Franklin Supply Company v. Tolman

• Decision Date: 07 January 1972
• Docket Number: No. 24989.,24989.
• Parties: FRANKLIN SUPPLY COMPANY, etc., Appellant, v. Albert W. TOLMAN, Jr. and Peat, Marwick, Mitchell & Company, etc., et al., Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

454 F.2d 1059 (1971)

FRANKLIN SUPPLY COMPANY, etc., Appellant, v. Albert W. TOLMAN, Jr. and Peat, Marwick, Mitchell & Company, etc., et al., Appellee.

No. 24989.

United States Court of Appeals, Ninth Circuit.

December 16, 1971.

As Amended on Denial of Rehearing January 7, 1972.

Irwin F. Woodland (argued), Julian O. von Kalinowski, Carl D. Lawson, Robert E. Cooper, of Gibson, Dunn & Crutcher, Los Angeles, Cal., Helmick, Conover & Burkhardt, Denver, Colo., Victor M. Earle III, New York City (of counsel), for appellant.

Ira C. Rothgerber, Jr. (argued), Robert S. Slosky, of Rothgerber, Appel & Powers, Denver, Colo., Melvin M. Belli, of Belli, Ashe, Ellison, Choulos & Lieff, San Francisco, Cal., Anthony F. Zarlengo, Denver, Colo., for appellee.

Before BARNES, HAMLEY and TRASK, Circuit Judges.

TRASK, Circuit Judge:

This appeal is from a judgment awarding damages to plaintiff below, Franklin Supply Company, from Peat, Marwick, Mitchell & Co., an international certified public accounting firm and defendant below, based upon multiple claims of negligence and misrepresentation; fraud; breach of contract; and fraudulent conspiracy in performing an audit. Also named as a defendant was Albert W. Tolman, a citizen of Texas, representing a class of persons known as Peat, Marwick, Mitchell & Co.

The action was filed in the United States District Court for the Central District of California with jurisdiction founded upon 28 U.S.C. § 1332 (Diversity of citizenship).

Franklin Supply Co. (Franklin) is a Nevada corporation with its principal place of business in Colorado, and is one of the large oil field supply companies in the United States. It entered into an agreement with Servicios Hydrocarb C. A. (Servicios), a Venezuela corporation, to purchase all of the capital stock of Petroleum Industry Consultants C. A. (Peticon), a Venezuela corporation, which was a wholly owned subsidiary of Servicios. Peticon was in the oil field supply business in Venezuela.

Negotiations leading to this transaction began in September 1958, between Gene Harper, president of Franklin, and Robert Champion, the largest individual shareholder of Servicios. Champion made it clear that the Servicios directors would not sell the Peticon stock for an amount less than its book value. Harper said that if Franklin purchased Peticon for book value it would want the inventory valued at the lower of cost or current replacement value. Harper sent William Kerin, Jr., a Franklin vice president and manager of its stores and warehouses, to Venezuela to examine Peticon. Kerin visited all three of the stores of Peticon and submitted to Franklin an unfavorable report on the Peticon inventory.

Nevertheless, Harper arrived in Venezuela in February 1959, with Kerin and William Quan, another Franklin vice president, and negotiations were resumed. Harper again suggested that inventory be valued at the lower of cost or current replacement value. On February 28, 1959, Harper, Kerin and Quan met with the Servicios directors and a tentative agreement was reached. Again the formula for pricing inventory was discussed. Laffan, president of Servicios, suggested that book value be used with Servicios retaining surplus or obsolete lines of inventory. In the end the Harper formula prevailed. It was agreed that Franklin would assume control on May 1, and that the purchase price of stock would be book value of the stock as of April 30, 1959.

The parties then decided to employ Jesse Guy Benson, an American who practiced law in Venezuela, to draft a contract and they also agreed to employ Peat, Marwick, Mitchell & Co. (P.M.M), Servicios' auditors, to perform an audit as of April 30, with each party to share legal and accounting fees equally.

Benson did prepare a draft according to the instructions given to him. Harper received it in March of 1959 and asked Alexander Grant & Co., Franklin's regular auditors, and Franklin's regular Chicago lawyers to review it. Harper later instructed Kerin to sign the document and Kerin, on behalf of Franklin, and Laffan, on behalf of Servicios, did so in Caracas on May 15, 1959. During the week prior to Franklin's take over on May 1, 1959, the inventory of Peticon was taken by Norris Culp, Controller of Peticon, and his staff. Inventory items were attempted to be priced at lower first-in-first-out landed costs, or the replacement cost from Peticon's regular suppliers on April 30, 1959. This had been the pricing method in prior financial statements and no substantial errors were made. (Finding of Facts 12, 13, 14. C.T. 1622, 1623).

William Kerin, Jr. and Lee Crogner of Franklin and representatives of PMM observed the taking of the inventory. Prior to and during the period of taking the inventory, Kerin also examined the inventory records and recommended to Harper that Franklin not purchase Peticon. Harper instructed him to buy it nevertheless.

On May 14, 1959, Kerin wrote to Laffan, president of Servicios, and complained of undesirable items of physical inventory, classifying some as slow moving and some as "obsolete or junk." These were itemized and totalled Bs 75,286.97 (Bolivars).¹ Kerin concluded his letter as follows:

"Needless to say, the aforementioned figure will have to be considered in connection with the formula used in purchasing Peticon."

Copies were sent to Jesse Guy Benson, Fred Southerland, Gene Harper and William P. Quan. Subsequently, Kerin met with Laffan and others in Caracas on July 2, 1959, and an agreement was made to reduce the total inventory valuation by an amount equal to one-third of the total value of obsolete or junk items, the agreement providing that the "total value of the final inventory shall be reduced by subtracting the sum of Twenty-Five Thousand Ninety-Five and 66/100 Bolivars. (Bs 25,096.66)."

The accountant's report and statement of Financial Position of Net Assets were issued in Venezuela on July 30, 1959. The book value shown was Bs 3,524,888.25 or $1,052,205.45. In November 1959, Franklin paid $52,205.45 by check and guaranteed Peticon notes in the amount of $1,000,000 in payment of the purchase price.

In April 1960, Franklin dishonored the first note and in July filed suit in Venezuela to rescind the Peticon transaction. In August, Servicios sued Franklin in the United States District Court in Colorado to collect the notes. Franklin filed counterclaims in that action asserting the over-valuation of inventory. There were other actions and counterclaims as well as unsuccessful attempts to join PMM.

On February 13, 1963, Franklin and Servicios stipulated in Colorado to substitute payments and notes in the sum of $800,000 for the original notes in the sum of $1,000,000. Mutual releases were exchanged and all litigation was dismissed. An amendment was entered into as a part of the stipulation to provide for a reservation of rights by Franklin against PMM.

In April 1963, Franklin filed its present action in the United States District Court for the Central District of California against PMM. The second amended complaint upon which the case was tried charged that PMM did not perform an independent audit because the audit was in the charge of one Fred W. Southerland who was an employee of PMM, but was also an alternate director of Servicios and had been a director of Peticon. Because of this and the failure of PMM to formally disclose these facts, PMM was charged with having acted in violation of a fiduciary relationship and in violation of an implied duty of independence. It was also charged that the audit of PMM did not comply with the agreement of the parties. It was further alleged that there was substantial concealment of the condition of the inventory, in that much of it was obsolete or unsaleable and that certain diamond bit credits constituting a liability of Peticon were not properly shown. Franklin also charged fraudulent conspiracy between PMM and Servicios to misrepresent the financial condition of Peticon and, finally, a breach of an implied warranty to perform the audit in compliance with generally accepted accounting methods. Compensatory and punitive damages were sought.

The district court held a partial trial in October 1967, in order to determine the effect of the Colorado settlement between Franklin and Servicios and to decide issues of conflict of laws and of Venezuelan law. The court ruled orally at the end of the partial trial and then signed and filed findings and conclusions. Those proceedings and the findings and conclusions will be referred to hereafter as well as other facts as they become pertinent. The trial on all remaining issues was held in April 1969 before the court without a jury. The district court found for the plaintiff and awarded $71,648.47 as compensatory damages for losses on salvage diamond transactions, $63,860 compensatory damages for litigation expenses, $200,000 compensatory damages for over-valuation of inventory in the audit and $150,000 as punitive damages, or an aggregate of $485,508.47.

JURISDICTION OF THE COURT

Initially, jurisdiction must depend upon diversity of citizenship under Article III, Section 2 of the Constitution and 28 U.S.C. § 1332. The plaintiff is alleged to be a Nevada corporation with its principal place of business in Colorado. The defendant, Tolman, is a citizen of Texas. The defendant Peat, Marwick, Mitchell & Co. is an organization composed of numerous unincorporated associations in which Tolman is a partner or owner of an interest. In addition, there is at least one, and perhaps more corporations of the same name, none of which is domiciled or has its principal place of business in Colorado or Nevada, but all connected with the unincorporated associations of the same name. The court found, pursuant to stipulation, that the executive offices of Peat, Marwick, Mitchell & Co. (U.S.) and Peat, Marwick, Mitchell (general) are at 70 Pine Street, New York, New York. The Venezuelan Civil Society of Peat, Marwick, Mitchell &...