Neblett v. Clairmont Paciello & Co., P.C. et al

Filing 35

MEMORANDUM (Order to follow as separate docket entry).Signed by Honorable Matthew W. Brann on 6/8/16. (km)

IN THE UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF PENNSYLVANIA
JOHN P. NEBLETT, as Chapter 7
Trustee of VALLEY FORGE
COMPOSITE TECHNOLOGIES,
INC.,
Plaintiff,
v.
CLAIRMONT PACIELLO & CO.,
P.C., MOUNTJOY CHILTON
MEDLEY LLP, MICHAEL DE
LEON HAWTHORNE and
THOMPSON COBURN LLP,
Defendants.

:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:

Nos. 4:15-cv-01622
4:15-cv-01731
4:15-cv-01826
(Judge Brann)

MEMORANDUM
June 8, 2016
There is no more ideal an image of hardworking American values
than that of a small-town manufacturer opening its factory doors. And in
recent years, there has been no more apt an illustration of the strength of
the American fiber than the way in which our country responded when
the terrorist attacks of September 11, 2001 threatened those values.

-1-

Although this case harkens to both of these examples of American
exceptionalism in a compelling way, the disloyal acts that initiated the
present dispute follow a more disappointing trajectory.
At this story’s beginning, Robert Frost’s nostalgic observation that
“nature’s first green is gold,” may be just the way to describe the early
flourishing of Valley Forge Composite Technologies, Inc., a Covington,
Kentucky manufacturer of advanced technologies established in 1996
(hereinafter “Valley Forge”). So prosperous was Valley Forge in its
incipient years that its devices were utilized in spacecrafts and in the wake
of the September 11 attacks, in security screening devices at airports and at
the 2014 Winter Olympics.
However, not even Frost, who admonished that gold was nature’s
“hardest hue to hold,” could have envisioned the precise denouement that
this American manufacturer would follow—to Frost’s credit, neither could
even the most inventive writers of fiction. As it unfolded, Valley Forge
would ultimately meet its demise at the hands of a criminal scheme
orchestrated by one of its co-founders. In stark contrast to the ideal

-2-

American company Valley Forge once billed itself to be, a federal
investigation would later culminate in the 2014 indictment of its cofounder and CEO Louis J. Brothers, as well as his wife, Rosemary Brothers.
The indictment charged the couple with exporting various defense
technologies to Hong Kong and the People’s Republic of China without
approval of the United States Department of State.
Upon his entering a plea of guilty to the indictment, Brothers
admitted that he used Valley Forge as a vehicle to further his illicit
international scheme by publicly reporting several contracts purchased for
Valley Forge products, contracts which never truly existed but instead
were intended to camouflage the revenues gained from his international
money laundering efforts. The hollowness of Valley Forge’s true business
now revealed, the price of the company’s stock plummeted, and the
company was forced to file for Chapter 7 bankruptcy in late 2013.
The cases presently before this Court suggest that certain of the
accounting and legal professionals who provided services to Valley Forge
during the time of Brothers’s scheme failed to fulfill their duty of

-3-

reasonable care to the company and consequently, to its shareholders. In
context, the sole issue presented in the underlying motions to dismiss is
whether Plaintiff, the Chapter 7 trustee for Valley Forge, has alleged
sufficient facts plausibly suggesting the Defendants’ negligence. Because
the facts alleged in the Amended Complaint satisfy the plausibility
standard, Defendants’ motions to dismiss will be denied. Nevertheless, the
foregoing analysis enumerates several factual considerations toward
which discovery and dispositive motions may effectively be directed.
I.

BACKGROUND
A.

Founded in 1996, Valley Forge begins developing
momentum wheels for spacecrafts, before expanding into
the production of high-security airport screeners and related
anti-terrorism devices in the wake of September 11, 2001.

Founded in 1996, Valley Forge Composite Technologies developed,
acquired, produced, and sold certain advanced technologies and devices. 1
At all relevant times, Valley Forge’s sole places of business were an
administrative office located at 50 East River Center Boulevard, Covington,

1

Pl.’s Am. Compl., 4:15-cv-01622, ECF No. 20 ¶ 20.

-4-

Kentucky and a separate facility located in Erlanger, Kentucky.2 Valley
Forge was founded by Louis J. Brothers and Larry K. Wilhide.3 At all times
relevant to this litigation, Brothers was President and CEO of Valley Forge,
and his wife, Rosemary Brothers, was an administrative employee of the
company who acted as an in-house bookkeeper.4
The company’s earliest product was a “momentum wheel,” a
component used to stabilize the altitude of a spacecraft without using fuel
or other mechanisms.5 The last Securities and Exchange Commission (SEC)
annual 10-K report filed by Valley Forge for the 2011 fiscal year explained
that momentum wheels “are used for energy storage to provide an
uninterrupted power supply.”6 The momentum wheels store energy and

2

Id. ¶ 6. Valley Forge was organized under the laws of the State of Florida. Id.
¶ 5.

3

Id. ¶ 7. See also See Neborsky v. Valley Forge Composite Technologies, Inc.,
3:13-cv-02307-MMA-BGS, ECF No. 25 at 2 ¶ 1 (S.D. Cal. May 12, 2014).

4

Id. ¶ 8.

5

Id. ¶ 20.

6

United States Securities and Exchange Commission 2011 Form 10-K: Valley
Forge Composite Technologies, Inc. at *4 (Mar. 30, 2012) (hereinafter “Valley

-5-

provide stabilization as they rotate at high speeds, “much like a spinning
top.”7 “As they spin down, the stored energy can be released to produce
power.”8
As a result of the September 11, 2001 terrorist attacks, Valley Forge
began developing homeland security and counter-terrorism products,
including a passenger weapons screening device used in airports and at
other high-security venues.9 The weapons scanner, which was capable of
detecting metal and non-metal objects hidden on or in the human body,
was known as “ODIN” and was featured as the official security scanning
device for the 2014 Winter Olympic Games in Sochi, Russia.10
In addition to the ODIN project, Valley Forge also was working to
develop and bring to market a system that it named “THOR,” which was a

Forge 2011 Form 10-K”), http://www.sec.gov/Archives/edgar/data/1332412/
000121465912001424/s32312110k.htm.
7

Id.

8

Id.

9

Am. Compl. ¶ 21.

10

Id.

-6-

particle accelerator designed to detect illicit narcotics, explosives, and biochemical weapons hidden in cargo containers.11 THOR operated by
“creating photo nuclear reactions in light elements” and “selectively
screening out all but the operational isotopes found in modern day
explosives and narcotics,” a process that could purportedly identify the
illicit substance by making automatic comparisons between the observed
particles and THOR’s internal database.12
B.

Valley Forge secures a $250,000.00 investment from Lincoln
Park Capital Fund.

To fund production, marketing and sale of momentum wheels, as
well as the ODIN and THOR systems, Valley Forge entered into a common
stock purchase agreement with Chicago-based institutional investor
Lincoln Park Capital Fund, LLC.13 According to Plaintiff’s Amended
Complaint, Lincoln Park agreed to purchase $250,000.00 worth of Valley

11

Id. ¶ 22.

12

Valley Forge 2011 Form 10-K at *5.

13

Am. Compl. ¶¶ 23, 26.

-7-

Forge’s common stock and committed to invest, at Valley Forge’s sole
option, up to an additional $20 million of equity capital.14
As Plaintiff characterizes it, the agreement with Lincoln Park gave
Valley Forge sole control over “the timing and amount of future
investment.”15 For instance, Valley Forge alleges that there no upper limits
on the price the fund was obligated to pay to purchase its common stock,
as “the purchase price of the shares would be based on the prevailing
market prices of Valley Forge’s shares immediately preceding the notice of
sale to Lincoln Park, without any fixed discount.”16 “Lincoln Park was
obligated to make the stock purchases as solely determined by Valley
Forge.”17
C.

14

Id. ¶ 23.

15

Id. ¶ 24.

16

Id. ¶ 25.

17

Brothers establishes and becomes co-owner of the Russian
entity Minitron Ltd., which he allegedly uses as a vehicle for
self-dealing at Valley Forge’s expense.

Id. ¶ 24.

-8-

At some point during the course of Valley Forge’s production and
capital acquisition, Brothers, together with Valery Raevsky, a nuclear
physicist at the Lebedev Physical Institute of the Russian Academy of
Sciences, established and operated a Russian business entity named
Minitron Ltd.18 Brothers was a fifty percent owner of Minitron.19 Valley
Forge now alleges that Brothers, acting solely for his own benefit, caused
Minitron to acquire licenses for critical technology required for the
development and production of THOR, including electronics, hardware,
and software.20
According to the Amended Complaint, Brothers never disclosed to
Valley Forge or its board of directors the extent or nature of his ownership
interest in Minitron.21 To the contrary, Valley Forge alleges that on
November 29, 2012, Brothers, having already overseen Minitron’s
acquisition of the above technology critical to THOR’s operation, caused
18

Id. ¶ 27.

19

Id. ¶ 28.

20

Id. ¶ 29.

21

Id. ¶ 31.

-9-

Valley Forge to enter into agreements with Minitron for Brothers’s own
personal benefit.22 Under these agreements, Minitron would provide the
technology to Valley Forge at an aggregate cost of $1,160,000.00.23
D.

Brothers uses Minitron to engage in the exportation of
radiation hardened chips to China in violation of federal
law and regulations.

Beginning in or around 2009, Brothers entered into several
agreements with foreign entities that permitted him to purchase thousands
of electronic components known as “radiation hardened chips,” also
referred to as “rad-hard chips” or simply “rad-chips.”24 According to the
Amended Complaint, “Rad-chips are a type of electronic component
specially developed to resist radiation levels for operation in space, high
altitude and nuclear facilities in order to prevent malfunctioning due to the
presence of ionizing radiation.”25 Because of their potential application in
military and nuclear devices, rad-chips are classified as a “defense article,”
22

Id. ¶ 30.

23

Id.

24

Id. ¶ 32.

25

Id. ¶ 33.

- 10 -

and their exportation is strictly regulated by the Arms Export Control Act,
the International Traffic in Arms Regulations, the Export Administration
Act of 1979, and the Export Administration Regulations.26
Brothers thereafter sold thousands of the rad-chips to China.27 The
rad-chips that Brothers sold to China were very highly radiation hardened,
capable of operating in the outermost satellite orbits used by the military.28
The rad-chips involved were classified as “weapon-grade defense articles,”
were designated as “controlled articles” and could not be exported absent
approval from the State Department’s Directorate of Defense Trade
Controls.29 In fact, certain government regulations provided that it is the
policy of the United States government to deny licenses or other approvals

26

22 U.S.C. §§ 2778 et seq.; 2 C.F.R. §§ 120 et seq.; 50 U.S.C. App’x §§ 2401 et
seq.; 15 C.F.R. §§ 730 et seq.

27

Am. Compl. ¶ 32.

28

Id. ¶ 35.

29

Id. ¶¶ 35–36.

- 11 -

for certain defense articles, including rad-chips, destined for certain
restricted or embargoed countries, including China and Russia.30
E.

Brothers uses revenues from the rad-hard chip deportation
scheme to defraud Valley Forge.

Plaintiff suggests that in an effort to conceal the ultimate destination
of the rad-chips and to facilitate the scheme, Brothers prepared and
submitted end-use certificates falsely representing that Valley Forge was
the end-user of the rad-chip shipments.31 According to the Amended
Complaint, Brothers and his wife opened several bank accounts in Valley
Forge’s name, without the company’s knowledge or approval, which the
couple subsequently utilized to launder funds from the illegal sale of radchips and to wrongfully divert portions of Valley Forge’s funds for use in
the rad-chip scheme.32
Plaintiff further alleges that Brothers “diverted Valley Forge’s capital
raised from investors and legitimate business operations . . . to the

30

Id. ¶ 37.

31

Id. ¶ 43.

32

Id. ¶ 44–45.

- 12 -

acquisition and export of additional rad-chips, all without Valley Forge’s
knowledge or consent.”33 In addition, Brothers allegedly used $400,000.00
in revenue generated from the rad-chip scheme to repay a personal loan he
had previously made to Valley Forge.34 “At all relevant times herein
mentioned, Valley Forge did not receive any benefit from Brothers aforedescribed scheme of illegal acquisition, sale and export of rad-chips.”35
F.

Defendant Clairmont Paciello & Co., P.C., prepares Valley
Forge’s accounting and financial records during the time of
Brothers’s rad-chip scheme.

Importantly for our purposes here, Plaintiff alleges that “Brothers, in
an effort to conceal his scheme of illegal acquisition sale and export of radchips, falsely represented to Valley Forge and its board of directors and
through public announcements and filings with the SEC, that all Valley
Forge’s revenues were generated through the sale of momentum
wheels.”36 As detailed more fully below, the Defendants allegedly

33

Id. ¶ 46.

34

Id. ¶ 48.

35

Id. ¶ 51.

36

Id. ¶ 49.

- 13 -

prepared, audited, or otherwise oversaw the preparation and filing of
Valley Forge’s accounting and financial records during the time of
Brothers’s rad-chip scheme.
Specifically, Plaintiff alleges that Defendant Clairmont Paciello &
Co., P.C., a King of Prussia, Pennsylvania-based accounting services firm,
“was engaged by Valley Forge to provide all of its accounting needs,
including, but not limited to, preparation of financial statements, profit
and loss statements, balance sheets, revenue statements, accounts payable
statements and accounts receivable statements.”37 Clairmont Paciello
provided these services to Valley Forge “in connection with its operations
in the State of Kentucky.”38 According to Plaintiff, “[t]he professional
accounting services which serve as the basis for Plaintiffs claims were
rendered in Kentucky, to an entity located in, and which operated its
business from, Kentucky.”39 In turn, Plaintiff suggests that Valley Forge’s

37

Id. ¶ 66.

38

Id.

39

ECF No. 31 at 9.

- 14 -

management and board of directors used the financial and accounting data
prepared by Clairmont Paciello to make important business decisions.40
Defendant’s obligation to review Valley Forge’s financial statements
with due diligence notwithstanding, Plaintiff contends that Valley Forge’s
disclosures represented that several new momentum wheel contracts
represented its sole source of revenue, even though “all the working
papers and spreadsheets prepared and utilized by Clairmont Paciello to
render the accounting services clearly indicated that Valley Forge did not
sell or derive any income from the sale of momentum wheels.” 41
Specifically, Plaintiff alleges that Defendant Clairmont Paciello and
Rosemary Brothers worked together to compile what were known as
“Lucy Spreadsheets,” documents that itemized and detailed, by contract
number, units, cost per unit, sale price per unit, supplier, number of units
shipped, total contract price, amounts received and invoice number, the

40

ECF No. 20 at 11 ¶ 67.

41

Id. ¶¶ 71, 73.

- 15 -

rad-chips illegally acquired by Louis Brothers for export.42 Plaintiff
contends that the Lucy Spreadsheets “clearly established” that the revenue
generated by Valley Forge during the pertinent reporting periods was
derived solely from the sale and export of rad-chips to China and not in
any part from the sale of momentum wheels.43
In fact, Plaintiff suggests that reasonable care and due diligence on
the part of Defendant Clairmont Paciello in the form of reconciling the
Lucy Spreadsheets with Valley Forge’s other financial statements would
have revealed the existence of the rad-chip scheme for several reasons.
First, he notes that the working papers and spreadsheets prepared and
utilized by Clairmont Paciello in rendering its accounting services to
Valley Forge show that the company did not purchase or acquire any
material for use in the production of momentum wheels.44 Second, Plaintiff
contends that a proper reconciliation of the financial statements would

42

Id. ¶ 74.

43

Id. ¶ 75.

44

Id. ¶ 76.

- 16 -

have shown that the revenue generated by Valley Forge derived solely
from the sale of rad-chips and not that of momentum wheels.45 Third,
Plaintiff notes that reasonable care in preparing the accounting and
financial statements would have revealed that no contracts for the sale of
momentum wheels between Valley Forge and customers existed during
the applicable reporting periods.46
In addition, Plaintiff points to several questionable features of
Valley Forge’s fund disbursement process that otherwise would have been
detected by an adequate review. For instance, Plaintiff notes that the
company’s disbursement process “presented an opportunity for
unauthorized payments and misappropriation” as a consequence of Mr.
and Mrs. Brothers having sole control over the cash disbursement process,
the payment of invoices, and the transfer of bank account funds.47 To that
end, Plaintiff suggests that a proper review would have revealed the

45

Id. ¶ 78.

46

Id. ¶ 80.

47

Id. ¶¶ 81–82.

- 17 -

existence of the bank accounts used by Brothers and his wife to launder
money in connection with the rad-chip scheme.48
From 2009 through 2012, Valley Forge paid Clairmont Paciello more
than $570,000.00 in fees for the accounting services it was to perform.49
Plaintiff contends that as a result of Clairmont Paciello’s negligence, it
suffered “significant losses and damages,” including “loss of business
opportunity and sales, cancellation of the Lincoln Park Agreement,
significant loss in its value as an operating and going business concern,
and damage to its reputation.”50 Plaintiff claims that this loss totals no less
than $50 million.51 Plaintiff’s Amended Complaint asserts counts of
negligence and gross negligence against Clairmont Paciello.52
G.

Defendant Mountjoy Chilton Medley, LLP, prepares Valley
Forge’s accounting and financial records during the time of
Brothers’s rad-chip scheme.

48

Id. ¶ 85.

49

Id. ¶ 94.

50

Id. ¶ 93.

51

Id. ¶ 95.

52

Id. ¶¶ 65–95, 96–100.

- 18 -

Plaintiff also asserts counts of negligence and gross negligence
against Mountjoy Chilton Medley, LLP, a Cincinnati, Ohio-based
accounting services firm.53 According to the Amended Complaint, from
October 2010 through December 2012, Mountjoy Chilton Medley was
engaged by Valley Forge as an independent registered public accounting
firm to audit its financial statements, consolidated balance sheets and
statements of operations, shareholder’s equity and cash flows, and to
express an independent opinion on these financial statements based on its
audits.”54
Plaintiff suggests that as the independent auditor of Valley Forge,
Mountjoy Chilton Medley failed to carry out its professional obligations as
prescribed by the Public Company Accounting Oversight Board (PCAOB)
standards and Generally Accepted Accounting Principles (GAAP).55
Specifically, Plaintiff points to Mountjoy Chilton Medley’s obligation to

53

Id. ¶¶ 101–43, 144–48.

54

Id. ¶ 102.

55

Id. ¶¶ 106, 127–28, 138–39.

- 19 -

“obtain reasonable assurance about whether the financial statements are
free of material misstatements.”56
To that end, Plaintiff points out that the notes to Valley Forge’s
consolidated financial statements for fiscal years 2010 and 2011 as filed
with the Securities Exchange Commission contain the following statement:
During [the prior two years], the Company won numerous
contracts to produce momentum wheels and various
mechanical devices for special projects. This represents all of
the Company’s revenues during these periods.57
According to Plaintiff, however, the above representation was “materially
false,” as Valley Forge did not win any contracts to produce momentum
wheels during the reporting period, nor did any such contracts represent
any of the company’s revenues during the reporting period.58
Nevertheless, Defendant Mountjoy Chilton Medley made the
following affirmative certification in 2011:
In our opinion, the consolidated financial statements . . .
present fairly, in all material respects, the financial position of
56

Id. ¶ 107.

57

Id. ¶ 112.

58

Id. ¶ 113.

- 20 -

Valley Forge Composite Technologies, Inc. and its subsidiaries
as of December 31, 2010, and the results of their operations
and their cash flows for the year then ended, in conformity
with U.S. generally accepted accounting principles.59
That certification was included with Valley Forge’s Security and Exchange
Commission S-1 initial securities registration form filed on December 30,
2011.60 Mountjoy Chilton Medley made a similar affirmative certification in
connection in 2012 as to Valley Forge’s 2011 financial statements.61 The
2012 certification by Mountjoy Chilton Medley was also included in two
subsequent amended S-1 registration forms filed by Valley Forge in 2012.62
Much like the allegations against Clairmont Paciello, Plaintiff
contends that had Mountjoy Chilton Medley acted with reasonable care

59

Id. ¶ 114.

60

Id. ¶ 115. Valley Forge executed one of its earliest privately exempt sales of
securities on or around August 24, 2006 pursuant to Rule 506 of the SEC’s
Regulation D. See https://www.sec.gov/Archives/edgar/vprr/06/999999999706-037166. However, the 2011 and 2012 S-1 and Amended S-1 forms were
submitted with the purpose of registering shares for a public offering
pursuant to the Securities Act of 1933. See https://www.sec.gov/Archives/
edgar/data/1332412/000121465911004582/s122810s1.htm.

61

Am. Compl. ¶ 121.

62

Id. ¶¶ 124–26.

- 21 -

and due diligence in by auditing the pertinent records in conformity with
accepted accounting standards, it would have discovered the existence of
Brothers’s illegal rad-chip scheme.63 Plaintiff attributes the same $50
million damages figure to Mountjoy Chilton Medley as it did to Clairmont
Paciello.64 It notes that from 2010 through 2012, Valley Forge paid
Mountjoy Chilton Medley $500,000.00 to perform the disputed audits.65
H.

Defendants Michael de Leon Hawthorne and Thompson
Coburn LLP purportedly assist Brothers in perpetuating the
illegal rad-chip scheme by refusing to report, reconcile, and
otherwise investigate the inconsistencies between Valley
Forge’s financial statements and its business operations.

According to the Amended Complaint, Defendants Thompson
Coburn LLP and Michael de Leon Hawthorne, Esquire, an employee of the
former, were engaged as outside legal counsel for Valley Forge during the
time Brothers carried out the rad-chip scheme.66 These legal services
Defendants were purportedly responsible “for the preparation, review and
63

Id. ¶¶ 129–39.

64

Id. ¶ 143.

65

Id. ¶ 142.

66

Id. ¶ 150.

- 22 -

filing of all required reports by Valley Forge with the SEC, including, but
not limited to, Form 8-K filings, Form 10-Q filings, and Form S-1 filings.”67
As recited earlier, several of these filings contained representations as to
Valley Forge having secured momentum wheel contracts, representations
that Plaintiff contends were material misstatements of the company’s true
status.68
Plaintiff essentially contends that these Defendants played a
knowing role in Brothers’s cover-up of the rad-chip scheme. Such cover-up
became apparent, Plaintiff suggests, in 2011, when Valley Forge entered
into a consulting and services agreement with Idaho State University,
pursuant to which the University through its Accelerator Center would
assemble one of Valley Forge’s THOR demonstration unites in Pocatello,
Idaho.69

67

Id. ¶ 151.

68

Id. ¶¶ 153–54.

69

Id. ¶ 155.

- 23 -

As Plaintiff recounts, things began to unravel during a March 2012
meeting between representatives from the University’s Accelerator Center
and Brothers, Valley Forge’s general counsel Keith McClellan, Esquire, and
Kyle Seger, one of Valley Forge’s aerospace engineers.70 During the course
of the meeting, Valley Forge’s representatives were apparently informed
by representatives from the University’s Accelerator Center that “the
racetrack accelerator portion of the THOR system was not a commerciallyviable tool.”71
Immediately following the meeting, McClellan informed Hawthorne
as to the conclusions offered by the University’s representatives.72
Specifically, McClellan told Hawthorne that this information should be
disclosed by Valley Forge in its SEC 10-Q report and its Form S-1
statements.73 Such disclosures were never made, despite Valley Forge’s
obligation as a publicly traded company to disclose relevant information
70

Id. ¶ 156.

71

Id. ¶ 157.

72

Id. ¶ 158.

73

Id.

- 24 -

regarding its financial position.74 Plaintiff contends this is the case despite
McClellan having informed Hawthorne via email on April 26, 2012 and
again in May 2012 as to the suspected misrepresentations.75 In those
emails, McClellan requested that Hawthorne provide a legal opinion as to
whether Valley Forge’s board of directors should be informed about the
suspected misrepresentations.76
According to the Plaintiff, the schism between Brothers and
McClellan widened in late May 2012 when McClellan learned from Seger
that contrary to the prior public announcements and representations, the
revenues generated by Valley Forge were not deriving from the sale of
momentum wheels at all.77At or around this same time, Brothers informed
Valley Forge’s board of directors that the company needed to post a bond
for approximately $300,000.00 to finalize a contract for the sale of THOR

74

Id. ¶¶ 159–62.

75

Id. ¶¶ 163–64.

76

Id.

77

Id. ¶ 166.

- 25 -

system in Guatemala.78 Thereafter, McClellan, who also served as secretary
of the board at the time, prepared an agenda for a meeting of the board
that specifically set forth in writing several issues concerning the
company’s commercial viability to be discussed at an upcoming meeting
of the board.79
Before the meeting took place, McClellan allegedly confronted
Brothers on May 24, 2012 as to the existence of the Guatemalan contract
and other purported sales of momentum wheels.80 McClellan allegedly
questioned Brothers as to whether his report of the Guatemalan contract
“was a fraud.”81 The next day, Brothers, acting on the advice of
Hawthorne, cancelled the upcoming board of directors meeting and
unilaterally authorized a payment of $300,000.00 that purported to secure

78

Id. ¶ 167. McClellan recalls the Guatemalan transaction purportedly
involving an entity known as the Symmetry Group LLC or “Symmetry.” Id.

79

Id. ¶ 168.

80

Id. ¶ 169.

81

Id. ¶ 170.

- 26 -

the Guatemalan contract.82 Five days later, Brothers issued a public
statement prepared by Hawthorne that suggested Valley Forge had
reached an agreement with to sell a THOR unit to the Guatemalan
government, worth upwards of $5 million.83 The announcement was
echoed in a May 2012 Form 8-K prepared with the assistance of
Hawthorne and Thompson Coburn.84 That 8-K Form read in pertinent part
as follows:
On May 30, 2012, Valley Forge Composite Technologies, Inc.
(the “Valley Forge”) announced that it had reached an
agreement in principle with a private US based company that
is negotiating an agreement (the “Agreement”) with a Latin
American government for the first commercial development,
delivery and maintenance of a THOR LVX photonuclear
detection system.85
Following the events of late May 2012, McClellan reports that
he repeatedly demanded a copy of the Guatemalan THOR contract

82

Id. ¶¶ 171–72.

83

Id. ¶ 173

84

Id. ¶ 175.

85

http://www.sec.gov/Archives/edgar/data/1332412/000121465912002456/
j529201238k.htm.

- 27 -

from Brothers, Hawthorne, and Thompson Coburn.86 A copy was
never provided.87 On November 14, 2012, at the advice and direction
of Defendants Hawthorne and Thompson Coburn, McClellan was
replaced as secretary and excluded from any further meetings of the
board as a result of his insisting that the prior announcements
regarding the Guatemalan contract needed to be amended or
retracted.88 Twelve days later, on November 26, 2012 and again at
the advice and direction of Defendants Hawthorne and Thompson
Coburn, McClellan’s employment with Valley Forge was
terminated.89
Plaintiff recites the same $50 million damages figure against
Hawthorne and Thompson Coburn.90 It alleges counts of gross
negligence and breach of fiduciary duty for the damages sustained
86

Am. Compl. ¶ 179.

87

Id.

88

Id. ¶ 180.

89

Id. ¶ 181.

90

Id. ¶¶ 186–87.

- 28 -

as a result of the two Defendants’ failure to exercise reasonable care
in its rendering legal services to Valley Forge while Brothers was
carrying out the rad-chip scheme.91 In Count Seven of the Amended
Complaint, Plaintiff also seeks to have Defendant Thompson
Coburn’s bankruptcy claim against Valley Forge declared ineffective
on the ground that it was procured by means of wrongful and illegal
conduct.92
I.

Brothers is indicted and later pleads guilty to aiding and
abetting the illegal export of defense articles and conspiracy
to launder money.

On February 6, 2013, Valley Forge made the following public
announcement:
The Company is discussing with the U.S. Attorney for the
Eastern District of Kentucky allegations that it exported over
$37 million worth of military semiconductors to Hong Kong
since about 2009 in violation of the International Traffic in
Arms Regulations. Although the Company’s internal
investigation is in its early stages, the Company has reason to
believe that the vast majority of these exports involved
commercial semiconductors that were clearly not subject to

91

Id. ¶ 186.

92

Id. ¶¶ 194–98.

- 29 -

control under the ITAR, and were not controlled for export to
Hong Kong under the Export Administration Regulations.
The U.S. Attorney executed a search warrant on the Company
and subsequently seized the bank accounts of the Company,
which held approximately $1.5 million, reportedly on the
basis that these funds were entirely the proceeds of illegal
exports or an instrumentality thereof, which the Company
denies.93
In response to the news, Valley Forge’s publicly traded common
stock plunged in value, falling from 14.9 cents per share to 5.7 cents
per share (or 62%) on a volume of 1.3 million shares on that day
alone.94 The company’s stock could not recover but effectively
became valueless, trading at or around 2 cents per share in late 2013
and early 2014.95
On August 14, 2014, a federal grand jury sitting in Covington,
Kentucky for the Northern Division of the United States District
Court for the Eastern District of Kentucky returned a 31-count

93

Valley Forge Composite Technologies, Inc. Form 8-K, http://www.sec.gov/
Archives/edgar/data/1332412/000121465913000631/c261318k.htm.

94

See Neborsky v. Valley Forge Composite Technologies, Inc., 3:13-cv-02307MMA-BGS, ECF No. 25 at 14 ¶ 34 (S.D. Cal. May 12, 2014).

95

Id. ¶ 38.

- 30 -

indictment against Brothers and his wife for their involvement in the
alleged rad-chip scheme.96 The indictment charged, among other
allegations, that the couple “did knowingly and willfully conspire to
export and cause to be exported goods designated as defense articles
. . . to Hong Kong and the [People’s Republic of China], without
obtaining a license or written authorization from the Department of
State.”97 It also accused the pair of “conspir[ing] to conduct and
attempt[ing] to conduct financial transactions . . . which involved the
proceeds of a specified unlawful activity.”98 The case was prosecuted
by counsel from both the United States Attorney’s Office for the
Eastern District of Kentucky and the Counter Espionage Section of
the United States Department of Justice’s National Security Division.
On July 30, 2015, Brothers agreed to plead guilty to several of
the counts in the indictment, including those charging that he aided

96

United States v. Brothers, et al., 2:14-cr-00035-ART-CJS, ECF No. 3 Ex. 3 (E.D.
Ky. 2014).

97

Id. at Page: 4 of 16, Page ID#: 43.

98

Id. at Page: 8 of 16, Page ID#: 47.

- 31 -

and abetted the illegal export of defense articles and conspired to
launder money.99 As part of the plea agreement, Brothers admitted
the following facts, of which this Court now takes judicial notice:
h.
At all times relevant herein, the Defendant was
the President and Chief Executive Officer (CEO) of Valley
Forge Composite Technologies (VFCT), a publically traded
company, the offices of which were located at 50 East
Rivercenter Boulevard, Suite 820., Covington, KY 41011.
i. VFCT’s stated business was the development,
manufacture, and distribution of detection systems and
instruments and the design and manufacture of attitude
control instruments for small satellites. Among VFCT’s
detection systems were "THOR LVX," a photonuclear
detection system, and "ODIN," a passenger weapons scanning
device. VFCT’s product for small satellites was mini
momentum reaction wheels.
j. VFCT was unsuccessful in developing THOR and
ODIN for manufacture and production. In fact, THOR and
ODIN were never manufactured, sold or distributed to any
person or business entity. In addition, a few mini momentum
reaction wheels were sold before 2006, but VFCT realized little
or no profit from those sales. VFCT never generated sales,
income or profit from THOR, ODIN, and the mini momentum
reaction wheels.
k. In 2009 and continuing through January 22, 2013, the
Defendant began to broker various microcircuits, which were
defense articles, to Hong Kong and the PRC [People’s
99

United States v. Brothers, ECF No. 49 at Page: 1 of 13, Page ID#: 177.

- 32 -

Republic of China]. Generally, the Defendant purchased the
microcircuits from manufacturers and other brokers,
specifically, Peregrine Semiconductors, Aero flex, and Avnet.
Peregrine, Aero flex and Avnet would ship the microcircuits
to the Defendant’s business address in Covington, Kentucky.
VFCT’s office contained an interior room with no windows
and one entrance. This room was used to repackage the
microcircuits for export. This room was secured by a lock the
Defendant had installed on the door to safely store the
microcircuits and limit access to them. When the microcircuits
were delivered to the office, the Defendant and others would
remove the microcircuits from their original packaging, which
was designed to insure the integrity of the microcircuits
during shipping. The Defendant and others would then
repackage the microcircuits in Federal Express (FEDEX)
packaging for export. They often marked the FEDEX packages
as "computer memory chips" and understated the value of the
contents. The Defendant and others insured the original
packaging and labels were destroyed or shredded. The
Defendant and others would then export the microcircuits to
Hong Kong and the PRC by FEDEX.
...
o. In the transactions charged, Peregrine and Avnet
required the Defendant to submit end-user statements to them
before shipping the microcircuits to VFCT. The Defendant
would falsify these end-user statements, stating the
microcircuits were for application in THOR or ODIN and
would not be exported from the United States. One Aeroflex
end user statement was executed by a purchaser of
microcircuits and showed the intended use of those products
in the People’s Republic of China. That end user statement

- 33 -

was not returned to Aeroflex. The Defendant falsified or failed
to return the end-user statements to avoid detection.100
Particularly relevant to the present action is Paragraph S of the plea
agreement, which reads as follows:
s. VFCT was a publically traded company, required to
make regular filings with the Security and Exchange
Commission (SEC). As the President and CEO, the Defendant
provided the factual basis for the filings, and approved each
document for filing with the SEC. The Defendant concealed
his activities exporting the microcircuits to China and the PRC
making false statements on the SEC filings so as to avoid
detection. In general, the Defendant represented to the SEC
and investors that VFCT’s revenues and profits were from the
sale of various aerospace products and other mechanical
devises including momentum wheels, but implied that sales
of THOR and ODIN were imminent when they were not. In
addition, the Defendant in March, 2008, represented VFCT
was in the business of buying and selling electronic parts for
resale to foreign markets, primarily Japan. In fact, almost all of
the revenues and profits of VFCT between 2009 and January,
2013 were from the export of microcircuits to Hong Kong and
the PRC without a license or written permission of the
Department of State.101

100

Id. at Pages 3–5 of 13, Page ID #’s: 179–81.

101

Id. at Pages 6–7 of 13, Page ID #’s: 182–83.

- 34 -

On March 2, 2016, Brothers was sentenced to a total of 93 months in
federal prison for his orchestration of the rad-chip scheme.102 The charges
against Rosemary Brothers were thereafter dismissed. 103
J.

After Valley Forge filed for bankruptcy, and this Court
withdrew the reference to the United States Bankruptcy
Court for the Middle District of Pennsylvania, the
Defendants filed the instant motions to dismiss, which now
must be denied.

On October 9, 2013, Valley Forge filed for Chapter 11 Bankruptcy
before the Honorable John J. Thomas in the United States Bankruptcy for
the Middle District of Pennsylvania.104 After the pertinent events giving
rise to this litigation had unfolded and ownership of Valley Forge had
changed hands, records indicate that the company relocated its principal
place of business to State College, Pennsylvania around that time.105 On

102

United States v. Brothers, ECF No. 75 at Page: 2 of 6, Page ID#: 424.

103

Id. at Page 1 of 6, ID#: 423.

104

See 4:13-bk-05253 ECF No. 1.

105

See, e.g., 4:13-bk-05253 ECF No. 1 at 1.

- 35 -

February 18, 2015, the bankruptcy was converted to a Chapter 7
proceeding.106
On September 21, 2015, this Court withdrew the reference to the
bankruptcy court pursuant to 28 U.S.C. § 157(d).107 This Court transferred
one companion case to the United States District Court for the Eastern
District of Kentucky for purposes of proper venue, pursuant to 28 U.S.C. §
1404(a), finding “that the Plaintiff’s principal place of business and
manufacturing operations [was] in Covington, Kentucky at all times
relevant to [ ] its underlying complaint.”108 After the Defendants each filed
a motion to dismiss, the Plaintiff filed its Amended Complaint on October
20, 2015.109 The Defendants thereafter filed renewed motions to dismiss. 110

106

See 4:13-bk-05253 ECF No. 530.

107

4:15-cv-01622 ECF No. 12.

108

Neblett v. Brothers, et al., 4:15-cv-01629 ECF No. 16. A securities law class
action lawsuit against Valley Forge, Brothers, and Wilhide is also proceeding
before the United States District Court of the Southern District of California.
See Neborsky v. Valley Forge Composite Technologies, Inc., 3:13-cv-02307MMA-BGS.

109

4:15-cv-01622 ECF No. 20.

- 36 -

The sole question before the Court at this stage of the litigation is
whether Plaintiff’s Amended Complaint has stated a claim against the
Defendants that plausibly entitles the estate to relief pursuant to the
decisions of the Supreme Court of the United States in Bell Atlantic Corp.
v. Twombly and Ashcroft v. Iqbal, as well as that of the United States
Court of Appeals for the Third Circuit in Connelly v. Lane Construction
Corp. As detailed more fully below, the factual allegations contained in
Plaintiff’s Amended Complaint far exceed the Supreme Court’s
plausibility requirement. Accordingly, the Defendants’ Motions to Dismiss
must therefore be denied.
II.

LAW
Under Federal Rule of Civil Procedure 12(b)(6), a defendant may file

a motion to dismiss for “failure to state a claim upon which relief can be
granted.” Such a motion “tests the legal sufficiency of a pleading” and
“streamlines litigation by dispensing with needless discovery and
110

Defendant Mountjoy Chilton Medley did not file a renewed motion to
dismiss, but rather argues that its original motion survived Plaintiff’s filing of
the Amended Complaint because that filing did not remedy the shortcomings
that the initial motion to dismiss purported to identify.

- 37 -

factfinding.”111 “Rule 12(b)(6) authorizes a court to dismiss a claim on the
basis of a dispositive issue of law.”112 This is true of any claim, “without
regard to whether it is based on an outlandish legal theory or on a close
but ultimately unavailing one.”113
Beginning in 2007, the Supreme Court of the United States initiated
what some scholars have termed the Roberts Court’s “civil procedure
revival” by significantly tightening the standard that district courts must
apply to 12(b)(6) motions.114 In two landmark decisions, Bell Atlantic
Corporation v. Twombly and Ashcroft v. Iqbal, the Roberts Court
“changed . . . the pleading landscape” by “signal[ing] to lower-court
judges that the stricter approach some had been taking was appropriate

111

In re Hydrogen Peroxide Litigation, 552 F.3d 305, 316 n.15 (3d Cir. 2008)
(Scirica, C.J.) (quoting Szabo v. Bridgeport Machines, Inc., 249 F.3d 672, 675
(7th Cir. 2001) (Easterbrook, J.)). Neitzke v. Williams, 490 U.S. 319, 326–27
(1989).

112

Neitzke, 490 U.S. at 326 (citing Hishon v. King & Spalding, 467 U. S. 69, 73
(1984)).

113

Neitzke, 490 U.S. at 327.

114

Howard M. Wasserman, The Roberts Court and the Civil Procedure Revival,
31 Rev. Litig. 313 (2012).

- 38 -

under the Federal Rules.”115 More specifically, the Court in these two
decisions “retired” the lenient “no-set-of-facts test” set forth in Conley v.
Gibson and replaced it with a more exacting “plausibility” standard.116
Accordingly, after Twombly and Iqbal, “[t]o survive a motion to
dismiss, a complaint must contain sufficient factual matter, accepted as
true, to ‘state a claim to relief that is plausible on its face.’”117 “A claim has
facial plausibility when the plaintiff pleads factual content that allows the
court to draw the reasonable inference that the defendant is liable for the
misconduct alleged.”118 “Although the plausibility standard does not
impose a probability requirement, it does require a pleading to show more
than a sheer possibility that a defendant has acted unlawfully.”119
Moreover, “[a]sking for plausible grounds . . . calls for enough facts to
115

550 U.S. 544 (2007); 556 U.S. 662, 678 (2009). Wasserman, supra at 319–20.

116

Iqbal, 556 U.S. at 670 (citing Conley v. Gibson, 355 U.S. 41 (1957))
(“[a]cknowledging that Twombly retired the Conley no-set-of-facts test”).

117

Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 570).

118

Iqbal, 556 U.S. at 678.

119

Connelly v. Lane Const. Corp., No. 14-3792, 2016 WL 106159, at *3 (3d Cir.
Jan. 11, 2016) (Jordan, J.) (internal quotations and citations omitted).

- 39 -

raise a reasonable expectation that discovery will reveal evidence of
[wrongdoing].”120
The plausibility determination is “a context-specific task that
requires the reviewing court to draw on its judicial experience and
common sense.”121 No matter the context, however, “[w]here a complaint
pleads facts that are ‘merely consistent with’ a defendant’s liability, it
‘stops short of the line between possibility and plausibility of entitlement
to relief.’”122
When disposing of a motion to dismiss, a court must “accept as true
all factual allegations in the complaint and draw all inferences from the
facts alleged in the light most favorable to [the plaintiff].”123 However, “the
tenet that a court must accept as true all of the allegations contained in the

120

Twombly, 550 U.S. at 556.

121

Iqbal, 556 U.S. at 679.

122

Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 557 (internal quotations
omitted)).

123

Phillips v. Cnty. of Allegheny, 515 F.3d 224, 228 (3d Cir. 2008) (Nygaard, J.).

- 40 -

complaint is inapplicable to legal conclusions.”124 “After Iqbal, it is clear
that conclusory or ‘bare-bones’ allegations will no longer survive a motion
to dismiss.”125 “Threadbare recitals of the elements of a cause of action,
supported by mere conclusory statements, do not suffice.”126
As a matter of procedure, the United States Court of Appeals for the
Third Circuit has instructed that:
Under the pleading regime established by Twombly and
Iqbal, a court reviewing the sufficiency of a complaint must
take three steps. First, it must tak[e] note of the elements [the]
plaintiff must plead to state a claim. Second, it should identify
allegations that, because they are no more than conclusions,
are not entitled to the assumption of truth. Finally, [w]hen
there are well-pleaded factual allegations, [the] court should
assume their veracity and then determine whether they
plausibly give rise to an entitlement to relief.127
III.

ANALYSIS
A.

Defendant Clairmont Paciello’s Motion To Dismiss Is
Denied Because Kentucky Law, Which Does Not Require A
Certificate Of Merit, Applies To The Instant Dispute.

124

Iqbal, 556 U.S. at 678 (internal citations omitted).

125

Fowler v. UPMC Shadyside, 578 F.3d 203, 210 (3d Cir. 2009) (Nygaard, J.).

126

Iqbal, 556 U.S. at 678.

127

Connelly, 2016 WL 106159, at *4 (internal quotations and citations omitted).

- 41 -

Counts I and II of Plaintiff’s Amended Complaint allege claims of
negligence and gross negligence, respectively, against Defendant
Clairmont Paciello & Co., P.C.128 In its Motion to Dismiss, the sole
justification that Defendant advances as to why Counts I and II should be
dismissed is that Plaintiff has failed to file a certificate of merit pursuant to
Pennsylvania Rule of Civil Procedure 1042.3.129 That rule mandates the
filing of such certificates in “any action based upon an allegation that a
licensed professional deviated from an acceptable professional
standard.”130
In response, Plaintiff contends that Rule 1042.3 is inapplicable
because the substantive law of the Commonwealth of Kentucky, which
does not require a similar certificate, applies to the instant matter.131
Because Plaintiff is correct about the application of Kentucky state law to
this dispute, Defendant’s motion to dismiss will be denied.

128

ECF No. 20 at 11–15, 16.

129

ECF No. 25 at 1.

130

Pa. R. C. P. 1042.3.

131

ECF No. 31 at 7–11.

- 42 -

“The first issue in deciding any choice of law question is to
determine the applicable choice of law rules.”132 “In most instances
bankruptcy courts rely on the rule observed by federal district courts
hearing diversity cases and use the choice of law rules of the forum
state.”133 “Because Klaxon v. Stentor Electric Manufacturing Co. make[s]
clear that federal law may not be applied to questions which arise in
federal court but whose determination is not a matter of federal law, state
choice of law rules must be applied in adversary proceedings in
bankruptcy court.”134
Accordingly, “[i]n the absence of a specific federal policy or interest
dictating the use of federal choice of law rules, it is well settled in this
Circuit that a bankruptcy court faced with the issue of which substantive
state law to apply to a claim for relief in an adversary proceeding applies

132

In re Eagle Enterprises, Inc., 223 B.R. 290, 292 (Bankr. E.D. Pa. 1998), aff’d, 237
B.R. 269 (E.D. Pa. 1999).

133

Id. (citing Klaxon Co. v. Stentor Electric Manufacturing Co., 313 U.S. 487, 496
(1941)).

134

In re SemCrude, L.P., 407 B.R. 112, 133 (Bankr. D. Del. 2009) (internal citations
and quotation marks omitted).

- 43 -

the choice of law rules of the forum state.”135 I will therefore turn to the
choice of law rules of the Commonwealth of Pennsylvania to determine
which state law should be applied.
Pennsylvania’s choice-of-law analysis follows a “flexible rule which
permits analysis of the policies and interests underlying the particular
issue before the court.”136 Under this approach, Pennsylvania courts are to
apply the law of the forum with the ‘most interest in the problem,’ rather
than the law of the place of injury.”137 “We must first determine whether
there is a true conflict between the relevant laws.”138 “If a true conflict
exists, the Court must then determine which state has the greater interest
in the application of its law.”139

135

Id.

136

Specialty Surfaces Int’l, Inc. v. Cont’l Cas. Co., 609 F.3d 223, 229 (3d Cir. 2010)
(quoting Griffith v. United Air Lines, Inc., 416 Pa. 1, 21, 203 A.2d 796, 805
(1964)).

137

Hammersmith v. TIG Ins. Co., 480 F.3d 220, 227 (3d Cir. 2007) (quoting
Griffith, 203 A.2d at 806).

138

Specialty Surfaces, 609 F.3d at 230.

139

Hammersmith, 480 F.3d at 231 (internal citation and quotation marks
omitted).

- 44 -

The parties do not dispute that while Pennsylvania law requires the
filing of a certificate of merit prior to the commencement of a professional
negligence claim, Kentucky law imposes no such prerequisite. 140 “When
both states’ interests would be harmed by the application of the other
state’s law, there is a ‘true conflict.’”141 I think it evident that the each
state’s governmental interests and policy preferences would be frustrated
by application of the other state’s law given that one state imposes a
certificate of merit requirement while the other does not.
Having established the existence of a true conflict, I must now
consider which state has the greater interest in the application of its law.
The United States Court of Appeals for the Third Circuit has characterized
Pennsylvania’s choice of law analysis “as a combination of the approaches
of both the Restatement II (contacts establishing significant relationships)

140

ECF No. 26 at 8.

141

Specialty Surfaces, 609 F.3d at 230.

- 45 -

and interests analysis (qualitative appraisal of the relevant States’ policies
with respect to the controversy).”142
In Hammersmith v. TIG Insurance Co., for example, the Third
Circuit applied § 188 of the Restatement (Second) of Conflict of Laws to
resolve a conflict arising under Pennsylvania state choice of law analysis.
That section, entitled “Law Governing in Absence of Effective Choice by
the Parties,” provides the following factors for a court’s consideration in
cases involving disputes arising from commercial contracts:
(a)

the place of contracting,

(b)

the place of negotiation of the contract,

(c)

the place of performance,

(d)

the location of the subject matter of the contract, and

(e)

the domicile, residence, nationality, place of incorporation and
place of business of the parties.

Relatedly, in cases involve tortious conduct, Pennsylvania courts
have applied the following list of similar factors from § 145 of the
Restatement (Second) of Conflict of Laws:

142

Hammersmith, 480 F.3d at 231.

- 46 -

(a)

the place where the injury occurred,

(b)

the place where the conduct causing the injury occurred,

(c)

the domicile, residence, nationality, place of incorporation and
place of business of the parties, and

(d)

the place where the relationship, if any, between the parties is
centered.

Significantly for our purposes, § 148 of the Restatement (Second) of
Conflict of Laws also provides a specific set of factors to consider in the
analogous context of fraud and misrepresentation cases.143 Subpart (1) of
that section states as follows:
When the plaintiff has suffered pecuniary harm on account of
his reliance on the defendant’s false representations and when
the plaintiff’s action in reliance took place in the state where
the false representations were made and received, the local
law of this state determines the rights and liabilities of the
parties unless . . . some other state has a more significant
relationship . . . to the occurrence and the parties, in which
event the local law of the other state will be applied.

143

I believe it worthwhile to note that a preordained list of factors for a choice of
law analysis in the professional negligence setting is not to be expected, given
that seekers of such services so often turn to certified public accountants,
doctors, or lawyers that do business in the client’s home state. Nevertheless, I
believe that each of these lists of factors proves instructive as to the salient
points that should be considered to resolve the parties’ dispute here.

- 47 -

Subpart (2) of § 148 thereafter lists the following factors for
“determining the state which, with respect to the particular issue, has the
most significant relationship to the occurrence and the parties”:
(a)

the place, or places, where the plaintiff acted in reliance upon
the defendant’s representations,

(b)

the place where the plaintiff received the representations,

(c)

the place where the defendant made the representations,

(d)

the domicile, residence, nationality, place of incorporation and
place of business of the parties,

(e)

the place where a tangible thing which is the subject of the
transaction between the parties was situated at the time, and

(f)

the place where the plaintiff is to render performance under a
contract which he has been induced to enter by the false
representations of the defendant.

“These contacts are to be evaluated according to their relative
importance with respect to the particular issue.”144 “[A] mere counting of
contacts is not what is involved. The weight of a particular state’s contacts
must be measured on a qualitative rather than quantitative scale.” 145 “At
least some of the factors . . . will point in different directions in all but the
144

Restatement (Second) of Conflict of Laws § 188(2) (1971).

145

Cipolla v. Shaposka, 439 Pa. 563, 566, 267 A.2d 854, 856 (1970).

- 48 -

simplest case. Hence any rule of choice of law, like any other common law
rule, represents an accommodation of conflicting values.”146
Interpreting Pennsylvania state choice of law analysis, the United
States District Court for the Eastern District of Pennsylvania has observed
that “[w]hen the injury sustained is of a pecuniary nature, the plaintiff’s
principal place of business is generally considered the place of injury and
represents a contact of substantial significance.”147 In that case, the district
court found that where a plaintiff corporation with a principal place of
business in Pennsylvania sued a defendant corporation with a principal
place of business in Tennessee for interference with contractual relations,
the appropriate law to be applied was that of the plaintiff’s principal place
of business.148 Such was the result because the alleged injury was “damage
to Plaintiff’s prospective business relationships,” which relationships were

146

Restatement (Second) of Conflict of Laws § 188 cmt. (c).

147

CAT Internet Servs., Inc. v. Magazines.com Inc., No. CIV. A. 00-2135, 2001
WL 8858, at *4 (E.D. Pa. Jan. 4, 2001).

148

Id.

- 49 -

necessarily “centered in” the state of the claimant’s principal place of
business.149
In a further decision, the New Jersey Superior Court, Appellate
Division, applying New Jersey’s nearly identical “governmental interest
analysis” to determine choice of law, held, in a professional malpractice
lawsuit between a plaintiff corporation doing business in New Jersey and
the defendant KPMG Peat Marwick, a New York accounting partnership,
that the appropriate substantive law to apply was that of New Jersey.150 In
that case, the defendant New York accounting firm had produced audit
reports for a third-party New Jersey corporation, upon which the plaintiff
New Jersey corporation relied in deciding to enter into certain agreements
with the third-party corporation.151 The third-party corporation ultimately
declared bankruptcy, causing the plaintiff to incur substantial losses.152

149

See id.

150

See Performance Motorcars of Westchester, Inc. v. KPMG Peat Marwick, 274
N.J. Super. 56, 58, 643 A.2d 39, 40 (App. Div. 1994).

151

Id. at 40.

152

Id.

- 50 -

To select the appropriate substantive law, the court considered “the
governmental policies underlying the law of each state and how those
policies are affected by each state’s contacts to the litigation and to the
parties.”153 The particular conflict in the case was a New York state law
requiring privity in professional malpractice actions and the nonexistence
at the time of such a requirement under New Jersey law.154 The court
acknowledged that the New York requirement signified “an undeniable
interest in regulating the extent to which an accounting firm licensed to
practice within its borders may be liable for work performed,” whereas the
New Jersey regime “sought to encourage accountants to exercise greater
care leading to greater diligence in conducting audits, thereby elevating
the standards of the profession.”155
The court thereafter reviewed the contacts of the state of New Jersey.
It noted that the plaintiff, as the ultimate end-user of the questioned audit,

153

Id. (quoting Veazey v. Doremus, 103 N.J. 244, 248, 510 A.2d 1187 (1986)).

154

Performance Motorcars, 643 A.2d at 40.

155

Id.

- 51 -

had its principle of place of business in New Jersey; all of the directors and
officers of the affected company were New Jersey residents; the plaintiff
was authorized to do business in New Jersey and paid various forms of tax
there; reliance on the audit report occurred in New Jersey; and the
eventual financial damage was incurred by the New Jersey plaintiff.156
In contrast, the court noted that “New York’s contacts with the
parties and this litigation are not insignificant, but are qualitatively less
than those of New Jersey’s.”157 That was the case even though the
defendant was a New York partnership regulated by “New York’s
policy.”158 The Court reasoned as follows:
We recognize for the purpose of this opinion that the Peat
Marwick partner in charge of the audit worked out of the
New York office; all of the planning and implementation of
the audit was conducted in New York; and the final auditor’s
report was drafted, signed and issued in New York. Thus, the
alleged negligent misrepresentations or other negligent
conduct occurred in New York. However, the audit report
was sent to a New Jersey client and used here in a business

156

Id. at 41.

157

Id.

158

Id.

- 52 -

transaction which was almost exclusively New Jersey
based. We do not believe that those contacts with New York
are qualitatively more significant than the parties’ contacts
with New Jersey.159
An important consideration in the Performance Motorcars decision
was the fact that the defendant was “clearly a national firm doing business
outside of New York’s territorial borders.”160 Therefore, New York
accountants “could not possibly expect [New York’s] protective rule to
apply where the accountant’s work, performed at least partially in another
state, caused injury outside its jurisdiction.”161 To hold otherwise “would
be an impermissible intrusion into the affairs of other states.” 162
Of all the arguments raised in the pertinent case law and in the
parties’ briefs, that is perhaps the most persuasive one, given the deference
this Court affords our Constitution’s federalist principles. As it relates to
the instant matter, when Defendant Clairmont Paciello chose to service

159

Id.

160

Id.

161

Id.

162

Id.

- 53 -

clients in other states, it implicitly acknowledged the possibility that it
would be bound by the regulations of those other states. Conducting
business outside of the home state functions for modern-day corporations
as a quid pro quo with the pertinent regulatory regimes of those states: the
corporation operates in a given state, reaps the benefits of ease of entry
and revenue collection, and in return, agrees to be bound by the pertinent
laws of that state. The presence or absence of a certificate of merit is no
exception.
As the Honorable Michael Chagares, writing for the United States
Court of Appeals for the Third Circuit, described this relationship in the
analogous context of personal jurisdiction, “Out-of-state residents who
exercise the privilege of conducting activities within a state enjoy the
benefits and protection of the state’s laws; in exchange, they must submit
to jurisdiction over claims that arise from or relate to those activities.”163
Any other outcome, particularly one that wrongly prioritized a defendant
corporation’s principle place of business in the choice of law analysis,
163

O’Connor v. Sandy Lane Hotel Co., 496 F.3d 312, 322 (3d Cir. 2007) (internal
quotation marks omitted).

- 54 -

would not only be inconsistent with the reciprocal nature of that
relationship but would also foster perverse incentives for professional
services corporations to shelter in states with liability-adverse regimes,
while continuing to reap the benefits of interstate commerce in other
forums.
Free market principles also counsel for application of Kentucky law,
the home state of the Plaintiff who was the recipient of Defendant’s
services. To the extent that the Defendant Clairmont Paciello argues that
the application of one state’s laws—here, Kentucky’s—make it more costly
to operate in that forum due to the prospect of malpractice liability
unchecked by a certificate of merit requirement, amelioration of such a
consequence is best left to the business’s own contractual decisions and to
the judgment of the Kentucky legislature.
For instance, if the prospect of serving clients in a state like
Kentucky creates more risk for a professional servicer like Clairmont
Paciello, then perhaps that servicer can adjust its rates accordingly. In turn,
if those higher rates make obtaining professional services more expensive

- 55 -

for Kentucky business owners, then perhaps those owners will petition
their legislators to adopt a certificate of merit requirement. The solution,
however, should be democratically arrived at, rather than judiciallyimposed.
Accordingly, as recounted by the facts alleged in the Amended
Complaint, Plaintiff was a Kentucky-based business whose principal place
of business was in Kentucky. Plaintiff’s CEO, Mr. Brothers, and his wife,
whose actions played a primary role in this litigation were both Kentucky
residents. The accounting services, although performed by Pennsylvania
accountants, had their ultimate end user in Kentucky, evaluated the
financial status of a Kentucky entity, affected the business decisions of
managers and directors in Kentucky, and ultimately were an alleged
source of harm to the state of Kentucky, its tax base, and its employees,
when the Kentucky-based manufacturer declared bankruptcy.
To that end, the facts gathered for the completion of the audit were
gathered in Kentucky from a Kentucky’s business’s records, the reports for
the Kentucky client were sent to and paid in Kentucky, and the audits and

- 56 -

reliance on those reports occurred in Kentucky, at which point
representations about a Kentucky’s company’s financial status were made
in formal reports and sent from Kentucky to the SEC. Eventually, the
investigation into the rad-chip scheme was also based in and prosecuted in
Kentucky.
These considerations embrace the factors as set forth in the
Restatement (Second) of Conflict of Laws §§ 145, 148, and 188 and applied
by the Third Circuit. Based on the foregoing analysis, substantive law of
the state of Kentucky should apply. It is worth noting for the record that
no other party to this litigation besides Clairmont Paciello challenges that
proposition.
Apart from its own weighting of the above factual considerations,
Defendant makes one additional argument. According to Defendant, the
certificate of merit rule “is not predicated upon substantive elements of a
negligence cause of action, nor burdens of proof in a professional liability
claim,” but is instead a procedural “prerequisite.”164 It cites Liggon-

164

ECF No. 32 at 3.

- 57 -

Redding v. Estate of Sugarman for support.165 This Court has reviewed the
Honorable Richard L. Nygaard’s opinion in the Liggon-Redding, and the
strained interpretation of the case that Defendant now offers is wholly
unpersuasive. As Judge Nygaard explained, “we conclude that
Pennsylvania Rule 1042.3, mandating a certificate of merit in professional
negligence claims, is substantive law under the Erie Rule and must be
applied as such by federal courts.”166
Therefore, because the law of Kentucky rather than that of
Pennsylvania applies and because the law of Kentucky does not require a
certificate of merit in professional negligence actions, Defendant Clairmont
Paciello’s motion to dismiss is denied in full.
B.

Defendants Mountjoy Chilton Medley, Thompson Coburn,
And Michael de Leon Hawthorne’s Motions To Dismiss Are
Denied, Because At This Stage In The Litigation,
Application Of The Doctrine Of In Pari Delicto Has Not
Been Properly Established; Running Of The Statue Of
Limitations Has Not Been Adequately Shown; And The
Gross Negligence Claims Have Plausibly Been Alleged.

165

ECF No. 32 at 1 (citing 659 F.3d 258 (3d Cir. 2011)).

166

Id. at 264–65.

- 58 -

The primary argument between the parties as to Defendant
Mountjoy Chilton Medley’s and the Thompson Coburn Defendants’
Motions to Dismiss is over application of the in pari delicto defense to
Plaintiff’s claims. “The Latin phrase Kentucky courts use as shorthand to
refer to ‘equal fault’ is in pari delicto.”167 “The doctrine does not require
that tortfeasors be literal 50/50 partners in the plaintiff’s injury. Parties are
in pari delicto where they are guilty of concurrent negligence of
substantially the same character, which converges to cause the plaintiff’s
damages.”168
The doctrine is often phrased as the maxim “when both parties are
guilty, the court will leave them where it finds them.”169 It derives from the
Latin phrase in pari delicto potior est conditio defendentis: “In a case of
equal or mutual fault . . . the position of the [defending] party . . . is the

167

Stanford v. United States, 948 F. Supp. 2d 729, 744 (E.D. Ky. 2013) (internal
quotation marks supplied).

168

Id. (internal quotation marks omitted).

169

Forbes v. City of Ashland, 246 Ky. 669, 55 S.W.2d 917, 919-20 (1932).

- 59 -

better one.”170 “The defense is grounded on two premises: first, that courts
should not lend their good offices to mediating disputes among
wrongdoers; and second, that denying judicial relief to an admitted
wrongdoer is an effective means of deterring illegality.”171
The United States Court of Appeals for the Third Circuit has
sanctioned the application the in pari delicto defense in the bankruptcy
context, when it joined several other circuits that “have also applied the in
pari delicto doctrine to bar claims of a bankruptcy trustee, standing in the
shoes of a debtor, against third-parties, without regard to the trustee’s
status as an innocent successor.”172 That being said, the doctrine “is subject
to appropriate and necessary limits” in that “matters of public policy are to
be taken into consideration in determining the defense’s availability in any
given set of circumstances.”173

170

Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 306, 105 S. Ct.
2622, 2626, 86 L. Ed. 2d 215 (1985).

171

Id. (internal footnote omitted).

172

Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340,
358 (3d Cir. 2001) (Fuentes, J.).

173

Id. at 354.

- 60 -

In pari delicto “is not to be woodenly applied and vindicated in any
and all instances, but instead may be trumped by another public policy
more important than the policy basis for the doctrine itself.”174 In fact,
“[t]here may be on the part of the court itself a necessity of supporting the
public interests or public policy in many cases, however reprehensible the
acts of the parties may be.”175
“Accordingly, a private action for damages in these circumstances
may be barred on the grounds of the plaintiff’s own culpability only where
(1) as a direct result of his own actions, the plaintiff bears at least
substantially equal responsibility for the violations he seeks to redress, and
(2) preclusion of suit would not significantly interfere with the effective
enforcement of the [ ] laws and protection of the [ ] public.”176 Specifically,
under Kentucky law, “Parties are in pari delicto when they ‘are guilty of
concurrent negligence of substantially the same character which converges

174

Id.

175

Bateman Eichler, 472 U.S. at 307.

176

Id. at 310–11.

- 61 -

to cause the plaintiffs damages.’”177 In Kentucky and elsewhere, the in pari
delicto doctrine appears to track closely the related agency law concept of
imputation of an agent’s (officer’s) wrongful acts to that of his principal
(the corporation).178
The primary exception to the doctrine is called the “adverse interest
exception.”179 “The adverse interest exception provides that knowledge of
the agent is not imputed to the principal when it is clear that the agent
would not communicate the fact in controversy to the principal.”180 “For
example, where the communication of a fact would ‘necessarily prevent
the consummation of a fraudulent scheme which the agent was engaged in
perpetrating,’ the agent’s knowledge is not imputed to the principal.”181

177

Compton v. City of Harrodsburg, Ky., No. 5:12-CV-302-JMH-REW, 2013 WL
5503195, at *5 (E.D. Ky. Oct. 2, 2013) ((citing Lexington Country Club v.
Stevenson, 390 S.W.2d 137, 143 (1965)).

178

See, e.g., BancInsure, Inc. v. U.K. Bancorporation Inc./United Kentucky Bank
of Pendleton Cty., Inc., 830 F. Supp. 2d 294, 301–02 (E.D. Ky. 2011).

179

See id. at 302.

180

Id.

181

Id. (emphasis in original).

- 62 -

Thus, the Court of Appeals of Kentucky has explained that application of
the in pari delicto doctrine “is destroyed and has no basis when the
transaction relates to personal matters of the agent or servant and where
his interests are adverse to those of his principal.”182
Not to be outdone, the adverse interest exception is itself subject to
three exceptions. That is to say, in three limited circumstances, presence of
the adverse interest exception can nevertheless be overridden so that the
defense may still apply. “The adverse interest exception is not applicable
under any of the following situations: ‘(1) [w]here the interested officer is
the sole representative of two corporations; (2) where the corporation
benefits by the transaction; and (3) where the interested agent acts for the
principal, instead of dealing with him, in which case the presumption of
communication obtains.’”183 It is the application of these second and third

182

Illinois Cent. R. Co. v. Fontaine, 217 Ky. 211, 289 S.W. 263, 268 (1926). At the
time the Illinois Central decision was issued, the Court of Appeals was
Kentucky’s highest court. That changed in 1976 with the establishment of the
Supreme Court of Kentucky.

183

BancInsure, Inc. v. U.K. Bancorporation Inc./United Kentucky Bank of
Pendleton Cty., Inc., 830 F. Supp. 2d 294, 302-03 (E.D. Ky. 2011) (quoting Ohio

- 63 -

exceptions to the exception that the parties vigorously contest, a debate
whose ultimately conclusion will likely hasten the resolution of this
litigation on motion for summary judgment or at trial.
Mountjoy Chilton Medley and the Thompson Coburn Defendants
both argue that Valley Forge benefited from Brothers’s scheme because
certain of the illicit proceeds were deposited in Valley Forge’s business
accounts and used to (artificially) bolster the company’s financial
statements. To the contrary, the Plaintiff suggests that Brothers’s scheme
was at all times conducted for his own personal gain, and to the extent that
his wrongdoing can even be characterized to have benefitted Valley Forge,
that benefit was incidental and short-lived. Essentially, the parties dispute
the quantum of benefit required by Kentucky courts to apply in pari
delicto as a matter of law, and perhaps more important at this stage
procedurally, the parties also contest the force of the particular facts of this
matter, the Amended Complaint’s assertions, and the proffered defenses,

Valley Banking & Trust Co. v. Citizens’ Nat’l Bank, 173 Ky. 640, 191 S.W. 433,
438 (1917)).

- 64 -

to the extent that they speak to the benefit, if any, that Valley Forge gained
from Brothers’s wrongdoing.
For instance, Plaintiff suggests, through several of its averments,
that Brothers acted solely for his own benefit and for the benefit of
Minitron, concealing the funds from Valley Forge and using the
company’s authorization solely to disguise the illegal transactions.
Essentially, Plaintiff contends that Valley Forge was a mere vehicle as to
Brothers’s fraudulent behavior, not an ultimate beneficiary. The Amended
Complaint further raises significant questions as to whether a fraudulent
scheme that ultimately led Valley Forge to file for bankruptcy can properly
be construed as having “benefited” the company in any fashion.184 Because
the Plaintiff has alleged facts plausibly suggesting that the doctrine of in

184

It is also worth noting here that although certain courts have granted motions
to dismiss on professional malpractice and related claims based on an in pari
delicto defense at the motion to dismiss stage, the majority of the recent
keynote decisions on topic have been disposed of at the summary judgment
stage. See, e.g., BancInsure, Inc. v. U.K. Bancorporation Inc./United Kentucky
Bank of Pendleton Cty., Inc., 830 F. Supp. 2d 294, 301–02 (E.D. Ky. 2011).
Official Comm. of Unsecured of Allegheny Health, Educ. & Research Found.
v. PricewaterhouseCoopers, LLP, 607 F.3d 346, 348 (3d Cir. 2010).

- 65 -

pari delicto does not apply here, these evidentiary disputes further
support my decision that this case is not ripe for disposition at the motion
to dismiss stage.
Accordingly, the parties are on notice that, when the Court
reevaluates application of the in pari delicto doctrine at the summary
judgment stage, evidence bearing upon the following questions will
greatly impact my disposition of that issue:
 To what extent can Valley Forge be said to have benefited from
Brothers’s rad-chip scheme?
 What quantum of benefit is required to trigger application of the in
pari delicto doctrine under Kentucky law?
 To what extent must the wrongdoing committed by Brothers be
similar in character and close in time to that allegedly committed by
the Defendants?
 To what extent did Valley Forge exercise possession or control of the
funds from the illicit scheme?
 Were the funds routed to or held in Valley Forge accounts for
significant periods of time or was Valley Forge merely used as an
intermediary to facilitate the fraud?
 To what extent were other employees or officers of Valley Forge
other than Rosemary Brothers aware of the accounts used to launder
proceeds from the rad-chip scheme, or were the accounts wholly
concealed?
- 66 -

 Did the illicit funds overstate Valley Forge’s financial metrics in a
way that allowed the company to issue additional stock, obtain
more favorable interest rates on loans or coupon rates on bonds, that
resulted in other favorable financial ratings for the company, or that
kept Valley Forge from becoming insolvent, defaulting on
obligations, or filing for bankruptcy earlier than it eventually did?
 Did Valley Forge use the subject funds to pay expenses, wages, etc.?
 Did Valley Forge benefit in any way from Brothers’ repayment of his
personal loan to the company?
 Did Valley Forge benefit in any way from its agreements with
Minitron?
 Did Valley Forge benefit from Brothers’s scheme in any other way(s)
not enumerated above that warrant application of the in pari delicto
doctrine or that otherwise warrant imputation of Brothers’s acts to
Valley Forge?
 How should the Court construe a fraudulent scheme by a
company’s officer in the context of the in pari delicto doctrine if that
scheme has both a beneficial short-term effect on the company but
also a negative long-term impact?
 To what extent were any other Valley Forge employees or officers
besides Rosemary Brothers aware of or participants in the rad-chip
scheme?
 Was Brothers working within the scope of his employment when he
committed the rad-chip fraud?
 Was Brothers’s scheme carried out solely for his own self-interest?
 Were Brothers’s interests completely adverse to those of Valley
Forge’s during the course of the rad-chip scheme?
- 67 -

 What are the economic and legal consequences that would result
from characterizing Valley Forge as a beneficiary in this and future
cases?
It is the Court’s view that resolving the above issues will assist resolution
of what is essentially a mixed question of law and fact. At the time for
filing dispositive motions, the Court is also likely to allow extensive
briefing on the in pari delicto issue and to request oral argument.
Relatedly, both the Mountjoy Chilton Medley and the Thompson
Coburn Defendants take issue with the Amended Complaint’s claims
calling for punitive damages to redress gross negligence. “‘Gross
negligence’ is a wanton or reckless disregard for the lives, safety or
property of others.”185 “The threshold for the award of punitive damages is
whether the misconduct was “outrageous” in character, not whether the
injury was intentionally or negligently inflicted.”186
That an alleged fraud of this extent went undetected is particularly
difficult to fathom, and Plaintiff has therefore alleged sufficient facts to

185

Peoples Bank of N. Kentucky, Inc. v. Crowe Chizek & Co. LLC, 277 S.W.3d
255, 267–68 (Ky. Ct. App. 2008).

186

Id. at 268.

- 68 -

permit the gross negligence and punitive damages claims to survive the
motion to dismiss stage. “If the plaintiff’s proof [ ] fails to make a
submissible case on ‘fraud’ but does make a submissible case on ‘wanton
and reckless misstatement,’ then the defendant accountant may be subject
to liability even though all of the strict elements of proof of intentional
fraudulent conduct are not sufficiently shown.”187
Plaintiff’s allegations that in fact no momentum wheel contracts
existed, that the Lucy spreadsheets made this explicit, that an appropriate
reconciliation was neglected, that generally accepted accounting standards
were not followed, and that materially false and misleading financial
statements were filed with the SEC as a result of these oversights satisfy
the plausibility requirement as to gross negligence claims in auditor
liability cases at the motion to dismiss stage.188

187

Ingram Indus., Inc. v. Nowicki, 527 F. Supp. 683, 685 (E.D. Ky. 1981).

188

See id. (“[T]he present status of common law liability of an accountant for
fraud is that gross negligence is sufficient to hold the accountant liable for
fraud, and that the failure to disclose after-acquired information which makes
the first report false, when it is known that third parties are relying on the
original report, can make the accountant liable for fraud.”). However, I find it
important to note that, at this stage, the Court considers the gross negligence

- 69 -

For similar reasons, Counts Six and Seven against the Thompson
Coburn Defendants, alleging breach of fiduciary duty and objecting to
Thompson Coburn’s bankruptcy claim based on related equitable
principles, should also survive the motion to dismiss stage for further
factual development. “[T]he basic elements of a breach-of-fiduciary-duty
cause of action [are]: (1) the existence of a fiduciary duty; (2) the breach of
that duty; (3) injury; and (4) causation.”189 As just recited, Plaintiff’s
Amended Complaint alleges sufficient facts in terms of a duty, breach,
causation, and damages to permit these claims to survive the motion to
dismiss stage. Moreover, Plaintiff’s objection to Thompson Coburn’s claim
necessarily depends on resolution of the substantive common law counts.
Again, however, the parties are reminded that survival of these claims at
this stage means little for how the Court will evaluate them on summary

allegation against Mountjoy Chilton Medley to be far less extensive and
compelling than that raised against the Thompson Coburn Defendants.
189

Baptist Physicians Lexington, Inc. v. New Lexington Clinic, P.S.C., 436 S.W.3d
189, 193 (Ky. 2013).

- 70 -

judgment—particularly if the evidence reveals no genuine dispute of
material fact as to Plaintiff’s claims of reckless conduct.190
Finally, Defendant Mountjoy Chilton Medley challenges the
timeliness of Plaintiff’s professional negligence claims. Mountjoy Chilton
Medley is the only Defendant to challenge this aspect of Plaintiff’s claim,
and I believe that, based upon the limited facts available to support the
Defendant’s contentions at this point in the litigation, its challenge should
fail. Kentucky’s applicable statute of limitations provides as follows:
Notwithstanding any other prescribed limitation of actions
which might otherwise appear applicable, except those
provided in KRS 413.140, a civil action, whether brought in
tort or contract, arising out of any act or omission in
rendering, or failing to render, professional services for others
shall be brought within one (1) year from the date of the
occurrence or from the date when the cause of action was, or
reasonably should have been, discovered by the party injured.
190

See id. (“This submissibility issue can only be determined after the evidence
on the merits produced by the parties has been assessed. The foregoing
discussion should not be taken to say that the plaintiff will be able to make a
submissible case on either or both of the claims asserted in Counts VII and
VIII. The Court is quite aware that it is dealing with a situation of restricted
liability. We are, however, unable to say at this time that the plaintiff is
unable to make such a submissible case as to either or both of the claims
asserted. Accordingly, the motion of the defendant Touche Ross to dismiss
Count VII and Count VIII of the plaintiff’s amended complaint will be denied
by separate order.”).

- 71 -

Time shall not commence against a party under legal
disability until removal of the disability.191
Plaintiff contends that the statute of limitations did not begin to run
until sometime in or around January or February of 2013, when the federal
investigation into Brothers’s conduct was initiated, and the company made
a corresponding public announcement. “At that time,” Plaintiff notes, “the
Government seized Valley Forge’s bank accounts and, upon the public
announcement of the Government’s action, the company’s stock
plummeted and it became unable to raise capital or continue its business
operations, thereby resulting in its financial collapse. At no time prior to
this period, had Valley Forge sustained any ‘irrevocable nonspeculative
injury’ under Kentucky law.”192 Thus, according to Plaintiff, because
Valley Forge filed for bankruptcy on October 9, 2013, 11 U.S.C. § 108’s
automatic stay provision permitting the filing claims for as long as “two
years after the order for relief” preserved the present action. To the
contrary, Defendant Mountjoy Chilton Medley contends that it began to

191

KRS § 413.245.

192

4:15-cv-01731, ECF No. 19 at 14.

- 72 -

run by May of 2012, at which time several of Valley Forge’s employees are
said to have been made aware of the scheme.
“Until the legal harm became fixed and non-speculative, the statute
did not begin to run.”193 In recent years, Kentucky courts have clarified
that “[t]he statute of limitations begins to run as soon as the injury
becomes known to the injured.”194 Such a determination also appears to be
contingent upon the type of professional conduct at issue. For instance,
legal malpractice claims based upon a pending litigation, transactional
legal malpractice claims, medical, engineering/surveying malpractice
claims, each necessarily implicate differing timelines.
At particular issue on this motion is the extent to which the extent of
the damages resulting from the rad-chip scheme and Defendant’s
purported negligent work needed to be ascertainable before the statute
began to run. As the United States District Court for the Eastern District of

193

Alagia, Day, Trautwein & Smith v. Broadbent, 882 S.W.2d 121, 125-26 (Ky.
1994).

194

Matherly Land Surveying, Inc. v. Gardiner Park Dev., LLC, 230 S.W.3d 586,
591 (Ky. 2007).

- 73 -

Kentucky stated in Northwestern National Insurance Company v.
Osborne:
[T]he present law of Kentucky requires the following three
elements for the accrual of a cause of action for legal
malpractice: (1) a negligent act or omission on the part of the
attorney; (2) the occurrence of damage that is not merely
speculative as a proximate result of such act or omission; (3)
discovery of the negligence and damage by the client. The
addition of the prerequisite of the discovery factor by the
statute did not negate the sine qua non of damage.195
That being said, “Kentucky law has never required a specified dollar
amount be known before the statute of limitations can run.”196
Still, Plaintiff finds plausible support in the pertinent case law. For
example, applying Kentucky law, one court has observed that “[a] cause of
action does not exist until the conduct causes injury that produces loss or
damage.”197 In that case, the court held that in a legal malpractice dispute
involving estate planning, “the discovery of negligence was ineffective as
the final result was not yet known. Not until damages were fixed by the
195

610 F. Supp. 126, 127 (E.D. Ky. 1985), aff’d, 787 F.2d 592 (6th Cir. 1986).

196

Matherly Land Surveying, Inc. v. Gardiner Park Dev., LLC, 230 S.W.3d 586,
591 (Ky. 2007).

197

Alagia, Day, Trautwein & Smith v. Broadbent, 882 S.W.2d 121, 126 (Ky. 1994).

- 74 -

final compromise with the IRS was there an occurrence of the type
required to commence the running of the statute.”198
Likewise, in a case involving negligent title searching, the Supreme
Court of Kentucky held that the statute of limitations began running “as of
the date of the foreclosure sale, when appellant’s loss was “realized.”199
“Prior to that date, Appellants had only a fear that they would suffer a loss
on the property. Their fear was not realized as damages until the sale of
the property.”200
Further, as the Supreme Court of Kentucky has described for
litigation-based negligence claims, “[w]here, as in the present case, the
cause of action is for ‘litigation’ negligence, meaning the attorney’s
negligence in the preparation and presentation of a litigated claim
resulting in the failure of an otherwise valid claim, whether the attorney’s

198

See id.

199

Meade Cty. Bank v. Wheatley, 910 S.W.2d 233, 235 (Ky. 1995).

200

Id.

- 75 -

negligence has caused injury necessarily must await the final outcome of
the underlying case.”201
Analogous to the present case, in 2007, the Supreme Court of
Kentucky heard a dispute dealing with application of the statute of
limitations in an auditing malpractice action. The fact pattern there
involved a plaintiff who sued its third-party auditors for failing to detect
inconsistencies on the financial statements of an insurance company that it
later purchased. The Supreme Court of Kentucky wrote, “the obvious
problems with [the insurance company’s] reserve setting system did not
by themselves mean [the plaintiff] should have known of [the auditor’s]
alleged negligence. However, that [the plaintiff] had to make a significant
adjustment, and in essence suffered losses after having had the benefit of
[the] audit report, should have put them on notice that something was
wrong with the report.”202 Thus, the statute began running when the
plaintiff completed its purchase and received a memorandum from one of
201

Michels v. Sklavos, 869 S.W.2d 728, 730 (Ky. 1994).

202

Queensway Fin. Holdings Ltd. v. Cotton & Allen, P.S.C., 237 S.W.3d 141, 151
(Ky. 2007).

- 76 -

the insurance company’s officials because “[a]t that time, [the plaintiff] had
knowledge of a reduction in the value of [the insurance company] and
should have known that something was amiss with the way reserves were
being calculated.”203
As such and similar to the in pari delicto issue in this matter,
although Plaintiff has alleged sufficient facts under the law to preserve its
claims, there exist several open questions as to whether the May 2012
timeframe can mark the beginning of the statute’s running, questions
whose answers could greatly influence the Court’s determination on
summary judgment. “Such questions are more appropriately decided at
the summary judgment stage or at trial, with the benefits of discovery and
a full evidentiary record.”204 For instance:
 Is knowledge of the rad-chip scheme the same as knowledge of the
accountant’s alleged negligence?
 Does Kentucky law require some legal or business outcome, such as
an indictment or declaration of bankruptcy, to properly ascertain the

203

Id.

204

Coloplast A/S v. Oakwell Distribution Inc., No. CIV.A. 15-1592, 2015 WL
3872295, at *2 (E.D. Pa. June 23, 2015).

- 77 -

extent of the negligence and to begin the statute’s running in
corporate fraud cases?
 Would knowledge of certain of a company’s officers or employees
be sufficient to begin the statute’s running, whereas knowledge by
others would be insufficient?
 Were the May 2012 concerns ever adequately communicated to
Valley Forge’s board of directors or officers other than Brothers?
 What evidence shows that knowledge of the cause of action and
nonspeculative damages was held by Valley Forge on or around
May 2012 but before the automatic stay became effective?
 How should alleged negligence in the accounting industry be
treated under Kentucky’s statute of limitations precedents, given its
prior legal malpractice holdings in both litigation and transactional
matters, as well as in other professional negligence settings?
 Should Valley Forge, in the exercise of reasonable diligence, have
discovered the fraud and the consequential accounting
misstatements on or before May 2012? How should that
determination impact the statute of limitations?
 When can a corporation be said to incur “damage” from an allegedly
negligent accounting work performed on its financial statements?
 Had the federal investigation never occurred, when, if at all, would
the statute of limitations begin to run?
 Relatedly, does the running of the statute of limitations in the
corporate fraud setting depend at all upon the corporation’s ability
or inability to raise additional capital, maintain solvency, etc.?
 Was Mountjoy Chilton Medley continuing to service certain of
Valley Forge’s accounting needs after 2012, and how should that
continued service affect the statute of limitations running, if at all?
- 78 -

“[T]he Court believes that the benefit of discovery would greatly
enlighten the issues in this case.”205 Accordingly, although I hold for the
purpose of this motion to dismiss that Plaintiff’s Amended Complaint
adequately alleges that the statute of limitations did not begin running
until the breadth of the rad-chip scheme was more fully realized and its
ultimate impact on the company’s continued existence was reasonably
evident, there will be significant opportunity for the Defendant to rebut
these allegations with the assistance of a more complete factual record.
For the foregoing reasons, the motions to dismiss filed by Mountjoy
Chilton Medley, Thompson Coburn, and Michael de Leon Hawthorne are
denied in full. However, several of the core issues, including those
involving application of the in pari delicto doctrine and the running of the
statute of limitations as to Mountjoy Chilton Medley, will necessarily be
revisited at the summary judgment stage with the benefit of discovery.

205

Mastercraft Interiors, Ltd. v. ABF Freight Sys., Inc., 284 F. Supp. 2d 284, 289
(D. Md. 2003).

- 79 -

IV.

CONCLUSION
For the foregoing reasons, Defendants’ motions to dismiss are

denied in full. Kentucky law governs this dispute. Given the open
questions of fact and law that remain at this point, application of the in
pari delicto defense and the precise running of the statute of limitations are
more appropriately disposed of at summary judgment in this matter.
An appropriate Order follows.

BY THE COURT:

s/ Matthew W. Brann
Matthew W. Brann
United States District Judge

- 80 -