Punitive damage issue found in professional negligence claim; breach of fiduciary duty and professional negligence claim by accounting firm: PEOPLES BANK OF NORTHERN KENTUCKY V. CROWE CHIZEK AND CO. LLC (COA 6/6/2008)


Peoples Bank (PBNK) appeals entry of summary judgment in favor of Crowe Chizek and its employee on PBNK’s professional negligence and breach of fiduciary duty claims, which were dismissed by the TC as barred by the statute of limitations and the release clause in the party’s contracts. The relevant facts to this action are as follows: PBNK’s largest loan customer was real estate developer Erpenbeck whose accounts were supervised by two of the bank’s internal officers (Finnan and Menne). The officers and Erpenbeck develop a close relationship and begin vacationing together. The officers then form a business (JAMS) to purchase properties from Erpenbeck at cost only to create fictitous purchase contracts to reflect a much higher price in order to obtain loans (not from PBNK) for the false amount. The excess loan proceeds were then divided between Erpebeck and JAMS, and Erpenbeck would rent the properties from JAMS while the rental payments were then used to pay the mortgages. Three years later, JAMS has received over half a million in excess loan proceeds on almost $4 million in total loans and was financially dependent on Erpenbeck.

This entire time the two JAMS owners remained officers at PBNK, and during this time they hired Crowe to perform tax services for JAMS (all of its accounts being held at PBNK) although the same Crowe partner was also still overseeing the independent auditing and accounting services for PBNK. Some two years later in 2002, one of the JAMS owner and still officer with PBNK informed the Crowe partner overseeing of Erpenbeck’s check diversion and check kiting schemes for which the officers had authorized additional loans through PBNK to cover the the overdraft fees. The Crowe partner advised the officer to inform the bank’s board of the officers’ and JAMS’ relationship with Erpenbeck and potential conflict of interest, which was done. PBNK then notified authorities and hired an independent law firm to conduct an investigation of the matter, which led to both officers’ resignation. The adverse publicity essentially forced the bank to close and sell its assets at a substantial loss. Both Erpenbeck and the officers were found guilty of numerous bank fraud charges. PBNK then filed suit against Crowe and the partner asserting a number of causes of action for which it sought compensatory and punitive damages. Four years later, Crowe files a number of motions most notably relying on the release in the contracts and the statute of limitations. The TC agreed and granted each of the motions effectively dismissing all claims.

On appeal, the COA began by affirming the TC’s dismissal of PBNK’s claim for aiding and abetting the two officers in breaching their fiduciary duty, noting that Kentucky law as never recognized a civil cause of action for this type of claim. The court also found no proof that the Crowe or its partner were active, knowing participants in the officers’ misconduct. Next, the COA turned to PBNK’s argument that the release clauses in Crowe’s engagement letters did not bar its claims since they only released Crowe for any opinion it offered attributable to misrepresentations made by PBNK during the audit. Instead, PBNK argued that its claims were based on Crowe having actual knowledge of the officers’ misconduct through its work for JAMS, and thus its losses were due to Crowe’s independent negligence. The COA agreed, and held that at a minimum PBNK had offered sufficient proof to create a genuine issue of fact on the matter since any evidence of the bank’s misrepresentations would be relevant as comparative fault rather than barring the claims altogether.

The COA then addresses PBNK’s argument that the one-year statute of limitations applicable to professional negligence and breach of fiduciary duty claims (KRS 413.245) had not expired by the time suit was filed. The court goes through a fairly detailed analysis of the two different limitations periods contained in this statute, the date of occurrence (accrual rule) and date of discovery (common law discovery rule). Crowe argued that the discovery rule applied to bar the claims since PBNK knew or should have known of the misconduct long before one year prior to suit being filed while PBNK argues that the limitations was tolled during the period of Crowe’s continuous representation of the bank. The COA, in reliance on the Supreme Court’s recent decision in Queensway v. Cotton & Allen, 237 S.W.3d 141 (Ky. 2007), noted that the discovery limitations period cannot begin to run until the accrual period begins (when negligence and resulting damages have both occurred). The court held that while the alleged negligence in this case occurred with the completion and delivery if each annual audit report, the damage from the officers’ breach of fiduciary duty did not become fixed and non-speculative until April 2002 when the Crowe partner compelled the officers to disclose the relationship with Erpenbeck to the bank board. The complaint filed in late March 2003 was therefore timely.

Turning to PBNK’s punitive damages claim, the COA ultimately determines that the bank had offered enough evidence to create a jury issue. The court acknowledged PBNK’s argument that Crowe should have discovered the conflict of interest during its auditing work for JAMS, and that Crowe’s failure to discover and disclose the wrongdoing amounted to concealment causing damage to the bank independent of those due to the wrongful acts themselves. While the COA held that Crowe did not intend to give assistance in the officers’ misconduct, the court found that PBNK had met its burden of offering sufficient proof of gross negligence to withstand a motion for summary judgment.

In conclusion, the COA ruled in favor of PBNK as follows: summary judgment was not appropriate on its professional negligence and breach of fiduciary duty claims as neither barred by the statute of limitations or the releases in the contracts between the parties; and these contracts did not bar PBNK’s damage claims arising from Crowe’s negligence prior to the auditing period covered by the contracts. But, the COA found summary judgment was appropriate on PBNK’s aiding and abetting claim, and the bank’s alleged damages arising from Erpenbeck’s conversion of checks not payable to him (since the check diversion scheme was not a foreseeable consequence of Crowe’s alleged negligence and Erpenbeck’s criminal conduct as well as bank’s own negligence in cashing the checks were superseding causes of the injury).

Digested By Chad Kessinger
Schiller Osbourn Barnes & Maloney

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