DANNING 11 11 v. ARTHUR ANDERSEN CO

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Court of Appeal, Second District, Division 7, California.

Curtis B. DANNING, as Chapter 11 Trustee, and David A. Gill, as Chapter 11 Trustee, for California Pacific Funding, Ltd. and A & B Loan Co., Plaintiffs and Appellants, v. ARTHUR ANDERSEN & CO., Defendant and Respondent.

No. B086427.

Decided: July 17, 1995

Lurie and Zepeda, Robert W. Denton and Richard P. Brull, Beverly Hills, for plaintiffs and appellants. Debevoise & Plimpton, Robert L. King and James B. Pickell, Los Angeles, for defendant and respondent.

Appellants, trustees in bankruptcy for “hard-money” lending companies, sued the companies' former accounting firm for professional negligence.   The accounting firms (defendant and respondent) demurred, asserting the statute of limitations.  (Code Civ.Proc., § 339, subd. (1).)  The trial court sustained the demurrer without leave to amend.   We affirm.

FACTUAL AND PROCEDURAL BACKGROUND

Alexander Spitzer and members of his family formed and controlled various partnerships and “alternative lender” companies which made loans to those “who might not qualify for loans made by most banks or savings and loan associations.”   The loans were “secured by junior interests in real property.”   The partnerships and companies included A & B Loan Company, Inc. (A & B), the managing general partner of California Pacific Funding, Ltd. (Cal Pac) which in 1985 “consolidate[d] the assets and operations of three limited partnerships:  California Pacific Funding Company, West Coast Loan Company, and Golden West Loan Company.”

The lending partnerships and companies engaged in the following practices:  they made “uncollectable loans and/or loans which were substantially overstated in value,” they had inadequate loan loss reserves, they made loans “unjustified by appropriate lending criteria” they “rolled over” defaulted loans into new loans to related parties and reported defaulted interest and loan fees as income, they used interest reserves to make new loans, they made loans secured by property which they had appraised only by a “drive-by[ ]” without inspecting the interior and “based upon dissimilar and/or incomplete market analysis data.”

Respondent audited the financial statements of the partnerships and companies annually from 1981–1988 but failed to disclose these practices in their audit reports and concluded that the subject “loan portfolio was adequately collateralized.”

The lending partnerships and companies obtained loan funds from banks and from investors who relied upon respondent's audit reports.

On March 28, 1989, the City of Los Angeles and others filed an action “to redress the practice ․ of maintaining and operating slum buildings through a complex set of financial machinations.”   Defendants included not just slum building owners but those “who have financed them.”   The complaint alleged “[t]he lender defendants have been aware of the slum and substandard character of these buildings;  have been aware of the lack of financial capability of the record owners;  have written loans which would absorb all or virtually all of the rental flow from the buildings;  have made huge sums from high interest and high ‘points' on each loan;  have assisted frequent property transfers, often only months apart and often timed such that the transfer undermined City Attorney prosecutions of the then existing record owners;  ․ have effectively operated as the real beneficial owners of ․ one or more of the buildings․”

The lawsuit 1 (City lawsuit) named 141 defendants including Alexander Spitzer, A & B, Cal Pac, and the three consolidated predecessor partnerships.   Of the eleven slum properties identified in the City lawsuit seven were financed and/or owned by one or more of the Spitzer partnerships or companies.

“[I]mmediately following the filing of the City's lawsuit, the banks refused to extend any further credit to A & B and Cal Pac.   In June 1989, Bank Hapoalim notified certain borrowers of A & B and Cal Pac that they should make their loan payments directly to the Bank, and not to A & B or Cal Pac.   This action caused many borrowers to cease payments on their loans to A & B and Cal Pac, thus creating a cash shortage․   Moreover, the banks prevented A & B and Cal Pac from foreclosing on their collateral․”

On November 24, 1989, “A & B and Cal Pac filed petitions under Chapter 11 of the United States Bankruptcy Code.”

In January 1990 Curtis B. Danning was appointed Chapter 11 Trustee for Cal Pac and A & B.

On March 26, 1990, investors in the Spitzer partnerships and companies filed a class action lawsuit (Small et al. v. Sunset Park Investments, et al., Superior Court No. CA001225) against Alexander Spitzer's two daughters, their husbands (none of whom had filed Chapter 11 bankruptcy petitions), Spitzer associates, the Bank of America, respondent, and others.   Among its many causes of action, professional negligence and negligent misrepresentation were alleged to have been committed by respondent in auditing the accounts of the Spitzer partnerships and companies.

Sometime before October 15, 1993, appellants and respondent agreed the statute of limitations would be tolled from January 23, 1992, through October 15, 1993.

On October 15, 1993, appellants filed the instant action for professional negligence, breach of written contract, and negligent misrepresentation.

On February 17, 1994, respondent demurred to the complaint and on March 10, 1994, appellants filed a first amended complaint (FAC).   On April 8, 1994, respondent again demurred.   Appellants opposed the demurrer and on April 29, 1994, respondent filed an amended demurrer and a request the trial court judicially notice the City lawsuit.2  Appellants opposed the amended demurrer and respondent replied to appellants' opposition.

On May 24, 1994, after a hearing and argument by counsel, the trial court sustained without leave to amend the amended demurrer, stating the two year statute of limitations barred the professional negligence cause of action because “[t]he City's suit provided sufficient notice to start the statute of limitations running.   Certainly, as of filing of bankruptcy, at the latest, the statute started running.”   As to the alleged breach of contract, “Plaintiff's action is not for breach of a specific provision, but for defendant's failure to perform in accordance with professional standard in community.”   As to negligent misrepresentation, “the negligent misrepresentation cause of action ․ is nothing more than the cause of action for professional negligence.   Nothing is alleged showing misrepresentation unrelated to and beyond the alleged malpractice.”

On June 17, 1994, the trial court signed an order dismissing the lawsuit.   This appeal followed.

DISCUSSION

1. Professional Malpractice

“[I]n a malpractice action against an accountant the statute of limitations does not run until the negligent act is discovered, or with reasonable diligence could have been discovered.”  (Moonie v. Lynch (1967) 256 Cal.App.2d 361, 365–366, 64 Cal.Rptr. 55;  Liberty Mut. Ins. Co. v. Harris, Kerr, Forster & Co. (1970) 10 Cal.App.3d 1100, 1104, 89 Cal.Rptr. 437.)  “The ‘discovery rule’ assumes that all conditions of accrual of the action—including harm—exist, but nevertheless postpones commencement of the limitation period until ‘the plaintiff discovers or should have discovered all facts essential to his cause of action [citations],’ which is to say ‘when “ ‘plaintiff either (1) actually discovered his injury and its negligent cause or (2) could have discovered injury and cause through the exercise of reasonable diligence.’ ” ' ”  (CAMSI IV v. Hunter Technology Corp. (1991) 230 Cal.App.3d 1525, 1536, 282 Cal.Rptr. 80.   Original italics.)

 When, on the face of the complaint, it appears the action is time barred, the complaint “must plead facts to negative a statutory bar to the action.”  (4 Witkin, Cal. Procedure (3d ed. 1985) § 379, p. 430.)  “Formal averments or general conclusions to the effect that the facts were not discovered until a stated date, and that the plaintiff could not reasonably have made an earlier discovery, are useless.   The complaint must set forth specifically (a) the facts of the time and manner of discovery;  and (b) the circumstances which excuse the failure to have made an earlier discovery.”  (5 Witkin, Cal. Procedure (3d ed. 1985) § 877, pp. 319–320;  CAMSI IV v. Hunter Technology Corp., supra, 230 Cal.App.3d at pp. 1536–1537, 282 Cal.Rptr. 80.)

“Arguments that discovery-rule issues are necessarily factual and cannot be resolved on demurrer have been rejected.”  (Id. at p. 1537, 282 Cal.Rptr. 80.)

The FAC alleged respondent's last act of professional negligence occurred April 1989 but the two year statute of limitations (Code Civ. Proc., § 339, subd. (1); 3  Bedolla v. Logan & Frazer (1975) 52 Cal.App.3d 118, 125, 125 Cal.Rptr. 59) was not tolled until January 23, 1992, almost two years and nine months later.   To avoid this two year time bar the FAC alleged “A & B and Cal Pac could not have reasonably discovered [respondent's] negligence any earlier than March 26, 1990 [when investors filed a class action lawsuit against respondent and others], because [respondent's] audits misled A & B and Cal Pac into believing that they were on sound financial footing and because the City's lawsuit and the bankruptcy filings did not adequately give A & B and Cal Pac notice that the collateral securing their loans ․ was inadequate․”

The trial court found, contrary to appellants' allegations, “[t]he City's suit provided sufficient notice to start [the] statute of limitations running.”   We conclude the trial court was correct.

a. Standard of review

 In reviewing the sustaining of a demurrer without leave to amend we apply these well settled rules:  the factual allegations of the complaint are deemed true (Perdue v. Crocker National Bank (1985) 38 Cal.3d 913, 922, 216 Cal.Rptr. 345, 702 P.2d 503), difficulty of proof is irrelevant (ibid.), the complaint should be liberally (Krawitz v. Rusch (1989) 209 Cal.App.3d 957, 962, 257 Cal.Rptr. 610) but reasonably construed (Dale v. City of Mountain View (1976) 55 Cal.App.3d 101, 105, 127 Cal.Rptr. 520), and appellant need only plead facts showing he is entitled to some relief.  (Ibid.)

 “While a demurrer admits all material and issuable facts, properly pleaded, it does not admit contentions, deductions or conclusions of law.”   (Ibid.) And “where an allegation is contrary to law or to a fact of which a court may take judicial notice, it is to be treated as a nullity.”  (Ibid.)  The court may take judicial notice of such records as appellant's affidavits (Del E. Webb Corp. v. Structural Materials Co. (1981) 123 Cal.App.3d 593, 604, 176 Cal.Rptr. 824), prior complaints in the same action (Perdue v. Crocker National Bank, supra, 38 Cal.3d 913, 923, fn. 5, 216 Cal.Rptr. 345, 702 P.2d 503), and records of any court of this state.  (Evid.Code, §§ 452, subd. (d) and 453.   See generally Blank v. Kirwan (1985) 39 Cal.3d 311, 318, 216 Cal.Rptr. 718, 703 P.2d 58.)

b. The City lawsuit

 Appellants 4 contend they could not with reasonable diligence have discovered respondent's negligence from the City's lawsuit for all of the following reasons:  (1) that lawsuit involved only seven of their properties out of a loan portfolio secured by hundreds of properties (2) “the City Lawsuit did not name [respondent], did not contain any reference to [respondent] or [respondent's] audits, or otherwise give notice that [respondent] failed to perform its audits in accordance with GAAS [Generally Accepted Accounting Standards] or committed any wrongdoing.”  (3) “nothing in the City Lawsuit suggested that the financial condition of the Companies was materially misstated in their financial statements” and (4) respondent issued an audit report after the City lawsuit filing which indicated “the Companies had a substantial net worth, their accounting procedures wholly complied with GAAP [Generally Accepted Accounting Principles] and their loan loss reserves were adequate.” 5  The contention does not bear scrutiny.

The 134–page City lawsuit complaint described the subject slum properties.   Those descriptions would have alerted any reasonable person, let alone a professional lender, to the almost worthlessness of the properties.   For example:  “These slum dwellings ․ have rodent and vermin infestation, lack of hot water and heat, severe fire hazards, undisposed of garbage and other unsanitary conditions, broken windows and doors, leakage from plumbing and roof defects, [and] a serious lack of personal security and similar conditions.”

As to appellants' seven involved properties, the City lawsuit complaint stated:  the 2616 Idell Street property “has been in substandard condition since 1982 or earlier”;  the 4020 South San Pedro property “has been a slum since 1981 ․ and [s]ince 1979 ․ has been cited 18 times for violations of the fire codes, health codes and building codes”;  the 5426 Virginia Avenue property “was cited for numerous housing code violations since at least 1981.   During the past five years, record owners have included ․ Manchester Associates, whose general partner is defendant Alex Spitzer”;  the 504 South Bonnie Brae St. property “has been a slum building, unfit for human habitation, since before 1981.   The property has been the subject of six criminal prosecutions ․ in the period 1981 to 1988․”;   the 526 South Union Avenue property was a slum building, unfit for human habitation from 1983 to 1988.   “Since 1983 it has been cited 47 times, most recently by the Fire Department in January 1989”;  the 1616 West 111th Street property “was a slum building, unfit for human habitation, since at least 1985, and continuing to 1988.   Since March 1982, the building has been cited at least 38 times for habitability violations ․ 27 were fire code violations”;  the 1000 Echo Park Avenue property were slums, unfit for human habitation, from the early 1980's until 1988․   The property has been transferred to 11 record owners in the last seven years.”

Further, any reasonable security holder should have been galvanized by the City's lawsuit complaint that “the buildings [were] unsafe, unsanitary, unhealthy and unfit for human habitation” and by this specification of building defects:

“A. Infestation by vermin, rodents, roaches and insects and maintenance of rodent harborage;

“B. Lack of hot water, inadequate supply of hot water and interruption of water services;

“C. Absent and defective windows and screening;

“D. Defective, damaged and deteriorated ceilings and walls;

“E. Inadequate and defective electrical systems and outlets, and interruption of electrical utility services;

“F. Lack of heat and inadequate heating including gas services;

“G. Inadequate plumbing;

“H. Inhabited rooms and common areas littered with accumulation of debris, filth, rubbish and garbage;

“I. Absent and chipped paint on walls, doors, and door frames;

“J. Damaged floors and floor tiles, and worn and torn carpeting;

“K. Storage of hazardous and combustible materials;

“L. Inadequately marked fire exits and absence of notice indicating proper response in case of fire;

“M. Open cap openings into drainage systems;

“N. Unsafe, inoperable and missing fire doors, standpipes, fire escape ladders, fire extinguishers, fire hoses, and sprinkler system;

“O. Absent and defective smoke detectors;  and

“P. Other substandard, dilapidated, dangerous, unhealthful and uninhabitable conditions.”

Finally, these City lawsuit allegations, irreconcilable with respondent's audits, should have led appellants to discover “all facts essential to [their] cause of action” against respondent (CAMSI IV v. Hunter Technology Corp., supra, 230 Cal.App.3d 1525, 1526, 282 Cal.Rptr. 80):  “Acting fraudulently, the lender defendants, with full knowledge of the slum character of these buildings have made loans for amounts exceeding the value of the slum buildings․”;   “The slum buildings ․, at material times ․ have had no reasonable rental value;  “․ the loans made by the lender defendants were unjustifiably high in that they were clearly unwarranted by the value of the slum building”;   “․ The loans were made ․ without any or with completely inadequate appraisals of the property;  lending without any or with completely inadequate credit checks of the borrowers”;  “The lender defendants routinely and repeatedly made loans to record owners in amounts that were far in excess of the true value of the slum buildings.   In addition, lender defendants repeatedly inflated the alleged value of the slum buildings despite the steady deterioration of the properties.”

c. Actual knowledge by a partner

 An additional reason supports the trial court's ruling.   Appellants' allegations describing respondent's report omissions simultaneously described appellants' business practices, euphemistically termed “accounting and business problems.”  For example, the FAC states respondent “should have discovered:  (a) A substantial portion of A & B, Cal Pac and the predecessor partnerships' loan portfolios were inadequately collateralized and consisted of substantial numbers of uncollectable loans and/or loans which were substantially overstated in value.”

But it was appellants who made the under-secured loans, the uncollectable loans, and the inflated loans.   What respondents “should have discovered” appellants already knew.   As Bedolla v. Logan & Frazer, supra, 52 Cal.App.3d 118, 128, 125 Cal.Rptr. 59—a strikingly similar case—notes:  “notice to any partner operates as notice to the partnership, and the knowledge of any partner is to be inputed to the partnership.”   Our Supreme Court has observed:  “An auditor is a watchdog, not a bloodhound.   As a matter of commercial reality, audits are performed in a client-controlled environment.   The client typically prepares its own financial statements;  it has direct control over and assumes primary responsibility for their contents ․ the client necessarily furnishes the information base for the audit.”  (Bily v. Arthur Young & Co. (1992) 3 Cal.4th 370, 399, 11 Cal.Rptr.2d 51, 834 P.2d 745.)

2. Other causes of action

 Because the trial court found that “Plaintiff's action is not for breach of a specific [contract] provision, but for defendant's failure to perform in accordance with professional standard in community” it sustained the demurrer to appellants' breach of contract cause of action.   The ruling was correct.  (See L.B. Laboratories, Inc. v. Mitchell (1952) 39 Cal.2d 56, 62–63, 244 P.2d 385.)

 For the same reason the trial court sustained the demurrer to appellants' negligent misrepresentation cause of action.   The trial court stated:  “Demurrer is sustained without leave to amend as to negligent misrepresentation cause of action, as the negligent misrepresentation cause of action in this case is nothing more than the cause of action for professional negligence.   Nothing is alleged showing misrepresentation unrelated to and beyond the alleged malpractice.”   The ruling was correct.  (See generally Slater v. Blackwood (1975) 15 Cal.3d 791, 795, 126 Cal.Rptr. 225, 543 P.2d 593.)

DISPOSITION

The judgment is affirmed.   Costs on appeal are awarded to respondent.

FOOTNOTES

1.   People v. Highland Federal Savings & Loan Ass'n et al., Superior Court No. C718828.

2.   The trial court took judicial notice of all requested matters.

3.   In pertinent part, the statute reads:  “Within two years:  1. An action upon a contract, obligation or liability not founded upon an instrument of writing․”

4.   For convenience we use “appellants” to refer to the partnerships and lending companies.

5.   Appellants also contend “the Companies did not suffer injury until after ․ Curtis B. Danning was appointed Chapter XI trustee on January 26, 1990.”   The contention is specious.   As the FAC itself states, it was the March 28, 1984, filing of the City lawsuit which “immediately” caused the companies to collapse and file Chapter 11 bankruptcy petitions.

FRED WOODS, Associate Justice.

LILLIE, P.J., and JOHNSON, J., concur.