PEOPLES BANK OF NORTHERN KENTUCKY, INC. , ET AL. VS. CROWE CHIZEK AND COMPANY LLC , ET AL.
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RENDERED: JUNE 6, 2008; 2:00 P.M.
TO BE PUBLISHED
Commonwealth of Kentucky
Court of Appeals
NO. 2007-CA-001174-MR
PEOPLES BANK OF NORTHERN
KENTUCKY, INC.; PBNK, INC.,
F/K/A BANCORPORATION OF
NORTHERN KENTUCKY, INC.
v.
APPELLANTS
APPEAL FROM BOONE CIRCUIT COURT
HONORABLE PAUL W. ROSENBLUM, SENIOR JUDGE
ACTION NO. 03-CI-00408
CROWE CHIZEK AND COMPANY
LLC; WILLIAM B. BRIZENDINE
APPELLEES
OPINION
AFFIRMING IN PART,
REVERSING IN PART, AND REMANDING
** ** ** ** **
BEFORE: COMBS, CHIEF JUDGE; ACREE AND WINE, JUDGES.
WINE, JUDGE: Peoples Bank of Northern Kentucky, Inc., and PBNK, Inc., f/k/a
Bancorporation of Northern Kentucky, Inc. (collectively “PBNK”) appeals from
summary judgments of the Boone Circuit Court dismissing its complaint against
Crowe Chizek and Company, LLC (“Crowe Chizek”) and William B. Brizendine
(“Brizendine”). We agree with PBNK that summary judgment was not appropriate
on its claims for professional negligence and breach of fiduciary duty as these
claims were not barred by the statute of limitations or by the release contained in
the contracts between PBNK and Crowe Chizek. Furthermore, the contracts do not
bar all of PBNK’s claims for consequential and punitive damages arising from
Crowe Chizek’s negligence. We also find that PBNK has presented sufficient
evidence of gross negligence to create a jury issue for punitive damages. However,
we agree with the trial court that PBNK is not entitled to recover its claimed check
conversion damages because those losses were not proximately caused by any
negligence of Crowe Chizek. We also find that summary judgment was
appropriate on PBNK’s claims of aiding and abetting liability because Crowe
Chizek’s alleged negligence does not meet the requirements for civil conspiracy.
Finally, we find that summary judgment was appropriate on PBNK’s claims under
Kentucky Revised Statute (“KRS”) 271B.8-300, but that statute may be relevant to
any defenses based on comparative fault and as a defense to Crowe Chizek’s thirdparty claims. Hence, we affirm in part, reverse in part, and remand for further
proceedings on the merits of the remaining claims.
For purposes of this appeal, the following facts are not in dispute:
PBNK was organized in 1992. John O. Finnan served as president and chief
executive officer of PBNK from its inception until April 2002. Marc Menne
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worked for PBNK during the same period, first as senior vice-president in charge
of commercial lending and later as executive vice-president in charge of
commercial lending. Both Finnan and Menne were also members of the board of
directors of PBNK.
In 1996, Eskew and Gresham, P.S.C., became the accountants and
auditors for PBNK. Brizendine was a partner with Eskew and Graham and had
primary responsibility for providing independent accounting and auditing services
to PBNK. In 1998, Crowe Chizek acquired the assets of Eskew and Gresham. As
a result of the merger, Brizendine became a partner with Crowe Chizek and he
continued to be primarily responsible for providing services to PBNK.
During this period, PBNK’s largest loan customer was real estate
developer William Erpenbeck and the entities he controlled (collectively
“Erpenbeck”). Finnan and Menne supervised Erpenbeck’s loan activities for the
bank. In addition, they began to develop a close friendship with Erpenbeck,
frequently traveling and vacationing with him. In addition, Erpenbeck built houses
and sold them to Finnan and Menne for below cost.
In December 1997, Finnan and Menne, along with their spouses,
created JAMS Properties, LLP (“JAMS”), a limited partnership specifically
organized to purchase model homes from Erpenbeck entities. Typically, JAMS
would purchase model homes or condominiums from Erpenbeck at cost, but would
create fictitious purchase contracts showing a much higher purchase price. The
parties would then go to banks other than PBNK to obtain mortgages for the
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amounts stated on the fictitious purchase contracts. To obtain these mortgages,
JAMS submitted fraudulent HUD statements to the lending banks. The excess
loan proceeds would then be divided between Erpenbeck and JAMS. Thereafter,
Erpenbeck would rent the properties from JAMS, which would use the rental
payments to pay the mortgages. From December 1997 through 2000, JAMS
purchased twenty-five properties from Erpenbeck and borrowed a total of
$505,950.00 in excess of the actual purchase prices of these properties. By 2000,
JAMS had a total mortgage indebtedness of nearly $3.9 million and was financially
dependent upon Erpenbeck.
Finnan and Menne hired Crowe Chizek in March 1998 to perform tax
services for JAMS. Brizendine served as engagement partner for Crowe Chizek’s
dealings with JAMS. Crowe Chizek prepared tax returns for JAMS for the tax
years 1997 through 2001. JAMS maintained all of its bank accounts with PBNK
during this period.
Beginning in January 2000, Erpenbeck began to deposit checks into
his PBNK account that were payable to other individuals, entities or banks. This
conduct continued until late March of 2002, when it was discovered by PBNK. In
early 2001, Erpenbeck also caused a kite of insufficient funds checks to be
conducted among various accounts, including the account at PBNK. When the
kiting scheme was discovered by another bank, Erpenbeck’s PBNK account
became substantially overdrawn. Finnan and Menne authorized additional loans to
Erpenbeck to cover these overdrafts.
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In April of 2002, Finnan informed Brizendine of Erpenbeck’s check
diversion and check kiting schemes. Upon further review of JAMS’ tax files,
Brizendine discovered the relationship between JAMS and the Erpenbeck-related
companies. He advised Finnan to inform the PBNK board of the relationship and
potential conflict of interest. Upon learning of the relationship, the PBNK board
notified authorities and hired an independent law firm to conduct an internal
investigation. The investigations revealed the extent of the dealings between
Erpenbeck, JAMS, Finnan and Menne, the extent of the check kiting and check
diversion schemes, the post-2001 loans to Erpenbeck, and Erpenbeck’s default on
the loans from PBNK and other banks. Finnan and Menne resigned their positions
shortly thereafter.
The adverse publicity related to the scandal caused many customers to
withdraw their funds from PBNK, significantly damaging its reputation and
eventually destroying its banking business. PBNK ceased operations in November
of 2002 and sold its remaining assets at a substantial loss. Erpenbeck was
eventually convicted on numerous federal bank fraud charges. Finnan and Menne
later pled guilty to other federal bank fraud charges.
In March of 2003, PBNK filed this action against Crowe Chizek and
Brizendine. The complaint, as later amended, asserted causes of action for: (1)
aiding and abetting Finnan’s and Menne’s breaches of fiduciary duty; (2) aiding
and abetting Finnan’s and Menne’s breaches of KRS 286.3-065; (3) professional
negligence; (4) breach of fiduciary duty; and (5) violation of KRS 271B.8-300.
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PBNK sought both compensatory and punitive damages for these claims. The
parties conducted substantial discovery over a four-year period.
On March 15, 2007, Crowe Chizek filed six motions: (1) motion for
summary judgment based on written releases executed by PBNK; (2) motion for
summary judgment based on the statute of limitations; (3) motion for summary
judgment on PBNK’s claim for punitive damages; (4) motion for judgment on the
pleadings on PBNK’s claim for violation of KRS 271B.8-300; (5) motion for
summary judgment on the aiding and abetting counts; and (6) motion for partial
summary judgment on PBNK’s claims for check conversion losses. After
considering the pleadings, record, and arguments of counsel, the trial court entered
orders on May 2, 2007, granting all of Crowe Chizek’s motions and dismissing
PBNK’s complaint. This appeal followed.
Since the trial court did not set out its grounds for granting the
motions for summary judgment, we shall presume that the court did so for the
reasons set out in Crowe Chizek’s motions. The standard of review governing an
appeal of a summary judgment is well settled. We must determine whether the
trial court erred in concluding that there was no genuine issue as to any material
fact and that the moving party was entitled to a judgment as a matter of law.
Scifres v. Kraft, 916 S.W.2d 779, 781 (Ky. App. 1996). Summary judgment is
appropriate “if the pleadings, depositions, answers to interrogatories, stipulations,
and admissions on file, together with the affidavits, if any, show that there is no
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genuine issue as to any material fact and that the moving party is entitled to a
judgment as a matter of law.” Kentucky Rules of Civil Procedure (“CR”) 56.03.
In Paintsville Hospital Co. v. Rose, 683 S.W.2d 255, 256 (Ky. 1985),
the Supreme Court of Kentucky held that for summary judgment to be proper, the
movant must show that the adverse party cannot prevail under any circumstances.
The Court has also stated that “the proper function of summary judgment is to
terminate litigation when, as a matter of law, it appears that it would be impossible
for the respondent to produce evidence at the trial warranting a judgment in his
favor.” Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d 476, 480 (Ky.
1991). Because factual findings are not at issue, there is no requirement that the
appellate court defer to the trial court. Goldsmith v. Allied Building Components,
Inc., 833 S.W.2d 378, 381 (Ky. 1992). “The record must be viewed in a light most
favorable to the party opposing the motion for summary judgment and all doubts
are to be resolved in his favor.” Steelvest, 807 S.W.2d at 480.
PBNK first argues that the trial court erred in dismissing its claims
that Crowe Chizek and Brizendine aided and abetted Finnan’s and Menne’s
misconduct. PBNK maintains that Crowe Chizek had actual knowledge of the
relationship between Finnan, Menne and Erpenbeck through its representation of
JAMS. Given Crowe Chizek’s failures to discover and disclose the misconduct
relating to JAMS, and to properly audit PBNK’s loan accounts, director’s
accounts, and related party transactions, PBNK alleges that “a jury could have
concluded that Crowe Chizek intentionally joined with and aided and abetted
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Finnan and Menne in breaching their fiduciary duties by concealing the [JAMS
and Erpenbeck] Venture and the financial dependency of Finnan and Menne for a
period of over four years.” Consequently, PBNK contends that Crowe Chizek may
be liable for damages caused by Finnan’s and Menne’s breaches of their fiduciary
duties.
But as Crowe Chizek correctly points out, Kentucky law has never
recognized a civil cause of action for aiding and abetting a breach of fiduciary
duty. The closest analogue to such a claim is civil conspiracy, which has been
defined as “a corrupt or unlawful combination or agreement between two or more
persons to do by concert of action an unlawful act, or to do a lawful act by
unlawful means.” Smith v. Board of Education of Ludlow, 264 Ky. 150, 94 S.W.2d
321, 325 (1936). In order to prevail on a claim of civil conspiracy, the proponent
must show an unlawful/corrupt combination or agreement between the alleged
conspirators to do by some concerted action an unlawful act. Montgomery v.
Milam, 910 S.W.2d 237, 239 (Ky. 1995).
In Farmer v. City of Newport, 748 S.W.2d 162 (Ky. App. 1988), this
Court referenced the Restatement (Second) of Torts, § 876 (1979), relative to
“concert of action”:
For harm resulting to a third person from the
tortious conduct of another, one is subject to liability if
he (a) does a tortious act in concert with the other or
pursuant to a common design with him, or (b) knows that
the other's conduct constitutes a breach of duty and gives
substantial assistance or encouragement to the other so to
conduct himself, or (c) gives substantial assistance to the
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other in accomplishing a tortious result and his own
conduct separately considered, constitutes a breach of
duty to the third person.
Id. at 164.
Based upon these requirements, the Court in Farmer held that the
plaintiffs in a product liability action could maintain a claim based on concert of
action if they proved that the manufacturers acted tortiously, pursuant to a common
design, or rendered substantial assistance to others to accomplish a tortious act,
they could maintain a viable claim based on concert of action. Id.
However, in James v. Wilson, 95 S.W.3d 875 (Ky. App. 2002), this
Court dismissed a civil conspiracy claim in a school shooting case. The plaintiffs
in James alleged that a group of students knew that a classmate had brought guns
to the school and had heard him discussing his plans to open fire at the school, but
they failed to alert authorities to the classmate’s actions and threats. Consequently,
the plaintiffs asserted that the students were liable as co-conspirators for
participating in acts in furtherance of the alleged conspiracy. This Court disagreed,
finding no evidence that the students’ actions or inactions amounted to substantial
assistance in accomplishing the school shooting. Id. at 897.
In both Farmer v. City of Newport, supra, and James v. Wilson, supra,
the Court stated that mere negligence is not sufficient to support a claim for civil
conspiracy. Rather, there must be proof that the defendants acted tortiously
pursuant to a common design, or that they rendered substantial assistance to others
to accomplish the tortious act. In this case, there is no proof that Crowe Chizek or
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Brizendine were active, knowing participants in the misconduct by Finnan and
Menne. At most, Crowe Chizek’s negligence allowed the misconduct to go
undetected for an extended period of time. But even when the evidence is viewed
in the light most favorable to PBNK, there is no evidence that Crowe Chizek or
Brizendine intended to give substantial assistance to Finnan’s and Menne’s
misconduct. Consequently, the trial court properly dismissed PBNK’s aiding and
abetting claims.
PBNK next argues that the trial court erred in dismissing its claims
based upon the releases contained in the engagement letters, which set out the
scope of Crowe Chizek’s duties and the parties’ respective responsibilities. In its
engagement letters, Crowe Chizek stated that it would perform the audit based
upon generally accepted auditing standards using the financial statements provided
by PBNK. “[These] standards require that we obtain reasonable, rather than
absolute, assurance about whether the financial statements are free of material
misstatement whether caused by error or fraud.” The engagement letters further
provided, “because of the importance of management’s representations to an
effective audit, the Corporation agrees to release Crowe Chizek and its personnel
from any liability and costs relating to our services under this letter attributable to
any misrepresentations by management contained in the representation letter.”
In its responsive representation letters, PBNK agreed to the terms set
out in Crowe Chizek’s engagement letters, and further stated that it had disclosed
all “[f]inancial records and related data,” all “[m]inutes of stockholders, directors,
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and committees of directors, or summaries of actions of recent meetings,” all
“[f]inancial instruments with significant ‘off balance sheet’ risk of accounting loss
to which the Company is a party,” and all “[s]ignificant accounting estimates that
are susceptible to changing materially as a result of an event or change in
conditions that is reasonably possible of occurrence within one year.” PNBK
further stated that there were no “[u]nrecorded transactions,” “fraudulent financial
reporting or misstatements,” or “[v]iolations or possible violations of laws or
regulations whose effects should be considered for disclosure in the financial
statements or as a basis for recording a loss.”
Despite these representations, Crowe Chizek contends that PBNK
failed to disclose material facts which were or should have been within its
knowledge. Crowe Chizek points out that Finnan and Menne disclosed their
interests in JAMS on the “Company Affiliation” forms which they annually
submitted to the PBNK board. Similarly, Crowe Chizek points to PBNK records
showing that the board approved Finnan’s and Menne’s loans to Erpenbeck in
2001, that PBNK had concerns about Erpenbeck’s financial condition, that other
PBNK directors had expressed concerns about the close relationship between
Finnan, Menne and Erpenbeck, and that PBNK knew of problems with its check
cashing procedures before Erpenbeck began his check diversion scheme. Since
PBNK failed to disclose these facts, Crowe Chizek maintains that the release
precluded PBNK from claiming any damages arising from its services to PBNK
during this period.
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In its briefs to this Court, PBNK does not dispute Crowe Chizek’s
assertion that the records provided with the representation letters contained
significant misrepresentations and material omissions. However, PBNK argues
that Crowe Chizek had actual knowledge of the misconduct by Finnan, Menne and
Erpenbeck through its auditing work for JAMS. Thus, PBNK contends that its
losses were attributable to the independent negligence of Crowe Chizek and
Brizendine. PBNK asserts that Crowe Chizek had actual knowledge of the extent
of the relationship between Finnan, Menne and Erpenbeck through its
representation of JAMS. PBNK also notes that it has produced an expert who
states that Crowe Chizek breached its duties to PBNK by failing to discover and
disclose this information as part of its auditing duties. PBNK argues that there is
an issue of fact about whether the losses are attributable to its negligence or Crowe
Chizek’s. PBNK further argues that any omissions or negligence on its part do not
bar its claims, but may be considered by the jury in determining the parties’
comparative fault.
We agree. A release is a contract enforceable by its plain terms.
Abney v. Nationwide Mutual Insurance Co., 215 S.W.3d 699, 703 (Ky. 2006).
Agreements to exempt future liability for either ordinary or gross negligence are
not invalid per se, but they are generally disfavored and are strictly construed
against the parties relying upon them. Hargis v. Baize, 168 S.W.3d 36, 47 (Ky.
2005). In the context of personal injury law, a pre-injury release will be upheld
only if:
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(1) it explicitly expresses an intention to exonerate by
using the word “negligence;” or (2) it clearly and
specifically indicates an intent to release a party from
liability for a personal injury caused by that party’s own
conduct; or (3) protection against negligence is the only
reasonable construction of the contract language; or (4)
the hazard experienced was clearly within the
contemplation of the provision.
Id., citing 57A Am. Jur. 2d, Negligence § 53.
While Kentucky has never applied this rule to claims for professional
negligence, other jurisdictions have applied similar tests. In Kitchens of the
Oceans, Inc. v. McGladrey & Pullen, LLP, 832 So. 2d 270 (Fla. App. 2002), a
panel of the Florida Court of Appeals held that an auditor’s engagement letter must
contain language specifically and clearly providing that the client agreed to release
auditors from the auditor’s own negligence. Id. at 272-73. Likewise, Texas
requires that a release that relieves a party of liability from its own negligence in
advance is valid only if it expressly so states. See Newman v. Tropical Visions,
Inc., 891 S.W.2d 713, 719 (Tex. App. 1994), Dresser Industries, Inc. v. Page
Petroleum, Inc., 853 S.W.2d 505, 508 (Tex. 1993), and Ethyl Corp. v. Daniel
Construction Co., 725 S.W.2d 705, 708 (Tex. 1987). See also Chemd, Inc. v.
KPMG Peat Marwick, L.L.P., 2001 WL 893989 (Tex. App. 2001) (not designated
for publication), which applied the rule to identical language in an auditor’s
engagement letter.
The releases in this case do not exempt Crowe Chizek from damages
resulting from its own negligence, but only from damages “attributable to
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misrepresentations by management contained in the representation letter.” PBNK
has presented expert testimony that Crowe Chizek breached its duties by failing to
discover and disclose Finnan’s and Menne’s misconduct which it learned during
the course of its representation of JAMS. Crowe Chizek contends that this
information was confidential and could not be disclosed without breaching its
separate duties to JAMS. It also points out that Brizendine insisted that Finnan
disclose his relationship with JAMS as soon as he discovered it. Be that as it may,
we are satisfied that PBNK has presented sufficient evidence to show that its
damages stemmed, at least in part, from Crowe Chizek’s independent negligence
rather than its own failures to discover and disclose the wrongdoing by Finnan,
Menne and Erpenbeck. At least, there is a genuine issue of fact on this matter.
Therefore, the releases contained in the representation letters do not absolutely
preclude PBNK from recovering on its claims.
PBNK next argues that the trial court erred in finding that claims
against Crowe Chizek and Brizendine for professional negligence and breach of
fiduciary duty were barred by the one-year statute of limitations contained in KRS
413.245, which 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. Time shall not
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commence against a party under legal disability until
removal of the disability.
The statute contains two periods of limitation. The first period begins
one year from the date of the negligent act or omission (the date of occurrence),
and the second period begins on the date of discovery if it is later in time. Faris v.
Stone, 103 S.W.3d 1, 3 (Ky. 2003). As explained in the recent opinion of the
Kentucky Supreme Court in Queensway Financial Holdings, Ltd. v. Cotton &
Allen, P.S.C., 237 S.W.3d 141 (Ky. 2007):
The “occurrence” limitation period begins to run
upon the accrual of the cause of action. [Michels v.
Sklavos, 869 S.W.2d 728, 730 (Ky. 1994).] The accrual
rule is relatively simple: “‘[A] cause of action is deemed
to accrue in Kentucky where negligence and damages
have both occurred . . . . [T]he use of the word
“occurrence” in KRS 413.245 indicates a legislative
policy that there should be some definable, readily
ascertainable event which triggers the statute.’” Id. at
730 (quoting Northwestern Nat. Ins. Co. v. Osborne, 610
F.Supp. 126, 128 (E.D. Ky.1985)) (alterations in
original). Basically, “a ‘wrong’ requires both a negligent
act and resulting injury. Damnum absque injuria, harm
without injury, does not give rise to an action for
damages against the person causing it.” Id. at 731. The
difficult question when applying the rule is usually not
whether negligence has occurred but whether an
“‘irrevocable non-speculative injury’” has arisen. Id. at
730 (quoting Northwestern Nat. Ins. Co. v. Osborne, 610
F.Supp. 126, 128 (E.D. Ky.1985)).
The second or “discovery” limitation period begins
to run when the cause of action was discovered or, in the
exercise of reasonable diligence, should have been
discovered. Id. at 730. This rule is a codification of the
common law discovery rule, id. at 732, and often
functions as a “savings” clause or “second bite at the
apple” for tolling purposes.
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The trial court and the Court of Appeals dealt with
this case primarily under the discovery rule. They
addressed the accrual issue, but did so in terms of the
discovery rule. Citing Perkins v. Northeastern Log
Homes, 808 S.W.2d 809 (Ky. 1991), they held that a
cause of action accrues when it is discovered or becomes
discoverable. But under the professional malpractice
statute of limitations, mere knowledge of some elements
of a tort claim, such as negligence without harm, is
insufficient to begin running the limitations period where
the cause of action does not yet exist. Michels, 869
S.W.2d at 731-32. In this respect, the approach
employed by the lower courts is improper under the
professional malpractice statute, in that it collapses the
accrual rule into the discovery rule when the two are
analytically distinct. Admittedly, Perkins does say that a
cause of action will not accrue until the plaintiff
discovers or reasonably should have discovered that he is
injured and that the injury was caused by the defendant,
id. at 819, but in so doing it is describing how the
common law discovery rule works under the general
limitations statute to extend the tolling of the limitations
period, which the general statute describes as running
only upon accrual of the cause of action. The fact that
the language employed in Perkins discusses a cause of
action accruing under the discovery rule does not remove
the distinction between it and the accrual rule where the
malpractice limitation statute expressly includes both.
The distinction between the two rules is important
because, when properly applied, the accrual rule means
that the limitations period does not even begin to run
until the cause of action accrues. Until that time, no
cause of action yet exists, meaning a lawsuit would be
premature and should be dismissed.
Where a plaintiff claims that its suit was filed
within the limitations period under both the accrual and
discovery rules, as in this case, analyzing a claim only
under the discovery rule does not make sense because, by
its very nature, the discovery limitations period cannot
begin to run until the accrual period begins.
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Queensway, 237 S.W.3d at 147-48 .
Crowe Chizek primarily relies on the discovery rule, asserting that
PBNK knew or reasonably should have discovered the misconduct based upon
facts within its own knowledge. Likewise, PBNK contends that the statute of
limitations was tolled during the period of “continuous representation” of the bank
by Crowe Chizek. But both of these arguments go to the running of the discovery
limitations period. As pointed out in Queensway, the discovery limitations period
cannot begin to run until the accrual period begins.
Addressing the discovery rule first, and then addressing
the accrual rule in terms of discovery, further turns the
required analysis on its head. Instead, the plaintiff's
statute of limitations claim must be evaluated separately
under both the accrual and discovery rules. Moreover, it
makes sense to begin with the accrual limitation period.
Id. at 148.
The Court in Queensway went on to address when a cause of action
for professional negligence accrues. The Court looked to three cases involving
legal malpractice: Michels v. Sklavos, supra; Alagia, Day, Trautwein & Smith v.
Broadbent, 882 S.W.2d 121 (Ky. 1994); and Meade County Bank v. Wheatley, 910
S.W.2d 233 (Ky. 1995). In each of these cases, the professional negligence
occurred during the attorneys’ representation of the clients in ongoing matters.
And in each of these cases, the Court held that the cause of action did not accrue
until the damages caused by the negligence became fixed and non-speculative
upon resolution of the underlying matter.
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In contrast to the facts of these other cases, the Court in Queensway
noted that there was no underlying, continuing negotiation or lawsuit in which the
allegedly negligent auditor was involved. Rather, the negligence occurred when
the auditor underestimated the reserves necessary for an insurance company which
Queensway was acquiring. And the injury which Queensway suffered became
fixed and non-speculative when it purchased the insurance company based upon
the auditor’s prior misevaluation of the company’s reserves. Queensway, supra at
149-50. Consequently, the Court concluded that Queensway’s cause of action
accrued upon its purchase of the overvalued insurance company.
As in Queensway, the current case involves a claim of professional
negligence against an auditor where there was no continuing negotiation or
lawsuit. But PBNK does allege breach of an ongoing duty - Crowe Chizek’s
failure to discover and disclose the misconduct by Finnan and Menne. Thus, the
negligence, if any, occurred with the completion and delivery of each annual audit
report. The injury, however, consists of the ongoing breaches of fiduciary duty by
Finnan and Menne and, more importantly, the damage which PBNK suffered as a
result of those breaches.
Between 1998 and 2000, JAMS acquired mortgage indebtedness of
nearly $3.9 million and was financially dependent on the rental payments from
Erpenbeck to service this debt. But while Erpenbeck had other loans from PBNK,
none of these loans were related to the JAMS transactions. The primary injury to
PBNK was caused by Finnan’s and Menne’s actions in 2001 and early 2002. Due
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to their conflicts of interest involving JAMS, they continued to authorize loans to
Erpenbeck to cover his troubled financial condition and his liabilities for the check
kiting scheme. The damage from Finnan’s and Menne’s breaches of fiduciary duty
did not become fixed and non-speculative until early April of 2002, when
Brizendine compelled Finnan to disclose his relationships with JAMS and
Erpenbeck to PBNK. Consequently, PBNK’s cause of action for the alleged
professional negligence accrued no earlier than that time.
Nevertheless, Crowe Chizek continues to argue that PBNK knew or
should have known of the conflict of interest and the other misconduct by Finnan
and Menne at a much earlier time. This may be true and may go to PBNK’s
comparative fault for its losses. But for purposes of the statute of limitations,
PBNK’s cause of action against Crowe Chizek for professional negligence did not
accrue until the damage caused by the alleged negligence became fixed and nonspeculative. Since we find that the cause of action did not accrue until at least
April of 2002, therefore, PBNK’s complaint against Crowe Chizek, filed March
24, 2003, was timely.
Consequently, PBNK is entitled to proceed to trial on its claims
against Crowe Chizek for professional negligence. If PBNK proves its losses
resulted from Crowe Chizek’s negligence or breach of fiduciary duty, it may be
entitled to compensatory damages.
Crowe Chizek further argues that its contract with PBNK specifically
limits the damages which PBNK can recover. The 2001 engagement letter
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incorporated a document called “Crowe Chizek Engagement Terms.” In the
section styled “BUSINESS RISK ALLOCATIONS,” the engagement terms state,
in pertinent part:
With respect to any services or work product or this
engagement generally, the liability of Crowe Chizek and
its partners shall not exceed the fees Crowe Chizek
receives for the portion of the work giving rise to liability
nor include any special, consequential, incidental or
exemplary damages or loss (nor any lost profits, savings
or business opportunity), and a claim for a return of fees
paid shall be the exclusive remedy for any damages.
Crowe Chizek argues that this language precludes PBNK from
recovering any damages other than the fees which it paid for the auditing services
alleged to be negligently performed. The contract specifically excludes any
consequential damages or punitive damages.
This Court held above that the release in the engagement letters
exempts Crowe Chizek from damages “attributable to misrepresentations by
management contained in the representation letter,” but not from damages resulting
from its own negligence. Our conclusion on this point is bolstered by the
limitation of liability set forth in the engagement terms. The latter term would be
unnecessary if the release exempted Crowe Chizek from liability for damages
caused by its own negligence. But by the same token, the limitation of liability
provision is subject to enforcement according to its plain terms.
But PBNK correctly points out that the provision was included only in
the engagement letter signed on September 21, 2001. Crowe Chizek completed
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that audit in early January of 2002. Consequently, the limitation of liability
provision only applies to damages arising from Crowe Chizek’s negligence in
performing the audit for fiscal year 2001. The vast majority of the alleged
negligence in this case relates to Crowe Chizek’s performance of the audits for
fiscal years 1997 to 2000. Indeed, Brizendine discovered the relationship between
JAMS and Erpenbeck shortly after the 2001 audit was completed. Consequently,
the contract does not preclude PBNK from recovering consequential and punitive
damages arising from the earlier audits.
However, we agree with Crowe Chizek that PBNK is not entitled to
recover its losses arising from Erpenbeck’s check conversion scheme. PBNK’s
losses occurred because it allowed Erpenbeck to cash checks which were clearly
not payable to him. Thus, PBNK is liable for the conversion losses under KRS
355.3-420. See also Tri-County National Bank v. GreenPoint Credit, LLC, 190
S.W.3d 360, 362 (Ky. App. 2006).
Article III of the Uniform Commercial Code only governs PBNK’s
liability to the authorized payee and payor of the checks. It does not preclude a
bank from asserting a claim against other parties who may have contributed to the
conversion. PBNK argues that it could have disassociated itself from Finnan,
Menne and Erpenbeck before the check diversion scheme started if Crowe Chizek
had disclosed the relationship between JAMS and Erpenbeck at an earlier time.
While this may meet the “but for” test of causation, PBNK presents
no evidence that Erpenbeck’s check diversion scheme was a foreseeable result of
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Crowe Chizek’s negligence. PBNK concedes that Crowe Chizek’s auditing duties
did not place it in a position to discover Erpenbeck’s check conversion scheme.
Furthermore, there is no evidence that Finnan, Menne or JAMS was involved in
that misconduct. So Crowe Chizek could not have discovered the scheme through
its auditing work for JAMS. Thus, Erpenbeck’s check diversion scheme was not a
foreseeable consequence of any negligence by Crowe Chizek. Rather,
Erpenbeck’s criminal conduct and PBNK’s own negligence in cashing the checks
were superseding causes of the injury. See NKC Hospitals, Inc. v. Anthony, 849
S.W.2d 564, 568 (Ky. App. 1993).
The issue of punitive damages is a much more difficult question.
Crowe Chizek argues that PBNK has failed to present evidence sufficient to
support an award of punitive damages in this case. Punitive damages are given to
the plaintiff over and above the full compensation for his injuries, for the purpose
of punishing the defendant, teaching him not to do it again, and deterring others
from following his example. Hensley v. Paul Miller Ford, Inc., 508 S.W.2d 759,
762 (Ky. 1974). For these reasons, KRS 411.184 authorizes an award of damages
only upon a showing by clear and convincing evidence that the defendant acted
with fraud, oppression or malice. We have previously found no evidence that
Crowe Chizek intended to give substantial assistance to Finnan’s and Menne’s
misconduct. Thus, punitive damages are not available on these grounds.
However, the Kentucky Supreme Court has held that, under the
common law, punitive damages may be awarded on a showing of gross negligence,
-22-
and that KRS 411.184 cannot constitutionally exclude recovery of punitive
damages on this basis. Williams v. Wilson, 972 S.W.2d 260, 264 (Ky. 1998).
“Gross negligence” is a wanton or reckless disregard for the lives, safety or
property of others. See Phelps v. Louisville Water Co., 103 S.W.3d 46, 51-52 (Ky.
2003). 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. Horton v. Union Light, Heat & Power Co., 690 S.W.2d 382,
389 (Ky. 1985). In a case where gross negligence is used as the basis for punitive
damages, gross negligence has the same character of outrage justifying punitive
damages as willful and malicious misconduct in torts where the injury is
intentionally inflicted. Just as malice need not be expressed and may be implied
from outrageous conduct, so too may wanton or reckless disregard for the rights of
others be implied from the nature of the misconduct. Id. at 389-90.
PBNK does not argue that Crowe Chizek had an inherent conflict of
interest in its separate roles as auditor for the bank and JAMS. Rather, it contends
that Crowe Chizek should have discovered the conflict of interest during the course
of its auditing work for JAMS. Thus, PBNK argues that Crowe Chizek’s breach of
its duties to the bank was not merely negligent, but was in reckless disregard for its
rights. It further argues that Crowe Chizek’s failure to discover and disclose the
wrongdoing amounted to a concealment, causing damages independent of those
flowing from the wrongful acts themselves. Hardaway Management Co. v.
Southerland, 977 S.W.2d 910, 917 (Ky. 1998). Therefore, PBNK asserts that
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Crowe Chizek’s negligence was gross, thus permitting an award of punitive
damages.
We agree. Where the potential for harm is great and directly evident,
Kentucky has found that a reckless disregard for the rights of others may be
inferred from the negligent act. See Horton v. Union Light, supra at 387 (a gas
company could be found grossly negligent for its failure to adopt procedures to
detect and contain gas leaks); Phelps v. Louisville Water Co., supra at 52
(employer’s failure to adopt procedures to protect the lives and safety of its
employees and concealment of hazardous conditions may be considered grossly
negligent); and Gersh v. Bowman, 239 S.W.3d 567, 572 (Ky. App. 2007) (driver
who drives well in excess of speed limit on a curvy road may be considered to be
grossly negligent). However, there is very little case law about what constitutes
gross negligence with regard to professional negligence. But a finding of gross
negligence clearly requires more than a failure to exercise ordinary care. It
requires a finding of a failure to exercise even slight care such as to demonstrate a
wanton or reckless disregard for the rights of others. Phelps, supra at 51-52. See
also Cumberland Valley Contractors, Inc. v. Bell County Coal Corp., 238 S.W.3d
644, 655 n. 33 (Ky. 2007)
In this case, PBNK’s expert, David Wallace, states that Crowe
Chizek’s failure to conduct detailed loan credit reviews on loans to Erpenbeck was
a gross violation of generally accepted auditing standards and generally accepted
accounting practices. Likewise, he contends that Crowe Chizek’s failure to
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discover the fraudulent transactions in JAMS’ records and disclose them to PBNK
amounted to a serious breach of its fiduciary duties. And finally, he states that this
information should have placed Crowe Chizek on notice of the serious conflict of
interest between its duties to PBNK and to JAMS. Under the circumstances, we
conclude that PBNK has submitted sufficient evidence for a jury to decide whether
Crowe Chizek was grossly negligent.
Finally, PBNK argues that the trial court erred in granting summary
judgment on the application of KRS 271B.8-300(3), which provides as follows:
In discharging his duties a director shall be entitled to
rely on information, opinions, reports, or statements,
including financial statements and other financial data, if
prepared or presented by:
(a) One (1) or more officers or employees of
the corporation whom the director honestly
believes to be reliable and competent in the matters
presented;
(b) Legal counsel, public accountants, or
other persons as to matters the director honestly
believes are within the person’s professional or
expert competence; or
(c) A committee of the board of directors of
which he is not a member, if the director honestly
believes the committee merits confidence.
Based on this statute, PBNK contends that the members of its board
reasonably relied on the reports issued by Crowe Chizek. PBNK states that it may
assert this reasonable reliance as a defense to any comparative fault and to Crowe
Chizek’s third-party claims against PBNK’s directors.
-25-
We agree to the extent that KRS 271B.8-300 is relevant to determine
the standard of care which PBNK’s directors were obliged to exercise. Thus, the
statute is applicable (but not necessarily controlling) to any issues of comparative
fault and to Crowe Chizek’s third-party claims against PBNK’s directors.
However, PBNK cites no authority that KRS 271B.8-300 may be used offensively
to support a separate cause of action against Crowe Chizek. To this extent,
therefore, the trial court properly granted summary judgment dismissing PBNK’s
cause of action based on this statute.
In conclusion, we agree with PBNK that summary judgment was not
appropriate on its claims for professional negligence and breach of fiduciary duty
as these claims were not barred by the statute of limitations or by the releases
contained in the contracts between PBNK and Crowe Chizek. Furthermore, the
contracts do not bar PBNK’s claims for consequential and punitive damages
arising from Crowe Chizek’s negligence prior to the 2001 audit. PBNK is entitled
to proceed to trial on these issues. However, we find that summary judgment was
appropriate on PBNK’s claims for aiding and abetting liability, for damages arising
from Erpenbeck’s conversion of checks not payable to him, and on PBNK’s
asserted cause of action under KRS 271B.8-300, but that statute may be relevant to
any defenses based on comparative fault and as a defense to Crowe Chizek’s thirdparty claims.
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Accordingly, the summary judgments entered by the Boone Circuit
Court are affirmed in part, reversed in part, and remanded for further proceedings
as set forth in this opinion.
ALL CONCUR.
BRIEFS AND ORAL ARGUMENT
FOR APPELLANT:
Ronald R. Parry
Covington, Kentucky
BRIEF FOR APPELLEES:
Gary L. Prior
J. Jeffrey Patton
Daniel I. Konieczny
Chicago, Illinois
Henry E. Kinser
Virginia Hamilton Snell
Lexington, Kentucky
ORAL ARGUMENT FOR
APPELLEES:
Henry E. Kinser
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