VENTURTECH II v. Deloitte Haskins & Sells

• Decision Date: 01 April 1992
• Docket Number: No. 88-1012-CIV-5-H.,88-1012-CIV-5-H.
• Citation: 790 F. Supp. 576
• Parties: VENTURTECH II, Limited Partnership; North Riverside Venture, Inc.; and Heritage Capital Corporation, Plaintiffs, v. DELOITTE HASKINS & SELLS, Defendant/Third-Party Plaintiff, v. LEARNING RESOURCES, INC., Kitty Hawk Capital, Inc., Christopher W. Hegele, Robert L. Chapman, and Thomas Barry, Third-Party Defendants and Additional Third-Party Plaintiffs, v. GREYLOCK PARTNERS & CO.; Advanced Technology Development Fund; David L. Strohm and Ronald W. White, Additional Third-Party Defendants.
• Court: U.S. District Court — Eastern District of North Carolina

790 F. Supp. 576

VENTURTECH II, Limited Partnership; North Riverside Venture, Inc.; and Heritage Capital Corporation, Plaintiffs, v. DELOITTE HASKINS & SELLS, Defendant/Third-Party Plaintiff, v. LEARNING RESOURCES, INC., Kitty Hawk Capital, Inc., Christopher W. Hegele, Robert L. Chapman, and Thomas Barry, Third-Party Defendants and Additional Third-Party Plaintiffs, v. GREYLOCK PARTNERS & CO.; Advanced Technology Development Fund; David L. Strohm and Ronald W. White, Additional Third-Party Defendants.

No. 88-1012-CIV-5-H.

United States District Court, E.D. North Carolina, Raleigh Division.

April 1, 1992.

COPYRIGHT MATERIAL OMITTED

William E. Sumner, Stephen J. Anderson, Sumner & Hewes, Atlanta, Ga., Daniel K. Bryson, Maupin Taylor Ellis & Adams, Raleigh, N.C., for plaintiffs and Thomas Barry.

James T. Williams, Jr., Jeffrey E. Oleynik, Brooks, Pierce, McLendon, Humphrey & Leonard, Greensboro, N.C., for defendants.

Richard D. Stephens, Lynn O. Wenige, Kennedy, Covington, Lobdell & Hickman, Charlotte, N.C., for Kitty Hawk Capital, Inc., and Christopher W. Hegele.

James D. Blount, Jr., Michael E. Weddington, Smith, Anderson, Blount, Dorsett, Michael & Jernigan, Raleigh, N.C., for Greylock Partners & Co. and David L. Strohm.

L. Joseph Loveland, Stephanie E. Parker, King & Spalding, Atlanta, Ga., for Advanced Technology Dev. Fund and Ronald W. White.

ORDER

MALCOLM J. HOWARD, District Judge.

This matter is before the court on numerous motions for summary judgment. Plaintiffs moved for partial summary judgment against defendant Deloitte Haskins & Sells ("DH & S") on their professional negligence and third-party contract claims related to the 1985 and 1986 financial statements. DH & S moved for summary judgment on plaintiffs' common law fraud, breach of contract, professional negligence, breach of fiduciary duty, and state securities law claims. Additional third-party defendants Greylock Partners & Co. ("Greylock"), Advanced Technology Development Fund ("ATDF"), David L. Strohm ("Strohm"), and Ronald W. White ("White") (collectively "Greylock, et al.") moved for summary judgment on the contribution claims based on negligence and state securities laws brought by additional third-party plaintiffs Kitty Hawk Capital, Inc. ("Kitty Hawk") and W. Christ Hegele ("Hegele").¹ Kitty Hawk and Hegele moved for summary judgment on the contribution claims based on negligence and state securities laws brought by DH & S. Plaintiffs North Riverside Venture, Inc., ("North Riverside"), Heritage Capital Corporation ("Heritage"), and third-party defendant Thomas Barry ("Barry") moved for summary judgment on the contribution claims based on negligence and state securities laws brought against them by DH & S, Kitty Hawk, and Hegele. Finally, third-party defendant Robert L. Chapman ("Chapman") requested summary adjudication of DH & S' claims against him for contribution based on negligence and state securities laws.

STATEMENT OF THE CASE

The plaintiffs, three venture capital investment firms, initiated this action on December 31, 1988, against DH & S, an international public accounting firm, alleging violations of the federal and state securities laws, common law fraud, breach of contract, professional negligence/negligent misrepresentation, and breach of fiduciary duty in connection with DH & S' examination of annual financial statements issued by Learning Resources, Inc. ("LRI"). In its answer, DH & S generally denied the material allegations of the complaint. DH & S later filed an amended answer asserting a counterclaim against North Riverside and filed a third-party complaint against LRI; Robert L. Chapman ("Chapman"), the president, a director, and member of the executive committee of LRI; Barry, a director and member of the executive committee of LRI; Kitty Hawk, a venture capital investment firm which invested in LRI in 1984; and Hegele, a principal of Kitty Hawk and a director and member of the executive committee of LRI. DH & S contended that it was entitled to contribution and indemnification from LRI, Chapman, Kitty Hawk, Hegele, and Barry,² because they each had participated in the solicitation of plaintiffs' investments.

Kitty Hawk and Hegele asserted claims for contribution and indemnification against North Riverside, Barry, and Heritage and filed a third-party complaint against Greylock, et al., two venture capital investment firms and their principals, who served on LRI's audit committee and on its Board of Directors ("the Board"). This court dismissed all claims for contribution and indemnification, except claims based on negligence and state securities laws, by order of January 3, 1991.

In August 1991, upon DH & S' motion for summary judgment pursuant to the rule announced in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, ___ U.S. ___, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991), this court dismissed as time barred plaintiffs' federal securities claims. On February 24, 1992, 790 F.Supp. 574, the court reinstated the plaintiffs' claims brought under § 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), and Rule 10b-5 promulgated thereunder, as required by § 27A of the 1934 Act, enacted as part of the Federal Deposit Insurance Corporation Improvement Act of 1991, Pub.L. No. 102-242. Meanwhile, Greylock, et al., Kitty Hawk and Hegele, and North Riverside, Heritage, and Barry moved for summary judgment on the remaining contribution and indemnification claims against them. Plaintiffs moved for partial summary judgment on their breach of contract and professional negligence/negligent misrepresentation claims related to the 1985 and 1986 financial statements. Defendant DH & S moved for summary judgment on all state law claims against it. After exhaustive and voluminous briefing by all parties on the pertinent issues, this matter is ripe for adjudication.

STATEMENT OF THE FACTS

Chapman purchased LRI³ in the mid 1970s. LRI engaged in the business of "visual publishing." A Delaware corporation operating out of Durham, North Carolina, LRI prepared and marketed audiovisual presentations describing colleges and universities for use in high schools. LRI also developed and marketed interactive audiovisual materials for corporate training and education.

Needing additional financial support, Chapman raised over one million dollars in venture capital from three venture capital investors — Greylock, ATDF, and Kitty Hawk — between 1981 and the end of 1986. Greylock, the initial venture capital investor, invested $400,000 in LRI in November 1982. Greylock received two seats on the Board in exchange for its investment, one of which was held by Strohm, its principal. On October 2, 1984, ATDF invested $300,000 in LRI and received a seat on the Board, which was held by White, its principal. Kitty Hawk invested $100,000 in LRI in December 1984, but did not receive a seat on the Board for its principal, Hegele, until June 1986. At the May 17, 1985, Board meeting, the Board approved the formation of an audit committee comprised of Strohm and White.

The three original venture capital investors made further investments in LRI as its need for capital continued. In September 1986, as LRI was attempting to expand its corporate division, LRI's officers solicited approximately six venture capital firms regarding an investment in LRI. As a result, two new venture capital firms invested in LRI on December 31, 1986: plaintiff North Riverside, investing approximately $350,000, and plaintiff Heritage, investing approximately $250,000. In the spring of 1987, LRI still needed approximately $750,000 in additional capital. After Duff Meyercord, a principal of Venturtech, attended a meeting of the LRI Executive Committee held on May 22, 1987, Venturtech invested approximately $500,000 on June 11, 1987, and Meyercord became a member of the Board and the Executive Committee.

In January 1988, the Board fired Chapman and dissolved the corporate division. In an effort to revive the educational division, LRI's officers drafted a new business plan which projected a need for additional capital in the amount of $750,000. The existing investors provided this additional capital in pro rata shares. By April 1988, LRI was again in need of further capital. At this point, the venture capital investors — Greylock, ATDF, Kitty Hawk, North Riverside, Heritage, Venturtech, and Hickory Venture Capital Corporation⁴ — refused to invest any further capital and LRI's remaining assets were eventually sold.

The facts pertaining to DH & S' initial involvement with LRI are somewhat sketchy. In a letter dated July 31, 1981, DH & S agreed to audit LRI's financial statements and issue a report thereon for the fiscal years ending on September 30, 1980, and September 30, 1981. Pls.' Ex. 25. However, the earliest document in the record prepared by DH & S is the Consolidated Financial Statement for the Year Ended December 31, 1981 and Auditor's Report. Pls.' Ex. 1. DH & S describes this document as a nine-month financial review, and not a full audit. DH & S audited and reported on LRI's financial statements for the years 1982, 1983, 1984, 1985, and 1986. DH & S represented that each examination was made in accordance with Generally Accepted Auditing Standards ("GAAS") and reflected the consistent application of Generally Accepted Auditing Principles ("GAAP").

Plaintiffs' allegations are centered around the contention that LRI's financial statements for the years 1982 through 1986 contain material misrepresentations and inaccuracies. Specifically, the plaintiffs contest the recognition of income, particularly the recognition of income in 1986 from a contract with the University of North Carolina (the "UNC contract") that had not been signed, and allege that DH & S failed to obtain management representation letters for 1985 and 1986 as required by GAAS. The notes to LRI's audited financial statements set forth the method of income recognition used by DH & S.

DI...