Quad City Bank & Trust v. Jim Kircher & Associates

• Decision Date: 23 September 2011
• Docket Number: No. 09–1151.,09–1151.
• Citation: 804 N.W.2d 83
• Court: Iowa Supreme Court
• Parties: QUAD CITY BANK & TRUST, Appellant,v.JIM KIRCHER & ASSOCIATES, P.C., Appellee.

804 N.W.2d 83

QUAD CITY BANK & TRUST, Appellant,

v.JIM KIRCHER & ASSOCIATES, P.C., Appellee.

No. 09–1151.

Supreme Court of Iowa.

Sept. 23, 2011.

Robert V.P. Waterman, Jr., and Thomas D. Waterman (until withdrawal) of Lane & Waterman LLP, Davenport, for appellant.Les V. Reddick of Kane, Norby & Reddick, P.C., Dubuque, for appellee.WIGGINS, Justice.

A bank attempted to prove an accounting negligence claim by using an expert witness to testify regarding the accountant's audit of a company. The district court refused to allow the expert to testify as to generally accepted Certified Public Accountant (CPA) auditing standards, whether the accountant breached those standards, and causation. The district court left open the question of whether the expert could testify as to the accountant's work papers. At trial, the bank made an offer of proof as to the work papers, but did not move to introduce them, so the court never ruled on their admissibility. The bank received an adverse jury verdict and appealed. We transferred the case to the court of appeals. The court of appeals reversed the district court and remanded for a new trial. On further review, we hold the bank failed to preserve error on the work-paper issue. Additionally, we hold the expert was not qualified to testify as to generally accepted CPA auditing standards, whether the accountant breached those standards, and causation. Therefore, we vacate the decision of the court of appeals and affirm the judgment of the district court.

I. Background Facts and Proceedings.

Keith Chapman owned Chapman Lumber Company, Inc., a lumber business located in Hopkinton. In February 2003 Quad City Bank & Trust (QCBT) provided Chapman Lumber with a $500,000 line of credit. In July QCBT loaned Chapman Lumber $1,935,000. The United States Department of Agriculture (USDA) guaranteed eighty percent of this loan. In September QCBT increased Chapman Lumber's line of credit to $750,000. As of October QCBT was aware Chapman Lumber defaulted on the $1,935,000 loan. Nevertheless, QCBT decided not to foreclose on the loan at that time.

As a condition of its guarantee, the USDA required a general audit of Chapman Lumber. Accordingly, on October 1 Chapman Lumber hired Jim Kircher & Associates, P.C. to perform a general audit for its fiscal year ending on June 30, 2003. According to Kircher, the objective of the audit was to express “an opinion about whether [Chapman Lumber's] financial statements [were] fairly presented in all material respects, in conformity with U.S. generally accepted accounting principles.” Brian Feltes, a CPA and employee of Kircher, performed the audit. QCBT relied on the audit to validate Chapman Lumber's financial performance and to decide whether to keep working with Chapman Lumber. In late December QCBT saw a preliminary version of the audit report. Kircher did not issue the final report until late January 2004. The audit showed that, for fiscal year 2003, Chapman Lumber had overdrafts of $59,474 and a deficit cash flow of $85,306.

By the end of January, Chapman Lumber was also in default on the $750,000 line of credit. Subsequently, QCBT informed Chapman Lumber that they had thirty days to acquire an infusion of venture capital or QCBT would foreclose on the loans. However, rather than foreclosing on the loans after the thirty days expired, QCBT entered into a forbearance agreement with Chapman Lumber. The agreement provided that QCBT would not foreclose on its loans as long as Chapman Lumber procured an injection of venture capital.

In April Chapman Lumber suffered a substantial fire that destroyed its kilns, which were central to its operations. These events left QCBT with a decision. It could either recoup the insurance proceeds and liquidate Chapman Lumber or reinvest the proceeds into the business and keep Chapman Lumber operational. QCBT chose to keep Chapman Lumber operational due to the increased efficiency from newly installed kilns and the expectation that Chapman Lumber would receive a substantial venture capital investment. While it was waiting for the insurance proceeds, Chapman Lumber procured a short-term loan of $150,000 from QCBT to be paid back in ninety days.

In January 2005 the forbearance agreement expired. Chapman Lumber had not yet secured a venture capital investment. Thus, QCBT called its loans with Chapman Lumber due. Subsequently, Chapman Lumber filed for bankruptcy protection. In March QCBT went to Chapman Lumber's premises to check on its collateral. During this check, QCBT discovered that Chapman Lumber had been defrauding the bank. QCBT found inventory at the facility, but Chapman Lumber did not own the inventory. Following this discovery, QCBT made a concerted effort to investigate Chapman Lumber's finances. QCBT learned that Keith Chapman had a personal Wells Fargo bank account through which he funneled approximately $600,000 of the company's money for his own personal expenses. Ultimately, QCBT netted $1,289,213 from Chapman Lumber's liquidation.

QCBT filed an accounting negligence claim against Kircher. QCBT alleged that Kircher negligently performed its fiscal-year-2003 audit of Chapman Lumber because it failed to discover and accurately convey the true financial condition of Chapman Lumber. QCBT claimed it relied on Kircher's audit when it delayed foreclosure on its loans with Chapman Lumber and, if it had known of the company's lack of inventory and fraud, it would have liquidated the company at the time of the fire. Furthermore, QCBT asserted that, had it liquidated in 2004 at the time of the fire, it would have netted $912,270.10 more than the $1,289,213 it netted in the 2005 liquidation.

QCBT identified Kerry Bolt as an expert witness. Bolt was a certified fraud examiner, but not a CPA. Bolt began his career as a revenue agent for the Internal Revenue Service (IRS), where he conducted field audits of income tax returns of individuals and businesses. Bolt then became an IRS special agent and conducted criminal investigations of income tax fraud, money laundering, and terrorist financing. Subsequently, he retired from the IRS and started a forensic accounting business. In relation to this case, Bolt reviewed all of Feltes's work papers, as well as other records, to determine whether Feltes sufficiently examined Chapman Lumber's internal controls, inventory, and risk of fraud.

Thirteen days before trial, Kircher filed a motion in limine seeking to prohibit QCBT from introducing “any evidence from plaintiff's designated expert Kerry Bolt with respect to standards of care applicable to certified public accountants, whether that standard was breached, or causation” and “any evidence from Kerry Bolt based upon his perceived errors in [Feltes's] work papers.” Kircher pointed to Bolt's deposition testimony as proof that he was unqualified to opine on whether Kircher performed the audit according to generally accepted auditing standards. In his deposition, Bolt testified he was not a CPA, had never performed a general audit of a business, and was not familiar with CPA auditing standards.

QCBT resisted the motion, arguing Bolt was qualified to opine that Feltes failed to meet generally accepted auditing standards by failing to adhere to the work papers. QCBT claimed that because Feltes admitted in his deposition that the generally accepted auditing standards required him to complete the work papers, Bolt could analyze Feltes's work contained in the work papers to assure he did everything the work papers required.

The district court held a hearing on the motion in limine on the first morning of the trial. QCBT argued that Feltes and Kircher's expert stated that the way you comply with the applicable professional CPA standards of care is to do as the work papers direct. Thus, QCBT argued:

Bolt is not coming in as a typical expert to say the standard of care for a certified public accountant doing an audit is the following GAAP and GAAS standard was violated. He's coming in to say, I'm assuming that you have to do what your work papers told you to do and here's why that can't have been the case, and he is qualified to do that because he's a certified fraud examiner and he's been running down situations somewhat similar to this for a long time.

Accordingly, while QCBT agreed that Bolt was not qualified to testify as to whether Kircher performed the audit negligently, it claimed Bolt could testify as to whether Feltes did what the work papers required, assuming the audit was supposed to be conducted pursuant to the work papers. Kircher claimed this was a backdoor attempt to prove an auditor's professional negligence with an unqualified expert.

The court then ruled on Kircher's motion in limine:

Plaintiff must still prove a violation of some generally accepted auditing standard, and from what I'm able to read from what has been given to me thus far in depositions of Mr. Bolt, he is not an expert who can determine whether or not an audit has been performed pursuant to some generally accepted auditing standard because he's not a CPA.... So I don't think that you can take a statement that was made by a CPA and then bring Mr. Bolt into the picture and say, well, based upon what he told me and then based upon other investigations that I made, I'm of the opinion that ... this audit was not performed negligently.... I'm not saying right off the top of my head, I guess, that Mr. Bolt cannot testify period, but I'm just saying that he can't testify to this ultimate fact. And I really can't say ... at this stage what my opinion would be in that regard because I just—with the fluidity of the trial process, it's very hard for me to try to figure out how this is all going to come out.

After this statement, Kircher asked for clarification on the court's ruling, to which the court replied, “Your motion is granted as to Bolt.” QCBT then stated the court's ruling left in doubt whether it could ask Bolt about the contents of...