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IN RE PHAR-MOR

June 1, 1995

IN RE: PHAR-MOR, INC. SECURITIES LITIGATION; PHAR-MOR, INC., Plaintiff,
v.
COOPERS & LYBRAND, Defendant.



The opinion of the court was delivered by: ZIEGLER

 ZIEGLER, Chief Judge

 Pending before the court are the motions of defendant, Coopers and Lybrand ("Coopers"), and third-party defendants, Corporate Partners, L.P., Corporate Offshore Partners, L.P., The State Board of Administration of Florida, Lazard Freres & Co., Lester Pollack and Jonathan Kagan (collectively "Corporate Partners"), for summary judgment with respect to the claims asserted by plaintiff, Phar-Mor, Inc. ("Phar-Mor"), against Coopers. *fn1" The central issue raised in the motions is whether the wrongful acts of certain Phar-Mor officers and employees should be imputed to the corporation as a matter of law so as to bar Phar-Mor's claims.

 Summary judgment is appropriate when there are no genuine issues of material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56; Celotex Corp. v. Catrett, 477 U.S. 317, 322, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986). In considering a motion for summary judgment, we must examine the evidence in the light most favorable to the non-moving party and draw all reasonable inferences in favor of that party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986).

 This civil action is one of over forty civil actions that have been consolidated in this court as part of the multidistrict litigation styled In re Phar-Mor, Inc. Securities Litigation, MDL No. 959. Phar-Mor, a deep discount drugstore chain, has alleged claims of negligence, misrepresentation, outrageous conduct and breach of contract against Coopers, its former auditors, for alleged accounting malpractice during the fiscal years 1989 through 1991. In essence, the company contends that Coopers failed to perform audits of Phar-Mor's financial statements in accordance with generally accepted auditing standards and, consequently, failed to detect the financial fraud perpetrated by several officers and employees of Phar-Mor. Coopers issued "clean" audit opinions after each of the audits during the fiscal years 1989 through 1991. The evidence of record establishes that the financial statements for those fiscal years falsely portrayed Phar-Mor as a profitable concern by overstating its financial performance by approximately $ 500 million. Shortly after the fraud was revealed in 1992, Phar-Mor filed for protection under Chapter 11 of the Bankruptcy Code.

 The movants contend that the knowing participation of certain officers of Phar-Mor in the fraud must be imputed to the corporation, and because "a participant in a fraud cannot also be a victim entitled to recover damages," Cenco Inc. v. Seidman & Seidman, 686 F.2d 449, 454 (7th Cir. 1992), cert. denied, 459 U.S. 880, 74 L. Ed. 2d 145, 103 S. Ct. 177 (1982), Phar-Mor's claims against Coopers cannot stand. *fn2" Phar-Mor rejoins that summary judgment is inappropriate because genuine issues of material fact exist concerning whether the wrongdoers were acting within the scope of their employment and whether such actions were adverse to Phar-Mor's interests. *fn3"

 The general rule of imputation provides that "the fraud of an officer of a corporation is imputed to the corporation when the officer's fraudulent conduct was (1) in the course of his employment, and (2) for the benefit of the corporation." Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 884 (3d Cir. 1975), cert. denied, 425 U.S. 993, 48 L. Ed. 2d 817, 96 S. Ct. 2205 (1976). This rule is premised on the principle that a corporation is merely "a creature of legal fiction," Lokay v. Lehigh Valley Coop. Farmers, Inc., 342 Pa. Super. 89, 492 A.2d 405, 408 (Pa.Super. 1985), and can operate only through its officers, agents, and employees. As the Court of Appeals explained in F.D.I.C. v. Ernst & Young, 967 F.2d 166 (5th Cir. 1992):

 
Because a corporation operates through individuals, the privity and knowledge of individuals at a certain level of responsibility must be deemed the privity and knowledge of the organization, else it could always limit its liability. Where the level of responsibility begins must be discerned from the circumstances of each case.

 967 F.2d at 171 (citations and internal quotations omitted).

 There is, however, a well-established exception to the imputation rule. A corporation is not imputed with the "knowledge of an agent in a transaction in which the agent secretly is acting adversely to the [corporation] and entirely for his own or another's purposes." F.D.I.C. v. Shrader & York, 991 F.2d 216, 223 (5th Cir. 1993), cert. denied, U.S. , 114 S. Ct. 2704, 129 L. Ed. 2d 832 (1994) (quoting Restatement(2d) of Agency § 282(1)(1957)). The exception "focuses on whether the misdeeds of the corporate employee worked to the benefit or detriment of the corporation." Comeau v. Rupp, 810 F. Supp. 1127, 1139 (D. Kan. 1992).

 The cases cited by the parties in support of their positions merely establish that the inquiry into the application of the adverse interest exception is fact-intensive. See, e.g., Cenco, supra (fraud imputed to corporation where corrupt officers were also stockholders in the company); F.D.I.C. v. O'Melveny & Myers, 969 F.2d 744 (9th Cir. 1992), rev'd. on other grounds, U.S. , 114 S. Ct. 2048, 129 L. Ed. 2d 67 (1994) (fraud by high level officers cannot be imputed to savings and loan where "disaster, not benefit" accrued to the S&L and recovery by bankrupt S&L would serve to compensate the victims of the fraud and not the wrongdoers).

 Pat Finn's testimony also supports denial of the motion. He testified that he knew that, during the cover up and proliferation of the fraud, Phar-Mor's directors were making critical business decisions based on false financial information. One such decision included the implementation of an aggressive expansion program in which Phar-Mor opened new and larger stores, most of which were unprofitable and increased Phar-Mor's losses. Finn testified that, had the Board of Directors known of the true financial condition of Phar-Mor, it would not have authorized the ill-fated expansion program. He also acknowledged that the opening of the new stores merely dug Phar-Mor "a bigger grave." Based on this testimony, a ...


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