The opinion of the court was delivered by: KAPLAN
LEWIS A. KAPLAN, District Judge.
The plaintiff in this case was the purchasing vehicle in a 1994 management buyout of ICD, Inc. ("ICD"), a large international dealer in petrochemical based commodities. It brings this action against Alfred M. Frankel and Jacques Leviant, who sold the ICD shares to plaintiff, and Richard A. Eisner & Co. ("Eisner"), certified public accountants who prepared certain materials contemplated by the purchase agreement for use in determining the price. All defendants move to dismiss the complaint.
This is the second action concerning this transaction, the first having occasioned three opinions by this Court that set out the pertinent aspects of the purchase agreement and the nature of the dispute between the buyer and the sellers.
There is, in consequence, no need to repeat any of that discussion here, and the Court will assume familiarity with the prior opinions. It is important, however, to focus on the nature and procedural history of the prior action in view of the former adjudication arguments raised by the defendants here.
In brief summary, the plaintiff in this case, ICD Holdings S.A. ("Holdings"), purchased all of the shares of ICD from Frankel and Leviant for (1) $ 5 million in promissory notes, and (2) cash equal to the Book Value, as defined by the purchase agreement, less $ 5.9 million. The notes were guaranteed by Holdings' two shareholders, Messrs. deGeus and Loffelhardt. The overall purchase price was subject to a post-closing adjustment in which the buyer or the sellers, as the case might be, would pay to the other any amount necessary to adjust the consideration transferred at the closing to an amount equal to the adjusted purchase price.
The prior action was commenced not by the filing of a complaint, but by the service of a motion for summary judgment in lieu of complaint as permitted in such cases by Section 3213 of the New York Civil Practice Law and Rules. As there was no complaint, Holdings, deGeus and Loffelhardt filed no answer.
Rather, they responded to the motion for summary judgment, contending, by way of defense, that Frankel and Leviant fraudulently had overstated the purchase price.
In Frankel I, this Court held that Holdings, by the terms of the notes it had signed, waived the defense of fraud in the inducement of the notes.
While it held that deGeus and Loffelhardt had not waived such a defense to the guarantees, it went on to conclude that they had not raised a genuine issue of fact as to the existence of any material overstatement of the purchase price and therefore granted summary judgment on the notes and guarantees.
It is important, moreover, to focus on the precise nature of the fraudulent inducement defense asserted by deGeus and Loffelhardt and on the basis for the Court's ruling.
The structure of this buyout transaction was complex. The purchase agreement, which is the document that obliged deGeus and Loffelhardt to execute their guarantees at the closing, conditioned their obligation to do so (as well as the obligation of Holdings to proceed with the purchase) on the receipt of a preliminary balance sheet showing the Estimated Cash Purchase Price -- the Book Value as defined less $ 5.9 million -- to be within ten percent of $ 67.8 million.
In other words, if the Estimated Cash Purchase Price, determined in accordance with the purchase agreement, had been less than $ 61.02 million or more than $ 74.58 million, Holdings, deGeus and Loffelhardt would have had the right to walk away from the deal. The accountant's statement that was delivered at or prior to the closing -- and that allegedly was overstated -- showed an Estimated Cash Purchase Price of $ 64.9 million and thus fell within the range in which the buyer and guarantors were obliged to proceed with the transaction.
In order to defeat the buyers' motion for summary judgment on the guarantees, Frankel I held, deGeus and Loffelhardt were obliged to adduce evidence sufficient to raise a genuine issue of fact as to the existence of a material overstatement of the Estimated Cash Purchase Price.
It concluded that they had not done so, "principally because the evidence is insufficient to permit the inference that properly prepared balance sheets as at September 30, 1993 would vary materially from those [the accountant] prepared."
DeGeus and Loffelhardt sought relief from the judgment under Rule 60(b)(2), relying on additional accounting evidence in support of their position that there had been a material overstatement. Among the evidence proffered was an opinion of a Price Waterhouse & Co. accountant, solicited after the date of the decision in Frankel I, to the effect that there had been an overstatement of the Estimated Cash Purchase Price of $ 5.4 million.
The Court, however, denied the motion on the alternative grounds that (i) the evidence had been available to deGeus and Loffelhardt when the original motion had been litigated and, (ii) in any case, was immaterial given the structure of the purchase agreement. The Court noted "the Guarantors can avoid their guarantees . . . only if they can establish that they would not have signed the guarantees if they had known the true state of affairs."
They were obliged by the purchase agreement to execute and deliver the guarantees provided the Estimated Cash Purchase Price fell anywhere within a broad range. The Court went on to say that the amount of the overstatement alleged by Price Waterhouse was less than the $ 6.78 million that the Court regarded as necessary to have given Holdings, deGeus and Loffelhardt the right to walk away from the deal.
The Court indicated also, however, that a smaller "error might well give [the Guarantors] a claim for a refund of part of the purchase price . . ."
The Complaint in this Action
This action was commenced during the pendency of the prior action.
The amended complaint, unsurprisingly, tells essentially the same story that Holdings, deGeus and Loffelhardt advanced in their effort to defeat summary judgment on the notes and guarantees save that Eisner here is a party to the suit. The complaint contains ten causes of action. The first through third seek damages against Frankel and Leviant for breach of contract on various theories. The fourth through sixth charge Frankel, Leviant and Eisner with common law fraud, negligent misrepresentation and securities fraud, respectively. The seventh accuses Eisner of aiding and abetting the alleged fraud by Frankel and Leviant. The eighth through tenth allege that Eisner breached its alleged contractual and fiduciary obligations to Holdings and committed professional malpractice.
Frankel and Leviant move to dismiss the entire complaint on the grounds that all of Holdings' claims are barred by both issue and claim preclusion, often referred to as collateral estoppel and res judicata, respectively. Eisner contends that Holdings' fraud, aiding and abetting and negligent misrepresentation claims must be dismissed on the basis of issue preclusion.
The fraud claims asserted here depend upon the allegation that the defendants made six misrepresentations to Holdings: that (1) Eisner would act independently, (2) Eisner would prepare the balance sheet in accordance with U.S. generally accepted accounting principles ("GAAP"), (3) Eisner would perform an audit or special procedures with respect to ICD and the retained subsidiaries, (4) the Estimated Book Value, as of September 30, 1993, was $ 70,573,766, (5) the Estimated Cash Purchase Price was $ 64,933,450, and (6) the 1992 financial statements were materially correct.
In fact, Holdings alleges, the Estimated Cash Purchase Price, accurately stated, would have been approximately $ 55,573,450 million, a figure that would have permitted it to walk away from the deal; the Estimated Book Value was overstated by about $ 9.3 million; Eisner was not independent and did not prepare the balance sheet in accordance with GAAP; and the 1992 financial statements were inaccurate.
All of the defendants contend that the Court's rulings in Frankel I decided these issues against Holdings and that these claims therefore must be dismissed. In addition, Frankel and Leviant argue that the breach of contract claims against them are based on one of two theories: either (1) there was a misrepresentation of the book value of the businesses on the balance sheet or (2) there was a breach of the purchase agreement in failing to account for the transaction in accordance with its terms. The rejection of the fraud defense asserted in Frankel I, they contend, precludes Holdings from establishing either theory and requires dismissal of the contract claims as well.
Litigants who have had a full and fair opportunity to litigate ordinarily will not be heard to relitigate an issue actually, finally and necessarily decided against them in a prior action. In order for this doctrine of issue preclusion to apply, four requirements must be satisfied:
"(1) the issues in both proceedings must be identical, (2) the issue in the prior proceeding must have been actually litigated and actually decided, (3) there must have been a full and fair opportunity for litigation in the prior proceeding, and (4) the issue previously litigated must have been necessary to support a final judgment on the merits."
It therefore is essential to determine at the outset exactly what Frankel I actually and necessarily decided.
1. Actually and Necessarily Decided
As described, the prior action, insofar as it dealt with the fraud defense on its merits, was a suit by Frankel and Leviant against deGeus and Loffelhardt on their guarantees. As a matter of law, deGeus and Loffelhardt could have avoided the guarantees only if they had raised a genuine issue of fact as to the existence of an overstatement of the Estimated Cash Purchase Price of sufficient magnitude that disclosure of the truth would have given them the right to decline to execute the guarantees of the $ 5 million in notes at the Closing.
This Court actually and necessarily decided that they had failed to do so and, in consequence, entered judgment on the guarantees. No broader holding, however, was required to dispose of the fraud defense. Nor did the Court make any determination with respect to the 1992 financial statements, which were not at issue in the prior action, or regarding Eisner's actions.
Frankel and Leviant argue that the Court previously determined that there were no material misrepresentations in connection with the purchase agreement. They place great emphasis on the Court's statement in Frankel I that "the evidence is insufficient to permit the inference that properly prepared balance sheets as at September 30, 1993 would vary materially from those Eisner prepared."
They come to an erroneous conclusion, however, because they take the word "materially," as used by this Court in the prior action, out of context.
In ordinary circumstances, the test of materiality, broadly speaking, is whether an alleged misstatement or omission would have been important to a reasonable buyer or seller.
But the issue in the prior action was different. As the Court carefully pointed out, in the unique context of the guarantors' defense to the action on the guarantees, the issue was whether they had raised a genuine issue as to the existence of an overstatement of the Estimated Cash Purchase Price of sufficient magnitude that disclosure of the true figure prior to closing would have relieved them of the obligation to guarantee the notes. The Court placed the size of the necessary overstatement at $ 6.78 million. Hence, the Court's holding was that there was insufficient evidence of a misstatement of that magnitude. Accordingly, the holding in the prior action actually and necessarily determined only that any ...