In re Allou Distributors, Inc.

• Decision Date: 29 September 2008
• Docket Number: Adversary No. 04-8384-ess.,Bankruptcy No. 03-82321-ess.
• Parties: In re ALLOU DISTRIBUTORS, INC., et al., Debtors. Kenneth P. Silverman, as Chapter 7 Trustee of Allou Distributors, Inc., et al., and LaSalle Business Credit, LLC, Plaintiffs, v. KPMG LLP, Arthur Andersen LLP, and Mayer Rispler & Company, P.C., Defendants.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Eastern District of New York

395 B.R. 246

In re ALLOU DISTRIBUTORS, INC., et al., Debtors Kenneth P. Silverman, as Chapter 7 Trustee of Allou Distributors, Inc., et al., and LaSalle Business Credit, LLC, Plaintiffs, v. KPMG LLP, Arthur Andersen LLP, and Mayer Rispler & Company, P.C., Defendants.

Bankruptcy No. 03-82321-ess.

Adversary No. 04-8384-ess.

United States Bankruptcy Court, E.D. New York.

September 29, 2008.

Anthony C. Acampora, Ronald J. Friedman, Jay S. Hellman, Silverman & Acampora LLP, Jericho, NY, for Chapter 7 Trustee.

Richard G. Haddad, Anthony M. Piccione, Erin E. Wietecha, Otterbourg, Steindler, Houston & Rosen, P.C., New York, NY, for LaSalle Business Credit, LLC.

Kevin A. Burke, Howrey LLP, New York, NY, for KPMG LLP.

Matthew I. Kliegman, Alan Raylesberg, Chadbourne & Parke LLP, New York, NY, for Arthur Andersen LLP.

Steven A. Coploff, Steinberg & Cavaliere, LLP, White Plains, NY, for Mayer Rispler & Company.

MEMORANDUM DECISION ON MOTIONS TO DISMISS THE THIRD AMENDED COMPLAINT

ELIZABETH S. STONG, Bankruptcy Judge.

Before the court are the motions (the "Motions to Dismiss") of defendants KPMG LLP ("KPMG"), Arthur Andersen LLP ("Andersen"), and Mayer Rispler & Company, P.C. ("Mayer Rispler") (collectively, the "Defendants") to dismiss with prejudice the third amended complaint dated June 30, 2006 (the "Third Amended Complaint" or "TAC"), filed by the plaintiffs Kenneth P. Silverman, as Chapter 7 trustee of Allou Distributors, Inc. (the "Trustee"), and LaSalle Business Credit, LLC, as agent ("LaSalle") (collectively, the "Plaintiffs"). By their Third Amended Complaint, the Plaintiffs allege that each Defendant committed malpractice and fraud through their gross negligence and failure to detect the fraud committed by the Debtors' principals during their respective audit years. The Trustee also alleges that Andersen and Mayer Rispler committed malpractice in the years in which they participated in the audit work but did not issue an audit report.

The Defendants bring these Motions to Dismiss pursuant to Rules 9(b), 12(b)(1), and 12(b)(6) of the Federal Rules of Civil Procedure, made applicable to this adversary proceeding by Rules 7009 and 7012 of the Federal Rules of Bankruptcy Procedure. The Defendants argue that the Plaintiffs do not state claims upon which relief can be granted and do not plead fraud with the particularity required by Rule 9(b). Andersen and Mayer Rispler also argue that the Trustee does not have standing to bring this adversary proceeding.

Jurisdiction

The Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. §§ 1334(b) and 157(b)(1).

Background

The Debtors' Bankruptcy Cases

On April 9, 2003, involuntary Chapter 11 petitions were filed against Allou Distributors, Inc. ("ADI"), and three of its affiliates, M. Sobol, Inc. ("Sobol"), Direct Fragrances, Inc. ("Direct Fragrances"), and Stanford Personal Care, Inc. ("Stanford") (the "Original Debtors"), by Congress Financial Corporation ("Congress"), Citibank, N.A. ("Citibank"), and LaSalle. Case No. 03-82321, Docket No. 1; Case No. 03-82323, Docket No. 1; Case No. 03-82324, Docket No. 1; Case No. 03-82325, Docket No. 1. The Original Debtors consented to entry of orders for relief under Chapter 11, and on April 10, 2003, the Court issued orders for relief in each of the Original Debtors' Chapter 11 cases. Case No. 03-82321, Docket Nos. 3, 4. The Original Debtors are wholly owned subsidiaries of Allou Health Care, Inc. ("AHI"), a publicly traded Delaware corporation. On April 18, 2003, Congress, Citibank, and LaSalle filed an involuntary Chapter 11 petition against AHI, and by consent order entered on July 14, 2003, the Court entered an order for relief. Case No. 03-82662, Docket No. 63.

On April 18, 2003, Congress, Citibank, and LaSalle filed involuntary Chapter 11 petitions against two of ADI's six subsidiaries, Trans World Grocers Inc. ("Trans World"), and Rona Beauty Supplies, Inc. ("Rona Beauty"). Case No. 03-82660, Docket No. 1; Case No. 03-82661, Docket No. 1. On May 1, 2003, the Court entered orders for relief in the Chapter 11 cases of Trans World and Rona Beauty (the "Subsequent Debtors"). Case No. 03-82660, Docket No. 9; Case No. 03-82661, Docket No. 9.

On April 25, 2003, voluntary Chapter 11 petitions were filed on behalf of ADI's four remaining subsidiaries, namely, Core Marketing, Inc. ("Core"), HBA Distributors, Inc. ("HBA Distributors"), HBA National Sales Corp. ("HBA National Sales"), and Pastel Cosmetic & Beauty Aids, Inc. ("Pastel") (the "Voluntary Debtors"). Case No. 03-82838, Docket No. 1; Case No. 03-82840, Docket No. 1; Case No. 03-82841, Docket No. 1; Case No. 03-82839, Docket No. 1. AHI, the Original Debtors, the Subsequent Debtors, and the Voluntary Debtors are collectively referred to as the "Debtors" or "Allou."

By order dated September 16, 2003, the Debtors' Chapter 11 cases were converted to cases under Chapter 7 of the Bankruptcy Code. Case No. 03-82321, Docket No. 583. Kenneth P. Silverman was appointed as the Chapter 7 trustee. Id. The Debtors' cases were substantively consolidated by order dated December 22, 2003. Case No. 03-82321, Docket No. 923.

The Debtors' Principals

Victor Jacobs and his sons Herman Jacobs and Jacob Jacobs (the "Jacobs") held approximately 61 percent of the voting stock of AHI. TAC ¶ 28. Victor was chairman of AHI, Herman was chief executive officer of AHI, and Jacob was executive vice president of AHI, and each also served on AHI's board of directors. TAC ¶ 29. On June 30, 2003, involuntary Chapter 7 bankruptcy petitions were filed against Victor Jacobs, Herman Jacobs, and Jacob Jacobs. TAC ¶ 166. Orders for relief were entered on September 9, 2003, and Allan B. Mendelsohn was appointed as the Chapter 7 trustee. TAC ¶ 171.

The Defendants and the Audits

Mayer Rispler served as Allou's independent auditor from 1990, when Allou issued shares to the public, until June 14, 2001. TAC ¶ 127. Thereafter, Mayer Rispler served as Allou's internal auditor. Id. Mayer Rispler issued an unqualified audit report dated June 19, 2000 (the "2000 Audit") on Allou's consolidated balance sheets as of March 31, 2000, and March 31, 1999, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the two-year period ending March 31, 2000 (the "2000 Financial Statements"). TAC ¶ 130.

Andersen replaced Mayer Rispler as Allou's independent auditor from June 14, 2001, until June 10, 2002. TAC ¶ 131. Andersen issued an unqualified audit report on or about July 2, 2001 (the "2001 Audit") on Allou's consolidated balance sheet as of March 31, 2001, and the related consolidated statements of income, stockholders' equity, and cash flows for the fiscal year ending March 31, 2001 (the "2001 Financial Statements"). TAC ¶ 132. Andersen also participated in the audit for the fiscal year ending March 31, 2002. TAC ¶¶ 131, 310, 314-22, 326, 351-52.

KPMG replaced Andersen as Allou's independent auditor in June 2002. TAC ¶ 134. KPMG issued an unqualified audit report on or about July 3, 2002 (the "2002 Audit") on Allou's consolidated balance sheet as of March 31, 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for the year ending March 31, 2002 (the "2002 Financial Statements"). TAC ¶ 136.

Procedural History

The Plaintiffs commenced this adversary proceeding on June 14, 2004, by filing a complaint against KPMG, Andersen, and Mayer Rispler. Docket No. 1. On August 26, 2004, the Plaintiffs filed an amended complaint (the "Amended Complaint") which substituted LaSalle for Congress as the agent authorized to prosecute this action on behalf of the Lenders, as defined below. Docket No. 23.

On September 24, 2004, KPMG, Andersen, and Mayer Rispler moved to dismiss the Amended Complaint on grounds that the Amended Complaint did not state a claim upon which relief could be granted and that, under Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991) (the "Wagoner rule"), the Trustee did not have standing to sue. Docket Nos. 28, 30, 32. These issues were bifurcated and the Defendants' challenge to the Trustee's standing was heard first. Docket No. 56. On May 26, 2005, former Judge Melanie Cyganowski granted the Defendants' motions and dismissed without prejudice the Trustee's claims for lack of standing. Docket Nos. 56, 59. The Plaintiffs were granted leave to replead, and on September 6, 2005, the Plaintiffs filed a second amended complaint (the "Second Amended Complaint"). Docket Nos. 59, 63.

On October 27, 2005, and October 31, 2005, the Defendants moved to dismiss the Second Amended Complaint on grounds that it did not state a claim upon which relief could be granted and that, under the Wagoner rule, the Trustee did not have standing. Docket Nos. 65, 68, 71. These issues were again bifurcated, and on January 30, 2006, the Court heard the Defendants' challenge to the Trustee's standing. Docket No. 87. The Court denied the Defendants' motion to dismiss the Second Amended Complaint with respect to question of the Trustee's standing. Docket Nos. 87, 93. The Court found that the "amended pleading has been sufficiently pled to deal with the so-called adverse interest exception of the Wagoner Rule." Docket No. 87 (transcript of January 30, 2006, hearing, at 57:1-4).

On March 30, 2006, the Court heard the balance of the Defendants' motions to dismiss the Second Amended Complaint. Docket No. 102. On May 16, 2006, the Court granted the Defendants' motions and dismissed without prejudice the Trustee's claims for failure to state a claim upon which relief could be granted. Docket Nos. 103, 105. The Plaintiffs were granted leave to replead, and on June 30, 2006, the Plaintiffs filed the Third Amended Complaint. Docket No. 106.

On August 7, 2006, the Defendants moved to dismiss the Third Amended Complaint. Docket Nos. 109, 117, 120. On October 31, 2006, the Court, by Judge Cyganowski, heard these...