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Herzfeld v. Laventhol

decided: July 15, 1976.

GERALD L. HERZFELD, PLAINTIFF-APPELLEE,
v.
LAVENTHOL, KREKSTEIN, HORWATH & HORWATH, DEFENDANT-APPELLANT. LAVENTHOL, KREKSTEIN, HORWATH & HORWATH, THIRD-PARTY PLAINTIFF-APPELLEE, V. ALLEN & COMPANY, INCORPORATED AND ALLEN & CO., THIRD-PARTY DEFENDANTS-APPELLANTS. ALLEN & COMPANY, INCORPORATED AND ALLEN & COMPANY, THIRD-PARTY COUNTERCLAIMANTS-APPELLANTS, V. LAVENTHOL, KREKSTEIN, HORWATH & HORWATH, THIRD-PARTY COUNTERCLAIM RESPONDENT-APPELLEE



Appeal from an amended judgment entered after a non-jury trial to the United States District Court for the Southern District of New York, Honorable Lloyd F. Mac-Mahon, Judge. The opinion is reported at 378 F. Supp. 112 (S.D.N.Y. 1974). The judgment awarded plaintiff-appellee Gerald L. Herzfeld $153,000 on his Rule 10b-5 claim against defendant-appellant Laventhol, Krekstein, Horwath & Horwath, allowed defendant-appellant's contribution claim against Allen & Company and Allen & Company, Incorporated, for one-half of the Herzfeld judgment, and dismissed Allen's counterclaims against Laventhol.

Moore and Timbers, Circuit Judges and Coffrin*fn* District Judge.

Author: Moore

MOORE, Circuit Judge:

Laventhol, Krekstein, Horwath & Horwath, a firm of certified public accountants ("Laventhol"), appeals from an amended judgment for the amount of $153,000, entered against it and in favor of plaintiff, Gerald L. Herzfeld ("Herzfeld") after a trial to the Court. Allen & Company and Allen & Company, Incorporated (referred to collectively as "Allen") appeal from that portion of the judgment which awarded Laventhol contribution against them and which dismissed their counterclaims against Laventhol. The opinion of the lower court is reported at 378 F. Supp. 112 (S.D.N.Y. 1974) (MacMahon, J.). We affirm the Herzfeld award and the dismissal of the Allen counterclaims. We reverse the Laventhol contribution award against Allen, and dismiss Laventhol's third-party contribution complaint.

Originally, Herzfeld had sued Laventhol and eleven other defendants*fn1 primarily to recover $510,000 which he claimed that he had paid for certain securities of Firestone Group, Ltd. ("FGL"), namely, two FGL units, each unit consisting of a $250,000 FGL note and 5000 shares of FGL stock at $1 a share, a total of $255,000 per unit. The substance of Herzfeld's charges was that the representations made to him by the defendants in connection with the purchase were materially misleading and that there were omissions of material facts, all of which were inducing factors, and on which he relied, in making his purchase and in not exercising his right of rescission. Herzfeld predicated his suit upon alleged violations of the securities laws of the United States,*fn2 Section 352-c of the New York General Business Law and common law fraud.

That suit was settled by all defendants except Laventhol for $357,000. Thereafter, by an amended complaint, Herzfeld sought to recoup the balance ($153,000) of the $510,000 from Laventhol. Laventhol thereupon, as a third-party plaintiff, sued nine settling defendants to recover, by way of contribution, a portion of such amount, costs and attorneys' fees for which it might be liable in the new Herzfeld suit. In their answer, Allen asserted counterclaims against Laventhol.

The specific facts are particularly important in determining the rights of the parties, Herzfeld, Laventhol and Allen, and are best developed in chronological order.

FGL was a California company engaged principally in the business of purchasing real estate and thereafter syndicating or reselling it. In November 1969, FGL planned to raise $7,500,000 by the private placement through Allen and Company, Incorporated, of the aforementioned units. Lee Meyer, a defendant, was an Allen vice-president and also a FGL director.

Through friends, Herzfeld became interested in the venture. A purchase agreement, entitled "Note and Stock Purchase Agreement", dated November 10, 1969, was delivered to Herzfeld by FGL with an accompanying letter which advised him that the closing date for the sale of the notes would be December 16, 1969, "to permit the preparation of audited financial statements, as at and for the eleven months ended November 30, 1969, copies of which will be delivered to you." The letter added that these "audited statements will serve as the basis for confirming the unaudited Projected Financial Statements annexed to the Note and Stock Purchase Agreement as Exhibit B."

Exhibit B was a balance sheet and income statement. It portrayed FGL as a strikingly profitable corporation with over $20 million in assets, a net worth of close to a million dollars, sales of over $17 million, deferred income of $2.7 million and an after-tax income of $315,000. FGL warranted that it fairly presented its financial condition as at November 30, 1969.

Herzfeld read the entire income statement and the balance sheet and noted that it represented FGL as being very profitable, with earnings of approximately $2 a share for the period ending November 30, 1969. He then signed the agreement to purchase two units thereunder.

To prepare the promised audit (to be as of November 30, 1969), FGL retained Laventhol as the accountants for the task. The Herzfeld-Laventhol lawsuit and this appeal therefrom involve only the deeds and alleged misdeeds of Laventhol in making its audit which was submitted to FGL and thereafter to the security purchasers, including Herzfeld. However, the third-party claim and cross-claims, hereinafter referred to, necessitate a review of the activities of Allen in the transaction.

The spotlight of Herzfeld's claim of a materially misleading audit, knowingly made with admitted awareness of the facts, focuses upon Laventhol's accounting treatment of two real estate transactions in which FGL allegedly engaged in late November 1969, referred to herein as the FGL-Monterey purchase and the FGL-Continental sale. Purporting to reflect these transactions are two agreements. Each agreement is on an identical printed form entitled "AGREEMENT FOR SALE OF REAL ESTATE" and certain typewritten provisions have been inserted therein.*fn3 The first is dated November 22, 1969 and is between Monterey Nursing Inns, Inc. ("Monterey") as seller and FGL as buyer. The transaction was subject to two conditions: (1) the buyer's approval of a preliminary title report and CC&R's*fn4 of Record on each property (there is no evidence that any such documents were ever prepared, delivered or approved); and (2) execution of a NNN lease per terms of "Exhibit D attached hereto" (no such exhibit appears to have been attached). Twenty-three (23) nursing homes were the subject of the sale "as per Exhibit 'A' attached hereto" (no such exhibit appears to have been attached). The purchase price is stated as $13,362,500, $5,000 of which was payable before November 30, 1969 (i.e., upon the signing of the contract).

On an identical printed form with almost identical typewritten inserts is an agreement by FGL as seller to sell to Continental Recreation Company, Ltd. ("Continental") as buyer. Again, there is no Exhibit A listing the properties. The purchase price is stated as $15,393,000 with $25,000 as a down payment, other payments to be made in 1970 and thereafter.

This purchase and sale of nursing homes, if ever consummated, would have been the largest single transaction in the history of FGL. Placing these two purported agreements side by side, if the obligations therein were ever fulfilled in the future, FGL would have bought Monterey for $13,362,500 and sold it for $15,393,000, thus producing a profit, when, as and if the transactions were consummated, of $2,030,500, no part of which was even contemplated as having been received prior to November 30, 1969, and only payments of $5000 by FGL to Monterey and $25,000 from Continental to FGL may have been made.

A comparison of the financial condition of FGL with and without these transactions demonstrates the importance of them to FGL:

Monterey Monterey

Included Excluded

Sa les $22,132,607 $6,739,607

Total Current Assets 6,290,987 1,300,737

Net Income 66,000 [169,000]

Deferred Profit 1,795,000 0

Earnings/Share $0.10 [0.25]

Thus, the accounting treatment of these transactions determined the health of FGL's financial picture. Laventhol knew this was so. By this treatment, namely, immediate recognition of a so-called profit, Laventhol notes, dated November 30, 1969, reveal the conversion of estimated $772,108 losses into a $1,257,892 gain by the addition of the $2,030,500 "profit". These work papers contain the following entries:

"Estimated loss 4 months ended

4/30/69 200,000

Estimated loss 7 months ended

11/30/69 572,108

Loss before sale to Continental

Recreation ...


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