In re Friedman's, Inc.
| Decision Date | 24 May 2007 |
| Docket Number | Adversary No. 07-4043.,Bankruptcy No. 05-40129. |
| Citation | 372 B.R. 530 |
| Parties | In the matter of FRIEDMAN'S, INC., et al., Debtor. Alan Cohen as Trustee of the Friedman's Creditor Trust, Plaintiff, v. Ernst & Young, LLP, Ernst & Young Corporate Finance, LLC (n/k/a Guiliani Capital Advisors, LLC), and Wedbush Morgan Securities, Inc., Defendants. |
| Court | U.S. Bankruptcy Court — Southern District of Georgia |
David W. Adams, Ellis, Painter, Ratterree & Adams, Paul W. Painter, Jr., Painter, Ratterree & Bart, Savannah, GA, Eric Kanefsky, William C. Fredericks, Bernstein Lotowitz Berger & Grossman LLP, Glenn B. Rice, Otterbourg, Steindler, Houston & Rosen, New York, NY, for Plaintiff.
John A. Chandler, Kristin B. Wilhelm, Patricia A. Gorham, Sutherland Asbill & Brennan LLP, Atlanta, GA, Stephen F. Greenberg, Weiner, Shearouse, Weitz, Greenberg, Aaron L. Buchsbaum, Buchsbaum and Lowe, Savannah, GA, Esther E. Cho, J. Stephen Young, Keesal, Young & Logan, Long Beach, CA, for Defendants.
MEMORANDUM AND ORDER ON THE MOTION OF ERNST & YOUNG LLP AND ERNST & YOUNG CORPORATE FINANCE LLC TO COMPEL ARBITRATION AND STAY ADVERSARY PROCEEDING
The Plaintiff, as Trustee for the Friedman's Creditor Trust (hereinafter, the Trustee), filed this adversary proceeding against the Defendants on January 12, 2007. See Dckt. No. 1 (January 12, 2007). Defendants Ernst & Young LLP (E & Y), and Ernst & Young Corporate Finance LEC (EYCF) filed a motion to compel arbitration of the Trustee's claims and to stay this adversary. See Dckt. No. 3 (January 26, 2007). The Trustee filed a response opposing the motion. See Dckt. No. 15 (February 22, 2007). E & Y and EYCF submitted a timely response to the Trustee's arguments. See Dckt. No. 25 (March 8, 2007). A hearing on this matter was held on March 30, 2007. After reviewing the factual allegations and legal arguments presented by the parties, I make the following Findings of Fact and Conclusions of Law pursuant to Federal Rule of Bankruptcy Procedure 7052.
The Debtors' plan of reorganization (the Plan) was confirmed on November 23, 2005, and became effective on December 9, 2005. See Case No. 05-40129, Dckt. No. 1338 (November 23, 2005). Under the Plan, the Trustee is charged with prosecuting and liquidating on behalf of Class 5 General Unsecured Creditors various causes of action that had been transferred from the Debtors' bankruptcy estate to the Friedman's Creditor Trust. See Id., Ex. A, ¶ 11.3(c). It is in this capacity that the Trustee has brought the present adversary proceeding against E & Y and EYCF.
According to the Trustee's complaint, E & Y provided Friedman's with various prepetition audit, review, tax, restructuring, valuation, and other related financial services. See Dckt. No. 1, p. 12 (January 12, 2007). These services included the year-end auditing of Friedman's financial statements for fiscal years 1998 through 2002; the auditing of never-completed restatements of financial statements for fiscal years 2000 through 2002; auditing Friedman's 2003 year-end financial statement; reviewing Friedman's unaudited quarterly financial statements for the years 1998 through the third fiscal quarter of 2000; and preparing federal, state, and local tax returns for the years 1998 through 2003. See Id. In addition, E & Y provided services to Friedman's in connection with its August 2002 investment of $85 million in Crescent Jeweler's, Inc. (the Crescent Investment), another jewelry retailer that was owned and controlled by some insiders of Friedman's. See Id.
EYCF was retained to provide certain services, primarily valuation services, in connection with audits of Friedman's financial statements for 2001 and 2002 as well as the Crescent Investment. See Id., p. 13. E & Y and EYCF terminated their relationship with Friedman's on January 24, 2005, shortly after the Debtors filed their Chapter 11 petition in this Court. See Id., p. 114.
In his complaint, the Trustee alleges that E & Y and EYCF committed various actionable acts, omissions, and misrepresentations while providing auditing and financial services to the Debtors during fiscal years 2000 through 2003. The eleven causes of action asserted by the Trustee against E & Y and EYCF can be summarized as follows:
1) The Trustee asserts negligence and professional malpractice against E & Y. He contends that E & Y failed in its duty to exercise appropriate care and competence within the professional standards of care. See Dckt. No. 1, p. 104 (January 12, 2007). In particular, the Trustee alleges that E & Y failed in its fiduciary duties to provide material information to Friedman's Audit Committee and Board of Directors concerning the proper valuation of Crescent and the potential impact the investment would have on Friedman's liquidity and financial stability. See Id., pgs. 105-106. Furthermore, E & Y negligently disregarded the fact that Friedman's financial statements contained numerous material misstatements. See Id., p. 105.
2) The Trustee asserts negligent misrepresentation against E & Y. He contends that E & Y negligently supplied Friedman's independent directors with false information in connection with the Crescent Investment and that the directors reasonably relied on this false information. See Dckt. No. 1, p. 107 (January 12, 2007).
3) The Trustee asserts fraudulent conveyance under O.C.G.A. § 18-2-70 et seq against E & Y. He contends that Friedman's paid approximately $5 million to E & Y for audit work that was never fully completed. See Dckt. No. 1, p. 108 (January 12, 2007).
4) The Trustee asserts fraudulent conveyance under 11 U.S.C. § 548 against E & Y. This cause of action arises from the same facts and circumstances as the fraudulent conveyance cause of action under O.C.G.A. § 18-2-70 et seq. See Dckt. No. 1, p. 109 (January 12, 2007).
5) The Trustee asserts breach of fiduciary duty against E & Y. He contends that E & Y breached its fiduciary duty by failing to disclose material information concerning the Crescent Investment to Friedman's Board of Directors. See Dckt. No. 1, p. 110 (January 12, 2007).
6) The Trustee asserts aiding and abetting a breach of fiduciary duty against E & Y. He contends that E & Y's actions aided and abetted several members of Friedman's senior management in breaching their own fiduciary duties to Friedman's. See Dckt. No. 1, p. 111 (January 12, 2007).
7) The Trustee asserts fraud and aiding and abetting fraud against E & Y. He contends that E & Y knowingly submitted materially false and misleading financial statements to Friedman's Board of Directors in connection with the Crescent Investment. See Dckt. No. 1, p. 112 (January 12, 2007). Furthermore, E & Y knowingly or recklessly aided and abetted the submission of materially false and misleading financial statements to the Friedman's Board of Directors by various members of Friedman's senior management. See Id.
8) The Trustee asserts breach of contract against E & Y. He contends that E & Y breached a June 1, 2004 contract to audit Friedman's financial statements for fiscal year 2003 and to audit Friedman's restatement of its financial statements for fiscal years 2001 and 2002. See Dckt. No. 1, p. 113 (January 12, 2007).
9) The Trustee asserts contempt for a violation of the automatic stay provisions of 11 U.S.C. § 362 against E & Y. He contends that E & Y's unilateral termination of its contract with Friedman's on January 24, 2005, was an intentional and/or willful violation of the automatic stay. See Dckt. No. 1, p. 114 (January 12, 2007).
10) The Trustee asserts a violation of the Georgia Public Accountancy Act under O.C.G.A. § 43-3-35(f) against E & Y. He contends that at the time it agreed to audit Friedman's restated financial statements for 2000 through 2002 as well as its fiscal year 2003 financial statement, E & Y had no intention of completing such audits. See Dckt. No. 1, p. 115 (January 12, 2007).
11) The Trustee asserts negligence and contributory negligence against EYCF. He contends that EYCF failed to exercise ordinary care, skill, and diligence in performing its valuations for the Crescent Investment. See Dckt. No. 1, p. 116 (January 12, 2007).
E & Y was a party to several prepetition engagement agreements with Friedman's that contain arbitration clauses. See Dckt. No. 3, Ex. 1, Exs. A-D (January 26, 2007). In the September 30, 1999 agreement, the parties agreed that:
Any controversy or claim arising out of or relating to the services covered by this letter or hereafter provided by us to the Company (including any such matter involving any parent, subsidiary, affiliate, successor in interest, or agent of the Company or of Ernst & Young LLP) shall be submitted first to voluntary mediation, and if mediation is not successful, then to binding arbitration, in accordance with the dispute resolution procedures set forth in the attachment to this letter. Judgment on any arbitration award may be entered in any court having proper jurisdiction.
The Dispute Resolution Procedures attached to the September 30, 1999 agreement state that:
Any issue concerning the extent to which any dispute is subject to arbitration, or concerning the applicability, interpretation, or enforceability of these procedures, including any contention that all or part of these procedures are invalid or unenforceable, shall be governed by the Federal Arbitration Act and resolved by the arbitrators.
See Id.
Although the wording may not be exactly the same, these provisions appear in the engagement agreements executed between E & Y and Friedman's on September 21, 2000, July 20, 2001,1 and June 1, 2004. See Id., Ex. 1, Exs. B-D.
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