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PNC BANK v. HOUSING MORTG. CORP.

March 8, 1994

PNC BANK, KENTUCKY, INC., successor by name change to CITIZENS FIDELITY BANK and TRUST COMPANY, Plaintiff, and PALM BEACH FEDERAL SAVINGS BANK, THE ALLEGHENY COUNTY RESIDENTIAL FINANCE AUTHORITY, FIRST NATIONAL BANK OF KEYSTONE, W. VA., PENNSYLVANIA STATE HOUSING FINANCE AGENCY, PENNSYLVANIA STATE EMPLOYES' RETIREMENT BOARD, RESOLUTION TRUST CORPORATION, Receiver of Aspen Federal Bank, and FEDERAL NATIONAL MORTGAGE ASSOCIATION, Intervenor-Plaintiffs,
v.
HOUSING MORTGAGE CORPORATION, IOANNIS AVRADINIS, a/k/a JOHN AVRADINIS, HARALAMBOS AVRADINIS, a/k/a HARRY AVRADINIS, AMARJIT SINGH BHALLA, a/k/a ARMJIT SINGH BHALLA, HARJIT SINGH BHALLA, JOHN R. HANCOCK, EDWARD A. RENDULIC, KENNETH HANNA, PETER KAKOYIANNIS, and EDWARDS & ANGELL, a law firm, Defendants.



The opinion of the court was delivered by: BENSON

 I. RECOMMENDATION

 It is respectfully recommended that defendant Grant Thornton's motion to dismiss pursuant to Rule 12(b)(6) (Docket #410) be granted with respect to the complaint filed by HMC, and granted with respect to the intervenor-plaintiffs' claims for professional malpractice and negligent misrepresentation, but denied with respect to the intervenor-plaintiffs' claim sounding in contract.

 II. REPORT

 This court has already described this case as a "complex multi-party lawsuit containing manifold claims and counterclaims between and among the parties, arising out of the alleged mismanagement of defendant Housing Mortgage Corporation by its former principals and former operating officers. The allegations of mismanagement are in the nature of claims of intentional conduct, viz., theft, conversion, forgery, fraud." (Docket #406). The case has acquired an added dimension with the filing complaints by HMC and the intervenor-plaintiffs *fn1" on September 30, 1993, adding a new party to the lawsuit, Grant Thornton. Defendant Grant Thornton is an accounting firm which, for the years 1989-1991, was hired by HMC to audit HMC's financial statements. HMC and the intervenor-plaintiffs allege that Grant Thornton failed to perform its duties in conformity with professional standards. The claims asserted are framed as professional negligence and breach of contract. Grant Thornton has responded to its inclusion in this litigation vigorously, and has filed a motion to dismiss pursuant to Rule 12(b)(6) (Docket #410), a motion to dismiss pursuant to Rule 12(b)(1) (Docket #412), a motion to drop it as a party for misjoinder under Rule 21, or for severance (Docket #414), and a motion to vacate earlier orders of this court authorizing the receiver to liquidate HMC's assets, and seeking to have this court terminate the appointment of the receiver (Docket #416). Presently before the court is Grant Thornton's Rule 12(b)(6) motion. The other motions will be dealt with in separate reports.

 LEGAL STANDARDS

 "In reviewing a motion to dismiss for failure to state a claim under Fed.R.Civ.P. 12(b)(6), all allegations in the complaint and all reasonable inferences that can be drawn therefrom must be accepted as true and viewed in the light most favorable to the non-moving party." Stobaugh v. Wallace, 757 F. Supp. 653, 656 (W.D.Pa. 1990), citing Wisniewski v. Johns-Manville Corp., 759 F.2d 271, 273 (3d Cir. 1985). A motion to dismiss pursuant to Rule 12(b)(6) cannot be granted unless the court is satisfied "that no relief could be granted under any set of facts that could be proved consistent with the allegation." Hishon v. King & Spalding, 467 U.S. 69, 73, 81 L. Ed. 2d 59, 104 S. Ct. 2229 (1984). The issue is not whether the plaintiff will prevail at the end, but whether he should be entitled to offer evidence to support his claim. Neitzke v. Williams, 490 U.S. 319, 104 L. Ed. 2d 338, 109 S. Ct. 1827 (1989).

 RELIANCE UPON THE AUDIT REPORTS

 The complaint filed by HMC contains allegations that Grant Thornton was negligent in preparing audits for HMC for the years 1989, 1990 and 1991. Grant Thornton asserts that HMC, through the allegations in its complaint, and through admissions on file, has conceded that its principals and officers were involved in a massive scheme of fraud during this time period, and that HMC, through these actors, knew that the audit reports were not accurate, and hence did not rely upon them. In other words, the knowledge that the audit report was unreliable due to the fraud ought to be imputed to HMC. Grant Thornton asserts, therefore, that HMC has not pleaded facts which would support a finding of proximate causation with respect to any of HMC's injuries, since no reliance upon the audit reports can be shown as a matter of law.

 Grant Thornton relies upon FDIC v. Ernst & Young, 967 F.2d 166, 170 (5th Cir. 1992), where the FDIC, as assignee of failed investment corporation, sued the failed corporation's accountant for professional negligence. The sole owner of the corporation, however, had engaged in fraud. The court imputed the knowledge of the sole owner of the corporation to the corporation itself, and determined that, based upon this knowledge of fraud, the corporation had never relied upon the accuracy of the audit reports, and that the FDIC could not establish proximate causation. In making this determination, the court noted that proximate causation was an element of professional negligence under Texas law, and required a finding that the "act or omission was a substantial factor in bringing about the injury and without which no injury would have occurred." Id., at 170. Hence, if no one relied upon the audit, then it could not have been a substantial factor in bringing about the harm. Id. Pennsylvania also requires a showing that the alleged negligence of an accountant was a "substantial factor" in bringing about the harm caused. See, Robert Wooler Co. v. Fidelity Bank, 330 Pa. Super. 523, 479 A.2d 1027, 1033 (1984) (an accountant who breaches its duty to exercise the care and skill customarily exercised by an accountant may be made to respond in damages if its negligence was a substantial factor in bringing about the harm). Thus, if Grant Thornton can establish, based upon the pleadings and admissions on file, that HMC did not rely upon the audits in conducting its affairs, then it will be entitled to dismissal of HMC's claims for negligence.

 This court has already ruled that HMC has admitted by default all of the requests for admission served by PNC Bank Kentucky. Grant Thornton asserts that these admissions, along with the facts pleaded by HMC, establish conclusively that HMC's owners and top management were all involved in a scheme to defraud HMC's creditors, and that, therefore, no one at HMC relied upon Grant Thornton's audit reports. HMC has both pleaded and admitted that its two former owners, Ioannis Avradinis and Amarjit Singh Bhalla, were intimately involved in a massive scheme of fraud which resulted in the diversion of funds from escrow accounts held by HMC, and in the misuse of millions of dollars of loan monies extended to HMC by creditors. HMC has also pleaded and admitted the intimate involvement of HMC's top management, defendants Rendulic, Hancock and Hanna, in the scheme to defraud HMC's creditors and clients. In this case, HMC and the intervenor-plaintiffs allege that Grant Thornton failed to recognize or report many of the acts of fraud, or acts which were designed to conceal that fraud, which occurred prior to or during Grant Thornton's preparation of audit reports for HMC's 1989, 1990 and 1991 financial statements. Thus, for all relevant purposes, the factual situation is identical to that presented in FDIC v. Ernst & Young. The only real difference between the two cases is that in Ernst & Young the corporation was dominated by a single person who was involved in fraud. Here, the fraud was committed by dual owners, with the participation of HMC's three top officers.

 HMC asserts, nonetheless, that the knowledge of fraud should not be imputed to it. Indeed, it must be kept in mind that the court in Ernst & Young was applying a Texas state rule for imputation of knowledge to a corporation, and that the court recognized the limited application of its decision:

 
Moreover, we are not holding that an auditor is never liable to a corporation when a corporation's employee or agent acts fraudulently on the corporation's behalf. We limit our holding narrowly to the facts of this case under Texas law-i.e. the FDIC, as assignee of a corporation with a dominating sole owner, sues an auditor for negligently performing an audit upon which neither the owner nor the corporation relied.

 967 F.2d at 172. HMC cites to Askanase v. Fatjo, 828 F. Supp. 461 (S.D.Tex. 1993), a case involving a lawsuit by the trustee in bankruptcy of a corporation against the corporation's auditors alleging professional negligence. The auditor moved to dismiss on the basis of the statute of limitations. The trustee argued that the negligence was not discovered until a date falling within the statutory period. The auditor asserted that certain of the officers and directors of the corporation had become aware of the alleged deficiencies in the audit more than two years prior to the filing of the lawsuit, and sought to have this knowledge imputed to the corporation itself. The court stated that an agent's knowledge is not imputed to his principal if he acts entirely for his own purposes, but that knowledge would be imputed where he acts jointly in his own interests and that of the corporation. Id., at 470-71. The court distinguished Ernst & Young on the basis that in Ernst & Young there was no question that the sole shareholder and owner acted on the corporation's behalf as well as his own, since he so dominated the corporation's actions. In Askanase, however, a fact question existed concerning whether the individual officers and directors who were aware of the improper conduct were acting only in their own interests, or were acting at least in part to benefit the corporation. ...


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