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GOODRIDGE v. HARVEY GROUP
August 23, 1991
ARNOLD D. GOODRIDGE, PLAINTIFF,
THE HARVEY GROUP, INC., AND COMPONENTS PLUS, INC., DEFENDANTS-COUNTERCLAIMANTS, V. FRANK FERNANDEZ AND ALFONSE DAULA, ADDITIONAL DEFENDANTS ON THE COUNTERCLAIMS. ARNOLD D. GOODRIDGE AND NEW WAVE ELECTRONICS, INC., PLAINTIFFS, V. THE HARVEY GROUP, INC. AND COMPONENTS PLUS, INC., DEFENDANTS-COUNTERCLAIMANTS, V. FRANK FERNANDEZ AND ALFONSE DAULA, ADDITIONAL DEFENDANTS ON THE COUNTERCLAIMS.
The opinion of the court was delivered by: Lasker, Senior District Judge.
Arnold Goodridge and his company, New Wave Electronics, Inc.
(collectively "Goodridge"), bring this action to recover on
contracts between Goodridge and his former company, Components
Plus, Incorporated ("Old CPI"), which were assumed by Neboc,
Inc., a subsidiary of The Harvey Group, Inc., after Neboc
acquired Old CPI.*fn1 Harvey has presented numerous
affirmative defenses and counterclaims which essentially allege
securities or common law fraud by Goodridge, his former Old CPI
co-owner Frank Fernandez, and another former official of Old
CPI, Alfonse Daula.*fn2 This decision follows a bench trial.
For reasons discussed below, Goodridge's contract claim is
granted, while Harvey's counterclaims and affirmative defenses
The bench trial and this decision culminate a lengthy
litigation history in which many factual issues have been ruled
upon and many others have been stipulated by the parties.
Familiarity with earlier proceedings is assumed, and this
opinion adopts the undisputed facts set forth in the decision
of summary judgment motions reported at 728 F. Supp. 275
(S.D.N.Y. 1990) as well as the stipulated facts submitted in
the Joint Pretrial Order dated March 20, 1991.
From September 1979 through January 21, 1981, Goodridge and
Fernandez each owned half the Class A Common Stock in Old CPI,
a New Jersey corporation which distributed electronic
components to industrial customers primarily in the defense
In roughly June 1980, Harvey officials began to consider
acquiring Old CPI, which appeared to them to complement
Harvey's existing activities. On July 7, 1980, Goodridge,
Fernandez and Harvey's Chief Executive Officer Harvey Sampson
met and discussed the nature and performance of Old CPI.
Fernandez and Goodridge informed Sampson that Old CPI had just
completed the most successful fiscal year in its history.
Following the July 7 meeting, Sampson made known to Fernandez
and Goodridge that because he had had unsatisfactory dealings
with Goodridge he would be unwilling to purchase Old CPI if
Goodridge were affiliated with the company. Nevertheless,
Harvey officials continued to evaluate prospective acquisitions
CPI, and on July 21 met with Fernandez but not Goodridge.
Fernandez and Goodridge meanwhile began negotiating a buyout
of Goodridge's shares in Old CPI. Goodridge's departure was
effected on January 21, 1981, when Goodridge and Old CPI closed
on a series of agreements including a promissory note,
employment agreement, consulting agreement and guarantee and
when Goodridge resigned as a director and officer of Old
CPI.*fn3 These agreements, taken as a whole, provided for
immediate payment of $1,444,000 and additional payments over
the next ten years to Goodridge. The Consulting and Employment
Agreements specifically provided that should Old CPI be
acquired by any other entity, that entity would assume in a
writing acceptable to Goodridge all of Old CPI's obligations to
Goodridge. After January 21, 1981 Goodridge was no longer a
stockholder, officer, director or full-time employee of CPI.
The March 31, 1981 Audited Consolidated Financial Statement
prepared for Old CPI indicated that Old CPI was obligated to
Goodridge for $20,000 per year on the Employment Agreement,
plus a total of $550,000 payable to New Wave on the consulting
agreement. The statement fixed the present value of those two
agreements at $395,000, and noted that under the agreements
neither Goodridge nor New Wave was obligated to perform any
services under the contracts. The statement also listed "long
term debt" of $124,335 owed to Goodridge under the Note.
Merger discussions between Old CPI and Harvey intensified
during early 1981. Goodridge took no part in the negotiations.
Harvey's President, Harvey Sampson, told Fernandez that he was
concerned by reports or rumors he had heard that Old CPI
engaged in unethical business methods, possibly including
bribes; Fernandez assured him that was not the case.
On June 26, 1981, Fernandez and Daula entered into a "Merger
Agreement" with Neboc, Inc., Harvey's subsidiary, pursuant to
which Neboc was to acquire all shares of Old CPI and was to
change its name to Components Plus, Inc. ("New CPI"). The
merger closed on August 5, 1981, with Neboc tendering to
Fernandez and Daula 311,972 shares of Harvey stock, valued by
management at $1,747,000, and also paying Old CPI's legal fees
of $56,323, in exchange for Fernandez's and Daula's stock in
Old CPI. At that time, Fernandez and Daula received five-year
employment contracts with Neboc. On August 5, 1981 New CPI
entered an "Assumption Agreement" by which it assumed all Old
CPI's obligations to Goodridge. Goodridge's approval was
necessary before completion of the merger, and his attorney did
review and authorize the merger agreement before the closing.
However, Goodridge did not personally review the various
closing documents, nor warrant their accuracy. New CPI
continued making all payments required by the contracts.
The Merger Agreement of June 26, 1981, pursuant to which the
August closing was completed, contained a number of specific
representations by Fernandez and Daula. Among these were:
2. That as of June 30, 1980 and March 31, 1981
"neither CPI nor any Subsidiary was liable for or
subject to any material direct or indirect
liability . . . known or unknown, fixed or
unfixed, . . . of a kind as would be reflected on,
or reserved for or against . . . in a consolidated
balance sheet of CPI and the Subsidiaries
presenting fairly [their] financial position"
except as disclosed in the balance sheets for
those dates. Merger Agreement ¶ 3.6.
3. That "since March 31, 1981 there has been no
change in the business, assets, . . . or condition
(financial or otherwise) of CPI . . . which has
had or will have a materially adverse effect on
its business. . . . Merger Agreement ¶ 3.8.
4. That Old CPI had "made timely payment of all
taxes . . . due and payable. . . . Provision in
conformity with generally accepted accounting
principles has been made in the Final Balance
Sheet for the payment of taxes accrued and unpaid
at March 31, 1981, whether or not yet due and
payable and whether or not disputed. [CPI shall
not] have any material liability for Taxes . . .
for or in respect of any period or periods up to
and including the Closing Date," except as
reflected in the March 31, 1981 balance sheet.
Merger Agreement ¶ 3.9.
5. That "Schedule XIII hereto," which made no
mention of potential litigation arising from a
bribe scheme, "is a true and complete schedule of
all disputes, claims, actions, suits or
proceedings, arbitrations or investigations,
either administrative or judicial, pending or, to
the knowledge of CPI or any of the Stockholders,
threatened or contemplated, by or against or
affecting CPI. . . ." Merger Agreement ¶ 3.17.
6. That "Neither CPI nor any of the Subsidiaries
is in material violation of any . . . law,
ordinance or regulation applicable to . . . the
operation . . . of its business." Merger Agreement
In late 1982, Harvey sold its military and electronics
business, which included all the business of Old CPI, to
Pioneer-Standard Electronics, Inc. Harvey received a total of
$26 million for those elements of its business. At the time of
the sale no allocation of value to the various business
operations sold was made, and Harvey has not presented any
evidence or argument to shed light on what value it received
for its sale of Old CPI's assets.
In early 1982, a federal grand jury in St. Louis which was
investigating corruption in the defense industry served CPI
with subpoenas duces tecum to provide information concerning
its practices from 1975 to 1980. In its review of CPI's records
pursuant to those subpoenas New CPI's counsel learned of
apparent improprieties in Old CPI's operations. By August 1982
New CPI suspected that Old CPI had falsified records to conceal
payments to individual officers and employees and that these
funds had been used in part to bribe purchasing agents at major
customers of Old CPI. New CPI also suspected Goodridge's
complicity in such bribes. In August 1982 it terminated payment
of its various contractual obligations to him.
It has been stipulated, and Goodridge testified, that while
Goodridge and Fernandez were co-owners of Old CPI, they had a
"mutual understanding" that each of them could withdraw funds
from Old CPI for any purpose. These withdrawals were not
closely monitored. While the exact amount of the withdrawals is
uncertain, it is clear that both Goodridge and Fernandez
through a variety of means extracted substantial amounts of
money from Old CPI, much of it for personal use, and much of it
through a shell corporation established by Goodridge and known
as Marlin Industries, Inc. ("Marlin").
Old CPI's payments to Marlin were recorded on Old CPI's books
as legitimate business expenses, and were deducted from Old
CPI's taxes and included in its financial reports. Marlin did
not in fact perform any work for Old CPI. Goodridge and
Fernandez both drew money from Marlin, with Goodridge using the
funds in part to
pay for a boat and part of a condominium in Puerto Rico.
Goodridge also caused Old CPI to write checks totalling $78,000
to his father-in-law, Joseph Reznikoff, although Reznikoff
performed no services for Old CPI. Both Goodridge and Fernandez
knew of or participated in a scheme to generate additional
funds "off the books" by causing sham "commission" checks to be
issued to various Old CPI employees, who then would cash the
checks and return the money to Goodridge, Fernandez or other
CPI employees. While the exact amount of such sham commissions
is disputed, it is stipulated that an employee named Mitchell
Stein received over $218,292.96 in sham commissions, and that
the amount of legitimate commissions paid to Old CPI
salespersons was "substantially less" than the amount reported
as deductible on Old CPI's 1980 corporate tax return. Goodridge
acknowledged arranging for these sham commission checks to be
issued in odd amounts so as to appear legitimate to anyone
reviewing Old CPI's books. It is stipulated that CPI's
legitimate deductions were overstated from 1976 through 1981.
The evidence as to the existence of a bribe scheme by Old CPI
officials comes from three sources: the testimony of Old CPI's
former Controller, Bernard Salter; the deposition testimony of
Terrence Gibbs, formerly a buyer at Emerson Electric Company;
and the deposition testimony of Herbert Myers, a principal of
Current Components, Inc., another distributor of military
Salter, whose duties including keeping Old CPI's books, made
entries for the sham commission checks, and prepared tax
returns containing deductions for those sham commissions.
However, he had no direct knowledge concerning the issuing or
cashing of checks in connection with the alleged kickback
scheme, nor of any actual bribes. Salter testified that during
the fiscal year ending June 30, 1980, he was told by his
superiors that the false commissions were used to generate
funds for kickbacks and bribes needed to secure contracts for
Old CPI. He could not remember specific conversations in which
he was told of Old CPI's bribe practices, but he believed that
both Fernandez and Goodridge (as well as another former CPI
official, Paul Weinstein) were the source of his understanding
that Old CPI practiced bribery as a means of obtaining
business. He recalled being told that purchasing agents at
three of Old CPI's customers, two of which were primarily
customers of Goodridge and one of which was primarily a
customer of Fernandez, required such payments. When pressed on
cross examination, Salter maintained that while he could not
recall a specific conversation in which Goodridge discussed
bribery practices with him, he was sure that such a
conversation took place.
Gibbs testified that he and Fernandez met in 1975 and
established a bid-rigging scheme in which apparent competitors
would submit inflated bids, with the winning bidder returning
a portion of the contract's proceeds to Gibbs in cash. At the
time Fernandez was employed at a contractor known as Lafayette,
while Goodridge and Weinstein operated Old CPI. According to
Gibbs, both Old CPI and Lafayette participated in the kickback
scheme, which was masterminded by Fernandez. Gibbs testified
that the kickback arrangement continued after Fernandez joined
Myers, who operated Old CPI's competitor Current Components,
stated that Frank Fernandez told him of a kickback scheme
governing sales to Emerson Electronics, and that on one
occasion he saw Fernandez give Gibbs an envelope which Myers
understood to contain cash in connection with the kickback
scheme. Neither Myers nor Serge Mandell, the other principal of
Current Components, could connect Goodridge with the kickback
Goodridge testified that between 1975 and 1980, he never
encountered the payment of bribes from Old CPI to its
customers, and that he never made such payments himself.
Additional evidence of the existence of a bribe scheme and of
Fernandez's involvement in it is the fact that Fernandez failed
to testify to rebut the evidence concerning his involvement in
such a scheme, and that he invoked the fifth amendment when
questioned on the topic in depositions. See Baxter v.
Palmigiano, 425 U.S. 308, 318, 96 S.Ct. 1551, 1557, 47 L.Ed.2d
810 (1976) (trier of fact may draw adverse inference against
civil litigant who asserts fifth amendment privilege).
Based on the evidence as to the existence of a bribe scheme
at CPI and as to Goodridge's involvement in it, I find that Old
CPI did engage in a kickback scheme at least as to Emerson, and
possibly as to other customers as well. Fernandez clearly knew
of, planned, and participated in this scheme, as is
demonstrated by the testimony of Salter, Gibbs and Myers. Based
largely on Salter's testimony that Goodridge would have been
aware of such a scheme and discussed it with him, and his
testimony that he understood bribes to have been paid to two of
Goodridge's customers, and on Goodridge's intimate involvement
with the conduct of Old CPI's affairs, I find that Goodridge
was aware of the existence of such payments. However, there is
insufficient evidence to establish that Goodridge himself ever
made, planned or facilitated any bribes. Salter's testimony
that he understood that two firms with which Goodridge dealt
received bribes was not specific to Goodridge's personal
behavior, was based on too uncertain a recollection and derived
from an insufficiently clear source to warrant a finding that
Goodridge himself participated in bribes at those companies.
All available evidence points to Fernandez as the chief
architect and implementer of Old CPI's scheme of kickbacks.
There has been no direct evidence presented as to the amount
of bribes paid by Old CPI, and it is uncertain what percentage
of money generated from sham commission checks and other
illicit methods went to bribes and what amount went to
Goodridge's and Fernandez's personal use.
None of the hidden income they received was reported in
Goodridge's or Fernandez's income tax returns for the relevant
years. The tax fraud and bookkeeping irregularities at Old CPI
were not disclosed to Harvey before the merger, nor was the
existence of any bribe scheme.
On April 11, 1986 Goodridge pled guilty to one count of
conspiracy to commit tax evasion and one count of conspiracy to
commit tax fraud on his income from 1979. Fernandez on June 20
pled guilty to conspiracy to defraud the United States through
the payment of unlawful bribes and kickbacks and to one count
of tax evasion.
Goodridge's present suit seeks to recover from Harvey and New
CPI under the Agreements they assumed through the Assumption
Agreement with Old CPI. Harvey has filed affirmative defenses
and counterclaims against Goodridge, Fernandez and Daula,
alleging essentially that those officers of Old CPI committed
common law fraud, securities fraud and violations of the
Racketeer Influenced and Corrupt Organizations Act (RICO),
18 U.S.C. § 1961-1968 (1988 & Supp. 1989), by failing to disclose
the material fact that Old CPI's profits were generated
primarily as a result of a scheme to bribe purchasing agents of
major defense contractors. Harvey alleges two theories of
damages, one that it was harmed because sales and profits
dropped sharply when it curtailed Old CPI's corrupt practices,
the other that it was harmed because Old CPI's book value, upon
which the sales price was based, was overstated because it did
not reflect tax liability caused by Old CPI's unlawful
deduction of false "commissions" that in fact were used as
bribes or as unreported dividends to Goodridge and Fernandez.
Harvey does not contend that Goodridge has not established a
prima facie case of its obligation to him on the contracts
Goodridge entered with Old CPI upon his departure from that
company. The Assumption Agreement expressly provides for
Harvey's assumption of all Old CPI's obligations to Goodridge
under the Employment and Consulting Agreements and the Note.
Harvey contends, however, that its affirmative defenses excuse
Fernandez has been held liable by summary judgment on that
Guarantee. 728 F. Supp. 275 (S.D.N.Y. 1990). However, Goodridge
has not received payment from Fernandez pursuant to that
judgment. The parties disagree as to whether Harvey's
obligation to anyone under the Indemnity Agreement is triggered
by the mere entry of judgment against Fernandez or only by
actual payment on the part of Fernandez. Harvey also contends
that in any case payment must be made to Fernandez rather than
directly to Goodridge, a contention Goodridge denies.
Because Harvey is liable to Goodridge under the Assumption
Agreement and because Harvey's counterclaims and affirmative
defenses against Goodridge are denied for reasons discussed
below, we need not resolve Goodridge's claim against Harvey
based on the Indemnity Agreement.
Harvey's counterclaims and affirmative defenses all stem from
the same nucleus of factual contentions — that Goodridge knew
of or participated in schemes to withdraw funds from Old CPI
and to bribe Old CPI customers, that he sold his share of the
company to Fernandez in order to facilitate a fraudulent sale
of Old CPI to Harvey, and that Harvey was harmed by receiving a
company with lower legitimate, sustainable sales and with
higher tax liability than was revealed during its merger
negotiations with Old CPI. Harvey alleges that the actions of
Fernandez, Daula and Goodridge constitute common law fraud,
violations of § 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j (1988), § 12(2) of the Securities Act of ...