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AMERICAN TISSUE, INC. v. ARTHUR ANDERSEN

May 5, 2003

AMERICAN TISSUE, INC., A CHAPTER 11 BANKRUPTCY DEBTOR-IN-POSSESSION PLAINTIFF, AGAINST ARTHUR ANDERSEN, L.L.P., DEFENDANT.


The opinion of the court was delivered by: Shira A. Scheindlin, District Judge

OPINION AND ORDER

American Tissue, Inc. ("ATI"), a Chapter 11 bankruptcy debtor-in-possession, is suing Arthur Andersen, L.L.P. ("Andersen") for its allegedly negligent certification of certain ATI financial (mis)statements. Because the false financials were the work of ATI's sole shareholders, ATI lacks standing to bring these claims, which rightly accrue to ATI's creditors. The case is therefore dismissed for want of subject matter jurisdiction. See Fed.R.Civ.P. 12(b)(1).

I. BACKGROUND

The following facts are drawn from ATI's complaint in this case ("Compl."), its complaint in the adversary proceeding styled American Tissue Inc. v. Gabayzadeh (In re American Tissue, Inc.), Adv. Proc. No. 02-4940 (Bankr.D.Del. filed Aug. 1, 2002) (the "Insider Complaint" or "Insider Compl."), Ex. 8 to the 1/30/03 Declaration of Tommy P. Beadreau, counsel to Andersen ("Beaudreau Decl."), and certain of ATI's public Securities and Exchange Commission filings.*fn1

A. The Parties

ATI is a Delaware corporation and a Chapter 11 bankruptcy debtor-in-possession whose principal place of business is in Hauppauge, New York. Compl. ¶ 1. ATI's bankruptcy is currently pending in the United States Bankruptcy Court for the District of Delaware, case number 01-10370. Id. ATI, along with twenty-seven debtor subsidiaries, was a leading manufacturer and distributor of consumer paper products, such as paper towels and toilet paper. Id.

ATI is a wholly-owned subsidiary of Middle American Tissue, Inc. ("MATI"), also a Delaware corporation. Id. ¶ 7. MATI is, in turn, wholly owned by Super American Tissue, Inc. ("SATI"). Id.*fn2 Finally, SATI is wholly owned, in equal parts, by Mehdi Gabayzadeh and his family trusts, and by Nourollah Elghanayan and his family members. Insider Compl. ¶ 31. In other words, Gabayzadeh and Elghanayan and their families "beneficially own 100% of the outstanding shares of [ATI's] common stock. . . . As a result, Messrs. Elghanayan and Gabayzadeh and their respective family members or trusts control[ed] . . . [ATI's] management, policies and financial decisions. . . ." 12/29/00 ATI Form 10-K Annual Report for Fiscal Year 2000 ("Form 10-K") at 31, Ex. 2 to the Beaudreau Decl. In addition to owning the company, Elghanayan served as ATI's Chairman of the Board and Gabayzadeh served as its President and Chief Executive Officer. Id. ATI alleges that Gabayzadeh and Elghanayan were ATI's alter egos: they "completely disregarded the corporate form of [ATI and its various related] companies. The companies had virtually identical boards of directors, they had almost identical officers, they acted by and through the same representatives and agents and they completely disregarded corporate formalities such as regular meetings of their respective boards of directors." Insider Compl. ¶ 40.

Andersen, an Illinois limited liability partnership, is an accounting and consulting firm that at all relevant time did significant business in New York. Compl. ¶ 2.

B. The False Financials

Andersen was retained by ATI to audit its 1999 and 2000 financial statements, to review its 2001 quarterly financials, to perform various accounting tasks in connection with an attempted debt offering in the summer of 2001, and to engage in periodic consulting work. Id. ¶ 11. In particular, Andersen audited ATI's year-end consolidated financial statements for the years 1998, 1999 and 2000. Id. ¶ 14. Andersen certified each year's financial statements without qualification. Id. ¶ 15. See also Form 10-K at F-23.

Nonetheless, ATI was forced to admit the existence of material misstatements in those financial statements. Compl. ¶ 17.

American Tissue Inc. Announces Financial Statement Inaccuracies and CFO Resignation
Hauppauge, New York, September 5, 2001 — American Tissue Inc. announced today that it has reason to believe that its consolidated financial statements for its fiscal years ended September 30, 1999 and 2000, as well as its consolidated financial statements for each of the first three quarters of fiscal 2000 and 2001, contain material inaccuracies. In connection therewith, the Company accepted Edward I. Stein's resignation as Executive Vice President and Chief Financial Officer effective September 3, 2001. PricewaterhouseCoopers LLP, recently hired as the Company's financial advisor, is conducting an investigation to determine the facts as to these matters.
9/5/01 ATI Form 8-K ("Form 8-K"), Ex. 3 to the Beaudreau Decl.

ATI has since identified a number of the misstatements in its annual financials, including:

• Overstatement of accounts receivable. Compl. ¶ 19(a); Insider Compl. ¶ 62.
• Overvaluation of inventory, particularly obsolete inventory. Compl. ¶ 19(b); Insider Compl. ¶ 61.
• Failure to disclose inflated sales and inventory reports. Compl. ¶ 19(c); Insider Compl. ¶ 64.
• Failure to disclose, or incomplete disclosure of, substantial inter-company transfers of cash, accounts receivable, equipment and inventory. Compl. ¶ 19(d); Insider Compl. ¶ 63.
• Failure to disclose, or incomplete disclosure of, information about insider loans. Compl. ¶ 19(e); Insider Compl. ¶¶ 51-57.
• Misstated inter-company debt between ATI and certain of its non-debtor affiliates. Compl. ¶ 19(f); Insider Compl. ¶¶ 64, 67-73.
• Overstatement of ATI's overall financial performance and profitability. Compl. ¶ 19(g); Insider Compl. ¶¶ 58-66.
• Failure to institute procedures to assure accurate financial reporting by ATI's internal accounting staff. Compl. ¶ 19(h); Insider Compl. ¶ 47.
• Misidentification of ATI's ...

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