In re CBI Holding Co., Inc.
| Decision Date | 05 April 2000 |
| Docket Number | Bankruptcy No. 94-B-43819(BRL). Adversary No. 96-9143A. |
| Citation | 247 BR 341 |
| Parties | In re CBI HOLDING COMPANY, INC., et al., Debtors. Bankruptcy Services, Inc., Plaintiff, v. Ernst & Young, Ernst & Young, LLP, Defendants. |
| Court | U.S. Bankruptcy Court — Southern District of New York |
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Kaye, Scholar, Fierman, Hays & Handler, LLP, New York City, by Jay G. Strum, Arthur Steinberg, Robert B. Bernstein, for Plaintiff.
Schulte Roth Zabel, LLP, New York City, by Irwin J. Sugarman, Harry S. Davis, Howard O. Godnick, for Defendants.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
This is an action brought by plaintiff Bankruptcy Services, Inc. ("BSI") as successor to the claims of CBI Holding Company, Inc. ("CBI"), a pharmaceutical wholesale distributor, and its subsidiaries, Commons Bros., Inc. ("Commons Bros."), Granain, Inc. ("Granain"), M. Brenner & Sons, Inc. ("Brenner"), Commons Metro, Inc. ("Metro"), Granain/Holsin, Inc. ("Holsin") and Commons Bros., Midwest, Inc. ("Midwest") (collectively, the "Debtors" or "CBI") against Ernst & Young and Ernst & Young LLP (collectively "E & Y" or the "Defendants"); as assignee of the Official Unsecured Creditors' Committee's Objection to the Defendants' Proof of Claim Against the Debtors; and as assignee of the claims of Trust Company of the West (with its affiliates "TCW") against Defendants.
E & Y performed audits of, and issued reports with respect to the financial statements of CBI, and its subsidiary Commons Bros. for each of the eleven months ended April 30, 1992 and the fiscal year ended April 30, 1993. BSI alleges that E & Y failed to conduct its audits of CBI for fiscal years 1992 and 1993 in accordance with generally accepted auditing standards ("GAAS"), and that E & Y's conduct caused CBI to file for bankruptcy. It is conceded that in each such year E & Y failed to detect unrecorded liabilities in material amounts. Plaintiff alleges that E & Y's conduct in failing to detect such unrecorded liabilities was reckless, and if not reckless, at least negligent. Plaintiff further alleges that E & Y's conduct was the proximate cause of the damages suffered by CBI and the damages suffered by TCW.
By Memorandum Decision, dated April 21, 1999, this court dismissed BSI's breach of fiduciary duty claim.1 (Id. at 16-17). The six remaining causes of action are based on three events: (a) E & Y's audit of CBI's 1992 financial statements; (b) E & Y's audit of CBI's 1993 financial statements; and (c) E & Y's agreement to perform additional procedures.
E & Y denies the material allegations, and asserts several affirmative defenses to be discussed infra.
Pursuant to the Trial Order, the issue of liability, but not damages, came on for trial. The trial consumed 17 trial days and produced over 3500 pages of transcript. Plaintiff called 10 witnesses, and Defendants called 9 witnesses. Numerous exhibits were offered and admitted into evidence. Summations consumed an entire trial day. Having considered all of the evidence, testimonial and documentary, as well as the arguments of the parties, and their Proposed Findings of Fact and Conclusions of Law, and keeping in mind that a court should not blindly accept findings of fact and conclusions of law proffered by the parties, see St. Clare's Hospital and Health Center v. Insurance Company of North America (In re St. Clare's Hospital and Health Center), 934 F.2d 15 (2d Cir. 1991) (citing United States v. El Paso Natural Gas Co., 376 U.S. 651, 656, 84 S.Ct. 1044, 12 L.Ed.2d 12 (1964)), and having conducted an independent analysis of the law and the facts, this Court makes the following Findings of Fact and Conclusions of Law.
1. CBI's principal business was that of a wholesale distributor of pharmaceutical products. The wholesale pharmaceutical distribution business consists primarily of buying pharmaceutical products from manufacturers, and warehousing such products for delivery to various entities, including retail pharmacies, hospitals, and long-term care facilities, which sell the products to end users. (Wiggins Report at 5, DX-879). Wholesale distributors purchase goods and store them in close proximity to their clients to facilitate rapid delivery of drugs to customers, and ultimately to patients. (Wiggins Report at 5, DX-879).
2. Trust Company of The West ("TCW") is a diversified money management firm. (Pados, Tr. at 1185). In May 1991, TCW made a $20 million investment in CBI, receiving in return $15 million of notes and $5 million of shares of CBI common stock. (1991 Securities Purchase Agreement, 5/31/91, PX-103; Pados, Tr. at 1187). This investment was intended to help CBI achieve its "growth by acquisition" strategy. (Pados, Tr. at 1189-1190).
3. In April 1993, TCW invested an additional $750,000 in CBI, paying $500,000 for notes with a face amount of $750,000, and $250,000 for shares of CBI common stock. (1993 Securities Purchase Agreement, 4/14/93, PX-104).
4. As a result of its initial investment, TCW acquired 48% and Robert Castello held 52% of CBI. (Shareholders Agreement at 2, 5/31/91, PX-111). Mr. Castello became President and Chairman of CBI. TCW also received the right to fill two of the five seats on the CBI Board of Directors and one of the three seats on the Audit Committee of the Board; Mr. Castello had the right to appoint the remainder. (Shareholders Agreement at TCW 000514, 5/31/91, PX-111).
5. E & Y, a limited liability partnership, is one of the country's leading accounting, tax and consulting firms.
6. E & Y became CBI's independent auditors in June 1990. At or about this time, Mr. Castello received an award for "Entrepreneur of the Year" in a promotion sponsored by E & Y and others. (Tr. 118-129; Deposition of Michael Ferrante, pp. 6-11). E & Y performed audits of financial statements for fiscal years 1990 through 1993. These independent audits were performed by auditors from E & Y's office in White Plains, New York. In addition to serving as an independent auditor, E & Y also received fees for performing supplemental mid-year reviews as well as due diligence procedures related to the acquisitions of the stock and/or assets of Granain, Blinn Wholesale Drug Co. ("Blinn"), Brenner, Holsin, and various pharmaceutical wholesalers in the Midwest.
7. E & Y audited the financial statements of each of CBI and its subsidiary Commons Bros. for the eleven months ended April 30, 1992. (PX 23, 31)
8. E & Y issued written reports dated August 6, 1992 with respect to its audits of the consolidated balance sheets of Commons Bros. and CBI, as of April 30, 1992, and the related consolidated statements of income and retained earnings and cash flows for the eleven months then ended. The opinions recite, inter alia, that E & Y conducted its audit in accordance with generally accepted auditing standards and that in the opinion of E & Y, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Commons Bros. and CBI at April 30, 1992 and the results of its operations and its cash flows for the eleven months then ended, in conformity with generally accepted accounting principles. (PX 23, 31)
9. The financial statements of Commons Bros. and the financial statements of CBI did not present fairly, in all material respects, the financial position of such companies at April 30, 1992 and the results of their operations and their cash flows for the eleven months then ended in accordance with generally accepted accounting principles.
10. In performing the fiscal 1992 audits of Commons Bros. and CBI, E & Y failed to detect unrecorded liabilities in respect of inventory purchases in the approximate amount of $321,218 at the Granain subsidiary of CBI, and in the approximate amount of $1,494,000 at the Commons Bros. subsidiary of CBI, for a total amount of approximately $1,815,218. (Expert Report of Robert J. Rock, PX 19 ("Rock Report") at p. 31).
11. The unrecorded amount of $1,815,218 was material in relation to the net income shown in CBI's audited financial statements for the eleven months ended April 30, 1992. (Id. at p. 31).
12. GAAS sets forth the accepted standards of practice for auditors.
13. GAAS requires an auditor to approach an audit with an appropriate degree of professional skepticism.
14. The facts known to E & Y, to be recounted hereinafter, demonstrate that E & Y was required to conduct the fiscal 1992 audit with a high degree of...
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