Alumax Mill Products, Inc. v. Congress Financial Corp.

• Decision Date: 31 August 1990
• Docket Number: No. 89-5014,89-5014
• Citation: 912 F.2d 996
• Parties: RICO Bus.Disp.Guide 7566 ALUMAX MILL PRODUCTS, INC., Appellee, v. CONGRESS FINANCIAL CORPORATION; Congress Financial Corporation-Midwest; Appellants, Hodroff & Novotny, Appellee. HODROFF & NOVOTNY, Appellee, v. McGLADREY, HENDRICKSON & PULLEN, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 996

912 F.2d 996

RICO Bus.Disp.Guide 7566

ALUMAX MILL PRODUCTS, INC., Appellee, v. CONGRESS FINANCIAL CORPORATION; Congress Financial

Corporation-Midwest; Appellants,

Hodroff & Novotny, Appellee.

HODROFF & NOVOTNY, Appellee, v. McGLADREY, HENDRICKSON & PULLEN, Appellee.

No. 89-5014.

United States Court of Appeals Eighth Circuit.

Submitted Oct. 11, 1989.

Decided Aug. 31, 1990.

J. Michael Schwartz, Minneapolis, Minn., for appellants.

David T. Erie, Chicago, Ill., and David E. Kendall, Washington, D.C., for appellee McGladrey, Hendrickson & Pullen.

Before McMILLIAN, Circuit Judge, SNEED, ^* Senior Circuit Judge, and WOLLMAN, Circuit Judge.

McMILLIAN, Circuit Judge.

Congress Financial Corp. and its wholly-owned subsidiary, Congress Financial Corp.-Midwest (hereinafter jointly referred to as Congress), appeal from an order entered in the District Court ¹ for the District of Minnesota approving a settlement agreement between Alumax Mill Products, Inc. (Alumax), and two accounting firms, McGladrey & Pullen, formerly McGladrey, Hendrickson & Pullen (McGladrey), and Hodroff & Novotny (Hodroff). Alumax Mill Products, Inc. v. Congress Financial Corp., No. 3-86-Civil-146 (D.Minn. Nov. 8, 1988) (dismissal and judgment). The district court directed entry of a partial final judgment pursuant to Fed.R.Civ.P. 54(b). For reversal Congress argues the district court erred in approving the settlement agreement between Alumax and the two accounting firms because the settlement agreement is unfair and prejudicial to Congress. For the reasons discussed below, we affirm in part, vacate in part and remand the case to the district court with directions to dismiss Alumax's claims against McGladrey for lack of jurisdiction.

This appeal involves the collapse of a Minnesota aluminum fabrication company, Northern Aluminum Co. (Northern). Northern molded and formed aluminum into siding and other building products. Alumax was one of Northern's suppliers of rolled and sheet aluminum. In March 1984 Northern approached Congress for a loan. Congress is a financial factor; it lends money to companies based on the value of the company's sales and inventory. In April 1984 Congress reviewed Northern's 1981 and 1982 certified financial statements, which had been prepared by McGladrey, and Northern's 1983 certified financial statement, which had been completed by Hodroff, and made a detailed analysis of Northern's financial status. McGladrey worked on but did not complete the 1983 audit, and Hodroff relied on McGladrey's work to complete the 1983 audit. In June 1984 Congress loaned Northern over $6 million secured by Northern's inventory and accounts receivable.

According to Alumax, Congress discovered in July 1984 that Northern had been engaged in a form of fraud known as "pre-billing." Pre-billing occurs when the borrower (Northern) receives an order, prepares the original and a copy of the invoice for the order, and sends the invoice to the asset-based lender (Congress) in order to borrow on its accounts receivable line of credit before the goods are shipped. Pre-billing inflates the borrower's accounts receivable. The borrower draws on its line of credit, which is secured by its accounts receivable, before the product has been shipped and before the customer is obligated to pay for the product, that is, before there is a corresponding account receivable.

Alumax alleged that Congress then assumed effective control of Northern's operations and, even though Congress knew Northern was bankrupt, continued to operate Northern in order to reduce Northern's indebtedness to Congress but at the expense of Northern's other creditors, including Alumax. According to Alumax, Congress concealed the fraud at Northern through the summer and fall of 1984. Between July and October 1984 Alumax shipped aluminum products worth $734,536.33 to Northern. Northern has not paid Alumax for these products. Alumax asserted that it did not discover Northern's true financial condition or the extent of Congress's involvement in Northern's operations until October 26, 1984, when one of its employees made an unannounced visit and confronted Congress representatives in Northern's offices. Alumax also alleged that during the summer of 1984 McGladrey and Hodroff learned of the pre-billing scheme but failed to revise the financial statements they had prepared for Northern. Alumax alleged that it relied on the financial statements prepared by McGladrey and Hodroff in deciding to continue to supply aluminum products to Northern during the summer and fall of 1984.

According to Congress, although it suspected as early as the summer of 1984 that Northern was engaged in "pre-billing," it did not in fact discover the pre-billing scheme until September 1984 when William "Chip" Goldwasser II, Northern's president, described in an affidavit the nature and scope of the pre-billing scheme at Northern. Goldwasser admitted pre-billing over $2.25 million in fiscal 1984. Congress also discovered false and forged records at Northern. Also during this period, but unknown to Congress, a Hodroff auditor discovered that Northern had maintained a second set of shipping records which documented false sales. By the end of November 1984, Congress had discovered additional evidence of commercial fraud at Northern. Congress then stopped lending any additional funds to Northern and turned over the information it had discovered to federal authorities. Goldwasser eventually pled guilty to seven counts of mail and wire fraud and was sentenced to seven years imprisonment.

In January 1985 Northern declared bankruptcy. Congress asserted that it lost over $6 million as a result of its loan to Northern.

FEDERAL LAWSUIT FILED BY CONGRESS

In November 1985 Congress filed a lawsuit in federal court against McGladrey, Northern's accountants until 1983, and Hodroff, McGladrey's accounting successor at Northern and Northern's accountants after 1983. The complaint asserted federal racketeering violations (Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. Secs. 1961-1968 (RICO)) and state law claims for accounting malpractice, negligent misrepresentation and fraud. According to Congress, employees of McGladrey and Anderson & Sieberlich, McGladrey's accounting predecessor at Northern, had discovered evidence of fraud in Northern's accounts receivable and inventory as early as 1979. Congress alleged that there were material discrepancies in Northern's accounts receivable and inventory for each of the years audited by McGladrey and that McGladrey improperly resolved the discrepancies by either accepting the representations of Northern employees or ignoring the discrepancies.

As noted above, McGladrey worked on but did not complete the 1983 Northern audit. Congress alleged that, shortly before McGladrey withdrew from the 1983 audit, Northern employees admitted certain financial irregularities to McGladrey. Congress alleged McGladrey covered up the financial irregularities and allowed Hodroff to undertake and complete the 1983 audit without informing Hodroff of the financial irregularities and without withdrawing any of its earlier, unqualified audit opinions. Hodroff completed the 1983 audit on the basis of McGladrey's inventory work and without confirming the accounts receivable for 1983. According to Congress, although Hodroff discovered substantial discrepancies that should have required significant audit adjustments, Hodroff nonetheless issued an unqualified opinion on Northern's 1983 financial statements.

Congress further alleged that, during the 1984 audit, Hodroff discovered additional discrepancies in Northern's accounts payable, including a fictitious customer and forged accounts receivable and accounts payable confirmations to that company. Hodroff confronted Northern's management in July 1984. Goldwasser admitted that he had been engaged in pre-billing and turned over to Hodroff certain documents that indicated that some $2.5 million in accounts receivable had been pre-billed during fiscal 1984. Congress alleged that Hodroff failed to inform Congress of these discoveries and instead attributed the delay in completing Northern's 1984 audit report to the illness of Northern's accountant. According to Congress, Hodroff provided Congress with Northern's interim financial statements for the first quarter of fiscal 1984 even though Hodroff knew that those statements would be substantially affected by the pre-billing scheme.

In June 1987 McGladrey filed a motion for summary judgment on the RICO claims, asserting that there was no RICO violation because there was no pattern of racketeering activity. The district court agreed and granted summary judgment in favor of McGladrey on the RICO claims and dismissed the remaining state law claims for lack of jurisdiction. Congress appealed. We held the appeal in abeyance pending the Supreme Court's decision in H.J. Inc. v. Northwestern Bell Telephone Co., --- U.S. ----, 109 S.Ct. 2893, 106 L.Ed.2d 195 (1989), rev'g 829 F.2d 648 (8th Cir.1987). We then reversed and remanded the case to the district court for reconsideration in light of the Supreme Court's decision. Congress Financial Corp. v. McGladrey, Hendrickson & Pullen, 902 F.2d 1571 (8th Cir.1990) (order).

In the meantime, in March 1988, following the district court's dismissal, Congress filed a lawsuit against McGladrey and Hodroff in state court, alleging conspiracy, accounting malpractice, and negligent misrepresentation and fraud. Congress Financial Corp. v. McGladrey, Hendrickson & Pullen, No. 88-04137 (Minn.Dist.Ct.).

FEDERAL LAWSUIT FILED BY ALUMAX

In February 1986 Alumax filed this lawsuit in federal court against Congress and Hodroff. Alumax essentially alleged that Congress and Northern conspired to defraud it of over $750,000. Alumax charged Congress with RICO violations and with state law claims for fraud, liability as Northern's agent, and breach of fiduciary duty. Alumax charged...