Blodgett Supply Co. v. PF Jurgs & Co.

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                                 No. 90-017




 Blodgett Supply Co., Inc. and                Supreme Court
 S.P.L. Associates, Inc.
                                              On Appeal from
      v.                                      Chittenden Superior Court

 P.F. Jurgs and Company, Webster              December Term, 1991
 S. Thompson, Jonathan K. Woods,
 Robert L. Morse, David D. Patrick
 and Frederick M. Reed



 John P. Meaker, J.

 John B. Kassell and David W. M. Conard of Miller, Eggleston & Rosenberg,
   Ltd., Burlington, for plaintiffs-appellants

 Michael B. Clapp and Frederic S. Lane, III, Law Clerk (On the Brief), of
   Dinse, Erdmann & Clapp, Burlington, for defendants-appellees



 PRESENT:  Gibson, Dooley, Morse and Johnson, JJ.



      JOHNSON, J.   Buyer sued the sellers of Blodgett Supply Co., Inc. for
 breach of warranties in the 1986 purchase and sale agreement, and the
 company sued its former accounting firm for negligence and breach of
 contract.  Both actions arose from an accounting error that resulted in
 additional tax liability for the company for the years 1983 and 1984.  The
 trial court dismissed the action against the sellers and entered judgment
 against the accountants for costs incurred in filing an amended tax return,
 but denied relief for consequential damages against the firm.  We reverse.
      Five individual owners of the stock of Blodgett, a plumbing and heating
 distribution company in Burlington, sold the company to a corporation
 controlled by Samuel Levin, S.P.L. Associates, Inc. (SPL), in October 1986.
 The company's accounting firm prior to the sale was P.F. Jurgs and Company.
 Jurgs erred in preparing the company's tax returns for 1983 and 1984,
 resulting in the company's payment in 1987 -- after its sale to SPL -- of
 $92,306 in additional taxes, penalties, and interest for those two years.
      The errors by Jurgs arose in computing the company's LIFO reserves in
 preparing its federal and state income tax returns for 1983 and 1984.  LIFO,
 which stands for "last in, first out," is a method of inventory accounting.
 The purpose of LIFO is to reduce income on which taxes must be paid. LIFO
 allows a company to match the cost of the most recently purchased inventory
 against current revenues, thereby reducing taxable profits and making more
 money available to buy goods.  LIFO has been described as "a flow-of-costs
 approach to inventory accounting rather than a flow-of-goods approach."
 Note, An Examination of Some Considerations Relating to the Adoption and Use
 of the Last-in, First-out (LIFO) Inventory Accounting Method, 28 Vand. L.
 Rev. 521, 523 (1975). It is most useful during inflationary periods, when
 the cost of replacement inventory is rising.
      In the present case, Jurgs overstated the cost of goods "sold" for LIFO
 purposes.  Consequently, profits for 1983 and 1984 were understated, and
 federal and state taxes were underpaid.   Because the cost of goods sold
 was overstated, the value of the "remaining inventory," as reflected in the
 LIFO reserve account, was understated.  Therefore, although the actual
 inventory purchased by plaintiffs did not change, its value for future tax
 purposes was higher than the amounts reflected on the financial statements
 of the company.  The adjustments made to the LIFO reserve, then, increased
 the value of the company above the amounts represented and warranted by
 sellers at the closing.  Jurgs's negligence and breach of contract were
 conceded at trial and are not at issue here.
      In 1986, the company's new accountants notified Jurgs of what it
 believed was a computational error relating to the LIFO reserve, and
 thereafter the company and SPL wrote the selling shareholders and Jurgs
 demanding indemnification, under the purchase and sale agreement, against
 additional federal and state taxes due as a result of the error.  Receiving
 no response from any party, the company filed amended federal and Vermont
 corporate income tax returns for the calendar years 1983 and 1984 and paid a
 total of $75,877 in additional taxes, interest, and penalties.  The company
 borrowed the money to pay this sum, and the interest cost to the date of
 trial was $15,734.  The company's accounting fees related to these events to
 the date of trial totalled $13,715 and legal fees totalled $25,341.  The
 company borrowed the money to pay these fees and paid interest in the amount
 of $3,816 to the date of trial.
      At issue in plaintiffs' case against the sellers are certain
 representations and warranties denominated as sections 3(F), 3(H), and 8 of
 the purchase and sale agreement, as follows:
                                  Section 3
                  Representations and Warranties of Sellers
                                *     *     *
        F. Financial Information.  The Company has delivered to the
      Buyer true, correct and complete copies of the Company's United
      States income tax returns for the years ending December 31, 1984
      and 1985.  Such tax returns fairly reflect in all material
      respects the results of operation of the company and the assets,
      properties and liabilities of the Company for the years stated,
      and the balance sheets appearing therein fairly reflect in all
      material respects the financial condition of the company at the
      dates stated.  The Company has also delivered to the Buyer prior
      to the closing financial statements for the twelve month periods
      ending December 31, 1984 and 1985 and for the seven month period
      ending July 31, 1986 (the "Financial Statements") and interim
      financial statements internally generated for the period from July
      31, 1986 to the month ending prior to closing (the "Interim
      financial Statements"). The Financial Statements were compiled by
      the Company's accountants in accordance with generally accepted
      accounting principles on a basis consistent with past practices.
      The Financial statements and Interim Financial Statements in all
      material respects present fairly the results of operations and the
      financial condition of the company for the years and periods
      stated, and fairly depict the assets, properties and liabilities
      of the Company as of the dates stated. . . .

                                *     *     *

        H. Tax Matters.  The Company has filed all applicable federal,
      state, local, foreign and other income tax, excise tax, sales tax,
      use tax, import duty, gross receipts tax, franchise tax, employ-
      ment and payroll related tax, property tax and all other tax
      returns which the company is required to file and has paid all
      taxes shown on such returns, and all deficiencies or other
      assessments of tax, interest or penalties and all estimated taxes
      owed by it.  No penalties or other charges are, or will become,
      due with respect to the late filing of any such return.  The
      federal and state income tax returns of the Company have been
      audited for the fiscal years set forth on Schedule 4, and all
      deficiencies and assessments of tax, interest or penalties made or
      proposed in connection therewith have been paid. . . .

                                *     *     *






                                  Section 8

                 Survival of Representations and Warranties

        All of the representations, warranties, covenants and agreements
      of the parties made in this Agreement shall be true at Closing and
      shall survive the closing for a period of three (3) years and no
      longer, except for such representations and warranties that relate
      to matters of title and ownership of Shares, each of which shall
      survive the Closing without limitation.  The Buyer Samuel E. Levin
      and the company have relied on such representations, warranties,
      covenants and agreements in connection with its purchase of the
      shares.  Subject to the foregoing limitations, the Sellers shall
      indemnify and hold harmless the Buyer Samuel E. Levin and the
      Company from any and all damages, payables, deficiencies, losses,
      obligations, claims, debts, liabilities, fees, expenses or other
      costs (the "Damages") that result from or arise out of any breach,
      default or nonperformance of any representation, warranty, coven-
      ant or agreement of the Sellers set forth in this Agreement, or
      the untruth or inaccuracy thereof, including, but not limited to,
      all statements or figures contained in any Schedules to this
      Agreement to the extent the Damages, and the like exceed in the
      aggregate $25,000.  The Sellers shall have no indemnity obligation
      unless and until such threshold amount of $25,000 in the aggregate
      is reached . . . .  (Emphasis supplied.)

      Plaintiffs brought the present action in 1987, and after three days of
 hearings, the court concluded that the sellers had not breached any of the
 warranties in the purchase and sale agreement and dismissed the action
 against the sellers.  It found that Jurgs had committed an error in
 preparing the company's 1983 and 1984 tax returns and entered judgment for
 $4,740, the cost of filing the amended returns.  The court denied recovery
 for the penalties and interest associated with the amended returns.  The
 plaintiffs brought this appeal.
                                     I.
      Plaintiffs argue first that the trial court erred in concluding that
 the company's underpayment of taxes for 1983 and 1984 did not result in the
 breach of any warranties in the purchase and sale agreement.   On this
 issue the court accepted defendants' argument that the undisclosed tax
 liability discovered after the sale of the company was fairly reflected on
 the financial statements in the form of an overstated LIFO reserve.  The
 court concluded that while Jurgs erred in preparing the tax returns, the
 balance sheets nevertheless "fairly reflect[ed] in all material respects the
 results of operation of the Company and the assets, properties and
 liabilities of the company for the years stated," quoting the warranty
 language contained in section 3(F) of the purchase and sale agreement.  The
 court specifically found that "[t]he balance sheets do fairly reflect such
 financial condition.  The final condition is no worse either from a
 profitability standpoint or a net worth standpoint as a result of the Jurgs
 error."
      These findings reflected defendants' contentions that the same error in
 computing the LIFO reserve that led to the understatement of net profits and
 the underpayment of taxes necessarily resulted in an understatement of the
 value of the company's assets, and therefore an increase in the actual net
 worth of the company in the amount of $134,000 -- a greater increase than
 the total amount of taxes, interest, and penalties paid by the company on
 its amended returns.  In short, defendants contended the balance sheet
 increase more than offset the harm caused by the accounting error.
 Defendants also sought to prove that the tax liability was not truly hidden,
 but, in fact, was reflected in the company's financial statement, because
 the LIFO error resulting in the understated 1983 and 1984 income resulted in
 an offsetting error in the LIFO reserve.  The words "LIFO reserve,"
 defendants contended, are nearly synonymous with "tax liabilities ahead."
      There was substantial and conflicting expert testimony on the question
 of whether the company financial statements fairly "reflect[ed] in all
 material respects the results of operation of the company and the assets,
 properties and liabilities of the company for the years stated. . . ."  But
 the court's findings will not be disturbed merely because they are contra-
 dicted by substantial evidence; rather, an appellant must show there is no
 credible evidence to support the finding.  See Gokey v. Bessette, 154 Vt.
 560, 564, 580 A.2d 488, 491 (1990).  In transactions involving conflicting
 financial testimony, "[t]he trial court has great discretion in accepting or
 rejecting expert testimony and such determinations should not be disturbed
 absent manifest error."  Anderson v. Heck, 554 So. 2d 695, 703 (La. Ct. App.
 1989) (buyer of business did not demonstrate that monthly loss was
 "materially adverse change" in company's financial condition);  see
 Spartech Corp. v. Opper, 890 F.2d 949, 955 (7th Cir. 1989) (trial judge's
 finding that seller did not misrepresent the extent of company's deferred
 tax liability would stand as not clearly erroneous).
      In the present case, however, we agree with plaintiffs that there was
 no credible evidence to support the court's finding that the warranty in
 section 3(F) of the agreement had not been breached.  The 3(F) warranty
 stated that the 1984 and 1985 tax returns correctly set forth the company's
 tax liabilities for these two years, and all parties agree that statement
 was wrong. (FN1) Being wrong, it plainly constituted a breach of the 3(F)
 warranty.
      It is no answer that the balance sheets annexed to the returns
 reflected the error in the form of an overstated LIFO reserve, which, if
 properly interpreted, allowed the perspicacious analyst to understand either
 that the return was wrong or that, at most, payment of taxes was merely
 postponed.  A warranty should be judged on the basis of what the purchaser,
 here a sophisticated purchaser, might fairly infer from its four corners,
 without conducting his own audit and without testing the words of the
 warranty against possibly conflicting statements elsewhere in the agreement.
 There was no evidence to support the conclusion that SPL was unreasonable in
 relying on the 3(F) warranty that the company's tax returns fairly reflected
 the results of its operations and its tax liabilities for the years in
 question.  Even Jurgs made significant errors in the handling of the LIFO
 reserve account for two tax years, and charging SPL with knowledge that the
 warranted statement of "the liabilities of the Company for the years stated"
 was wrong because of related information in the statement of the LIFO
 reserve would render the warranty meaningless.(FN2)
      There is no merit in the argument that the balance sheet increase
 resulting from the post-acquisition adjustments more than offset the outlay
 for taxes, interest, and penalties.  Plaintiffs paid taxes, interest, and
 penalties in cash.  The offsetting savings, if any, would come in later
 years in amounts that were not determinable on the date of the acquisition
 and were surely not adjusted to reflect the time value of money.  Thus the
 "enhanced balance sheet" defense went to the extent of plaintiffs' damages
 and not to whether there was a breach of warranty.
      The trial court erroneously concluded that defendants had not violated
 any of the warranties in the purchase and sale agreement, and its decision
 must be reversed and the matter remanded to determine plaintiffs' damages,
 if any.
                                     II.
      Because the trial court ruled in defendants' favor, it did not reach
 the issue of damages.  We will consider that issue here because it will
 arise on remand and is integrally related to our holding on liability.
      Damages for breach of warranties by sellers of a business should be the
 "'loss of the bargain' -- the difference between the worth of the article as
 represented and that as actually delivered."  Coleco Industries, Inc. v.
 Berman, 567 F.2d 569, 577 (3d Cir. 1977) (accounting errors causing
 underestimation of cost of pools resulted in breach of warranties of profit-
 ability).  As applied to the present case, that would be the difference
 between the purchasers' reasonable expectations as to the worth of the
 company, as fairly described in the warranties, and the actual worth of the
 company as a result of any breach of warranties.  Here, plaintiffs laid out
 certain amounts of cash relatively soon after purchase, on account of an
 undisclosed tax liability.  There is no dispute as to the amount that
 plaintiffs paid in federal and state taxes, together with penalties and
 interest, on the amended returns for 1983 and 1984. (FN3) If those damages were
 minimized or eliminated by offsetting savings, the burden of demonstrating
 that was on defendants. (FN4) The sellers presented expert testimony explaining
 that the underpayment of taxes for 1983 and 1984 did not prejudice
 plaintiffs, because the amount of the underpayment, $75,877, was less than
 the increase in the actual net worth of the company of $134,000, and
 counsel argued on this basis that SPL got more dollar value than it
 bargained for in the company purchase.
      But there was no testimony that the $134,000 that was added to the
 value of assets in the amended corporate tax returns put plaintiffs in the
 financial position they would have been in had the 1983 and 1984 taxes been
 timely and accurately paid -- hence precluding any "loss of the bargain."
 To the contrary, the testimony was clear that actual value of the company's
 assets did not change upon discovering the Jurgs error.  The company could
 not raise its prices to customers on the basis of the adjustments in the
 LIFO reserve.
      The adjustments to the reserve account in the amended returns were
 nevertheless likely to be of some value to the company, since they would
 tend to lessen future tax liability by increasing the stated cost of goods
 sold and lowering net profits.  Again, the trial court did not review the
 record on the issue of damages, and we cannot determine whether, or to what
 extent, defendants might demonstrate offsets to some or all of plaintiffs'
 damages.  Those amounts may be determinable on the present record or may
 require further testimony and additional documentary evidence, within the
 court's discretion upon remand.
                                     III.
      The trial court concluded that because there had been no breach of any
 warranty or representation, there was "no need to apply the $25,000
 'deductible'" found in Section 8 of the purchase and sale agreement.  In
 light of our holding, Section 8 is an integral part of the damages issue.
 Consequently, we will consider the questions raised by plaintiffs relating
 to Section 8 "in order to conserve judicial resources and avoid an
 unnecessary duplication of effort."  Pfeil v. Rutland District Court, 147
 Vt. 305, 308, 515 A.2d 1052, 1055 (1986).
      We hold that Section 8 of the agreement is a threshold, not a
 deductible.  Two clauses in the section refer to a $25,000 amount.  The
 first implies that a deductible is intended, in that it uses the phrase "to
 the extent the Damages, and the like exceed in the aggregate $25,000."  But
 the next sentence uses the word "threshold" and clearly implies that $25,000
 is the amount of damages that must be reached for any recovery, but that
 once that amount is reached, "any and all" damages may be recovered.  This
 construction is most sensible in reconciling the two conflicting clauses.
 Any other construction would render the second clause meaningless, and it
 must be assumed that the parties included it for a reason.  Vermont State
 Colleges Faculty Federation v. Vermont State Colleges, 141 Vt. 138, 143, 446 A.2d 347, 349 (1982) (contract must be construed, if possible, to give
 meaning to all its provisions).
                                     IV.
      Finally, the company appeals from the court's limited judgment against
 Jurgs for the cost of filing an amended tax return due to Jurgs's admitted
 error in the computation of the company's 1983 and 1984 income tax returns.
 The court found that Jurgs's errors did not constitute bad faith conduct and
 properly denied attorney's fees.
      The court did not explain why it denied judgment against Jurgs for the
 amount of penalties paid by the company to the State of Vermont in connec-
 tion with the late returns.  Defendant Jurgs does not argue that penalties
 were not reasonably foreseeable, and hence, compensable.  It argues that the
 company failed to present evidence of the penalty payment, because the entry
 "Penalties and Interest" in the company's proposed findings of fact was the
 same amount that witness Levin had testified was interest alone.  Since the
 trial court did not rule on this question and the question of damages will
 be before the court on remand, the trial court must weigh the evidence as to
 the payment of a penalty to Vermont together with the other damage issues.

                                     V.
      Damages should also include reasonable fees paid by plaintiffs in
 accordance with the covenants in the purchase and sale agreements.  Section
 8 of the purchase and sale agreement provided for payment of "fees, expenses
 or other costs . . . that result from or arise out of any breach, default or
 nonperformance of any representation, warranty, covenant or agreement of the
 Sellers set forth in this Agreement."  Plaintiffs have asked for all of
 their considerable legal and other fees to be borne by defendants, but they
 have prevailed on only one of their warranty claims.  More importantly,
 they have not prevailed on their theory of damages, which focused
 exclusively on the gross outlays resulting from breach of warranty,
 rejecting the notion that any later savings realized from the error should
 be offset against the costs of the breach.  It is clear from the lengthy
 trial, voluminous record, and the briefs before this Court that significant
 attorneys' time was expended on damages issues on which plaintiffs did not
 prevail.  We cannot say on the present record to what degree plaintiffs'
 erroneous position on damages contributed to the length and complexity of
 the trial.  The trial court should compute the fee award on the basis of
 time spent on issues on which plaintiffs prevailed.  Specialized Tours, Inc.
 v. Hagen, 392 N.W.2d 520, 542-43 (Minn. 1986) (in action for breach of
 warranty in sale of company, successful plaintiffs' fee award under state
 statute should reflect federal fee award provisions for partially successful
 claim).

      The judgment is reversed and the matter remanded for reconsideration
 consistent with this opinion.



                                    FOR THE COURT:



                                    ______________________________
                                    Associate Justice




FN1.    The tax computation errors occurred in 1983 and 1984, although the
 warranty in the purchase and sale agreement warrants the returns of 1984 and
 1985.  Presumably, the LIFO reserve error made in 1983 tainted the 1984
 return, and if it did not, errors were, in fact, made in 1984.  This was not
 an issue at trial or on appeal.

FN2.    Plaintiffs also argue that sellers violated the warranties
 contained in section 3(H) of the purchase and sale agreement.  The company
 did not fail to file "all applicable federal, state . . . income tax . . .
 returns which the company is required to file" and did pay all taxes shown
 on such returns."  It is true that the returns were erroneous, and these
 errors were implicated in the breach of the 3(F) warranties, but the
 language of 3(H) was not violated.  Similarly, "all deficiencies or other
 assessments of tax, interest or penalties and all estimated taxes owed by"
 the company as reflected on such returns had been paid.  Finally,  3(H)
 warranted that "all deficiencies and assessments of tax, interest or
 penalties made or proposed in connection" with audits of the company had
 been paid, but 3(H) did not purport to speak for deficiencies, assessments,
 interest, or penalties not detected by audit.

FN3.    Defendants do not appear to dispute the amounts expended by
 plaintiffs for attorney and accounting fees and the cost of borrowing to
 pay sums owed on the returns.  But defendants do not concede that such
 expenditures were damages contemplated by the purchase and sale agreement.

FN4.    Plaintiffs moved at trial to bar testimony on defendants' behalf
 relating to tax benefits accruing after filing of the amended returns and
 offsetting some or all of the amounts paid with the amended returns.
 Plaintiffs argued that the offsets were barred under the collateral source
 rule.  See Coty v. Ramsey Associates, Inc. 149 Vt. 451, 462-63, 546 A.2d 196, 204 (1988).  The motion was denied, and plaintiffs have not raised the
 collateral source rule issue in this appeal.