Shapiro v. Glekel, 73 Civ. 2324 (JMC).

• Court: United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
• Writing for the Court: CANNELLA
• Citation: 380 F. Supp. 1053
• Parties: Leo SHAPIRO, as Trustee in Proceedings for the Reorganization of Beck Industries, Inc., under Chapter X of the Bankruptcy Act, Plaintiff, v. Newton GLEKEL et al., Defendants.
• Docket Number: No. 73 Civ. 2324 (JMC).,73 Civ. 2324 (JMC).
• Decision Date: 28 June 1974

380 F. Supp. 1053

Leo SHAPIRO, as Trustee in Proceedings for the Reorganization of Beck Industries, Inc., under Chapter X of the Bankruptcy Act, Plaintiff, v. Newton GLEKEL et al., Defendants.

No. 73 Civ. 2324 (JMC).

United States District Court, S. D. New York.

June 28, 1974.

Shea, Gould, Climenko & Kramer, New York City (Ralph L. Ellis, New York City, of counsel), for plaintiff.

Davis, Polk & Wardwell, New York City (Robert B. Fiske, Jr., Bartlett H. McGuire, Stephen D. Hoffman and Rhea Kemble Neugarten, New York City, of counsel), for defendant Ernst & Ernst.

MEMORANDUM DECISION

CANNELLA, District Judge.

Defendant Ernst & Ernst's motion, pursuant to Rule 12(c) of the Federal Rules of Civil Procedure, for an order granting it judgment on the pleadings dismissing Count IV of the instant complaint, or, in the alternative, for partial summary judgment, pursuant to Rule 56(b) of the Federal Rules of Civil Procedure, dismissing Count IV as against it, is denied.

Count IV of the complaint asserts that as a result of Ernst & Ernst's negligent performance of its auditing and accounting contract, Beck Industries, Inc. hereinafter "Beck" was allowed to overstate its earnings and financial condition in certain financial statements, and that these errors caused the financial demise of Beck and Beck's petition for reorganization under Chapter X of the Bankruptcy Act. In essence, plaintiff alleges that Ernst & Ernst is liable to Beck, because Beck's financial statements for 1968 and 1969 were inaccurate and because the accountants negligently failed to detect such inaccuracies and report them to Beck's Board of Directors. It is further claimed that the accountants' failure to determine and report the true financial condition of Beck renders them legally responsible to the trustee for permitting the Beck directors to engage in an ill-advised program of acquisitions. These claims against Ernst & Ernst are predicated upon both negligence and breach of engagement theories.

On the instant motion, movant asserts that the plaintiff, by his statements in the pleadings, has conceded that the President and the Chairman of the Executive Board of Beck knew or should have known that Beck's earnings were materially less, and its financial condition was materially worse, than that represented in the financial statements and, therefore, that such knowledge and negligence on the part of Beck's two top officers precludes the trustee, who stands in the shoes of Beck, from suing the accountants for their negligence in permitting the overstatements in the financial reports to occur. Ernst & Ernst point to the following matters as supportive of their thesis: (1) that the President and Executive Committee Chairman of Beck (Messrs. Glekel and McDevitt) were aware or should have been aware of the fact that Beck's financial condition was materially worse than that reported in the financial statements; (2) that all the directors of Beck, "except defendants Glekel and McDevitt, were misled into believing that Beck was prospering, whereas it was not"; and (3) that the majority of Beck's directors, "except for defendants Glekel and McDevitt, and others, would have known of Beck's true financial condition" had Ernst & Ernst properly performed its duties. In short, movant argues that assuming, as it must, the truth of the allegations made in the complaint, a recovery against Ernst & Ernst is here precluded as a matter of law because Beck was itself contributorily negligent and that, in any event, any negligence on the accountants' part was not, as a matter of law, the proximate cause of Beck's losses.

CONTRIBUTORY NEGLIGENCE

In support of its position that the negligence of the employer precludes recovery against the accountants, Ernst & Ernst places reliance upon Craig v. Anyon, 212 App.Div. 55, 208 N.Y.S. 259 (1 Dept.1925), aff'd without opinion, 242 N.Y. 569, 152 N.E. 431 (1926), and a line of cases which have apparently, albeit not exclusively, embraced the rationale of that case. Social Security Administration Baltimore Federal Credit Union v. United States, 138 F.Supp. 639 (D.Md.1956); Delmar Vineyard v. Timmons, 486 S.W.2d 914 (Tenn.Ct.App. 1972); Cereal Byproducts Co. v. Hall, 8 Ill.App.2d 331, 132 N.E.2d 27 (1 Dist. 1956); International Laboratories, Ltd. v. Dewar, 1933 3 D.L.R. 665 (Manitoba Ct.App.). In Craig v. Anyon plaintiffs, a firm of stock and commodity brokers, were defrauded of more than $1,250,000 over a period of about five years by an employee (Moore) who was in charge of plaintiffs' commodities department. Plaintiffs brought suit on the theory that the accountants had negligently conducted an audit of plaintiffs' books, asserting that a proper audit would have uncovered the falsification of the books, led to the discharge of Moore, and prevented further losses. In affirming the trial court's reduction of the jury's verdict to the amount which had been paid to the accountants as compensation for their services, the Appellate Division, First Department, stated:

Moore's various and diverse duties and powers put him in a position to keep records and papers, or cause them to be kept so as to deceive the accountants who relied on them. If it be assumed that they should not have done so, it is nevertheless true that the plaintiffs also relied upon them to an extent beyond all reason in view of the circumstances. They were guilty of the same kind of negligence of which they now complain. It may be true that a proper accounting would have put the plaintiffs on guard with reference to Moore's wrongdoing, but it is also true that, if the plaintiffs had attended to their business and, in view of the large transactions involved, had looked up Zabriskie's account when payments were being made to it, the dishonesty of Moore would have been discovered.

. . . . . .

There is no doubt in this case that plaintiffs could have prevented the loss by the exercise of reasonable care and that they should not have relied exclusively on the accountants.

We think the damages cannot be said to flow naturally and directly from defendants' negligence or breach of contract. Plaintiffs should not be allowed to recover for losses which they could have avoided by the exercise of reasonable care. . . .

. . . . . .

The plaintiffs in effect contend that defendants are chargeable with negligence because of failure to detect Moore's wrongdoing, wholly overlooking the fact that, although they were closely affiliated with Moore, who was constantly under their supervision, they were negligent in failing properly to supervise his acts, or to learn the true condition of their own business and to detect his wrongdoing.

212 App.Div. at 63-67, 208 N.Y.S. at 266-269. By a parity of reasoning, movant here asserts that the conduct of Messrs. Glekel and McDevitt and their knowledge of Beck's true financial position is similarly preclusive of a recovery against the accountants in this litigation.

Plaintiff, on the other hand, in support of the position that a recovery against the accountants is not barred by the acts alleged to have been committed by Messrs. Glekel and McDevitt, places primary reliance upon the subsequent Appellate Division, First Department decision in National Surety Corp. v. Lybrand, 256 App.Div. 226, 9 N.Y.S.2d 554 (1 Dept.1939). In that case, the defendant accountants were charged with negligence in failing to discover that Halle & Stieglitz, members of the New York Stock Exchange, had, for several years, been subject to embezzlements by their cashier. To this claim, the accountants asserted a defense of contributory negligence, offering evidence "that Halle & Stieglitz so conducted their business as to make possible the cashier's defalcations." In reversing the trial court, which had barred plaintiff's claim in reliance upon Craig v. Anyon, the Appellate Division stated:

We are . . . not prepared to admit that accountants are immune from the consequences of their negligence because those who employ them have conducted their own business negligently. . . . Accountants, as we know, are commonly employed for the very purpose of detecting defalcations which the employer's negligence has made possible. Accordingly, we see no reason to hold that the accountant is not liable to his employer in such cases. Negligence of the employer is a defense only when it contributed to the accountant's failure to perform his contract and to report the truth. . . . That was the principle applied in Craig v. Anyon . . . where the embezzler had been negligently represented to the accountants as a person to be trusted. In the present case, the loss consisted of thefts by a cashier not so represented "whose own account of his receipts and payments could not reasonably be taken by an auditor without further inquiry." Emphasis added

256 App.Div. at 235-236, 9 N.Y.S.2d at 563. The trustee contends that this narrower, more restrictive formulation of the contributory negligence defense, as it was expressed by the court in Lybrand, is here applicable and, he asserts that viewing the conduct of Messrs. Glekel and McDevitt in a light most favorable to plaintiff, such cannot be said to have contributed to the accountants' failure to perform their contract and to report the truth.

Ernst & Ernst, of course, does not agree with this analysis, contending instead, first, that Lybrand adopts a position not supported by the weight of authority and that the proper rule is that found in Craig v. Anyon; and, second, assuming arguendo that Lybrand is here found controlling, the facts of the instant case demonstrate negligence on the part of Beck's officials sufficient under that standard.

The later cases, both in New York and elsewhere, do not attempt to clarify the apparent conflict between Craig v. Anyon and Lybrand or to reconcile their holdings. Indeed, these cases have been cited, perhaps erroneously, for the same legal proposition. See, e. g., Social Security Administration...