The Colonial BancGroup, Inc. et al v. PricewaterhouseCoopers LLP et al(LEAD CASE)

Filing 72

MEMORANDUM OPINION AND ORDER that Defendants' Motions to Dismiss (Docs. #34 and #35 ) are DENIED as further set out in the opinion and order. Signed by Chief Judge William Keith Watkins on 9/9/2014. (dmn, )

IN THE UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF ALABAMA
NORTHERN DIVISION
THE COLONIAL BANCGROUP, INC.,
and KEVIN O’HALLORAN,
Plaintiffs,
v.
PRICEWATERHOUSECOOPERS, LLP,
and CROWE HORWATH, LLP,
Defendants.

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) CASE NO. 2:11-CV-746-WKW
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[WO]
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MEMORANDUM OPINION AND ORDER
This case is before the court on the motions to dismiss (Docs. # 34 & 35)
filed by Defendant PricewaterhouseCoopers, LLP (“PwC”), and Defendant Crowe
Horwarth, LLP (“Crowe”). Defendants seek dismissal of the breach of contract
and professional malpractice claims brought against them in the Amended
Complaint (Doc. # 28) filed by Plaintiffs The Colonial BancGroup, Inc. (“CBG”),
as post-confirmation debtor, and Kevin O’Halloran, as plan trustee acting for and
on behalf of the debtor (collectively, “the Trustee”).1

The parties have fully

briefed the issues and provided the contracts and other documentation underlying
the claims. The motions are due to be denied.

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A similar suit against Defendants was initiated by FDIC as Receiver of Colonial Bank.
FDIC v. PricewaterhouseCoopers, LLP, 2:12-CV-957-WKW.

I. JURISDICTION AND VENUE
The Trustee commenced this suit in the Circuit Court of Montgomery
County, Alabama, and it was removed by Crowe to this court. Removal to the
district court of civil proceedings arising in or related to bankruptcy cases is
authorized. See 28 U.S.C. § 1334(b) and § 1452(a). Because this action relates to
CBG’s bankruptcy, the court has jurisdiction. Venue is also proper, as the Circuit
Court of Montgomery County lies within this district and division. See 28 U.S.C.
§ 1441(a) and § 1452(a). Personal jurisdiction is not contested.
II. STANDARD OF REVIEW
A Rule 12(b)(6) motion tests the sufficiency of the complaint against the
legal standard articulated by Rule 8: “a short and plain statement of the claim
showing that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a)(2). To survive a
motion to dismiss under Rule 12(b)(6), a complaint must contain sufficient factual
allegations, “accepted as true, to ‘state a claim to relief that is plausible on its
face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v.
Twombly, 550 U.S. 544, 570 (2007)).

While detailed factual allegations are

unnecessary, the standard demands “more than labels and conclusions,” something
beyond a “formulaic recitation of the elements of a cause of action.” Twombly,
550 U.S. at 555. It is not enough for a plaintiff to allege that it is entitled to relief;

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it must plead facts that “permit the court to infer more than the mere possibility of
misconduct.” Iqbal, 556 U.S. at 679.
III. BACKGROUND
The allegations of the Amended Complaint (Doc. # 28) are briefly
summarized here. Additional allegations will be cited as necessary throughout the
opinion.
The Trustee alleges that CBG, a bank holding company, and its wholly
owned subsidiary, Colonial Bank, were victimized by a massive fraud from
approximately 2002 to 2009. The fraud was perpetrated by two Colonial Bank
employees, Catherine Kissick and Teresa Kelly, who conspired with employees of
Taylor Bean & Whitaker Mortgage Corporation (“TBW”), Colonial Bank’s
mortgage warehouse lending division’s (“MWLD”) largest customer, and TBW’s
president, Lee Farkas. The fraud primarily consisted of TBW selling to CBG
interests in qualifying pools of mortgages that did not exist. When the fraud was
finally detected, the FDIC closed and sold Colonial Bank; CBG filed for
bankruptcy; and the fraudsters were convicted for their crimes. Defendants are the
accounting firms retained by CBG to serve as Colonial Bank’s auditors during the
relevant time period. Crowe provided internal auditing services, and PwC served
as outside independent auditor. The Trustee alleges that both PwC and Crowe
failed to detect the fraud, which caused financial injury to CBG. This failure gives
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rise to CBG’s claims against Crowe and PwC for breach of contract and
professional negligence.
IV. DISCUSSION
A.

Breach of Contract Claims
1.

Crowe

Crowe argues that CBG does not allege facts that plausibly support CBG’s
substantial performance of its own obligations under the contract. Specifically,
Crowe complains that CBG has not alleged – and indeed cannot allege – facts to
support the inference that CBG “ensure[d] that all information provided to [Crowe]
is accurate and complete in all material respects, contains no material omissions,
and is updated on a prompt and continuous basis,” one of “The Bank’s
Responsibilities” contained in their engagement letters. (Doc. # 34-1, 4/17/2007
Engagement Letter, at 4.) CBG counters that Crowe merely assumes that the
criminal fraud perpetrated by Colonial Bank employees is conclusive proof that
CBG could not have provided accurate information as required by the contract, but
that it is a factual issue not appropriate for resolution at the motion to dismiss
stage. CBG argues that its substantial performance of all material contract terms is
sufficiently alleged to survive a motion to dismiss.
The parties agree that, based on their engagement letters’ choice-of-law
provision, the breach of contract claim is governed by Illinois law. To properly
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plead a breach of contract claim, a plaintiff must allege the existence of a valid and
enforceable contract, performance by the plaintiff, defendant’s failure to comply
with a duty imposed by the contract, and a resultant injury to the plaintiff.
Van der Molen v. Wash. Mut. Fin., Inc., 835 N.E.2d 61, 69 (Ill. App. Ct. 2005);
Gallagher Corp. v. Russ, 721 N.E.2d 605, 611 (Ill. App. Ct. 1999). To survive a
motion to dismiss, the plaintiff must have alleged his own substantial compliance
with all material terms of the agreement. George F. Mueller & Sons, Inc. v. N. Ill.
Gas Co., 336 N.E.2d 185, 188 (Ill. App. Ct. 1975); see also InsureOne Indep. Ins.
Agency, LLC v. Hallberg, 976 N.E.2d 1014, 1025 (Ill. App. Ct. 2012). “Whether a
contract has been performed according to its terms is a question of fact,” George F.
Mueller & Sons, 336 N.E.2d at 188, to be decided by the jury. Ralph v. Karr Mfg.
Co., 314 N.E.2d 219 (Ill. App. Ct. 1974).
CBG adequately alleges substantial performance of its duties under the
engagement letters:
At all relevant times, [CBG] performed, or substantially performed, its
material obligations under the engagement letters, including, without
limitation, the payment of millions of dollars in fees and expenses to
Crowe for services rendered, the arrangement of onsite workspace for
the conduct of the audit services as and when requested by Crowe and
the provision of access to books and records of [CBG] and its
subsidiaries to the extent and in accordance with Crowe’s request. At
no time during the course of the engagements did Crowe ever provide
notice to [CBG] of any failure to perform its obligations under any of
the engagement letters.

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(Am. Compl. ¶ 180.)

The factual allegations of the Amended Complaint are

incorporated into Count IV, the breach of contract claim against Crowe. Whether
the parties performed their contractual obligations are questions of fact that cannot
be decided at least until after discovery, and probably not until trial. Moreover, it
needs to be determined whether the provision at issue is a material contract term (if
not, then performance need not be pleaded at all) or a condition precedent (if so,
then performance may be pleaded generally under Rule 9(c) of the Federal Rules
of Civil Procedure). Crowe does not address these legal issues, perhaps because
CBG’s characterization of “The Bank’s Responsibilities” in the engagement letters
as a general obligation on the part of CBG to cooperate with Crowe’s auditing
services is a fair interpretation of the contract. In any event, the pleading is
sufficient to state the element of the claim requiring the plaintiff’s performance.
Twombly and Iqbal do not require CBG to prove the breach of contract, only to
assert its plausibility. CBG has met this burden. Crowe’s motion to dismiss on
this ground is due to be denied.
2.

PwC

PwC makes similar arguments in support of dismissal of CBG’s breach of
contract claim against PwC.

PwC asserts that CBG has not alleged its own

performance under the engagement letters and that the alleged facts documenting
the fraud by Colonial Bank employees show that CBG did not, and could not have,
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performed its contract obligations. The contracts between CBG and PwC do not
contain a choice of law provision, but the parties agree that the contract is
governed by Alabama law. To plead a breach of contract claim, a plaintiff must
allege the existence of a valid and binding contract, performance under the contract
by the plaintiff, the defendant’s nonperformance, and damages. See Jones v. Alfa
Mut. Ins. Co., 875 So. 2d 1189, 1195 (Ala. 2003); Winkleback v. Murphy, 811
So. 2d 521, 529 (Ala. 2001).
CBG adequately alleges substantial performance of its duties under the
contracts with PwC. (Am. Compl. ¶ 169.) The factual allegations of the Amended
Complaint are incorporated into Count II, the breach of contract claim against
PwC. Both CBG’s and PwC’s performances under the contracts are questions of
fact that cannot be decided at the motion to dismiss stage, where the breach of
contract is plausibly alleged. PwC’s motion to dismiss on this ground is due to be
denied.
B.

Professional Negligence Claims
1.

Crowe

While Crowe asserts that Alabama law governs the negligence claim, CBG
asserts that Florida law may ultimately govern due to where the injury took place.
Crowe’s arguments at this stage will be addressed under the assumption that
Alabama law applies.
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Crowe argues that CBG’s professional negligence claim should be dismissed
for two reasons. First, Crowe argues that, because the alleged injury occurred in
relation to Crowe’s contractual duties, CBG cannot allege a negligence claim in
addition to a breach of contract claim. This argument misstates indisputably clear
Alabama law on professional malpractice. Alabama law imposes on accountants a
“duty to exercise reasonable professional care,” regardless of the existence of a
valid contract between accountant and client. Blumberg v. Touche Ross & Co.,
514 So. 2d 922, 925 (Ala. 1987). Where a valid contract does exist, plaintiffs
injured by their accountant’s misconduct are not precluded from bringing an action
in either contract or tort:
In Alabama, one who contracts with another and expressly promises
to use due care is undoubtedly liable in both tort and contract when
his negligence results in injury to the other party. He is liable in
contract for breaching an express promise to use care. He is liable in
tort for violating the duty imposed by law on all people not to injure
others by negligent conduct. The injured party has the choice of
remedies when a contract contains an express promise to use due care.
Id. at 927. CBG alleges that Crowe contracted with CBG to perform accounting
services and promised to comply with particular accounting standards when
providing those services.

(Am. Compl. ¶¶ 119–160.)

Therefore, CBG may

maintain both causes of action against Crowe.
Crowe’s second argument for dismissal is that, although it provided internal
auditing services to CBG, it was not CBG’s internal auditor, and thus it had no
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professional duty of care to CBG. The distinction between “provider of outsourced
internal audit services” and “internal auditor” is reed thin, and it makes no
difference with regard to an accountant’s duty to exercise reasonable professional
care. The allegations, taken as true, establish that Crowe engaged in auditing
services and thus had a duty of professional care.
2.

PwC

PwC argues that CBG’s professional negligence claim against PwC must be
dismissed because the Amended Complaint alleges contributory negligence on the
part of CBG and CBG’s agent, Crowe. The parties disagree as to which state’s law
governs the negligence claim. Again, assuming without deciding, the court will
address the arguments at this stage under Alabama law.
Under Alabama law, “[c]ontributory negligence is an affirmative and
complete defense to a claim based on negligence.” Serio v. Merrell, Inc., 941
So. 2d 960, 964 (Ala. 2006) (quotation marks and citation omitted). That is, even
if PwC is found to be negligent, CBG would not be able to recover if CBG’s own
negligence is found to have proximately contributed to its damages. However,
contributory negligence is a question of fact for the jury. Id. Although the issue
may be decided as a matter of law in rare circumstances, the allegations of the
Amended Complaint do not establish the contributory negligence of CBG any
more conclusively than they establish the negligence of PwC and Crowe. For this
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reason, the motion is due to be denied. Still, the court briefly addresses the
substance of PwC’s arguments.
PwC’s contributory negligence defense fails under both of its agency
theories.2 PwC proposes two theories under which wrongful conduct of others
may be imputed to CBG. First, PwC argues for the imputation of Kissick’s and
Kelly’s fraud to CBG, characterizing those Colonial Bank employees as members
of CBG’s management or at least as agents of CBG. Even if those allegations
were made in the Amended Complaint, which they are not, the theory fails because
Kissick and Kelly are alleged to have defrauded CBG. CBG cannot be charged
with the knowledge of Kissick and Kelly where those Colonial Bank employees
were scheming to defraud CBG or at a minimum were acting adversely to CBG’s
interests. See Florence v. Carr, 148 So. 148, 149 (Ala. 1933). Second, PwC
argues for the imputation of Crowe’s alleged wrongful conduct to CBG,
characterizing Crowe as CBG’s agent.

Taken as true, the allegations of the

Amended Complaint (as well as the engagement letters between CBG and Crowe
and the professional standards for auditors) do not establish that Crowe was an
agent of CBG, as CBG did not retain the right of control over what Crowe’s
auditing services entailed and how Crowe conducted those services. Brown v.

2

To the extent that PwC argues an in pari delicto defense, its applicability in this case is
questionable. Nevertheless, the defense fails at the motion to dismiss stage because the alleged
facts do not support a conclusion that CBG was equally at fault with the defendants.
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Commercial Dispatch Publ’g Co., 504 So. 2d 245, 246 (Ala. 1987). In any event,
agency generally is a question for the trier of fact. Id.
C.

Damages
1.

Proximate Causation

Crowe makes an argument, in which PwC joins, that the Amended
Complaint does not properly allege that Defendants’ misconduct was the
proximate cause of CBG’s damages.3
Under Alabama law, “[p]roximate cause is an act or omission that in a
natural and continuous sequence, unbroken by any new independent causes,
produces the injury and without which the injury would not have occurred.”
Gooden v. City of Talladega, 966 So. 2d 232, 239 (Ala. 2007). A “natural and
continuous sequence” means “unbroken by any new independent causes.”
Subsequent causes of injury, such as fraudulent or criminal acts of a third person,
are not “new independent causes” that intervene or break the chain of causation,
unless those subsequent causes are unforeseeable by the defendant. Thetford v.
City of Clanton, 605 So. 2d 835, 840 (Ala. 1992). The notion of foreseeability is
key to a proximate cause analysis. Gen. Motors Corp. v. Edwards, 482 So. 2d
1176, 1194 (Ala. 1985). If the defendant could have reasonably anticipated the
3

Crowe refers to proximate causation as “loss causation.” Although loss causation is
comparable to proximate causation in the context of securities fraud, the label is inappropriate
here.
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plaintiff’s injury as a result of the defendant’s actions or omissions, then the
defendant may be liable. Thetford, 605 So. 2d at 840.
Proximate cause is a question to be determined by the trier of fact. Gooden,
966 So. 2d at 239. At this stage, the Amended Complaint adequately alleges that
the actions or inactions of Crowe and PwC resulted in foreseeable injuries to CBG.
(Am. Compl. ¶¶ 37, 47–49.)
2.

Consequential Damages

Crowe argues that its engagement letters with CBG preclude consequential
damages. Taken as true, the allegations of the Amended Complaint state a claim
for direct damages proximately caused by Crowe’s alleged breach and negligence.
Should CBG ultimately prevail in its breach of contract claim against Crowe, the
court will revisit the issue of which damages are allowable under the contracts.
V. CONCLUSION
The court does not, at least on the pleadings, buy into PwC’s express and
Crowe’s implied arguments that they are fraud victims here. Such arguments
fundamentally misstate the professional role of auditors in the banking business.
The court appreciates the vigor with which all parties are litigating their respective
cases. That being said, all parties are cautioned to stay in bounds. Some
characterizations of the alleged facts and citations to case law were misleading and
perilously close to constituting dishonesty toward the court.
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For the reasons stated above, it is ORDERED that Defendants’ Motions to
Dismiss (Docs. # 34 and 35) are DENIED.
DONE this 9th day of September, 2014.

/s/ W. Keith Watkins
CHIEF UNITED STATES DISTRICT JUDGE

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