In re Jack Greenberg, Inc., Bankruptcy No. 95-13891DWS. Adversary No. 97-0068.

• Citation: 240 BR 486
• Decision Date: 05 October 1999
• Docket Number: Bankruptcy No. 95-13891DWS. Adversary No. 97-0068.
• Parties: In re JACK GREENBERG, INC., Debtor. Larry Waslow, Trustee for Jack Greenberg, Inc., Plaintiff, v. Grant Thornton LLP, Defendant.
• Court: United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Eastern District of Pennsylvania

240 B.R. 486 (1999)

In re JACK GREENBERG, INC., Debtor Larry Waslow, Trustee for Jack Greenberg, Inc., Plaintiff, v. Grant Thornton LLP, Defendant.

Bankruptcy No. 95-13891DWS. Adversary No. 97-0068.

United States Bankruptcy Court, E.D. Pennsylvania, Philadelphia Division.

October 5, 1999.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Walter Weir, Weir & Partners, Philadelphia, PA, for trustee/plaintiff.

Arlene Fickler, Hoyle, Morris & Kerr, Philadelphia, PA, for defendant.

Dave Adams, Philadelphia, PA, United States Trustee.

OPINION

DIANE WEISS SIGMUND, Bankruptcy Judge.

Before the Court is the motion ("Motion") of Defendant Grant Thornton, L.L.P. ("Grant Thornton") for summary judgment of the claims set forth in Counts II, III, IV and V of the Amended Complaint ("Amended Complaint") for "negligence," "fraud," "negligent misrepresentation" and "aiding and abetting fraud," respectively. A hearing on the Motion was held and the parties have submitted post-hearing briefs. The matter is now ripe for decision. Upon consideration and for the reasons stated below, I grant the Motion in part and deny it in part.

BACKGROUND

A. The Debtor

Plaintiff, Larry Waslow (the "Trustee"), is the Chapter 7 Trustee for the Debtor, Jack Greenberg, Inc. ("Debtor"). Amended Complaint ¶ 1.¹ The Debtor is a corporation whose business was the wholesale and retail sale of domestic and foreign meat and cheese products. Id. ¶ 3. The President and Vice President of the Debtor were Emanuel Greenberg ("Emanuel") and Fred Greenberg ("Fred"), respectively. Id. ¶ 6. Emanuel and his family own fifty percent of the stock while Fred and his family own the other fifty percent. Deposition of Fred, dated Nov. 13, 1998 (hereinafter referred to as "Fred Dep.") at 15; Deposition of Emanuel dated December 8, 1998 (hereinafter referred to as "Emanuel Dep.") at 76.² While the business was operating, Fred and Emanuel, together with their mother,³ were also the directors of the company. Id. at 41.

In 1986 or 1987, Steve Cohn ("Cohn"), was hired by Debtor as its controller. Deposition of Cohn dated January 19, 1999 (hereinafter referred to as "Cohn Dep.") at 11.⁴ He held that position until sometime in 1995 when his title was changed to Chief Financial Officer. Id. at 12. As the company's controller, Cohn "was responsible for the accounting area of the company, including the payables, receivables, payroll." Id. at 17-18. In this role, he also prepared monthly financial statements. Id. at 23. In addition, he was in charge of the data processing area and was involved in administrative matters with the banks with which the Debtor dealt.⁵ Id. at 18.

B. Debtor's Credit Facilities

In the early 1990's, Debtor had credit facilities with three banks, namely Meridian Bank, Philadelphia National Bank and First Fidelity Bank (hereinafter referred to collectively as the "Banks"). Amended Complaint at ¶ 16. As a condition to one or more of these credit facilities, Debtor was required to limit the aggregate amount of its borrowing from the Banks. Cohn Dep. at 97-98. During the period in question, the aggregate amount varied from $10,000,000 to $15,000,000. Id. at 98-99. Emanuel, Fred and Cohn were each aware of the Debtor's aggregate borrowing limits. Id. at 106; Fred at 30-34. While Fred was not aware at any time that Debtor had exceeded its aggregate borrowing limit with the Banks, Emanuel was aware on a daily basis of the amount of money which Debtor had borrowed from its lenders. Id. at 188; Emanuel Dep. at 78. On a monthly basis, Cohn completed certifications which he sent to at least one of the Banks stating the aggregate amount of the Debtor's borrowings. Cohn Dep. at 105-106.

C. Prepaid Inventory and Fred's Fraudulent Conduct

As part of its business, Debtor would purchase frozen meat from overseas. Because the overseas vendors required prepayment in advance of delivery, Debtor would pay for these products prior to its receipt of them. Debtor recorded these prepaid products as "prepaid inventory" on its balance sheets. Emanuel Dep. at 35-36; Cohn Dep. at 13-14. Pursuant to Debtor's accounting policy, after an item of "prepaid inventory" was "received" by Debtor, it was supposed to be reclassified as "merchandise inventory" on the balance sheet.⁶ Fred Dep. at 51-52; Cohn Dep. at 13-14. Debtor deemed an item to have been received after it was delivered to Debtor's warehouse and inspected by the United States Department of Agriculture. Fred Dep. at 51; Emanuel Dep. at 36-37.

Until the fall of 1994,⁷ Fred was in charge of the Company's prepaid inventory of frozen meat.⁸ Emanuel Dep. at 31-32; Cohn Dep. at 22-23, 73 (Fred assumed sole responsibility for the imported frozen beef portion of the business); Amended Complaint at ¶ 10. He ordered the vast majority of this product for the company. Fred Dep. at 46. Generally, Fred would place an order with a vendor. Id. at 47. Then, the meat would be inspected overseas by the applicable authority, loaded into refrigerated containers and placed on a boat. Id. at 47-49. While the shipment was underway, notice of it would be given to Debtor and Debtor would prepay for the meat. Id. at 49-50. When the shipment reached a port in the United States, a custom broker, John A. Steer, Inc. ("John Steer"), would arrange for entry with United States custom officials. Id. at 50. Thereafter, John Steer would send notice of the delivery to Debtor. Id. at 51. The shipment would subsequently be delivered to the Debtor's warehouse, opened up and inspected by an inspector from the United States Department of Agriculture ("USDA"). Id. at 51. For each shipment that passed inspection, the inspector completed a form, namely Form 9540-1. Burns Dep. at 98, 105. This form showed the date upon which the shipment had arrived in Debtor's warehouse. Id. After a shipment passed inspection, it was received into inventory. Fred Dep. at 51. Debtor's warehouse manager, Chuck McCloskey, was responsible for overseeing the inventory count when it arrived at the warehouse, stamping the meat after it was inspected and signing off on a document ("Delivery Receipt") which identified the date of arrival, the vendor, the product and the total number of boxes received. Cohn Dep. at 32-35, 48; Emanuel Dep. at 20-21. This Delivery Receipt would then be attached to the shipping document from the vendor. Id. at 35. Fred had sole responsibility for matching up the Delivery Receipt to the invoices and providing these documents to Cohn so that he could enter the inventory as received as of the date listed on the Delivery Receipt. Fred Dep. at 58-59, 134 (Fred was the only one at the company assigned the responsibility of providing Cohn with the receiving dates of prepaid inventory), 136 (from 1990 through 1994, Fred was the only person responsible for "assembling the documentation on prepaid inventory"); Emanuel Dep. at 32-34 ("Fred matched up the receiving invoices, and when he—when the product was received, he matched them up and turned them in to Steve Cohn to be recorded."). However, beginning sometime in 1987 or 1988, Fred began discarding the Delivery Receipts which he received from the warehouse manager and substituting new receipts. Id. at 86. On the new receipt, he forged the warehouse manager's initials and recorded an incorrect receiving date to make it appear as though the inventory was received by the Debtor at a later date than it was actually received. Fred Dep. at 70-71, 80. He provided this false information to Cohn. Id. at 81. Cohn used the false information in preparing the company's prepaid inventory log for the company's financial statements. Id. at 81; Emanuel Dep. at 91. Because of this, the financial statements overstated the amount of prepaid inventory, and misstated the company's net income and the cost of goods sold. Id. at 84-85.

Fred manipulated the dates upon which the prepaid inventory was received in order to make it appear that the company's operations generated the same general financial performance from period to period. Id. at 88. He did this by determining how much inventory needed to be prepaid inventory so that the percentages of gross profit and net income would remain consistent.⁹Id. at 88-89. See also Emanuel Dep. at 52 (Fred falsified "the amounts of the prepaids to increase the earnings statement.").

D. Grant Thornton, its Audits and the Discovery of Fred's Fraud

Grant Thornton, a public accounting firm, provided accounting and auditing services to Debtor from 1986 through 1994. Amended Complaint ¶ 5. For each of its audits, Debtor and Grant Thornton entered into a letter agreement which set forth the terms of Grant Thornton's engagement. Fred Dep. at 134-35 & Exhibits. 16 and 23 thereto; Cohn Dep. at 51-52. In connection with each audit, Grant Thornton also required Fred and Emanuel to make written representations to it on behalf of the Debtor. Cohn Dep. at 69-70. Id.

To facilitate each of its audits, Grant Thornton provided Cohn with an "Engagement Compliance Checklist" identifying the information which was needed for the audit. Cohn Dep. at 52-56. Cohn would assemble the requested information and provide it to the auditors. Id. One of the items listed on the aforementioned checklist was "detail listing of invoices comprising prepaid inventory, invoices and receiving reports on the list."¹⁰ Id. at 55-56. For each audit, Fred provided Cohn with a package of documents to satisfy this item on the checklist and Cohn provided the package to Grant Thornton. Id. at 55-58; Emanuel Dep. at 86-87, 92. The package included government forms, bills of lading, insurance information and the Delivery Receipts purportedly prepared by the warehouse personnel evidencing the date upon which the inventory was received at the Debtor's warehouse. Fred Dep. at 86-87; Cohn Dep. at 56; Deposition of David Burns dated January 18, 1999 (hereinafter referred to as "Burns Dep."), at 67-68, 73, 98;¹¹ Deposition of Eric Nagle dated ...