Baena v. Kpmg Llp

• Decision Date: 22 June 2006
• Docket Number: No. 05-2868.,05-2868.
• Parties: Scott L. BAENA, Litigation Trustee of the Lernout & Hauspie Speech Products, N.V. Litigation Trust, Plaintiff, Appellant, v. KPMG LLP and Klynveld Peat Marwick Goerdeler Bedrijfsrevisoren, Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

Page 1

453 F.3d 1

Scott L. BAENA, Litigation Trustee of the Lernout & Hauspie Speech Products, N.V. Litigation Trust, Plaintiff, Appellant, v. KPMG LLP and Klynveld Peat Marwick Goerdeler Bedrijfsrevisoren, Defendants, Appellees.

No. 05-2868.

United States Court of Appeals, First Circuit.

Heard May 2, 2006.

Decided June 22, 2006.

Robert W. Turken and David W. Trench with whom Raquel M. Fernandez, Bilzin Sumberg Baena Price & Axelrod LLP, Dana A. Zakarian, Joel G. Beckman, William C. Nystrom and Nystrom Beckman & Paris LLP were on brief for appellant.

Michael P. Carroll with whom Michael S. Flynn, Sean C. Knowles, Phineas E. Leahey, Davis Polk & Wardwell, Kevin J. Lesinski, William J. Hanlon, Kristin G. McGurn and Seyfarth Shaw LLP were on brief for appellee KPMG LLP.

George A. Salter with whom Nicholas W.C. Corson, Hogan & Hartson LLP, Michael J. Stone and Peabody & Arnold LLP were on brief for appellee Klynveld Peat Marwick Goerdeler Bedrijfsrevisoren.

Before BOUDIN, Chief Judge, TORRUELLA and HOWARD, Circuit Judges.

BOUDIN, Chief Judge.

Lernout & Hauspie Speech Products, N.V. ("L & H") was a Belgian company, with its U.S. headquarters in Massachusetts, engaged in developing and licensing speech recognition software. Its first public stock offering occurred in 1995. From 1998 to 2000, it reported soaring revenues and profits and acquired other companies; in March 2000, it contracted to acquire two U.S. companies—Dictaphone Corp. ("Dictaphone") and Dragon Systems, Inc. ("Dragon")—and took on massive new debt in connection with these acquisitions.

In August 2000, newspaper stories triggered investigations which concluded that the company had greatly overstated revenues and profits. In November 2000, an audit ordered by the audit committee of the L & H board found that revenues during the prior two and a half years had been overstated by over a quarter billion dollars. Ultimately, certain top officers and directors were implicated in apparent fraud; we refer to them as "the implicated managers."¹

The accounting devices employed in overstating the revenues and profits included (it appears) recording revenue from contracts L & H had yet to execute, booking revenue in a lump sum where the amount should have been amortized across several years, and recording revenue from clients who did not exist or who had not made payments or commitments that could properly be recorded. Following the disclosures, the chairman, managing directors and CEO (among others) resigned, and shortly thereafter L & H filed for chapter 11 reorganization in Delaware. 11 U.S.C. § 1101 et seq. (2000).

In May 2003, the bankruptcy court approved a plan of liquidation. The plan gave authority to prosecute claims on behalf of L & H to a litigation trustee appointed by a committee of unsecured creditors; there is apparently no prospect of anything being left over for stockholders. After the plan became effective, the trustee brought the present action, in August 2004, against L & H's former accountants—KPMG's U.S. and Belgian affiliates (collectively "KPMG").

The action, originally filed in the federal bankruptcy court in Delaware, was transferred to the federal district court in Massachusetts. The only claim pertinent to this appeal was brought under Mass. Gen. Laws ch. 93A §§ 1-11 (2002). The complaint also charged, as tort violations, aiding and abetting the breach of a fiduciary duty and accounting malpractice, but the district court dismissed these two claims as barred by the statute of limitations and no appeal has been taken as to them.

Chapter 93A, so far as it applies to business-to-business transactions, provides a civil cause of action, with the possibility of multiple damages and attorneys' fees for willful violations, for unfair or deceptive trade practices. Id. § 11. To apply at all, it requires a level of fault going beyond mere negligence, Darviris v. Petros, 442 Mass. 274, 812 N.E.2d 1188, 1192-94 (2004), and also connections between the wrong and Massachusetts that for present purposes the parties assume to be satisfied.²

The complaint charged that KPMG had wide access to L & H's financial records and activities; that despite discovering and in some cases warning managers of serious problems, KPMG failed to alert the independent directors of L & H and instead issued unqualified opinions and certified balance sheets and operating statements of L & H for fiscal years 1998 and 1999; and that these actions permitted L & H to proceed with the Dictaphone and Dragon acquisitions, thereby incurring $340 million in new debt which after the disclosures it could not repay.

The allegations include but go beyond claims of negligence by KPMG and in effect charge that the accounting firms knowingly tolerated patently improper accounting practices by L & H in order to retain a lucrative client for KPMG. These are only allegations but, because the claim was disposed of on a motion to dismiss, Fed.R.Civ.P. 12(b)(6), we must assume the allegations to be true. Rogan v. Menino, 175 F.3d 75, 77 (1st Cir.), cert. denied, 528 U.S. 1062, 120 S.Ct. 616, 145 L.Ed.2d 511 (1999).

In moving to dismiss the complaint, KPMG argued, so far as is pertinent to this appeal, (1) that it was charged in substance only with negligence, which is not embraced by chapter 93A; (2) that the chapter 93A claim belonged to the creditors individually and not L & H, for whom the trustee alone could sue; and (3) that such a claim in all events was barred by the doctrine of in pari delicto.

In a decision dated September 27, 2005, the district court agreed with KPMG that in pari delicto barred the trustee's claim under chapter 93A and dismissed the action. On this appeal, the trustee challenges the in pari delicto ruling. KPMG defends the ruling as correct, and as alternative grounds for affirming the dismissal says the trustee also lacks standing and that the allegations did not make out a claim under chapter 93A.³

Objections based on "standing" must be addressed at the threshold if they implicate our authority to hear a case under Article III of the Constitution. Steel Co. v. Citizens for a Better Env't, 523 U.S. 83, 94-95, 118 S.Ct. 1003, 140 L.Ed.2d 210 (1998). At different times KPMG has made, and tangled together, two different standing arguments. On close scrutiny, neither one presents a serious standing objection under Article III.

A common formulation of Article III standing is that the plaintiff must allege injury, fairly traceable to the defendant's conduct, that a court can redress. Valley Forge Christian Coll. v. Americans United for Separation of Church and State, Inc., 454 U.S. 464, 472, 102 S.Ct. 752, 70 L.Ed.2d 700 (1982); Becker v. Fed. Election Comm'n, 230 F.3d 381, 384-85 (1st Cir.2000), cert. denied, 532 U.S. 1007, 121 S.Ct. 1733, 149 L.Ed.2d 658 (2001). The statement's simplicity is deceiving; the requirements present endless complexities. See Chemerinsky, Federal Jurisdiction § 2.3, at 56-113 (4th ed.2003).

In its appellate brief, KPMG argues principally that the trustee in this case is seeking redress for an injury to the creditors that the creditors must present their own claims directly by suing as plaintiffs themselves, and that therefore this is a classic case of a plaintiff (the trustee) who is wrongly seeking to assert the claims of others (the creditors) who are not parties to this case. See, e.g., Warth v. Seldin, 422 U.S. 490, 509-10, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975).

Courts often do use the term "standing" for cases in this category, but— illustrating one of the complexities—they normally say that the question of who may assert an otherwise proper claim is an issue of "prudential," rather than Article III, standing. Valley Forge, 454 U.S. at 474-75, 102 S.Ct. 752; Chemerinsky, supra § 2.3.4, at 83. After all, courts can be empowered to hear claims of injury to others; trustees, parents and guardians make such claims all the time. Objections of this kind do not have to be resolved at the threshold under Steel Co. See 523 U.S. at 97-98 & n. 2, 118 S.Ct. 1003; McBee v. Delica Co., Ltd., 417 F.3d 107, 127 (1st Cir.2005).

In any event this objection is without merit. A creditor who relied on false earnings statements might under certain circumstances have a claim against a complicit accountant. See Nycal Corp. v. KPMG Peat Marwick LLP, 426 Mass. 491, 688 N.E.2d 1368, 1371-74 (1998). But the trustee in this case does not even purport to be asserting such claims: in the complaint the trustee advances only claims of L & H, which under the plan of reorganization, he is entitled to do. See also 11 U.S.C. §§ 323, 541(a)(1) (2000).

That the creditors will benefit if such a suit is successful does not mean that their own claims against KPMG are at issue. See Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., Inc., 267 F.3d 340, 348-49 (3d Cir.2001). They will benefit because they have claims against L & H, it is bankrupt, and under the plan they have access to the company's residual assets; among the assets are such claims as L & H may have against KPMG. There is no threat that such a creditor or any other plaintiff will be allowed to recover twice for the same loss. See Dobbs, Law of Remedies § 3.3(7), at 231-32 (2d ed.1993).

Of more interest is a different "standing" objection that KPMG asserted in the district court; whether KPMG is renewing the objection on this appeal is unclear, but if it were a valid Article III objection we would have to dismiss sua sponte. Spenlinhauer v. O'Donnell, 261 F.3d 113, 120 (1st Cir.2001). This is the argument that inflating its earnings cannot have injured L & H itself: at worst, this inflation led L & H to borrow and expend money on the strength of its false documents—but for which L & H received valuable assets in the acquisition of Dictaphone and Dragon.

The intuitive appeal of such arguments is that where a company inflates its earnings, the victims may appear to be only others...