Audiovisual Publishers, Inc. v. Cenco Inc.

• Decision Date: 22 May 1997
• Docket Number: No. 72 Civ. 1681(WCC).,72 Civ. 1681(WCC).
• Citation: 964 F.Supp. 861
• Parties: AUDIOVISUAL PUBLISHERS, INC., Plaintiff, v. CENCO INCORPORATED, Defendant.
• Court: U.S. District Court — Southern District of New York

964 F.Supp. 861

AUDIOVISUAL PUBLISHERS, INC., Plaintiff, v. CENCO INCORPORATED, Defendant.

No. 72 Civ. 1681(WCC).

United States District Court, S.D. New York.

May 22, 1997.

COPYRIGHT MATERIAL OMITTED

Sullivan & Cromwell, New York City, for Plaintiff; D. Stuart Meiklejohn, Michael E. Swartz, Of Counsel.

Weil, Gotshal & Manges, New York City, for Defendant; Stephen A. Radin, Mary Lou Peters, Of Counsel.

OPINION AND ORDER

WILLIAM C. CONNER, Senior District Judge.

This case is before the court on defendant's motion to vacate the findings of an audit that examines the royalty certification statement defendant submitted pursuant to the parties' 1975 Consent Judgment. The auditor, William Shulman, has concluded that Plaintiff Audiovisual Publishers ("AVP") is entitled to approximately $6.7 million in royalty payments and accrued interest from Defendant Cenco, Inc. ("Cenco"). Defendant contends that the assumptions and methodology that Mr. Shulman employed are flawed and that his conclusions should be rejected. In defendant's view, it owes no money to plaintiff. Not surprisingly, plaintiff argues that Mr. Shulman's audit was proper and asks the court to direct defendant to pay the amount Mr. Shulman determined to be due plaintiff.

I. BACKGROUND

The convoluted history of the instant litigation, which spans almost a quarter century, is set forth in the court's prior opinions. However, in order to place the most recent iteration of this long-running dispute in context, a brief review of past events is warranted. AVP, a producer of educational film strips and cassettes, initiated this breach of contract action against Cenco in 1972, claiming that Cenco had deprived it of royalties for certain cassettes under an arrangement between the parties.

The action was settled by a consent judgment on July 10, 1975 ("Consent Judgment"), pursuant to which Cenco agreed, inter alia, to pay AVP a royalty on each tape previously made and to be made in the future from AVP's scripted master tapes. The Consent Judgment calls for Cenco to provide an initial multi-year royalty report and regular periodic reports thereafter. It gives AVP the express right to request an audit of Cenco's books and records to confirm the accuracy of Cenco's royalty reports with regard to (1) the number of cassettes and other tapes purchased and acquired by Cenco upon which royalties are due, and (2) the amount due based on the difference between the weighted average price charged by AVP for production of tapes and the weighted average price charged by Deryck Waring ("DW"), from whom defendant also obtained cassettes, for production services. The Consent Judgment also entitles AVP to compensation for new filmstrips prepared by defendant that duplicate more than twenty-five percent of the frames of a previously-existing filmstrip for which AVP scripted the audio master. This court retained jurisdiction over the matter to ensure compliance with the Consent Judgment.

Defendant submitted its royalty certification statement for the period August 1, 1971 through June 30, 1975, and plaintiff objected. However, the parties discovered that many of defendant's relevant records were missing. Because plaintiff was subsequently unable to locate an auditor willing and able to review defendant's royalty statement, the court directed defendant to obtain an audit. In April 1984, Arthur Andersen & Co. ("Arthur Andersen") completed an audit of defendant's royalty statement. Consistent with the court's directive, Arthur Andersen limited its review to the period from August 1, 1971 to April 30, 1973. Arthur Andersen confirmed the royalty statement's accuracy subject to two significant qualifications.¹ On December 10, 1986, Magistrate Judge Gershon rejected AVP's challenges to the audit and approved Arthur Andersen's finding that plaintiff was entitled to additional royalties in the amount of $200.² This court adopted the magistrate's findings, and the Court of Appeals for the Second Circuit denied plaintiff's subsequent appeal.

After the proceedings related to the Arthur Andersen audit concluded, AVP exercised its right under the Consent Judgment to an audit of defendant's royalty certification statements for the years 1973 to 1975, which were outside the scope of Arthur Andersen's examination. In 1991, AVP nominated the firm of Shulman & Solomon to perform this audit, and defendant eventually consented to plaintiff's choice of auditor. Mr. Shulman then conducted the audit in two parts. In a December 1994 report, Mr. Shulman concluded that defendant owed AVP $3,449,928.44 in royalties and interest pursuant to the Consent Judgment's cassette royalty and filmstrip provisions. In a separate report, Mr. Shulman also found that defendant owed plaintiff $538,453.27 including interest under the Consent Judgment's "Deryck Waring" provisions.

In response to defendant's objections to the December reports, Mr. Shulman first modified his original reports and then issued a revised report in July 1995 ("Revised Report"). The Revised Report reduced plaintiff's recommended award by $184,049.91 before interest to correct for several accounting errors. However, Mr. Shulman also made substantive alterations to his report that resulted in a net increase of $532,012 before interest.³

II. DISCUSSION

Defendant, in several lengthy submissions to the court, forcefully, albeit repetitively, raises numerous challenges to the Shulman audit. Defendant urges first that the audit suffers from methodological defects that render the entire audit invalid. Second, defendant contends that, aside from the audit's systemic flaws, Mr. Shulman's substantive conclusions are incorrect.

A. Mr. Shulman's Methodology

Defendant argues that Mr. Shulman's conclusions deserve no weight because Mr. Shulman did not perform his audit in accordance with Generally Accepted Auditing Standards ("GAAS"). Although the Consent Judgment is silent as to the type of audit required, defendant argues that an audit is an "attest service" that must be conducted pursuant to GAAS or the Statements of Standards for Attestation Engagements. In support of this position, defendant observes that Magistrate Judge Gershon, after denying plaintiff's request for a conference to consider the specific auditing methods and procedures to be followed by Arthur Andersen, expressly directed Arthur Andersen to "conduct the audit under the generally accepted standards and procedures of its profession." Order dated Jan. 27, 1984, at 3. Similarly, Magistrate Judge Sinclair found that "[g]enerally accepted auditing standards ... apply to special purpose audits such as royalty reviews." Order dated July 23, 1981, at 18.

Defendant maintains that plaintiff indicated prior to the audit that Mr. Shulman would adhere to GAAS and that on the basis of plaintiff's representations defendant assented to plaintiff's nomination of Mr. Shulman. Last, defendant argues that in 1986 plaintiff challenged the Arthur Andersen audit on the ground that it deviated from GAAS. Therefore, in defendant's view, it is disingenuous for plaintiff now to claim that Mr. Shulman need not have adhered to GAAS in conducting his audit.

We are unpersuaded by defendant's argument that Mr. Shulman erred by not adhering to GAAS.⁴ The Consent Judgment does not expressly require the application of GAAS testing standards. Moreover, we agree with plaintiff that the absence of a substantial number of relevant records in this case justifies resort to reasonable alternative methods of accounting. As we previously observed with respect to the Arthur Andersen audit, "it is clear that a patchwork of alternative procedures will be required in any attempt to apply generally accepted auditing standards.... [T]he need for alternative methods of testing the royalty statements for 1971 and 1972 is occasioned by the state of defendant's documentations." Opinion dated Feb. 23, 1983, at 10.

We note that, contrary to defendant's assertion, plaintiff did not misrepresent to either the court or defendant that Mr. Shulman would conduct a strict GAAS audit. Rather, in the 1991 letter to the court upon which defendant relies, Maxime Ferris, AVP's owner, stated, "I imagine that all other auditing matters could and should be left to the discretion of the accounting firm conducting the audit.... I would imagine that the accountant who undertakes this or any other audit would want to do his work as he sees fit within the guidelines of GAAS ..." Letter from Ferris to the court dated Apr. 15, 1991, at 2. Mr. Ferris' statements cannot reasonably be read as an assurance that the audit now at issue would be conducted in strict conformity to GAAS. To the contrary, Mr. Ferris' statements are clearly an expression of his view that the auditor would be afforded significant latitude in conducting his examination.⁵

Defendant next attacks Mr. Shulman's report on the ground that Mr. Shulman failed to perform his work with due professional care. In support of this claim, defendant offers numerous examples of what defendant and defendant's expert believe are fatal flaws in Mr. Shulman's conduct of the audit. Defendant's principal criticisms are that Mr. Shulman failed to examine the internal control structure in effect at Eye Gate, Cenco's predecessor in interest, during the audit period; that he failed to cite source material supporting the factual assertions in his report; that he did not consider relevant evidence; and that he lacked impartiality.

We find that defendant overstates the importance of a review of internal controls at Eye Gate. Defendant contends that such a review by Mr. Shulman was necessary in order for Mr. Shulman to "develop[] an understanding of ... how various types of books and records (such as invoices, voucher registers and bank statements) supported and complimented [sic] one another...." Cenco Reply Mem. at 25. Had he conducted this review, according to defendant, Mr. Shulman would have performed...