Armco Indus. Credit Corp. v. SLT Warehouse Co., 84-1828

• Decision Date: 07 February 1986
• Docket Number: No. 84-1828,84-1828
• Citation: 782 F.2d 475
• Parties: RICO Bus.Disp.Guide 6164 ARMCO INDUSTRIAL CREDIT CORPORATION, Plaintiff-Appellee, v. SLT WAREHOUSE COMPANY, and Richard B. Conklin, Defendants-Appellants.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 475

782 F.2d 475

RICO Bus.Disp.Guide 6164

ARMCO INDUSTRIAL CREDIT CORPORATION, Plaintiff-Appellee, v. SLT WAREHOUSE COMPANY, and Richard B. Conklin, Defendants-Appellants.

No. 84-1828.

United States Court of Appeals Fifth Circuit.

Feb. 7, 1986.

Matthews & Thorp, Howard Jensen, John D. Exline, Dallas, Tex., William G. Guerri, St. Louis, Mo., Stephen G. Anderson, Washington, D.C., for SLT Warehouse.

Ewing Adams, Longview, Tex., for Conklin.

Aden L. Vickers, Dallas, Tex., for plaintiff-appellee.

Appeals from the United States District Court for the Northern District of Texas.

Before CLARK, Chief Judge, BROWN and GEE, Circuit Judges.

JOHN R. BROWN, Circuit Judge:

The defendants SLT Warehouse Co. and Richard Conklin appeal from a $2 million RICO judgment that was based on losses sustained by the plaintiff in extending credit to a now-defunct oilfield supply company. In a nutshell, the case turns on the actions or nonactions of Conklin. The verdict in the trial court was based upon the jury's apparent conclusion that Conklin's knowledge of a fraud perpetrated on the plaintiff by third parties and his failure to alert the plaintiff constituted aiding and abetting the fraud. The jury also apparently determined that Conklin's knowledge and failure to warn could be imputed to his employer SLT under agency principles for purposes of finding that SLT aided and abetted the fraud. Because we find that the evidence was insufficient to find Conklin liable for aiding and abetting the fraud, we reverse the judgment against both defendants.

A Baleful Tale of Creative Financing

This case arises out of a simple fraud set against the background of the economic downturn in the oilfield supply business in the early 1980s. The parties have painted somewhat different pictures of the facts of this case, but the essential facts are undisputed.

There are three companies involved in this drama. The first of these is Pritchett and Company (Pritchett), a now-defunct oilfield supply manufacturer located in Longview, Texas. Guy Pritchett served as president of Pritchett and Co., and Robert Rigby served as treasurer.

Armco Industrial Credit Corporation (Armco) is a commercial lender who, at the time of this case, was seeking to expand its fledgling asset-based lending business. On March 17, 1981, Armco and Pritchett entered into a loan and security agreement under which Armco would advance to Pritchett up to 85% of the value of Pritchett's inventory. By this agreement, Armco acquired a security interest in Pritchett's accounts receivable and inventory to secure its loans.

The procedure under which Armco advanced money to Pritchett worked as follows. Approximately once a day, Rigby would prepare a schedule of Pritchett's accounts receivables supported by invoices to Pritchett's customers and would forward this schedule to Armco. Armco would compute the line of credit available to Pritchett and would wire these funds to Pritchett's bank in Longview. When Pritchett was paid by its customers, it initially forwarded those checks to Armco in repayment of Armco's loan, but later, without objection from Armco, Pritchett increasingly repaid Armco's loan with checks drawn on Pritchett's own account.

As part of their financing agreement, Armco and Pritchett also entered into a three-party "Inventory Certification Agreement" with SLT Warehouse Co. (SLT), a national "field warehouse" or "collateral control" company. These companies give lenders safeguard protection on inventory financing; essentially they are third-party watchdogs over the debtor's inventory. In the three-party agreement, SLT's duties were described as follows:

(a) to supervise the installation and maintenance of records and procedures required for the control of inventory to be covered by SLT's Inventory Certification Service.

(b) to supervise and participate in the taking of a beginning inventory, and to deliver to [Armco] its Inventory Certificates certifying to value of inventory in [Pritchett's] premises, calculated at values designated or approved by [Armco] on inventory described by [Armco] as being the subject of [Armco's] interest; and subsequently to furnish to [Armco] its Inventory Certificates, at regular intervals, to be agreed upon between [Armco] and SLT.

(c) to comply with instructions which SLT has accepted or will accept hereafter from [Armco], setting out the conditions under which Company may remove inventory subject to [Armco's] interest, and to allow no further removal of inventory from the premises by Company, when such limitation as provided by [Armco's] instructions has been reached.

(d) SLT shall be liable to [Armco] for any loss [Armco] may suffer as a result of reliance upon SLT's Inventory Certificates, not in excess of the value authorized by [Armco], to the extent of any deficiency of inventory then outstanding on Inventory Certificates subject to deliveries made pursuant to [Armco's] delivery authorizations, or arising out of any failure by SLT to perform its obligations as set forth in this paragraph.

(e) to send to [Armco] a copy of SLT's monthly statement of its account with [Pritchett]. ¹

In the three-party agreement, however, SLT contracted only to certify the dollar amount of Pritchett's inventory according to stipulated cost values; it did not contract to verify or certify any of Pritchett's receivables which formed the bulk of the collateral for Armco's loans.

In implementing the agreement between Pritchett, Armco, and SLT, a Pritchett employee named Richard Conklin was transferred from Pritchett's payroll to SLT's payroll. Conklin was to serve as SLT's agent in Longview, supervising the inventory certification program for the Pritchett/Armco loan agreement. Three other Pritchett employees, Kelly Allen, Jimmy McGrede, and Linda Vick, also were transferred to SLT's payroll at various times to assist in the inventory certification.

Conklin was put on SLT's payroll to prepare weekly inventory certificates to assure Armco that Pritchett's inventory would not fall below a minimum dollar "hold figure" value. Since taking frequent physical counts of inventories that turn over rapidly is impractical if not impossible, Conklin employed the standard procedure of measuring the additions to and shipments out of inventory and adding or subtracting this net difference from a "beginning" inventory figure. As part of this calculation, Conklin deducted the quantities of various inventory items listed on invoices of actual shipments from the previous week's inventory amounts.

In mid-1981, several months after the Armco/Pritchett arrangement was initiated, the oilfield supply industry began to experience a steep downturn in orders, reflecting falling oil prices and the contraction of the national economy. Pritchett also began to experience cash flow problems, having elected to expand its product line before the downturn became apparent. About this time, Guy Pritchett and Robert Rigby, and possibly other members of Pritchett's management, elected to solve their temporary cash flow problem by submitting phony invoices to Armco. Armco did not discover the fraud and advanced money against the bogus invoices.

As Pritchett's economic position continued to worsen, Pritchett increasingly was forced to rely on its bogus invoice scheme to obtain necessary operating funds from Armco. These phony accounts receivable represented increasingly greater proportions of the schedule of accounts receivable submitted to Armco. For example, in December 1981, Pritchett reported to Armco that it invoiced four customers for 59 shipments in the sum of $5,603,317.23. For the same period, Conklin certified actual shipments from Pritchett's main inventory in Longview in the amount of only $360,877.07. The comparable figures for February 1982 were $10,658,725.25 and $274,387.05, respectively.

Conklin became aware that Pritchett was generating phony invoices some time in the second half of 1981 when he noticed that certain invoice numbers were missing from the information which Pritchett provided to him for his inventory certification responsibilities. Concerned that he might be overlooking something, Conklin asked Pritchett management about the missing invoices and was initially told that the missing invoices represented "drop shipments," i.e., Pritchett-brokered shipments that were shipped from Pritchett's suppliers directly to its customers without passing through Pritchett's inventory.

Later, when this explanation failed to assuage Conklin, he inquired further and was told that all of the invoices which pertained to his inventory control job were being passed to him, and that any invoices which he did not have did not pertain to his job. Conklin apparently made no further inquiries, but he was able to deduce the essential features of Pritchett's scheme from his knowledge of Pritchett's operations and the trickle of sales out of inventory of which he had firsthand knowledge.

About the time that Conklin discovered the existence of the missing invoice numbers and learned that bogus invoices were being generated, Pritchett management began to pass some if not all of the bogus invoices to Conklin along with the invoices that represented actual sales. Conklin knew that the bogus invoices did not represent actual shipments from inventory so he segregated the genuine and bogus invoices and used only the genuine invoices for his inventory certification calculations. It is undisputed that by omitting the bogus invoices from his calculations, Conklin prepared certificates that accurately reflected Pritchett's actual inventory for the duration of the Armco/Pritchett/SLT agreement. When an annual physical inventory was taken, Conklin's inventory value was corroborated nearly to the dollar.

Pritchett's scheme to obtain operating funds was able to continue undetected until the spring of 1982 for several reasons. First, by allowing Pritchett to repay its loans with...