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PLAN COMMITTEE v. PricewaterhouseCOOPERS

August 31, 2005.

THE PLAN COMMITTEE, Plaintiff,
v.
PRICEWATERHOUSECOOPERS, LLP, Defendant.



The opinion of the court was delivered by: RICHARD ROBERTS, District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff, established by the United States Bankruptcy Court for the District of Columbia to oversee bankruptcy proceedings on behalf of the unsecured creditors of the Greater Southeast Healthcare Providers ("Greater Southeast"), filed a two-count diversity action against defendant PricewaterhouseCoopers, LLP ("PWC") alleging that defendant negligently conducted its independent audits of Greater Southeast's accounts and breached its contract to provide for Greater Southeast accounting and audit services in compliance with the Generally Accepted Auditing Standards and Principles. Defendant filed a motion to dismiss on four grounds arguing that (1) plaintiff lacks capacity to sue under Federal Rule of Civil Procedure 9; (2) plaintiff fails to state a negligence or breach of contract claim under Rule 12(b)(6); (3) the claims are barred by Greater Southeast's contributory negligence; and (4) the claims are barred by the statute of limitations notwithstanding tolling agreements signed by plaintiff and defendant. Because plaintiff has set forth claims upon which relief may be granted, defendant's motion to dismiss will be denied. Because plaintiff has standing to sue under the Bankruptcy Code but lacks capacity to sue, but has stated that it would move to join another party who does have capacity to sue, plaintiff will be granted leave to move to amend its complaint to substitute a party with capacity to sue as plaintiff.

BACKGROUND

  Defendant provided auditing and accounting services during the 1990's to Greater Southeast, a group of healthcare providers and administrative offices, before Greater Southeast filed for bankruptcy in 1999.*fn1 (Compl. ¶¶ 3, 11, 17.) Defendant conducted annual audits of Greater Southeast's financial statements for 1995, 1996, 1997 and 1998, and prepared annual "Reports of Independent Auditors," purporting to have conducted those audits in conformity with Generally Accepted Auditing Standards ("GAAS").*fn2 (Id. ¶¶ 19, 21.) Plaintiff alleges that defendant acknowledged that an audit conforming with GAAS would reasonably assure that the audit was free of material misstatements, and that it would have been conducted after defendant had "examine[d] the evidence, assess[ed] the accounting principles, review[ed] significant estimates, and otherwise evaluate[d] the overall presentation of [Greater Southeast's] financial statements." (Id. ¶ 21.) Plaintiff asserts that defendant, contrary to its representations, failed to conduct its audits in accordance with GAAS for audit years 1995 through 1998 by preparing reports which materially overstated Greater Southeast's "net realizable value." (Id. ¶ 26.)

  The inflated net realizable value, plaintiff contends, resulted from defendant's failure to account for Greater Southeast's accounting practices in which net revenue was accrued. (See id. ¶ 24.) Although Greater Southeast's hospitals collected payments after services had been rendered by later billing their patients, net revenue was recorded at the time services were delivered. (Id.) Those services were in large part then billed to third party payors in amounts above the amount for which the third party payors would be responsible. As a result, without accurately reflecting the difference between the amounts charged and the actual amounts received, Greater Southeast's accounts receivable balances were overstated, or "not presented at `net realizable value.'" (Id. ¶¶ 25-26.)

  When defendant conducted its audits of Greater Southeast's finances, plaintiff states that defendant should have — but failed to — scrutinize the hospitals' accounts receivable balances. (Id. ¶ 31.) According to plaintiff, established audit practices required defendant to "take into account [Greater Southeast's] internal controls, underlying contractual arrangements, post collection history, and subsequent collection experience" to determine whether Greater Southeast's accounts realizable balances accurately reflected the net realizable value. (Id.) Because defendant failed to note the difference between the net realizable value and the accounts receivable balances, plaintiff contends that Greater Southeast "did not discover the nature and severity of its financial situation" until it could not avoid insolvency and bankruptcy. (Id. ¶ 49.) Plaintiff alleges that if defendant had "complied with its professional standards of care with respect to its audits, . . . [Greater Southeast] would have taken actions to avoid insolvency and bankruptcy" because Greater Southeast would have recognized its financial troubles. (Id. ¶¶ 50, 51.)

  Plaintiff asserts that defendant should have noted that Greater Southeast's financial statements were overstated because defendant had audited a number of clients in the healthcare industry which had similar accounting practices; had been responsible for Greater Southeast's debt refinancing in 1993 which should have made the defendant familiar with Greater Southeast's financial structure; and because in 1997 a third party purchased only some of Greater Southeast's accounts receivables, an indication, plaintiff alleges, that Greater Southeast's statements were inaccurate. (Id. ¶¶ 34, 35, 39.) As a result of defendant's failure to discover the misstatements, plaintiff alleges that Greater Southeast's net operating income was overstated by $27 million for years prior to 1998, and that Greater Southeast was not made aware of "the nature and the severity of its financial situation until early in 1999." (Id. ¶ 49.) Greater Southeast filed for bankruptcy in 1999 under Chapter 11 of the United States Bankruptcy Code. (Id.; see In re The Greater Southeast Community Hosp. Found., Inc., et al., 237 B.R. 518 (Bankr. D.D.C. 1999).)

  Under the Second Amended Joint Plan ("Plan") of liquidation for the bankruptcy proceedings of Greater Southeast, approved by the bankruptcy court in a Confirmation Order in 2001, plaintiff was established to "[c]ommence, prosecute, and if appropriate, settle all causes of action vested on behalf of creditors . . . and prosecute all causes of action of the Debtors' Estates, the Committee, the Plan Committee, or on behalf of the creditors of an Estate generally," among other responsibilities. (Pl.'s Opp'n to Def.'s Mot. to Dismiss ("Pl.'s Opp'n") Ex. 4 ("Second Am. Plan") at 45.) The Plan required that the Plan Committee consist of three members of the Committee of Unsecured Creditors, and granted it the responsibility to "pursu[e] . . . all litigation which is intended to result in recovery to the General Claim Fund" for the creditors. (Id. at 46.) The Plan provided for the Plan Committee to "retain and . . . enforce for the sole and exclusive benefit of creditors pursuant to the terms of [the Plan] any claims, rights and causes of action that the respective Estates, the Committee, or creditors as a group, may hold against any Person." (Id. at 47.) As the purported successor to the Creditor's Committee formed before and dissolved after the Plan was confirmed, plaintiff executed an agreement with defendant pursuant to plaintiff's putative authority from the Confirmation Order and the Plan to toll any unexpired statutes of limitations on causes of action plaintiff could have brought against the defendant. (Pl.'s Opp'n at 28; Def.'s Mem. in Supp. of Mot. to Dismiss ("Def.'s Mot.") at 34.) The agreement was extended four times to July 31, 2002. On July 26, 2002 plaintiff filed its two-count complaint, alleging in Count I professional negligence and audit malpractice based on defendant's alleged failure to exercise appropriate care and competence in reviewing and auditing Greater Southeast's finances for 1995 through 1997, and in Count II breach of contract based on defendant's failure to audit Greater Southeast's finances from 1995 through 1999 in conformity with GAAS. Plaintiff seeks compensatory damages of $70 million on each count.

  Defendant filed a motion to dismiss, arguing that the Plan Committee does not have the capacity to sue under Rule 9, that the claims fail as a matter of law under Rule 12(b)(6), that plaintiff was contributorily negligent such that it is precluded from recovering damages from defendant, and that the purported tolling agreements are void, rendering plaintiff's claims time barred by the statute of limitations. Plaintiff opposes.

  DISCUSSION

  I. STANDING

  Defendant states briefly, without citing legal authority, that "the Plan Agent is the sole trustee, and under applicable law it is the trustee who has standing to sue on behalf of a trust, not a board of advisors such as the Plan Committee. . . ." (Reply Mem. of P. & A. of Def. PricewaterhouseCoopers in Supp. of Mot. to Dismiss ("Def.'s Reply Mem.") at 9.) Because any recovery here would go to the Plan Agent, defendant argues that plaintiff lacks standing to bring those claims which would benefit directly only the Plan Agent. "[B]ecause standing is jurisdictional under Article III . . ., it is a threshold issue in all cases since putative plaintiffs lacking standing are not entitled to have their claims litigated in federal court." Official Comm. of the Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d 147, 156 (2d Cir. 2003) (internal quotation omitted).

  Under the Bankruptcy Code, a trustee of a bankruptcy estate "stands in the shoes of the [bankrupt debtor] and has standing to bring any suit that [the bankrupt debtor] could have instituted had it not petitioned for bankruptcy." Id. (internal quotation omitted); see also 11 U.S.C. § 541 (2000) (deeming "all legal or equitable interests in property as of the commencement of the case" property of the estate); id § 323(b) ("The trustee in a case under this title has the capacity to sue and be sued."). Although typically only the trustee has standing to pursue claims on behalf of the bankrupt debtor, some circuits have interpreted the Bankruptcy Code and the equitable purposes of bankruptcy law to authorize derivative standing on creditors' committees under limited circumstances. For instance, a "creditors' committee may acquire standing to pursue the debtor's claims if (1) the committee has the consent of the . . . trustee, and (2) the court finds that suit by the committee is (a) in the best interest of the bankruptcy estate, and (b) is `necessary and beneficial' to the fair and efficient resolution of the bankruptcy proceedings." In re Commodore Int'l Ltd., 262 F.3d 96, 100 (2d Cir. 2001); see also Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548, 566, 568 (3d Cir. 2003) (en banc) ("We believe that the ability to confer derivative standing upon creditors' committees is a straightforward application of bankruptcy courts' equitable powers."). Derivative standing allows parties "to pursue valuable actions when the [party with direct standing or express statutory authorization to have standing] unreasonably refus[es]" to bring suit. See Chinery, 330 F.3d at 568. By extension, some courts have allowed creditors' committees to pursue those valuable actions with the permission of the trustee, even if the trustee has not refused to bring suit. See id. at 568-69 (exhaustively examining Bankruptcy Code sections 1109(b), 1103(c)(5), and 503(b)(3)(B), and the role of creditors' committees in bankruptcy proceedings, to hold that the committees have standing to pursue actions on behalf of the debtor).*fn3 In addition, the committee must demonstrate to a court that its claims are both in the best interest of the estate, and necessary and beneficial to the bankruptcy proceedings. Without such a finding, the committee may lack derivative standing and authority to bring suit in court.

  Plaintiff obtained the consent of the Plan Agent, as successor in interest to the debtor, to "further examine/pursue claims against [Greater Southeast's] prepetition auditors." (Def.'s Mot. Ex. C ("Emergency Mot. of the Official Comm. of Unsecured Creditors") at ¶ 12; Def.'s Mot. Ex. C (Debtors' Response) at ¶ 1 ("The Debtors do not oppose the Committee's request for authority to bring the causes of action.").) In addition, although the Bankruptcy Court did not expressly find that this litigation would be necessary and fair to the bankruptcy, it granted the Creditors' Committee "immediate authority and formal standing to . . . prosecute . . . causes of action arising out of the Damages Actions. . . ." (Def.'s Mot. Ex. C (Order of Apr. 2, 2001) at ¶ 2; see also Emergency Mot. of the Official Comm. of Unsecured Creditors at 1 (defining Damages Actions to include a cause of action against Greater Southeast's pre-petition auditors).) The court found "that there [was] just cause to grant to the Committee the relief [it] sought" (Def.'s Mot. Ex. C (Order of Apr. 2, 2001) at 1), based on the Creditors' Committee's representation in its motion that "there is a probability that it will obtain a valuable recovery on the Damages Actions [and] . . . that pursuing the Damages Actions is beneficial to the estate and for unsecured creditors." (Emergency Mot. of the Official Comm. of Unsecured Creditors at ¶ 29.) In any event, a potential recovery of $70 million as plaintiff requests in its complaint, weighed against the costs of litigation, would suggest that the case could be in the best interest of the bankruptcy estate and necessary and fair to Greater Southeast's bankruptcy proceedings. Plaintiff has established the requirements necessary to gain derivative standing to pursue this action. II. CAPACITY TO SUE

  Defendant also challenges under Federal Rule of Civil Procedure 9*fn4 plaintiff's capacity to sue in this court as an unincorporated association, which lacks capacity to sue under District of Columbia law.*fn5 Plaintiff counters that it is not an unincorporated association, and that it has capacity to sue because it was established by the Bankruptcy Code which, by operation of the Supremacy Clause of the United States Constitution, vests it with capacity to sue. Plaintiff also asserts that it may sue because it is a "fiduciary" — which has putative authority under District of Columbia law to bring suits — with a duty to bring causes of action on behalf of the debtor and unsecured creditors.

  "Capacity has been defined as a party's personal right to come into court, and should not be confused with the question of whether a party has an enforceable right or interest or is the real party in interest." Bd. of Educ. of the City of Peoria v. Illinois State Bd. of Educ., 810 F.2d 707, 709-710 (7th Cir. 1987) (quoting 6 C. Wright & A. Miller, Federal Practice and Procedure § 1559). Rule 17 provides in relevant part that "capacity [of a party that is not an individual or a corporation] to sue or be sued shall be determined by the law of the state in which the district court is held[.]" Fed.R.Civ.P. 17(b). Therefore, to proceed in this court on state common law claims, as plaintiff does here, a party may have the capacity to sue only if the law of the District of Columbia permits it to sue. See Busby v. Electric Utilities Employees Union, 323 U.S. 72, 74 (1944); D.C. Super. Ct. R. Civ. P. 17(b).

  A. Supremacy Clause and Preemption of State Law

  "In determining whether a state statute is pre-empted by federal law and therefore invalid under the Supremacy Clause of the Constitution, [the] sole task is to ascertain the intent of Congress." California Fed. Sav. & Loan Ass'n v. Guerra, 479 U.S. 272, 280 (1987). Article I, § 8 of the Constitution vests Congress with the authority to establish uniform bankruptcy laws and where "Congress has chosen to exercise [that] authority, contrary provisions of state law must accordingly give way." In re Princeton-New York Investors, Inc., 219 B.R. 55, 59 (D.N.J. 1998) (citation omitted). There is a "basic assumption that Congress did not intend to displace state law" in the bankruptcy context, ...


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