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CHASE v. COLUMBIA NATL. CORP.

May 24, 1994

SYLVIA CHASE, Executrix of the Estate of Myron L. Chase, STEPHEN CHASE, JOHN A. WITTE and DONJON MARINE CO., INC., Plaintiffs,
v.
COLUMBIA NATIONAL CORPORATION, DAVID MILLER and JAMES D. LARR, Defendants.


SWEET


The opinion of the court was delivered by: ROBERT W. SWEET

Sweet, D.J.

 Plaintiffs Sylvia Chase, Executrix of the Estate of Myron Chase, Stephen Chase ("Chase"), John A. Witte ("Witte") and Donjon Marine Co., Inc. ("Donjon Marine") (collectively, the "Plaintiffs") sought in this diversity action to obtain payment for certain equipment sold to the defendants Columbia National Corporation ("Columbia"), David Miller ("Miller") and James D. Larr ("Larr") (collectively, the "Defendants"). The Defendants counterclaimed seeking damages for fraud and breach of fiduciary duty arising out of the purchase of stock in the Witte Chase Corporation ("Witte Chase") from certain of the Plaintiffs in 1987. Upon all the proceedings had herein and the following findings of fact and conclusions of law, judgment will be entered granting relief to Plaintiffs with costs and dismissing the counterclaims of the Defendants.

 Certain of the Plaintiffs in 1987 sold a 50% interest in Witte Chase, one of the largest exporters of scrap metal in the United States, to the Defendants, who owned and operated one of the largest dealers in domestic scrap, Columbia. After almost two years of operation, the parties concluded that their joint enterprise was not working out, and in 1989 the assets of Witte Chase were sold to a third party, Hugo Neu & Sons, Inc. ("Hugo Neu"). The sale disclosed a significant discrepancy between the inventory accounts and the actual scrap on hand. An investigation was undertaken by the Defendants which disclosed certain accounting practices and conduct which caused them to believe that the 1987 contract of sale by which they had acquired their interest in Witte Chase had been violated, that the acts of the Plaintiffs and others had been fraudulent and a breach of fiduciary duty. A race to the courthouse ensued.

 The events of 1986, 1987 and 1988 which surrounded the calculation of the scrap metal inventory on hand at Witte Chase were revealed. It turns out that the calculation of inventory for scrap metal is not as precise or as well understood as the parties, and particularly the Defendants, had assumed. The dispute vividly demonstrates the danger of assumption, particularly by persons with experience and training in the matters at hand. There was misunderstanding aplenty, but no fraud or breach of fiduciary duty, for the reasons set forth in greater detail below.

 This action was initiated by the Plaintiffs in the Supreme Court of the State of New York after they had received a letter from counsel for the Defendants indicating an intention to litigate a controversy arising out of the transaction between the parties in 1987. It was removed to this court by the Defendants on May 16, 1991. The parties were represented by able counsel, and discovery proceeded appropriately. The Plaintiffs moved for summary judgment to dismiss the Defendants' counterclaims, a motion which was denied as reported in an opinion dated September 9, 1993. See Chase v. Columbia National Corp., 832 F. Supp. 654 (S.D.N.Y. 1993).

 Trial before the Court was commenced on April 18, 1994, and concluded on April 21, after hearing twelve witnesses and the introduction of a number of documents and depositions. Final submissions were made on April 29, and the matter was considered finally submitted at that time.

 Findings of Fact

 Prior to 1986, Witte Chase, a New York corporation, purchased scrap metal and sold it principally overseas through its main operation at a yard at Port Newark. Witte Chase also maintained a small office in New York. It was owned fifty percent by Donjon Marine which in turn was owned by Witte, and fifty percent by Myron Chase.

 Columbia, now known as Columbia National Group, is an Ohio corporation with its principal place of business in Cleveland, Ohio. Columbia is involved in steel-related businesses, including the buying and selling of scrap, principally domestic. Miller is Columbia's owner, Chief Executive Officer and President. Larr is Columbia's Vice President of Finance and Administration.

 For several years prior to and including the fiscal year ending February 28, 1986, Witte Chase had employed the accounting firm of LaGuardia and Petrella to conduct an audit of its financial statements. The audit was performed on a consolidated basis, including the parent corporation as well as a wholly-owned subsidiary called Clean Venture, Inc. and an 85% owned subsidiary called Nicromet, Inc.

 In performing audits on Witte Chase's financial statements, LaGuardia and Petrella reviewed the inventory account of Witte Chase, which was one of the significant assets of the company. The auditors accepted the company's use of the Perpetual Inventory Record ("PIR") as the measure of the quantity of inventory held by the company. In order to develop a level of confidence in the PIR maintained by the company, at the time of the audit the auditors took a walk through the scrap yard and consulted with William Schmeidel ("Schmeidel"), Vice President of operations.

 The PIR was a running balance of the company's purchases and sales of scrap, maintained on a computer which was programmed to record automatically purchases and sales and to update the account accordingly. For example, if the company made a purchase of a quantity of scrap from a seller that used a barge to deliver the scrap, the company would record on the computer system the name of the seller, the number of the purchase order, the quantity purchased, the method of delivery, and the price. When delivery was made, the company would record the exact amount of the purchase. The PIR would then be increased by the computer to reflect both the additional tonnage and the average price of that commodity of scrap as shown on the company's records. Likewise, upon a sale of a commodity, the particular information about the contract of sale was recorded, and the computer recalculated the amount of inventory to reflect the sale.

 The PIR also had a program that permitted "transfers and adjustments" to inventory. A transfer occurred if some portion of scrap already within Witte Chase's inventory was reclassified from one grade of scrap to another (some sixteen grades were classified) at which time a quantity was changed from one category to another and the PIR adjusted accordingly. An adjustment occurred if the company decided, for one reason or another, to change the amount of inventory shown in a particular commodity. For example, Witte Chase sometimes made negative adjustments in various inventory categories to reflect the amount of dirt and debris that was likely included in the overall inventory weight. Adjustments also resulted when at the time of shipment on an ocean-going vessel to a foreign buyer, the invoice stated the weight of the cargo as measured and recorded at the time of loading and at its destination, the cargo was weighed again. The buyer and Witte Chase would adjust the invoice to reflect the weight as reported at the place of unloading, requiring reduction of the effect of the invoice on the PIR. In addition, as shipments were made, on occasion a greater proportion of high grade steel would be added ("sweetening") or the amount of low grade steel increased ("souring") which would also result in an adjustment which would be directed by Schmeidel, the manager of operations.

 In 1986, the Chemical Bank, which was financing Witte Chase and its inventories, requested that it select new auditors of national stature. In August 1986, Witte Chase hired Oppenheim, Appel and Dixon ("OAD"), one of whose partners was then doing personal tax work for Myron Chase, to perform the audit for the fiscal year ending February 28, 1987. The individuals at OAD who worked on the Witte Chase audit did not have prior experience with scrap companies. During the course of their introduction to the business of Witte Chase and review of its papers and those of the predecessor accountants, it was noted that Witte Chase had significant overages in its inventory at the yard, ...


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