GOODRIDGE v. HARVEY GROUP

The opinion of the court was delivered by: Lasker, Senior District Judge.

For reasons discussed below, Goodridge's contract claim is granted, while Harvey's counterclaims and affirmative defenses are dismissed.

I.

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 industry.

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 including Old 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:

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 electronics components.

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 Old CPI.

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 scheme.

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.

II.

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 performance.

As an alternate theory, Goodridge alleges that he is entitled to collect directly from Harvey as an intended third party beneficiary of Harvey's agreement to indemnify Fernandez for any liability to Goodridge arising from Fernandez's personal guarantee that CPI would fulfill its obligations to Goodridge under the Consulting and Employment Agreements and the Note.

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.

III.

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 ...