individuals, were named as defendants and charged with certain security violations by the Attorney General's Office in Florida. As of the date of these financial statements, the Company is not sure what impact, if any, these charges will have on its financial position. As of December 31, 1999, the financial statements reflect accounts receivable in the amount of $2,403,122 from this customer and related deferred revenues in the amount of $960,000.⁵

This second financial statement, from which stems this suit, was taken to a February 2000 CitX shareholder meeting. Even with its weakened financial condition and in suspect circumstances (at least one shareholder had by this time decided that the company was a Ponzi scheme), CitX was still able to raise more than $1,000,000 in equity. The company thereby prolonged its existence and went on to accrue millions of dollars in debt.

C. Seitz sues Detweiler

Seitz sued Detweiler in July 2003. His complaint contained four causes of action: (1) malpractice; (2) "deepening insolvency";⁶ (3) breach of fiduciary duty; and (4) negligent misrepresentation. The Bankruptcy Court dismissed Seitz's fiduciary duty claim. Later, after withdrawing the reference to the Bankruptcy Court of this adversary proceeding, the District Court granted summary judgment to Detweiler on the negligent misrepresentation claim. Finally, the District Court granted summary judgment to Detweiler on Seitz's malpractice and deepening-insolvency claims. Seitz appeals only the ruling on the latter two claims.

II. Jurisdiction and Standard of Review

The District Court had jurisdiction over this case under 28 U.S.C. §§ 157 and 1334. We have jurisdiction under 28 U.S.C. § 1291 because this is an appeal from a final order.

We exercise plenary review of a District Court's grant of summary judgment. Huu Nam Tran v. Metro. Life Ins. Co., 408 F.3d 130, 135 (3d Cir.2005). In so doing, we apply the same test as the District Court: we therefore decide "whether there is a genuine issue of material fact and, if not, whether the moving party is entitled to judgment as a matter of law." Id. (internal quotation marks omitted). We also view the facts "in the light most favorable to the party against whom summary judgment was entered." Id. (internal quotation marks omitted).

III. Discussion

A. Was summary judgment correctly granted on the malpractice claim?

To survive summary judgment on his malpractice claim, Seitz must present sufficient evidence to allow a reasonable jury to find in his favor. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986); Fed.R.Civ.P. 56(e). Pennsylvania recognizes professional malpractice claims on a theory of negligence. See Guy v. Liederbach, 501 Pa. 47, 459 A.2d 744, 750 (1983). Thus, Seitz must establish that (1) Detweiler owed a duty to CitX, (2) Detweiler breached that duty,⁷ (3) CitX was actually harmed, and (4) Detweiler's breach caused that harm. See Martin v. Evans, 551 Pa. 496, 711 A.2d 458, 461 (1998).

1. Harm

Seitz must establish harm to CitX — "actual loss or damage" — to support a negligence action. Id. He alleges harm to it in the form of "deepening insolvency" — that Detweiler "dramatically deepened the insolvency of CitX, and wrongfully expanded the debt of CitX and waste of its illegally raised capital, by permitting CitX to incur additional debt by virtue of the compilation statements prepared and relied upon by third parties." Compl. ¶ 32.

This requires us to decide whether deepening insolvency is a viable theory of damages for negligence (as opposed to whether it is a viable cause of action — a topic dealt with in section B below). Our only opinion to address "deepening insolvency," Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir.2001), defined it, in predicting Pennsylvania law, as "an injury to [a debtor's] corporate property from the fraudulent expansion of corporate debt and prolongation of corporate life." Id. at 347. In that opinion, we concluded that deepening insolvency was a valid Pennsylvania cause of action. Id. at 344. Although we did describe deepening insolvency as a "type of injury," id. at 347, and a "theory of injury," id. at 349, we never held that it was a valid theory of damages for an independent cause of action. Those statements in Lafferty were in the context of a deepening-insolvency cause of action. They should not be interpreted to create a novel theory of damages for an independent cause of action like malpractice.⁸

Also, we note that Seitz did not provide sufficient evidence to allow a reasonable jury to find harm. Assuming for the sake of argument that Detweiler's financial statements allowed CitX to raise over $1,000,000, that did nothing to "deepen" CitX's insolvency. It did the opposite. Cf. Sabin Willett, The Shallows of Deepening Insolvency, 60 Bus. Law. 549, 552-57 (2005) (discussing loans). Before the equity infusion, CitX was $2,000,000 in the red (using round numbers for ease of discussion). With the added $1,000,000 investment, it was thereby insolvent only $1,000,000. Insolvency decreased rather than deepened. Any later increase in insolvency (i.e., the several million dollars of debt incurred after the $1,000,000 investment) was wrought by CitX's management, not by Detweiler.

The crux, then, is the claim that the $1,000,000 equity investment allowed CitX to exist long enough for its management to incur millions more in debt. But that looks at the issue through hindsight bias. As noted, the equity investment was hardly harmful to CitX....