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CORTEC INDUS. v. SUM HOLDING L.P.

December 10, 1993

CORTEC INDUSTRIES, INC. and CORTEC HOLDINGS, INC., Plaintiffs,
v.
SUM HOLDING L.P., DUBIN CLARK & COMPANY, INC., DUBIN CLARK CAPITAL CORP., RONALD N. DUBIN, J. THOMAS CLARK, JEAN-PIERRE DAMMANN, NORMAN J. YERKE, MICHAEL CANIPE, BOWLES HOLLOWELL CONNER & CO., and ERNST & YOUNG, Defendants, v. LEACH McMICKING & CO. LIMITED PARTNERSHIP, LEACH McMICKING & CO., HOWARD LEACH, LAWRENCE CHAMBERLAIN, MARTHA FRAY and HENRY McMICKING, Additional Counterclaim Defendant.


HAIGHT, JR.


The opinion of the court was delivered by: CHARLES S. HAIGHT, JR.

HAIGHT, District Judge:

 In this securities fraud case with pendent state and common law claims, plaintiffs and certain defendants move the Court for an order approving a settlement which inter alia would bar claims by the nonsettling defendant against the settling defendants. The nonsettling defendant objects to the proposed settlement, including the bar order, as unfair.

 I.

 The facts are stated in this Court's opinion dated January 3, 1991, the Second Circuit's opinion reported at 949 F.2d 42 (2d Cir. 1991), and this Court's memorandum dated March 22, 1993. I assume familiarity with those writings and describe herein only those facts necessary to provide an understanding of the present issue and its resolution.

 Cortec Industries, Inc. is engaged in the business of manufacturing pre-engineered metal buildings. On May 12, 1989 plaintiffs purchased all of Cortec's stock and its outstanding debt for $ 53 million. Plaintiffs are "new" Cortec Industries, Inc. and Cortec Holdings, Inc., which were formed to implement the transaction. Prior to the transaction "old" Cortec was held by four different categories of owners: defendants, corporate and individual, affiliated with Dubin Clark & Company, Inc., which had formed old Cortec; individual defendants who were members of old Cortec's management; Woodlawn Foundation, a not-for-profit corporation which owned some old Cortec shares; and Westinghouse Credit Corporation, holder of a warrant to purchase shares of old Cortec.

 In addition to these defendants, plaintiffs' original complaint named as defendants Bowles Hollowell Connor & Co., an investment banking firm retained by the Dub in Clark and management defendants to assist them in selling old Cortec; and the accounting firm of Ernst & Young, old Cortec's outside auditors and accountants, which plaintiffs also retained to give a "comfort letter" with respect to Cortec's March 1989 financial statements as a condition precedent to plaintiff going through with the purchase. At the pertinent times Ernst & Young was known by the name of its predecessor firm, Arthur Young. I will refer to the accounting firm by its present name, Ernst & Young, throughout this opinion.

 The thrust of plaintiffs' federal securities charges was that the defendants, in various ways and at various times, by fraudulent misrepresentations or failures to disclose, misled plaintiffs with respect to the financial stability and prospects of old Cortec.

 All defendants moved on various grounds to dismiss the original complaint. In this Court's opinion dated January 3, 1991, I granted those motions in part and denied them in part. With respect to the claims that were dismissed, I granted leave to replead in some instances but denied leave in others.

 Plaintiffs had sued Westinghouse Credit Corporation for violating § 12(2) of the 1933 Securities Act. I dismissed that claim without leave to replead. In its opinion reported at 949 F.2d 42, the Second Circuit reversed and held that leave should have been granted plaintiffs to replead their § 12(2) claim against Westinghouse as a solicitor of the old Cortec sale.

 Thereafter plaintiff filed their first amended complaint (hereinafter the "complaint"). Plaintiffs did not replead their § 12(2) claim against Westinghouse. Certain other individual defendants were dropped from the case. The remaining defendants are Sum Holding, L.P., Dubin Clark & Company, Inc., Dubin Clark Capital Corp., Ronald N. Dubin, J. Thomas Clark, and Jean-Pierre Dammann, all affiliated with Dubin Clark; Norman J. Yerke and Michael Canipe, former officers of old Cortec; Bowles Hollowell Connor & Co., the investment banking firm; and Ernst & Young, the accounting firm.

 Plaintiffs have entered into a proposed settlement with all defendants except Ernst & Young. Under the settlement and the order and judgment I am asked to sign in order to implement it, the settling defendants will pay to plaintiffs the total sum of $ 4,250,000. Ernst & Young, as nonsettling defendant, will be entitled to a $ 4,250,000 reduction in the amount of any damages ultimately awarded to plaintiffs against Ernst & Young. The order implementing the settlement also provides:

 
. . . it is further
 
ORDERED, that all claims for contribution, indemnity or otherwise against Sum Holding, L.P., Dubin Clark & Co., Inc., Dubin Clark Capital Corp., Ronald N. Dublin, J. Thomas Clark, Jean-Pierre Dammann, Norman J. Yerke, Michael Canipe and Bowles Hollowell Conner & Co. (the "Settling Defendants") that have been or could have been asserted by Ernst & Young (the "Non-Settling Defendant"), whether under the federal securities laws, state laws or common law, arising out of (i) the matters which are or could have been alleged in the First Amended Complaint in this Litigation; or (ii) the purchase and sale of Cortec Industries, Inc. ("Cortec") on May 12, 1989, are hereby extinguished, discharged and barred;, and it is further
 
ORDERED, that the Non-Settling Defendant is permanently barred and enjoined from instituting, prosecuting or continuing to prosecute, either directly, representatively or in any other capacity, any action against the Settling Defendants to the extent such action asserts any claim, demand, right or cause of action, on whatsoever theory, arising out of (i) the matters which are or could have been alleged in the First Amended Complaint in this Litigation; or (ii) the purchase and sale of Cortec on May 12, 1989; . . ."

 Ernst & Young contends that the proposed settlement and accompanying bar order are unfair to it because Ernst & Young is not adequately compensated for the loss of its barred claims against the settling defendants.

 II.

 The fairness of a bar order in cases of partial settlement was most recently considered by the Second Circuit in In re Masters Mates & Pilots Pension Plan, 957 F.2d 1020 (2d Cir. 1992) ("MM&P").

 The Second Circuit observed in MM&P that a partial settlement with a bar order requires courts "to weigh the policy favoring settlement of claims by injured plaintiffs against the need to protect the rights of nonsettling defendants." 957 F.2d at 1023. On the particular facts of that case, the Second Circuit concluded "that this settlement is unbalanced, in part because it reflects a misunderstanding of recent case law and in part because the district court gave inadequate consideration to relative culpability before approving the settlement bar." Id.

 The defects perceived by the Court of Appeals in MM&P are separate but related. The nonsettling defendant in MM&P objected to the settlement "on the grounds that it unfairly cuts off [his] rights and potentially subjects him to a disproportionate share of liability for the injuries caused the plaintiffs." Id. The issue of relative culpability between defendants does not arise in a vacuum. Relative culpability depends upon the application of recent case law to the particular facts of the litigation.

 While plaintiffs' complaint alleges a considerable variety of fraudulent misrepresentations and omissions against one defendant or another, corporate or individual, the claims against Ernst & Young focus upon two particular aspects of Cortec's financial condition.

 First, plaintiffs allege that during 1988 and the first quarter of 1989 Cortec fraudulently understated the amounts of accounts receivable that were doubtful of collection, while reducing bad debt reserves to entirely unreasonable amounts.

 Second, plaintiffs allege that during 1988 Cortec violated generally accepted accounting principles ("GAAP") by treating as "accrued" income the value of fabricated product that had been produced but not yet shipped to customers. Plaintiffs contend that GAAP requires that income not be ...


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