Askanase v. Fatjo

United States Court of Appeals,
Fifth Circuit.
No. 96-21001.
David ASKANASE, Trustee; Fitness Corporation of America,
Plaintiffs-Appellants,
v.
Tom J. FATJO, et al., Defendants,
Tom J. Fatjo, Jr.; C.A.J.A. Enterprises, Inc.; Bayou Park Club
Partnership, A Texas General Partnership; Criterion Research,
Inc.; Elstead Investment Co., A Texas General Partnership; Ron
Hemelgarn; Air 500 Ltd.; Beechmont Partnership; Coordinated Spa
Services, Inc.; Deluxe Office Products; Fitness Research
International; Great Lakes Leasing Agency; H & C International;
Hemelgarn Racing, Inc.; Management Computer; Newtowne
Enterprises, Inc.; Quad Cities Ltd.; Spa One Advertising; Spa
Computer; Spa Janatorial; Spa Lady, Inc.; Spa Printing; Twenty-
First Century; WHM Enterprises; Watson Melby Hemelgarn
Partnership; Westchester Spa Partnership; Ernst & Young, formerly
known as Ernst & Whinney; Housprops, Inc., A Texas Corporation;
Houstonian Holdings Partnership, A Texas Partnership; Peter M.
Jackson; Ahmed Mannai; Fitness Investment N V, A Netherlands
Antilles Corporation; Fitness Investment (Texas), Inc., A Texas
Corporation; Houstonian Estates Investment Co. N V, A Netherlands
Antilles Corporation; Mannai Investment Company, Inc., C, A
Delaware Corporation; Xantor, Inc., A Panamanian Corporation;
Parkgate Associated Ltd.; Parkgate, Inc., A Corporation; Roger A.
Ramsey; John Snideman, doing business as Financial Services
Corporation; John Snideman, doing business as Management
Accounting, Inc.; Gerald M. H. Stein; Joseph J. Zilber; JZL
Ltd., A Nevada Corporation; ZL Company, Inc., A Delaware
Corporation; Zilber, Inc.; Zilber Ltd., A Nevada Corporation;
Financial Services Corporation; Management Accounting, Inc.;
Hfund, Inc.; Corporate Communications Center, Defendants-
Appellees.
In the Matter of: LIVINGWELL, INC., Debtor.
David ASKANASE, Trustee, Appellant,
v.
Tom J. FATJO, Jr., Appellee.
In the Matter of: LIVINGWELL (NORTH), INC.; LivingWell (Midwest),
Inc., Debtors.
1
David ASKANASE, Appellant,
v.
M W B LEASING, INC., Appellee.
In the Matter of: LIVINGWELL (MIDWEST), INC.; LivingWell, Inc.,
Debtors.
David J. ASKANASE, Appellant,
v.
TOWNE REALTY, INC.; Joseph J. Zilber, Appellees.
In the Matter of: LIVINGWELL, INC., Debtor.
David J. ASKANASE, Appellant,
v.
ZILBER LTD.; Joseph J. Zilber, Appellees.
Dec. 23, 1997.
Appeal from the United States District Court for the Southern
District of Texas.
Before GARWOOD, DUHÉ and DeMOSS, Circuit Judges.
DUHÉ, Circuit Judge:
Appellant, the Bankruptcy Trustee of LivingWell, Inc. and
related companies, appeals from a take nothing judgment in favor of
the Defendants, Ernst & Young, LivingWell's auditors, and Tom Fatjo
et al., who are either former directors, officers, or shareholders
of LivingWell, Inc. or separate businesses owned by these officers,
directors, or shareholders. The fifteen issues asserted on appeal
basically involve five claims. First, the Trustee argues that he
may recover money LivingWell paid its subsidiaries, officers and
directors, and their related businesses. He does so under the
trust fund doctrine, which prohibits an insolvent corporation from
2
paying money or distributing assets to its directors in preference
to creditors. Second, the Trustee sues the directors alleging
misconduct and breach of the duty of loyalty and care and their
fiduciary duty. Third, the Trustee claims that the directors
fraudulently caused LivingWell to transfer money and assets to
themselves and unlawfully redeemed LivingWell stock. Fourth, the
Trustee sues the majority shareholder, Ahmed Mannai, for damages on
the basis that Mannai controlled the board of directors through his
two agents and is therefore responsible as a director. Last, the
Trustee sues Ernst & Young, who audited LivingWell, for breach of
contract, negligence, gross negligence, fraud, and fraud based
conspiracy. We affirm.
I
In October of 1983, three Texas limited partnerships, the
Houstonian Properties, Ltd.("HPLtd"), the Houstonian Estates,
Ltd.,("HELtd") and LivingWell, Ltd., and one Texas general
partnership, Houstonian General Partnership ("HGP") combined to
form the Houstonian, Inc., a Texas Corporation. The Houstonian's
major assets were: the Houstonian Properties Hotel, Conference
Center, and Club, the Manor and Ambassador Houses, twenty-nine
condominium units in the Houstonian Estates Condominiums, a 4.8
acre parcel of land adjacent to the Club and Condominium, the
Houstonian Preventive Medicine Center and its exclusive rights to
market, develop, and sell the LivingWell Programs and related
operating assets. In exchange for these assets HPLtd received
Houstonian Inc. common stock; HGP received common stock which it
3
distributed to HELtd; LivingWell received common stock. In 1985,
the Houstonian was merged into LivingWell.1
In 1984, LivingWell purchased 82 fitness clubs in the
southeastern United States for over $10 million cash, shares of its
common stock, and an agreement that, if, over the next five years,
the clubs achieved certain earnings goals, then the sellers would
receive additional consideration up to $10 million (50% in cash and
50% in value of common stock). Ron Hemelgarn, one of the principal
shareholders of the seller, became a LivingWell director.
In March of 1985, LivingWell acquired over 200 fitness
facilities nationwide for $15.5 million cash, 1,774,750 shares of
LivingWell common stock and 68,572 shares of LivingWell's Series C
Convertible Preferred Stock. As an additional part of the
transaction, LivingWell could issue up to 750,000 shares of common
stock over the next five years if one of the acquired groups
reached specified earnings levels.
On March 29, 1985, Zibler, Ltd., purchased 50,000 shares of
LivingWell's Series D Convertible Preferred Stock for $5 million.
Zibler, Ltd., loaned an additional $10 million to LivingWell and
Zibler had the option to acquire warrants to purchase 3,233,790
shares of common stock at prices of $4 to $8 per share.
A. Source of Capital
In September of 1985, LivingWell sold $16.1 million of 12%
convertible, subordinated debentures. Net proceeds were used to
1
"LivingWell" will refer to the Houstonian both before and
after the merger.
4
pay existing debt and increase capital. Through 1985 and into
1986, LivingWell successfully converted preferred stock into common
stock thereby raising additional funds in the public markets. In
May 1986, LivingWell sold $52 million of subordinated debentures
and warrants. Of the nearly $51 million in net proceeds, $40.15
million was used to retire outstanding debts.
B. Relevant Transactions
1. PAC
In June 1986, LivingWell and certain of its individual
shareholders created a separate financing company, Paramount
Acceptance Corporation ("PAC"), a Delaware corporation, to collect
LivingWell's receivables. PAC had its own officers and directors.
Prior to PAC's creation, LivingWell collected its receivables (club
and membership fees and dues) through its regional subsidiaries (LW
North, LW South, and LW Midwest).
2. Sale of Clubs
During 1986, LivingWell sold 41 clubs to Powercise, Inc., a
corporation formed by some LivingWell employees. Shortly
thereafter, T.H.E. Fitness Centers, Inc., an outside group,
acquired other of LivingWell's small clubs. As part of the deal,
T.H.E. received rights to the Powercise technology owned by
LivingWell and LivingWell received equivalent stock in T.H.E.
3. Hfund Transaction
When the Houstonian Hotel and Conference Center experienced
financial difficulty that threatened foreclosure, a new entity,
called Hfund, Inc., was created. LivingWell exchanged its interest
5
in the Houstonian fitness operations for preferred stock in the
newly formed Hfund, Inc., a Delaware corporation. Pursuant to the
exchange, additional cash was made available to the mortgage holder
thereby avoiding foreclosure.
4. Bankruptcy Filing
When the prospect of bankruptcy became apparent LivingWell
attempted to restructure its organization. LivingWell continued
its operations and in 1988 generated $136 million in revenues.
From 1988 through most of 1989, LivingWell attempted to restructure
its debt. In the meantime, Powercise, T.H.E., and Hfund failed.
LivingWell then filed for bankruptcy protection in late 1989.2 In
October 1990, LivingWell ceased to operate and converted from a
chapter 11 to a chapter 7 filing. David Askanase was appointed
Trustee for LivingWell and FCA3, a wholly owned subsidiary of
LivingWell.
The Trustee sued most of LivingWell's directors, certain
officers and control persons, LivingWell's auditors, Ernst & Young,
and certain related parties. The Trustee sought damages and
recovery of sums paid to the directors and their businesses during
periods of alleged insolvency. He also claimed: 1) that
LivingWell and its subsidiaries had made fraudulent transfers to
directors and their businesses for less than fair value; 2) that
2
LivingWell and its three wholly-owned subsidiaries, LW North,
LW South, LW Midwest, filed for bankruptcy.
3
Although FCA (Fitness Corporation of America) never filed for
bankruptcy, the Trustee brings claims on behalf of FCA. His
authority to do so is neither explained nor questioned.
6
the defendant directors and officers had breached their duties of
due care and loyalty as well as their fiduciary duty; 3) that
there was a fraud based conspiracy; 4) breach of contract,
negligence, fraud and fraud based conspiracy against Ernst & Young;
5) that the directors and Ahmed Mannai, a large shareholder, had
unlawfully redeemed stock. When LivingWell became insolvent was
central to the determination of certain claims so the district
court bifurcated the trial. In Phase One, which determined
solvency, the court granted LivingWell's Rule 50(a) motion for a
judgment as a matter of law finding that LivingWell was not
insolvent before December 31, 1986. The question of insolvency
thereafter was submitted to the jury, and it found that LivingWell
was continuously insolvent from December 31, 1986 until it filed
for bankruptcy in 1989. Because the Trustee failed to submit the
issue of the LivingWell subsidiaries' solvency to the jury and no
jury finding was made, the district court deemed those claims
waived and determined that subsidiaries were solvent until
bankruptcy was filed. Based on the jury verdict and the court's
finding that the subsidiaries were not insolvent until filing, the
Appellees filed a series of motions for summary judgment which the
trial court granted. Thus, this appeal results from the district
court's rulings during the insolvency trial and its rulings on
defendants' motions made after the jury finding.
II
We turn first to the claims dismissed by summary judgment
based on limitations.
7
A. Standard of Review
Summary judgment is reviewed de novo and the evidence is
viewed in the light most favorable to the motion's opponent.
Gremillion v. Gulf Coast Catering Co., 904 F.2d 290, 292 (5th
Cir.1990) Summary judgment is inappropriate when conflicting
inferences and interpretations may be drawn from the evidence.
James v. Sadler, 909 F.2d 834, 836-37 (5th Cir.1990).
B. Limitations
The trial court found that limitations barred the Trustee's
trust fund claims, the director misconduct claims, the fraudulent
transfers claim, and the negligence claims against Ernst & Young.
The Trustee argues that the district court erred because either the
court misconstrued the applicable law of limitations or
alternatively did not toll the period.
1. Trust fund claims
The Trustee sued LivingWell's directors on the basis of the
trust fund theory of Texas law claiming that the directors breached
their fiduciary duty to LivingWell when they caused LivingWell and
its subsidiaries to make certain payments to them and their
businesses. The Trustee contends that the district court erred in
granting summary judgment against all trust fund claims arising
before October 27, 19874 because it applied a two year period of
limitations. Incredibly, the Trustee argues that in Texas a four
year statute of limitations applies because four years is the
4
LivingWell filed for bankruptcy October 27, 1989; therefore
a two year statute of limitations would bar all claims arising
before October 27, 1987.
8
limitations period for the recovery of monies paid to a
director/officer-trustee based on a breach of fiduciary duty. Peek
v. Berry, 143 Tex. 294, 184 S.W.2d 272, 275 (1944). Additionally,
Appellant contends that the four year limit should apply because
that is the limit for a breach of fiduciary duty claim which
subsumes a constructive fraud claim. Spangler v. Jones, 797 S.W.2d
125, 132 (Tex.App.—Dallas 1990, writ denied).
The district court was correct. The applicable period of
limitations is two years. Appellant relies heavily on Spangler v.
Jones, 797 S.W.2d 125 (Tex.App.—Dallas 1990, writ denied) and our
cases that follow its reasoning. See e.g., Sheet Metal Workers
Local No. 54 v. E.F. Etie Sheet Metal Co., 1 F.3d 1464, 1469 (5th
Cir.1993), cert. denied, 510 U.S. 1117, 114 S. Ct. 1067, 127 L. Ed. 2d
386 (1994). However, we rejected the reasoning of Spangler and our
cases that followed it in Kansa Reinsurance v. Congressional Mortg.
Corp., 20 F.3d 1362, 1374 (5th Cir.1994):
[I]n Williams [v. Khalaf, 802 S.W.2d 651 (Tex.1990) ],
Texas' highest court expressly stated that: "... In general,
torts developed from the common law action for "trespass', and
a tort not expressly covered by a limitation provision nor
expressly held by this court to be governed by a different
provision would presumptively be a "trespass' for limitations
purposes. The same common law development simply does not
apply to fraud as to most other torts." [Id.] at 654-55.
Breach of fiduciary duty is clearly a "tort" under Texas law
and thus, would appear to fall within this reasoning.
Moreover, the Texas Supreme Court declined to overrule prior
decisions setting forth a two-year statute of limitations for
certain similar tort claims, such as legal malpractice and
breach of the duty of good faith and fair dealing, which had
been raised as analogies for employing the two-year statute of
limitations for fraud. Williams, 802 S.W.2d at 654 n. 2. For
these reasons, we do not find persuasive the reasoning in
Spangler that Williams dictates the application of the
four-year statute of limitations for fiduciary duty claims and
decline to follow the opinions of this court which rely upon
9
Spangler.
Moreover, Smith v. Chapman, 897 S.W.2d 399 (Tex.App.-Eastland 1995)
held that the trust fund theory puts directors in a fiduciary
relationship to the creditors. Id. at 402. A breach of that duty
gives rise to the cause of action and is subject to a two year
statute of limitations. Id. Thus, the statute of limitations for
the trust fund claim is two years.
The Trustee further argues that even if the applicable period
is two years, limitations is tolled because the discovery rule
applies. The discovery rule, which applies to both the act and the
injury, requires that a claim be (a) inherently undiscoverable and
(b) objectively verifiable. S.V. v. R.V., 933 S.W.2d 1,6
(Tex.1996). Moreover, the Trustee contends, even if the discovery
rule does not apply, the adverse domination theory tolls
limitations. For this tolling principle to apply, the interested
directors must constitute a majority of the board of directors,
FDIC v. Henderson, 61 F.3d 421, 428 (5th Cir.1995), and the Trustee
must show intentional misconduct by the directors. RTC v. Acton,
49 F.3d 1086, 1091 (5th Cir.1995).
Neither the discovery rule nor the adverse domination theory
tolls limitations in this case. The discovery rule assumes that
the wrongful act is inherently undiscoverable. S.V. v. R.V., 933
S.W.2d at 6. This assumption is in direct conflict with the general
rule that courts are to impute an officer/director's knowledge to
the corporation. See FDIC v. Ernst & Young, 967 F.2d 166, 170 (5th
Cir.1992)(imputing a bank officer's knowledge to the bank). Texas
10
law applies the imputation principle to determine when the statute
of limitations begins to run on a corporation's claim. FDIC v.
Shrader & York, 991 F.2d 216, 222 (5th Cir.1993), cert. denied, 512
U.S. 1219, 114 S. Ct. 2704, 129 L. Ed. 2d 832 (1994). Courts will
impute knowledge to the corporation as long as the officer/director
is acting on the corporation's behalf. FDIC v. Ernst & Young, 967
F.2d at 171. As this sentence implies and as the Appellees
acknowledge there is an exception to imputation. If the plaintiff
can show that the officer/director was acting adversely to the
corporation and entirely for his own or another's purpose, then
limitations will be tolled. FDIC v. Shrader & York, 991 F.2d at
223-24. The officer/director, though, must act so that his
endeavors are so incompatible that they destroy the agency. Id.
Appellant has made no showing that the Appellees acted entirely for
their own purpose. Appellant argues that the Appellees breached
their fiduciary duty by unlawfully preferring themselves; however,
while there is some evidence that the corporation overpaid for some
transactions, we agree with the district court that this evidence
does not raise a material fact issue that the Appellees acted
entirely for their own purposes.
Nor does the adverse domination exception toll the statute.
Assuming that the interested directors are a majority, the Trustee
must also prove intentional misconduct. RTC v. Acton, 49 F.3d at
1090-91. In Acton, this Court held that mere negligence was
insufficient to trigger adverse domination. Id. There had to be
active participation in wrongdoing. In FDIC v. Dawson, 4 F.3d
11
1303, 1312 (5th Cir.1993), cert. denied, 512 U.S. 1205, 114 S. Ct.
2673, 129 L. Ed. 2d 809, this Court implied that breach of fiduciary
duty was not sufficient to trigger adverse domination:
"We do not believe that Texas courts would extend the "very
narrow doctrine', Shrader & York, 991 F.2d at 227, of adverse
domination to cases in which the wrongdoing by a majority of
the board amounts to mere negligence. To do so would
effectively eliminate the statute of limitations in all cases
involving a corporation's claims against its directors."
There must be active participation in wrongdoing or fraud. Id.
Even gross negligence is not enough. RTC v. Acton, 49 F.3d at
1091. Moreover, in RTC v. Bright, 872 F. Supp. 1551, 1565
(N.D.Tex.1995), the court found that breach of fiduciary duty does
not satisfy Dawson 's active fraud requirement. As the district
court explained, under Texas law, breach of fiduciary duty is
constructive fraud by virtue of the breach itself. Id.
Constructive fraud does not require active participation because a
duty may be breached through mere negligence. Here, as the Trustee
alleges in his Second Amended Complaint, he seeks to recover all
preferential payments made to Appellees "regardless of whether the
payment was for a lawful purpose or [a] permissible debt owing by
the Company to the director." Such a claim does not allege
intentional wrongdoing.
We affirm the district court's grant of summary judgment
against all trust fund claims that arose before October 27, 1987.5
2. Director misconduct claims
Again, the Trustee contends that the district court erred in
5
We address the remaining trust fund claims in section III C
hereof.
12
granting summary judgment based on a two year statute of
limitations. He argues that the misconduct was a breach of
fiduciary duty and intentional wrongdoing which entitled him to a
four year limitations period. For the reasons stated above, we
disagree.
In response to the claim of intentional misconduct, the
Appellees argue that the Trustee did not allege fraud in Count I
(corporate waste, mismanagement, negligence, gross negligence, and
breach of fiduciary duty of officers and directors) of the First
Amended Complaint. Nor did the Trustee add any new allegations in
the Second Amended Complaint. In fact, in the Plaintiff's Response
and Opposition to Defendant's Rule 9, 12(e), and 12(b) Motions to
Dismiss, Appellant stated that "five of the six claims that
collectively comprise Count I are not even arguably fraud based."
While Appellant acknowledged that breach of fiduciary duty is
constructive fraud, he argued vociferously that constructive fraud
is not actual fraud and thus, his claim is not fraud based. The
Trustee stated in his Response:
As they did in their original motion to dismiss, the
defendants further devote a considerable portion of their
efforts to the proposition that fraud pleadings must
sufficiently specify which defendants committed which
fraudulent acts ... This proposition remains undoubtedly true
and especially so in cases alleging common law fraud,
securities fraud, and/or RICO violations, all of which are
subject to Rule 9(b)'s heightened pleading requirements. This
case, however, invokes none of those types of claims.
(emphasis in the original)
The Trustee contends in this Court that his response in the
district court to the First Amended Complaint cannot be used
against him because he made new allegations of fraud in the
13
Supplemental Complaint. He contends that he clearly stated that
Appellees joined Ernst & Young in a fraud-based conspiracy;
therefore, the period of limitations is four years. This argument
ignores, however, the fact that the conspiracy claim was brought
against Ernst & Young only. The Trustee brought no new claims
against the LivingWell directors. We affirm the district court's
finding that the period of limitations is two years.
The Trustee again argues that even if the period of
limitations is two years, the adverse domination theory tolls the
statute. For the reasons stated in section 1 above, adverse
domination does not toll the statute. Therefore, we affirm the
trial court's finding that the director misconduct claims that
arose before October 27, 1987 are time barred.
3. Fraudulent transfers
Both Appellant and Appellee agree that the limitations period
for fraudulent transfers is four years and that no claim after
October 27, 1985 is barred. The Trustee claims, however, that the
claims before October 27, 1985 are not barred because the discovery
rule applies. Additionally, the Trustee argues that the district
court erred by ruling that the adverse domination theory did not
apply because the Trustee could not show that the directors were
active participants in wrongdoing. For the reasons discussed in
section 1 above, we affirm the district court's ruling that all
fraudulent transfer claims arising before October 27, 1985 are
barred.
We also affirm the district court's finding that limitations
14
had run on all of FCA's6 transfers made before October 25, 1987.7
All issues not briefed are waived. Villanueva v. CNA Ins. Co., 868
F.2d 684, 687 n. 5 (5th Cir.1989); Cinel v. Connick, 15 F.3d 1338,
1345 (5th Cir.1994). Here, the Appellant does not contest this
finding in his brief.
4. Negligence claim against Ernst & Young
The statute of limitations for negligence in Texas is two
years from the time the tort was committed. TEX. CIV. & REM. CODE
§ 16.003(a) (Vernon 1994); Kansa, 20 F.3d at 1372. Here, Ernst &
Young completed its allegedly negligent audit opinion March 31,
1987, and LivingWell did not file for bankruptcy until October 27,
1989; therefore the claim was already time barred at the time of
bankruptcy. Thus, unless the Trustee can show that the statute was
tolled, the negligence claim against Ernst & Young is time barred.
The Trustee argues that the discovery rule tolls the statute
of limitations and that the directors were unaware of the allegedly
negligent audit; however, this argument is specious. The Trustee
contradicts himself in his own brief. He argues that the directors
had knowledge of the allegedly negligent audit and intended that
the audit be inaccurate when he argues the fraud and conspiracy
claims against Ernst & Young. When he argues the negligence claim,
however, the Trustee asks this Court to disregard his claims of
6
FCA, Fitness Corporation of America, is a wholly owned
subsidiary of LivingWell. The Trustee filed its suit against the
Appellees on behalf of LivingWell and FCA.
7
FCA never filed for bankruptcy; however, the Trustee filed
this suit on FAC's behalf October 25, 1991. Thus, the four year
statute bars all claim arising before October 25, 1987.
15
knowledge and intent. He cannot have it both ways. If the
directors had the requisite knowledge and intent for the fraud and
conspiracy claims, then that knowledge is imputed to the
corporation unless the Appellant makes a showing of adverse
interest. See FDIC v. Shrader & York, 991 F.2d at 223-24. As
previously noted, Appellant has made no showing that the directors
acted entirely for their own interest and against the interests of
the corporation; therefore, Appellant has failed to make a showing
of adverse interest.
In the alternative, the Trustee argues that Ernst & Young
fraudulently concealed its wrongdoing and that the LivingWell
directors conspired with Ernst & Young to conceal their misconduct.
Again, this argument is contradictory. Either the directors knew
or they did not know of the allegedly bad audit. If the directors
knew, then the knowledge is imputed to the corporation. See FDIC
v. Shrader & York, 991 F.2d at 223-24.
Moreover, even if the directors were unaware that the audit
was performed negligently, the discovery rule would still not
apply. As stated earlier, the discovery rule requires (a) inherent
undiscoverability and (b) objectively verifiable evidence. S.V. v.
R.V., 933 S.W.2d at 6. Objectively verifiable evidence is the key
factor for determining the discovery rule's applicability. Id. The
Trustee states that he has a "plethora of contemporaneous records"
verifying Ernst & Young's misconduct, but the only evidence of
these records is a cite to the record that does not exist.
Trustee's Reply Brief p. 43-44, citing R. 58/15791.
16
Finally, in the face of directly contrary authority, the
Trustee claims that the statute is tolled by the doctrines of
repeated reassurance and continuous representation. The Trustee
contends that the Texas Supreme Court adopted the rule of
continuous representation in Hughes v. Mahaney & Higgins, 821
S.W.2d 154, 157 (Tex.1991), Gulf Coast Inv. Corp. v. Brown, 821
S.W.2d 159, 160 (Tex.1991), and Rowntree v. Hunsucker, 833 S.W.2d
103, 104-08 (Tex.1992); however, the Trustee is incorrect in his
understanding of these cases. Hughes and Gulf Coast stand for the
proposition that when an attorney commits malpractice, the statute
of limitations is tolled on the malpractice claim until all appeals
on the underlying claim are exhausted. Hughes, 821 S.W.2d at 157;
Gulf Coast Inv. Corp., 821 S.W.2d at 160. Rowntree is a medical
malpractice case that decides when a continuing course of treatment
ended for tolling purposes. Rowntree, 833 S.W.2d at 106-08.
Not only does Appellant incorrectly interpret the above cases,
but the Texas Supreme Court in Willis v. Maverick, 760 S.W.2d 642
(Tex.1988) held that the continuous representation doctrine does
not apply in Texas. There, the court held that the discovery rule
was more in line with previous Texas cases and better balanced the
policies underlying the statute of limitations. Id. at 645 n. 2.
Therefore, we affirm the district court's holding that the
Trustee's negligence claim against Ernst & Young is barred.
III
We review now claims not disposed of by limitations.
A. Standard of Review
17
As before, claims decided on summary judgment are reviewed de
novo. Decisions to admit or exclude evidence are reviewed for
abuse of discretion. Kelly v. Boeing Petroleum Services, Inc., 61
F.3d 350, 356 (5th Cir.1995). Findings on choice of law, the
definition of insolvency, the applicability of the trust fund
doctrine, the motions to strike, the Rule 49(a), Rule 50(a), Rule
12(b)(6) and Rule 9(b) motions to dismiss are also reviewed de
novo. Pullman-Standard v. Swint, 456 U.S. 273, 287, 102 S. Ct.
1781, 1789, 72 L. Ed. 2d 66 (1982); Joslyn Mfg. Co. v. Koppers Co.,
40 F.3d 750, 753 (5th Cir.1994); Little v. Liquid Air Corp., 37
F.3d 1069 (5th Cir.1994) (en banc ); Conkling v. Turner, 18 F.3d
1285 (5th Cir.1994). Admissibility of expert witness testimony is
reviewed for manifest error. Christophersen v. Allied Signal
Corp., 939 F.2d 1106, 1109-10 (5th Cir.1991) (en banc ).
B. Insolvency on a Consolidated Basis
Following the trial on insolvency, the Appellees moved for
summary judgment on the fraudulent conveyance and trust fund claims
asserted against the subsidiaries. The Trustee argued that
LivingWell and its subsidiaries were a single business enterprise,
and the jury's finding that LivingWell was insolvent as of December
31, 1986 was the same as finding LivingWell and the subsidiaries
insolvent as a single business enterprise.8 The Appellees
countered by filing a Rule 49(a) motion requesting that the
district court find that LivingWell and its wholly owned
8
We do not address the single business enterprise theory for
reasons explained below.
18
subsidiaries were not insolvent on a consolidated basis at any time
before October 27, 1989. Under Rule 49(a), if the court requires
the jury to return only a special verdict in the form of a special
written finding upon each issue of fact and the verdict omits any
issue of fact raised by the pleadings or evidence, then each party
waives the right to a jury determination of the omitted issue. The
court is then free to supply the finding on the issue. FED. R.
CIV. P. 49(a).
The district court granted both the summary judgment motions
and the Rule 49(a) motion. In granting summary judgment, the
district court stated that Appellant had failed to raise his single
business enterprise theory during the insolvency trial. Appellant
had, instead, treated the subsidiaries as separate from LivingWell.
The court held that the evidence, therefore, failed to establish
the subsidiaries' insolvency and so found the subsidiaries solvent
at all relevant times. Because they were solvent at all relevant
times and because the record indicated that the businesses
maintained separate books, the court found the single business
enterprise theory inapplicable. Thus, the court granted summary
judgment for all preference and fraudulent conveyance claims
against the LivingWell subsidiaries. While it is unclear why the
district court granted both the motion for summary judgment and the
Rule 49(a) finding, we hold that the district court did not err in
making the Rule 49(a) finding. Having made that finding, the
Trustee's single business enterprise theory is deprived of a
factual basis upon which to stand, and we do not address it.
19
Appellant correctly states that a Rule 49(a) finding cannot
be inconsistent with the jury verdict. McDaniel v. Anheuser-Busch,
Inc., 987 F.2d 298, 306-307 (5th Cir.1993). The Appellant argues
that the Rule 49(a) finding is inconsistent because, since the jury
found LivingWell insolvent, then by definition LivingWell on a
consolidated basis was insolvent. In support, the Trustee points
out that LivingWell's assets included the stock of its three wholly
owned subsidiaries: LW North, LW South, and LW Midwest. In
calculating the effect of the subsidiaries' stock on LivingWell's
worth, the Trustee argues that the subsidiaries assets have a
positive value when their fair market value exceed liabilities and
a zero value when liabilities exceed assets. Thus, LivingWell's
balance sheet solvency necessarily determines the solvency of its
subsidiaries.
We reject the Trustee's arguments. The finding is not
inconsistent with the verdict. As the Appellees point out, the
Trustee cites no legal or accounting authority for his argument
that LivingWell's solvency necessarily determines the solvency of
its subsidiaries. For example, the Trustee argues that the
subsidiaries' stock value was equal to their assets minus their
liabilities. Stock, however, is not valued so easily. There are
other factors to take into account such as the type of stock and
its marketability. See S. Ritchie and J. Lamberth, The Valuation
Process of Closely Held Corporate Stock, 54 Tex. B.J. 548, 550-54
(1991). Moreover, according to accounting standards of the
Financial Accounting Standards Board, intercompany balances and
20
transactions are eliminated when considering a company on a
consolidated basis. These intercompany balances and transactions
include open account balances, security holdings, sales and
purchases, interest, and dividends. Intercompany loss or profit is
not considered. GENERAL STANDARDS, Consolidation Procedure
Generally, § C51.109 (Financial Accounting Standards Bd.1986).
Additionally, it could be that LivingWell's subsidiaries were
solvent but that LivingWell's debts were so great that LivingWell
on a consolidated basis is insolvent. Thus, LivingWell's balance
sheet solvency does not necessarily determine the solvency of its
subsidiaries; therefore, we affirm the district court's Rule 49(a)
finding that LivingWell and its subsidiaries were not insolvent on
a consolidated basis until October 27, 1989.
C. LivingWell's Insolvency
1. Choice of Law
Federal courts sitting in Texas apply the law of the state of
incorporation when a corporation's internal affairs are implicated.
Maher v. Zapata Corp., 714 F.2d 436, 464 (5th Cir.1983). The
Trustee contends that the court erred in deciding that Texas law
controlled all trust fund claims. He contends that because trust
fund doctrine claims cannot exist unless the payee of the
challenged transaction is a director of an insolvent company, the
trust fund claims here implicate the internal affairs of
LivingWell. Further, because LivingWell reincorporated in Delaware
June 12, 1985, Delaware law should control all trust fund claims
arising after that date.
21
In Edgar v. MITE Corp., 457 U.S. 624, 645, 102 S. Ct. 2629,
2642, 73 L. Ed. 2d 269 (1982), the Supreme Court defined the internal
affairs of a corporation as "matters peculiar to the relationships
among or between the corporation and its current officers,
directors, and shareholders[.]" The question, here, then is
whether allegedly preferential transfers in a bankruptcy context
are matters peculiar to the relationship between a corporation and
its directors and officers. We hold they are not. Here, the trust
fund claims involve the rights of third party creditors. These
claims, then, are not peculiar to the relationship between
LivingWell and its officers and directors.
Having decided that the place of incorporation does not
decide necessarily which law to apply to the trust fund claims
arising as of June 12, 1985, we must still decide what law does
apply. To do so, we look to the Restatement (Second) of Conflict
of Laws. Section 301 states that when a corporation acts in a way
that an individual can, the choice of law principles that apply to
non-corporate parties apply to the corporation. RESTATEMENT
(SECOND) OF CONFLICT OF LAWS § 301 (1971). Those principles,
referred to as the "most significant relationship" test, are stated
in § 69, and Texas has adopted and applies that test. Duncan v.
9
§ 6 Choice-of-law Principles states in pertinent part:
(2) When there is no [statutory] directive, the factors
relevant to the choice of the applicable rule of law include
(a) the needs of the interstate and international
systems,
(b) the relevant policies of the forum,
22
Cessna Aircraft Co., 665 S.W.2d 414, 421 (Tex.1984). Thus, we
apply that test. Here, LivingWell's only tie with Delaware is that
it was incorporated there; however, its principal place of
business was in Texas, the challenged payments were made from
Texas, LivingWell's board met in Texas, and LivingWell's principal
asset, the Houstonian, was in Texas. Therefore, we affirm the
district court's holding that Texas law and not Delaware law
applies.
2. The Merits
To bring a trust fund claim in Texas, the corporation must be
insolvent and have ceased doing business when the challenged
transactions occurred. Mancuso v. Champion (In re Dondi Financial
Corp.), 119 B.R. 106, 111 (Bankr.N.D.Tex.1990).
The Trustee makes several claims as to both elements. First,
he argues that the district court erroneously restricted his proof
of insolvency to the balance sheet test which focuses on whether
liabilities exceeded assets at a fair valuation. See 11 U.S.C. §
101(32). Rather, the Trustee, pointing to Fagan v. La Gloria Oil
(c) the relevant policies of other interested states
and the relative interest of those states in the
determination of the particular issue,
(d) the protection of justified expectations,
(e) the basic policies underlying the particular
field of law,
(f) certainty, predictability and uniformity of
result, and
(g) ease in the determination and application of the
law to be applied.
23
& Gas Co., 494 S.W.2d 624, 629 (Tex.Civ.App.-Houston (14th Dist.)
1973), claims that he was entitled to prove insolvency either
through the balance sheet test or by showing that LivingWell was
unable to meet currently maturing debts in the ordinary course of
business. Assuming arguendo that the Trustee is correct, the error
is harmless. The Trustee wants to use the second definition of
insolvency to prove that LivingWell was insolvent before December
31, 1986; however, Appellant's trust fund claims arising before
October 27, 1987 are time barred. Thus, the error is harmless.
Second, the Trustee contends that the court erroneously
excluded evidence which he contends would have shown that
LivingWell was insolvent before December 31, 1986. Again, assuming
arguendo that the court erred, the error is harmless since all
claims arising before October 27, 1987 are time barred.
Third, the Trustee contends that the district court erred in
granting the Rule 50(a) motion finding that LivingWell was, as a
matter of law, solvent for all periods before December 31, 1986.
Again, the error was harmless for the reasons stated above.
The Trustee's final argument concerning trust fund claims is
that the district court erred in granting summary judgment
dismissing the remaining trust fund doctrine claims. As mentioned
above, to pursue a successful trust fund claim, one must prove that
a corporation is a) insolvent and b) ceased to do business at the
time of the challenged transaction. Fagan v. La Gloria, 494 S.W.2d
at 628. If the plaintiff, however, cannot show that the
corporation has ceased doing business, his claim may still succeed
24
if the plaintiff can show that the corporation has ceased doing
business in good faith. Id. at 631. Here, the Trustee claims that
there was substantial evidence that the Appellees acted in bad
faith. In support of his argument, the Trustee refers to his
summary of evidence and the testimony of three witnesses: Knepper,
Harris, and Schwartz. This evidence however is not sufficient to
overcome summary judgment. The summary of evidence is nothing but
a summation of conclusory affidavit testimony, and the testimony of
the first two witnesses was inadmissible for reasons explained
below in section III E. As for the third witness, Schwartz, he
merely states that certain data suggest that one transaction was
suspect. Therefore, we affirm the district court's dismissal of
the trust fund claims.
D. The Subsidiaries' Insolvency
The district court granted Appellee's 50(a) motion finding
that the subsidiaries were solvent until October 27, 1989.
Appellant argues that this finding was error because he had both
direct and indirect evidence of the subsidiaries, insolvency under
either the balance sheet or the equity test. The Trustee, however,
points to no evidence the subsidiaries' liabilities were greater
than their assets. Rather, he discusses LivingWell's insolvency.
As previously noted, the fact that LivingWell was insolvent does
not necessarily show the subsidiaries' insolvency.
In arguing that the subsidiaries were insolvent under the
equity test because they were unable to pay their debts as they
matured, the only evidence the Trustee offers is the testimony of
25
Randy Watson who testified that "We showed nice profits, but cash
flow-wise, we were broke." This testimony concerned only
LivingWell South and is not enough to overturn the Rule 50(a)
finding. We affirm the district court's finding that LivingWell's
subsidiaries were not insolvent before October 27, 1989.
The Trustee contends that the district court erred in
refusing to allow the Trustee to recover payments FCA made as a
nominee for LivingWell. The district court found, and the Trustee
does not dispute, that the statute of limitations barred the
recovery of transfers of money that belonged exclusively to FCA.10
While Appellant argued he could still recover transfers FCA made as
a nominee of LivingWell, the court rejected that argument stating
this claim fell within the "single business enterprise" claims
which the court had already rejected. The Trustee argues that the
"single business enterprise" theory is irrelevant as recovery is
simply a matter of agency or nominee relationship. Appellant,
though, does not offer this Court any evidence of agency or a
nominee relationship; therefore, we have no basis upon which to
reverse the district court. We affirm the district court's grant
of summary judgment on all trust fund claims based upon transfers
FCA made before October 27, 1989.
E. Director Misconduct
Appellant argues that the district court erroneously excluded
10
FCA never filed for bankruptcy so § 108(a) of the Bankruptcy
Code does not apply. The statute of limitations is two years and
this suit was filed October 25, 1991; thus, all claims arising
before October 25, 1989 are barred.
26
or ignored his evidence of director misconduct. In the case of
William Knepper, one of Appellant's experts, the court ruled the
proffered testimony inadmissible because Knepper was a lawyer and
his testimony would be conclusory and cumulative. The Trustee
argues that this was manifest error because the fact that Knepper
is a lawyer does not per se disqualify him as an expert witness.
Rather, the issue is whether Knepper had specialized training,
education, and experience that would enable him to assist the jury
in determining issues of director misconduct. The Trustee contends
that Knepper has the necessary training, education, and experience
because Knepper has been practicing law for 60 years, 25 of which
were in the fields of corporate officer and director liability,
director's and officer's indemnity insurance, and professional
liability insurance.
We agree that merely being a lawyer does not disqualify one
as an expert witness. Lawyers may testify as to legal matters when
those matters involve questions of fact. See e.g., Huddleston v.
Herman & MacLean, 640 F.2d 534, 552 (5th Cir. Unit A March 1981),
aff'd in part, rev'd in part on other grounds, 459 U.S. 375, 103
S. Ct. 683, 74 L. Ed. 2d 548 (1983)(lawyer could testify that language
in a boilerplate contract was standard because the effect of the
language went to scienter). However, "it must be posited as an a
priori assumption [that] there is one, but only one, legal answer
for every cognizable dispute. There being only one applicable
legal rule for each dispute or issue, it requires only one
spokesman of the law, who of course is the judge." Specht v.
27
Jensen, 853 F.2d 805, 807 (10th Cir.1988) (internal citations
omitted).
The Specht case involved a warrantless search. There, the
plaintiff's expert witness testified that warrantless searches were
unlawful, that the defendants committed a warrantless search, that
the only possible exception was unavailable, and that the acts of
an individual could be imputed to the accompanying officer under §
1983. Id. at 808. The Tenth Circuit held that such testimony was
not only inadmissible but harmful. The Court stated that while
experts could give their opinions on ultimate issues, our legal
system reserves to the trial judge the role of deciding the law for
the benefit of the jury. Id. at 808-09. Moreover, allowing
attorneys to testify to matters of law would be harmful to the
jury. Id. at 809. First, the jury would be very susceptible to
adopting the expert's conclusion rather making its own decision.
There is a certain mystique about the word "expert" and once the
jury hears of the attorney's experience and expertise, it might
think the witness even more reliable than the judge. Id. Second,
if an expert witness were allowed to testify to legal questions,
each party would find an expert who would state the law in the
light most favorable to its position. Such differing opinions as
to what the law is would only confuse the jury. Id. Thus, the
issue here is whether Knepper is testifying to purely legal matters
or legal matters that involve questions of fact.
In the report that Knepper submitted to Appellant, he stated
that he would give his opinion on "[w]hether LivingWell's officers
28
and directors fulfilled their fiduciary duties to the Company, its
creditors, and shareholders. If not, how and to what extent did
[they] breach their fiduciary duties." Such testimony is a legal
opinion and inadmissible. Whether the officers and directors
breached their fiduciary duties is an issue for the trier of fact
to decide. It is not for Knepper to tell the trier of fact what to
decide. Therefore, the trial court did not err in finding
Knepper's testimony inadmissible.
Even without Knepper's testimony, the Trustee argues he could
still prove director misconduct through his summary of evidence,
through the testimony of other expert witnesses, and through the
affidavit of a former LivingWell employee, Russell Harris.
Most of the "substantial evidence" in the summary of evidence
was either based on claims that were time barred or based on
conclusory statements in affidavits. The evidence that does not
fall within these two categories, such as statements that the board
of LivingWell declined to issue written directions to its
consultants, is not sufficient to overcome summary judgment.
As for the testimony of the other expert witnesses, their
opinions either were based on claims that are time barred or were
tentative and preliminary and therefore insufficient to overcome
summary judgment. Moreover, the district court properly sustained
the objection to Russell Harris' affidavit. While it purports to
show personal knowledge on its face, there is sufficient sworn
testimony to show that he does not have personal knowledge.
For the above reasons we affirm the district court's grant of
29
summary judgment on the director misconduct claims.
F. The Fraudulent Transfers
The Trustee brings his fraudulent transfer claims under TEX.
BUS. & COM. CODE § 24.006(a) which requires the claimant to prove
that the transferor was (1) insolvent at the time of the transfer
and (2) received less than fair value for the consideration it
paid. We assume, and the Appellees do not contest, that the
Trustee has standing to avoid the preferences LivingWell made.11
The district court dismissed both LivingWell's fraudulent
transfer claims arising before December 31, 1986 and the
subsidiaries' claims arising before October 27, 1989. The Trustee
argues that this was error because there was substantial evidence
that LivingWell and its subsidiaries transferred money and assets
while insolvent for less than fair value. To prove that the
district court erred where the subsidiaries are concerned, the
Trustee again argues the single business enterprise theory. For
the reasons stated above in section III D, we reject that theory
and affirm the district court's finding that the subsidiaries were
solvent at all times before October 27, 1989.
As for LivingWell, the Trustee argues that the finding that
LivingWell was not bankrupt before December 31, 1986 was error. We
agree. TEX. BUS. & COM. CODE § 1.201 states that unless otherwise
provided the definition of "insolvent" is either a person who has
11
We do affirm, however, the trial court's holding that the
Trustee does not have standing to bring FCA's fraudulent transfer
claims. While the Trustee argues that he has standing because FCA
is a nominee of LivingWell, that argument fails for the reasons
stated in section III D hereof.
30
ceased to pay bills in the ordinary course of business or cannot
pay debts as they come due or is insolvent within the meaning of
the federal bankruptcy code. TEX. BUS. & COM. CODE § 1.201(23).
Appellees argue that this is not the correct definition because
until 1993 the definition was "generally unable to pay debts" not
cannot pay debts. Assuming arguendo that the Appellees are
correct, the trial court still erroneously limited the definition
of insolvency to the balance sheet test. The error, however, was
harmless because the Trustee has not raised an issue of fact as to
lack of fair value.
The Trustee has preserved error with regard to four
transactions: the Gold Membership, the advertising fees paid to
Hemelgarn Racing, the equipment rental payments made to MWB
Leasing, and the payments to the Officer & Director ("O & D")
insurance trust. While the Trustee does mention "other
transactions" such as salary and consulting fees, he does not tell
this Court either the place in the record to find the evidence or
what the evidence is that supports his claim of excessive fees and
salaries. Both are required. Moore v. FDIC, 993 F.2d 106, 107
(5th Cir.1993).
The Appellees argue that the claim regarding the Gold
Membership is baseless because the transferee is not a party to the
appeal. Because the Trustee had settled with the transferee, the
Trustee can no longer pursue this fraudulent transfer claim. The
Trustee did not respond to this argument so we assume that the
Trustee was made whole by the settlement.
31
As for the advertising fees paid to Hemelgarn Racing, Inc.,
the Trustee relies wholly upon an expert witness report. The
expert's report, though, states that his conclusions are "tentative
and preliminary". Such evidence is not sufficient to overcome
summary judgment. The same problem afflicts the expert report on
the value of the lease payments made to MWB Leasing. There, the
expert states that his opinion is only preliminary and is subject
to a full appraisal report. In fact, he only states "the actual
payments appear to be excessive in the range of approximately 20%
over fair market value" (emphasis added). Again, such evidence is
not sufficient to overcome summary judgment.
The Trustee's final fraudulent transfer claim involves the O
& D insurance trust fund. This claim also fails. The sole basis
for the Trustee's claim that no value was received for the transfer
was the testimony of the lawyer, Knepper. For reasons which we
explained above, Knepper's testimony was excluded. Because the
evidence supporting the O & D insurance trust fund claim fails, the
claim also fails. Therefore, we affirm the district court's grant
of summary judgment for the fraudulent transfer claims.
G. Unlawful Stock Redemption
The Trustee alleges that on March 31, 1988 LivingWell
redeemed some of its stock by reacquiring LivingWell common stock
owned by Hfund. Because LivingWell is a Delaware corporation,
Delaware law controls. Section § 160(a)(1) of the Delaware General
Corporation Law states in pertinent part:
Every corporation may ... redeem ... its own shares;
provided, however, that no corporation shall: (1) ... redeem
32
its own shares of capital stock for cash or other property
when the capital of the corporation is impaired or when such
... redemption would cause any impairment of the capital of
the corporation[.] DEL. CODE ANN. tit. 8, § 160(a)(1) (1996).
The purpose of the statute is to protect creditors. In re Reliable
Manufacturing Corporation, 703 F.2d 996, 1001 (7th Cir.1983). The
statute is designed to prevent a corporation from rearranging its
capital structure so as to alter the assumed basis upon which
creditors have extended credit. Id. In other words, the statute
prevents a corporation from defrauding its creditors by
redistributing assets to its shareholders. Id.
We assume without deciding that there was a redemption.
Moreover, LivingWell, by jury finding, was insolvent when the
assumed redemption occurred. Thus the corporation was impaired.
The issue, however, is whether LivingWell redeemed the stock to
defraud its creditors. The Trustee does not show this Court how
the redemption defrauded LivingWell's creditors. On the contrary,
the Appellees offer evidence that the redemption was part of
dispute settlement and enabled LivingWell to pay off certain
existing debts. LivingWell's redemption does not fall within the
purposes of § 160; therefore, we affirm summary judgment.
H. Claims Against Majority Shareholder Mannai
There are three claims the Trustee alleges against
LivingWell's majority shareholder, Ahmed Mannai, and his companies.
First, that Mannai himself participated in intentional misconduct,
fraud-based conspiracy, and wrongdoing. Second, that Mannai and
his companies received payment for the unlawful stock redemption,
and third, that Mannai is liable as a director because of his
33
control over LivingWell's board of directors, including the
placement of his agents on the board. The district court dismissed
the first two claims for being inadequately pled because they were
not specified in the Second Amended Complaint and because the
Trustee stated in his deposition that the agency theory was the
exclusive basis for suing Mannai.12 The Trustee contends that this
was error because a theory of recovery does not have to be stated
specifically; rather, the pleadings only have to give adequate
notice. The Trustee, however, does not show this Court how his
Second Amended Complaint gives adequate notice. We affirm the
dismissal of the first two claims.
The sole issue, then, is whether the district court erred in
granting summary judgment on the Trustee's agency claim. The
Trustee argues that a shareholder who controls an insolvent
corporation stands in a fiduciary relationship to the corporation.
12B FLETCHER, CYCLOPEDIA OF LAW OF PRIVATE CORPORATIONS § 5765
(rev.perm. ed.1990). The Trustee contends that Mannai controlled
the board of directors because he helped create LivingWell, was its
largest shareholder, participated in the decision to create PAC and
through one of his companies, to pledge LivingWell stock to borrow
money through PAC. Moreover, he participated in the decision to
create Hfund and owned 100% of the equity in that company. Most
important, he controlled LivingWell by placing two of his agents on
the board of LivingWell and Hfund. Assuming arguendo that all
12
In his deposition, the Trustee states that the sole basis for
his allegation that Mannai was part of the directors who controlled
LivingWell was his conservations with his counsel.
34
these statements are true, they do not show that Mannai completely
dominated the board of LivingWell. As Appellees point out, and the
Trustee does not contradict, during the periods that Mannai's two
"agents" served concurrently on LivingWell's board, the LivingWell
board had no fewer than eight members. Thus, they were never a
majority of the board and Mannai could not have exercised complete
domination. Therefore, we affirm the district court's grant of
summary judgment for the claims against Mannai.
I. The Ernst & Young Claims
The Trustee's claims against Ernst & Young are for breach of
contract, fraud, and fraud based conspiracy. The Trustee, to
support the contract claim, merely tells this court that the trial
court's 12(b)(6) dismissal of the claim was error and that he is
entitled to recover the fees paid for the audit. As Ernst & Young
correctly points out, we decided in FDIC v. Ernst & Young, 967 F.2d
166, 172 (5th Cir.1992) that Texas law does not permit a breach of
contract claim based upon accounting malpractice. Therefore, we
affirm the dismissal of the breach of contract claim.
In deciding the fraud and fraud based conspiracy claim, we
address the fraud claim first because it is the underlying basis
for the conspiracy claim. The trial court dismissed that fraud
claim under Rule 9(b) which states that conclusory allegations of
fraud are not sufficient to survive dismissal. FED. R. CIV. P.
9(b). The court found that the trustee had failed to plead facts
to support his allegation of detrimental reliance. The Trustee
argues that this was error because while Rule 9(b) has a heightened
35
standard of pleading, the challenged conduct involves so many
complex transactions that less specificity is required. The
Supplemental Complaint satisfies the purposes underlying Rule
9(b)'s heightened pleading requirement because it states who, what,
when, where, why, and how the false statements were made and to
whom they were made. Ernst & Young challenges the statement that
the Supplemental Complaint advances a theory of detrimental
reliance but for the purpose of this opinion, we assume it does.
The Trustee argues that but for Ernst & Young's alleged
misrepresentations, LivingWell would not have continued to exist,
could not have incurred more debt, and would not have lost more
money.
This theory of detrimental reliance is insufficient. Under
Texas law, a cause of action is legally insufficient if the
defendant's alleged conduct did no more than furnish the condition
that made the plaintiff's injury possible. Union Pump Co. v.
Allbritton, 898 S.W.2d 773, 776 (Tex.1995). The Trustee's theory
would make Ernst & Young an insurer of LivingWell because Ernst &
Young would be liable for LivingWell's losses no matter what
created LivingWell's losses, i.e. a recession or a decline in the
fitness industry. Because the Trustee does not adequately allege
detrimental reliance, his fraud claim must fail. Moreover, because
the fraud claims fails the fraud based conspiracy claim must fail
also. Thus, we affirm the dismissal of the claims against Ernst &
Young.
CONCLUSION
36
For the reasons stated above, we AFFIRM the take nothing
judgment against the Trustee.
37