Appeal from the Order entered on December 28, 2010 in the Court of Common Pleas of Allegheny County, Civil Division, No. GD-09-015557
The opinion of the court was delivered by: Musmanno, J.
BEFORE: MUSMANNO, ALLEN and MUNDY, JJ.
Mark Kirschner ("Trustee"), in his capacity as the Liquidation Trustee of the Le-Nature's Liquidation Trust,*fn1 appeals from the Order sustaining the Preliminary Objections to the Amended Complaint filed on behalf of K&L Gates LLP and Sanford Ferguson ("Ferguson") (collectively, "K&L Gates"), and Pascarella & Wiker, LLP ("P&W"), and Carl A. Wiker (collectively, "Defendants"). We reverse the Order of the trial court and remand for further proceedings.
The facts, as alleged in Trustee's Amended Complaint, are as follows. In 1992, Greg Podlucky ("Podlucky") founded Le-Nature's, Inc. ("Le- Nature's"), a Delaware corporation. Amended Complaint at ¶ 30. Le- Nature's held itself out as an innovator in the bottled beverage industry, in particular, its use of cutting edge technologies and distribution methods. Id. at ¶ 31.
In 2000 and in 2002, Le-Nature's issued over eight million shares of convertible preferred stock. Id. at ¶ 32. Two investment funds purchased shares: SW Pelham Fund, L.P. (affiliated with Smith Whiley & Company) (the "Pelham Fund"), and the George K. Baum Employee Equity Fund, L.P. (Affiliated with George K. Baum Merchant Banc, L.L.C.) (the "Baum Funds") (the Pelham Fund and the Baum Funds hereinafter collectively referred to as the "Minority Shareholders"). Id. The amended certificate governing the shares granted the Minority Shareholders the right to appoint directors ("Independent Directors") to the Board of Directors of Le-Nature's. Also on the Board were Podlucky and certain interested corporate officers (collectively, the "Inside Directors") (Inside Directors and Independent
Directors collectively referred to as the "Board of Directors" or "Board"). Id. The Independent Directors were to approve all extraordinary capital expenditures and compel a sale of Le-Nature's by no later than September 2006. Id.
In August 2003, Ernst & Young ("E&Y"), Le-Nature's auditor, conducted its quarterly review of Le-Nature's financial statements. Id. at ¶ 33. Richard J. Lipovich ("Lipovich"), the E&Y audit partner responsible for the audit, met with Chief Financial Officer ("CFO") John Higbee ("Higbee"), Chief Administrative Officer ("CAO") Jennifer Fabry ("Fabry"), and Vice President of Administration Stacy Juchno ("Juchno") (collectively, "Senior Financial Managers"). Id. During the August 13, 2003 meeting, Lipovich solicited the concerns of Le-Nature's Senior Financial Managers regarding the company's financial activities, inquiring whether the Senior Financial Managers suspected fraudulent activity. Id. Such inquiries were part of standard E&Y audit procedures. Id. At this meeting, each member of LeNature' Senior Financial Managers expressed concerns about the accuracy of Le-Nature's sales figures. Id.
The next day, Higbee, a veteran auditor with more than 20 years of experience, resigned. Id. at ¶ 34. Fabry and Juchno also submitted written resignation letters to Le-Nature's Chief Executive Officer ("CEO"), Podlucky. Id. In their resignation letters, the Senior Financial Managers stated that they suspected Podlucky of engaging in improper conduct with Le-Nature's tea suppliers, equipment vendors and certain customers. Id. The Senior Financial Managers expressed serious concerns about recent "unusual" transactions "surrounding bulk tea sold in tankers and about possible unlawful collusion between Podlucky and the suppliers, vendors and customers." Id. In particular, the Senior Financial Managers reported a large increase in tea inventory and raw material, and the extraordinary level of "equipment deposits." Id.
In his resignation letter, CFO Higbee explained that he repeatedly had asked Podlucky for access to documentation supporting Le-Nature's general ledger details. Id. at ¶ 35. Podlucky's refusal, according to Higbee, constituted "an astonishing and extremely improper restriction for any chief executive officer to impose upon a company's chief financial officer." Id. Higbee explained that by conducting business transactions "without any normal review by others, such as the CFO," Podlucky had rendered it impossible for Higbee to discharge his duties and responsibilities to LeNature's. Id. In conclusion, Higbee stated to Podlucky, I consider 1) the absolute control you maintain over the Company's detail[ed] financial records[,] 2) the lack of checks and balances related to deposits on equipment[,] 3) the lack of checks and balances related to deposits on tea leaf[, and] 4) the lack of checks and balances related to the sale of bulk tea concentrate and bulk tea leaf to be material weaknesses in the Company's internal controls.
Upon being informed of the concerns of Senior Financial Managers and their resignations, E&Y wrote a letter requesting that Le-Nature's hire "competent independent legal counsel to conduct a thorough and complete investigation of the allegation made by the [Senior Financial Managers]." Id. at ¶ 37 (emphasis omitted) (quoting E&Y Letter, 8/22/03). E&Y further advised Le-Nature's that, because of the resignations of the Senior Financial Managers, E&Y [would] be unable to be associated with any unaudited interim financial statements or historical audited financial statements, including issuing any consents or comfort letters, until the allegations are investigated thoroughly by independent counsel, we complete our review of the report of the investigation, we perform any additional procedures we consider necessary in the circumstances, and we interview the former employees[.]
Amended Complaint at ¶ 37 (emphasis omitted) (quoting E&Y Letter, 8/22/03).
On August 26, 2003, the Le-Nature's Board of Directors passed a unanimous consent resolution ("Resolution") declaring that it was "in the best interest of the Company to appoint a special committee of independent directors to conduct an investigation into the reasons underlying the resignations of the Senior Financial Managers." Id. at ¶ 38 (emphasis added). Accordingly, the Board of Directors unanimously consented to the creation of a special committee (the "Special Committee") to investigate the circumstances underlying the resignation of the Senior Financial Managers. Id. Of particular note, the Board's Resolution authorized the Special Committee to "provide findings and recommendations to the Board of Directors as a result of such investigation." Amended Complaint, Exhibit E (Resolution), at 1. The Board of Directors authorized the Special Committee to retain legal counsel and accountants "to assist in the investigation."
Amended Complaint at ¶ 38 (emphasis added).
The Board appointed three independent, non-employee directors to serve on the Special Committee. Id. at ¶ 39. Lacking the expertise necessary to conduct internal corporate investigations, the Special Committee determined that "it was critical to retain on behalf of the company, legal counsel with experience in conducting such investigations." Id. at ¶ 40 (emphasis added). Ferguson, a partner at K&L Gates, represented to the members of the Special Committee "that he personally possessed precisely the type of investigative experience required by the Special Committee." Id. Relying on Ferguson's representations, the Special Committee retained K&L Gates to conduct the Le-Nature's investigation "on behalf of the Company." Id. (emphasis added). At its first meeting on August 28, 2003, the Special Committee authorized K&L Gates to investigate the circumstances underlying the resignation of the Senior Financial Managers. Id. at ¶ 41.
By a letter dated August 28, 2003 ("Retention Letter") to the Special Committee, K&L Gates confirmed its understanding of the scope of and nature of its engagement. The Retention Letter provided, in relevant part, as follows:
You have asked us to represent the Special Committee ("Special Committee") of the Outside directors of Le- Nature's Beverages, Inc. ("Company") in connection with a review of the circumstances attendant upon the recent resignation of three members of the finance staff of the company.
It is our Firm's practice to confirm in writing the identity of the client whom we represent, the nature of our undertaking on behalf of that client and our billing and payment arrangements with respect to our legal services.
We understand that we are being engaged to act as counsel for the special committee and for no other individual or entity, including the Company or any affiliated entity, shareholder, director, officer or employee of the Company not specifically identified herein. We further understand that we are to assist the Committee in investigating the facts and circumstances surrounding the aforementioned resignations and assist the Special Committee in developing any findings and recommendations to be made to the full Board of the Company with respect thereto. The attorney- client relationship with respect to our work, including our work product, shall belong to the Committee. Only the Committee can waive any privilege relating to such work.
Our firm currently represents Star Associates in connection with a contract dispute with the Company. This matter is substantively unrelated to the scope of the work of the Special Committee. We believe that our ongoing representation of Star Associates will not adversely affect our exercise of independent professional judgment on behalf of the Special Committee. Nonetheless, we will establish a "Chinese Wall" between those of our personnel working on the Star Associates matter and those working on the Special Committee matter. In view of the ongoing duties of loyalty we would owe to both Star Associates and the Special Committee, we wish to confirm at the outset of our engagement by the Special Committee that you concur with our conclusions set forth above and that you waive any potential or actual conflict of interest relating thereto.
It is our Firm's practice to render statements for professional services and related charges on a monthly basis. We will expect payment to be made within thirty days of your receipt of our statement, without regard to the outcome of any matter. In the event that our statements are not timely paid, we reserve the right to suspend our services until satisfactory payment arrangements are made or, if necessary, to terminate such services. Our clients, of course, may terminate our services at any time.
Id., Ex. A at 1-2 (emphasis added).
Subsequently, K&L Gates retained P&W to assist in the investigation. P&W confirmed its understanding of the engagement in a letter to K&L Gates, dated September 12, 2003 (the "P&W Retention Letter"). The P&W Retention Letter provided, in relevant part, as follows:
UNDERSTANDING OF P&W'S ROLE
It is understood that P&W is being retained to assist K&L [Gates] as a financial expert related to the special investigation of certain transactions involving Le[-]Nature's, Inc.  P&W shall provide general consulting, financial accounting, and investigative or other advice as requested by K&L [Gates] to assist it in rendering legal advice to Le[-]Nature's. Acting as a consultant to counsel, we understand that all work and communications relating to this engagement are expected to be confidential and privileged and will be so treated unless otherwise directed by you, or required by law or court order.
P&W will render monthly invoices to K&L [Gates]. K&L [Gates] will then include our charges as part of its regular monthly invoices to Le[-]Nature's. We understand that under the terms of K&L [Gates's] engagement by Le[-]Nature's, K&L [Gates's] invoices are payable within thirty days of submission. We reserve the right to cease all work if any K&L [Gates] invoice to Le[-]Nature's becomes past due, without regard to the status of our services or any related procedures. K&L [Gates] will promptly pay our invoices as the funds therefore are received from Le[-]Nature's. It is understood that K&L [Gates] will not be otherwise responsible for payment of fees and expenses to P&W, as such responsibility ultimately rests with Le[-]Nature's, Inc.
Id., Ex. B at 1-2 (emphasis added).
The Special Committee provided K&L Gates with, inter alia, the August 22, 2003 letter from E&Y, which requested that Le-Nature's conduct a competent, independent and thorough investigation of allegations made by the Senior Financial Managers. Id. at ¶¶ 36, 41. Ferguson led the investigation for K&L Gates. Id. at ¶ 42. Details of the investigation will be discussed in greater detail, infra.
On November 25, 2003, the Defendants provided a draft of their Report to Podlucky. Id. at ¶ 75. Podlucky was not a member of the Special Committee. Id. Notwithstanding the fact that the Special Committee had not received the Report, Podlucky immediately called a meeting of the Board of Directors for the purpose of discussing the draft Report. Id. Podlucky also provided comments on the draft Report to K&L Gates. Id. On December 5, 2003, K&L Gates provided the draft Report to the Special Committee. Id.
P&W approved the Report, which Ferguson then signed, representing that the Defendants "found no evidence of fraud or malfeasance with respect to any of the transactions" subject to the investigation. Id. at ¶¶ 76, 77 (emphasis omitted) (quoting Report at 1). The Special Committee attached a cover memorandum ("Memorandum") to the Report. Amended Complaint at ¶ 77. The Memorandum, which was reviewed by K&L Gates, stated the following:
The Special Committee of the Board of Directors of [Le-Nature's] hereby submits the report attached herein prepared by the Committee's Counsel, [K&L Gates,] and its financial consultants[, P&W].
The Special Committee was formed in August 2003 to investigate certain specific business transactions identified by three former [Le-Nature's Senior Financial Officer], all of whom resigned in mid-August 2003. The Special Committee consists of two outside directors who are representatives of the [Pelham Fund,] and one director representing [the Baum Fund].
Upon the advice of [K&L Gates], the [Special] Committee limited the scope of its investigation to seven specific transactions identified by the [Senior Financial Managers] as areas of concern and that could potentially impact [Le-Nature's] financial statements....
The Committee is pleased to report that K&L [Gates] and P&W "found no evidence of fraud or malfeasance with respect to any of the transactions reviewed by it. Further[, K&L Gates] found no evidence which suggests that the transactions identified by the [Senior Financial Managers] as being of concern had not been properly reported on Le[-]Nature's financial statements." ...
Memorandum at 1. The Memorandum included the recommendations proposed by K&L Gates. Id. at 2. The Memorandum concluded with the following pronouncement:
The [Special] Committee concurs strongly with all the recommendations outlined above.
We look forward to talking with the full Board of Directors on these recommendations and other findings of fact as soon as possible and to work with the Company in addressing the issues raised herein.
Throughout their investigation, the Defendants failed to uncover the massive fraud being perpetrated by Podlucky. Amended Complaint at ¶ 79. Podlucky and his senior managers continued to "loot" Le-Nature's, incurring further corporate debt and wasting corporate funds on avoidable transactions. Id. Podlucky and his senior management used the "no evidence of fraud" finding in the Report to retain their senior positions at LeNature's. Id.
However, between January 2004 and November 2006, Podlucky and his senior managers employed fraudulent schemes involving almost $200 million in equipment deposits. Id. at ¶ 80. Le-Nature's continued to add to its debt by, inter alia, building and commencing operations at unnecessary facilities. Id. at ¶¶ 81-83. In September 2006, Le-Nature's obtained a $285 million replacement line of credit through Wachovia. Id. at ¶ 83. Through 2005, Le-Nature's long-term secured debt increased to $275 million. Id. at ¶ 84. Le-Nature's continued borrowing funds, thereby substantially leveraging its assets and balance sheet. Id. at ¶ 84. By the end of 2005, Le-Nature's had production facilities in Latrobe, Pennsylvania and Phoenix, Arizona. Id. at ¶ 85. In late 2005, the Independent Directors learned that Podlucky intended to build a third facility in Florida. Id.
In May 2006, the Minority Shareholders of Le-Nature's, who were represented on the Board by the Independent Directors, commenced in Delaware Chancery Court an injunctive action against Le-Nature's and its four inside directors.*fn2 Id. The Chancery Court granted a preliminary injunction enjoining Le-Nature's from certain actions, including making capital expenditures outside the ordinary course of business, i.e., in excess of $1,000, without the approval of the Minority Shareholders. Id.
Subsequently, in September 2006, Podlucky requested the assistance of Ferguson in preparing an initial public offering ("IPO") of Le-Nature's stock. Id. at ¶ 86. Ferguson, with the assistance of K&L Gates's London, England, office, commenced work on the IPO. Id. However, prior to October 19, 2006, the Independent Directors learned of a new allegation of fraud involving Le-Nature's. Id. at ¶ 87. A financial institution alleged that Le-Nature's had forged American International Group ("AIG") letters relating to the purchase of equipment for the company. Id. At the request of the Minority Shareholders, the Chancery Court granted a Temporary Restraining Order enjoining Le-Nature's from (a) making or incurring expenditures exceeding $1,000 without Board authorization; (b) accessing, tampering with or destroying any Le-Nature's' property; (c) selling, leasing or disposing of Company assets; (d) making or committing the Company to make any loans, advancements or investments; or (e) causing or committing the Company to incur any debt. Id.
Because the Temporary Restraining Order precluded Podlucky from proceeding with Le-Nature's IPO, Podlucky placed Ferguson in charge of negotiating with the Minority Shareholders to vacate the Chancery Court's Order. Id. at ¶ 88. Unable to reach an agreement, the Minority Shareholders and Independent Directors filed an application for the appointment of a receiver for Le-Nature's. Id.
On October 27, 2006, the Delaware Chancery Court appointed Kroll Zolfo Cooper, Inc. ("Kroll"), as custodian of Le-Nature's, placing it in charge of management and operations. Id. at ¶ 89. Within several days, Kroll uncovered massive fraud at Le-Nature's. Id. On November 1, 2006, Steven G. Panagos, a Kroll managing director, filed an affidavit with the Delaware Chancery Court setting forth the evidence of the financial fraud he had discovered at Le-Nature's. Id. at ¶ 90.
On November 1, 2006, several of Le-Nature's creditors initiated involuntary bankruptcy proceedings against Le-Nature's under Chapter 7 of the United States Bankruptcy Code, 11 U.S.C.A. § 101 et seq. Amended Complaint at ¶ 91. Kroll converted the proceedings from Chapter 7 to Chapter 11. Id. On July 8, 2008, the Bankruptcy Court issued an Order confirming a liquidation plan for Le-Nature's. Id. at ¶ 23. In accordance with the liquidation plan and the Bankruptcy Court's confirmation Order, the Bankruptcy Court created the Le-Nature's Liquidation Trust ("Trust") and appointed Trustee. Id. Under the liquidation plan, all assets and property of Le-Nature's, including all claims and causes of action, were conveyed to and retained by the Trust. Id. Trustee also uncovered the massive fraud perpetrated by Podlucky and other insiders. Id. at ¶ 93.
On September 9, 2009, Trustee filed, in the Court of Common Pleas of Allegheny County, a Civil Complaint against Defendants. Defendants filed Preliminary Objections demurring to all counts, after which Trustee filed an Amended Complaint. Again, Defendants filed Preliminary Objections demurring to the counts averred in the Amended Complaint. Trustee filed a response to Defendant's Preliminary Objections, and an objection to one of the Preliminary Objections filed by P&W. After oral argument, on December 28, 2010, the trial court entered an Order sustaining Defendants' Preliminary Objections and dismissing all counts of Trustee's Amended Complaint. Trial Court Order, 12/28/10. Thereafter, Trustee filed the instant timely appeal, followed by a court-ordered Concise Statement of matters complained of on appeal, in accordance with Pa.R.A.P. 1925(b).
On appeal, Trustee presents the following claims for our review:
1. Whether the Trial Court erred in dismissing [Trustee's] professional negligence claim against K&L Gates despite (a) the existence of an express or implied attorney-client relationship between [Le-Nature's] and K&L Gates and (b) [Trustee's] allegation that K&L Gates's wrongdoing directly and proximately caused cognizable and recoverable damages to [Le-Nature's] under Pennsylvania Law[?]
2. Whether the Trial Court erred in dismissing [Trustee's] breach of contract claim against K&L Gates despite [Trustee's] allegations of facts showing a contractual relationship between K&L Gates and [Le-Nature's] (either through the Special Committee or as a third-party beneficiary) and that the Company suffered damages resulting from the breach of contract[?]
3. Whether the Trial Court erred in dismissing [Trustee's] breach of fiduciary duty claim against K&L Gates where [Trustee] alleges facts establishing that K&L Gates owed a fiduciary duty to [Le-Nature's], which ...