Opinion
Nos. 00 CIV. 2798 (DLC), M 19-375
March 6, 2003
William B. Fleming, GAGE SPENCER FLEMING, New York, NY, for Plaintiffs.
Richard H. Dolan, Jeffrey M. Eilender, Elizabeth Prickett-Morgan, SCHLAM STONE DOLAN, New York, for Defendant.
OPINION ORDER
Universal Appliances, Ltd. ("UAL") has moved for reconsideration of the December 27, 2002 Opinion and Order ("December 27 Opinion") entered in this proceeding. The December 27 Opinion granted the motion by North American Foreign Trading Corporation ("NAFT") to pierce the corporate veil of Smoothline Ltd. ("Smoothline") and Greatsino Electronic Ltd. ("Greatsino") to reach UAL, their indirect owner, and thereby to require UAL to arbitrate disputes arising from Smoothline contracts with and Greatsino guarantees to NAFT. At the heart of this motion for reconsideration is the extent and appropriateness of the reliance that the December 27 Opinion placed on the failure of UAL, Smoothline and Greatsino to produce, during the discovery period that preceded the motion, the standard accounting documents that are necessary to make the general ledgers that they did produce comprehensible.
This motion does not meet the requirements for a motion for reconsideration since it does not point to any law or evidence that was overlooked in issuing the December 27 Opinion. Even when addressed on its merits, however, it must be denied.
BACKGROUND The December 27 Opinion
The December 27 Opinion applied the New York standard for piercing the corporate veil, which requires the movant to show both that a corporate owner exercised complete domination over its subsidiary with respect to the transaction at issue and that the domination was used to commit a fraud or wrong. Smoothline Ltd. et. al. v. North American Foreign Trading Corp., No. 00 Civ. 2798 (DLC), 2002 WL 31885795, at *9 (S.D.N.Y. Dec. 27, 2002). In concluding that NAFT had met the first prong of the test and had shown that UAL exercised complete domination over both Smoothline and Greatsino, the December 27 Opinion relied on many factors, heeding the admonition in Freeman v. Complex Computing Co., 119 F.3d 1044 (2d Cir. 1997), that no one of the factors relevant to a judgment regarding domination is "decisive". Id. at 1053. Even without the evidence that there was a failure to produce standard accounting documents, and the inferences that were drawn from that failure, there was overwhelming evidence that UAL dominated the operations of both Smoothline and Greatsino. Indeed, UAL does not suggest in this motion for reconsideration that the finding of domination was in error. UAL does not argue with the conclusion in the December 27 Opinion that Greatsino and Smoothline were simply sales divisions in the UAL organization and not independent, fully-functioning companies. What is at stake in this motion for reconsideration, therefore, is the reliability of the conclusion that UAL used its domination of Smoothline and Greatsino to commit a fraud or wrong.
The December 27 Opinion recognized that NAFT has the burden to show that UAL used its domination of Smoothline and Greatsino to "commit wrong, fraud, or the breach of a legal duty, or a dishonest and unjust act in contravention of plaintiff's legal rights, and that the control and breach of duty proximately caused the injury complained of." Smoothline, 2002 WL 31885795, at *11 (citing Freeman, 119 F.3d at 1053). The December 27 Opinion also found that NAFT had shown that Smoothline and Greatsino are "dormant and essentially judgment proof." Id. UAL does not argue with that finding. UAL's concern is with the next step in the analysis. UAL argues that the December 27 Opinion incorrectly found that it had improperly drained money from Smoothline and Greatsino, shifted the burden of proof to UAL in doing so, and erred in drawing inferences about its failure to produce documents. UAL argues that Smoothline and Greatsino are impoverished as a result of NAFT's decision to cease doing business with them and not because of UAL's wrongdoing. UAL's arguments in its motion for reconsideration each hinge on what occurred during the discovery period that preceded the most recent motion to pierce the corporate veil.
The Discovery Period
During the discovery period, UAL, Smoothline and Greatsino produced general ledgers but did not produce the standard accounting documents that are necessary to make a general ledger comprehensible. They did not produce, for instance, a trial balance, bank reconciliation, reconciliation of intragroup transfers, and subsidiary ledgers for accounts receivable and accounts payable. As the December 27 Opinion noted, the failure to produce these financial records had
a profound effect on NAFT's ability to illuminate the relationship between either Smoothline or Greatsino and UAL. The damage from the absence of critical financial records was aggravated by the inability or unwillingness of the plaintiffs' witnesses to shed light on the financial arrangements among the companies. The officers and agents of the plaintiffs were unable to explain in their depositions the reason for many of the intracompany transfers or even such basic information as the elements that determined the price of the goods and services that Smoothline and Greatsino purchased from their sister companies in the UAL Group.
Id. at *6.
UAL now admits that these standard accounting documents do exist, but contends that in an April 26, 2002 discovery conference the Court ordered that these critical documents did not need to be produced, and that the Court denied NAFT's renewed request for their production in its August 21, 2002 Order, or in the alternative, that there was a misunderstanding about the Court's orders. UAL is simply wrong.
The Court and the parties have operated (1) from April 26, 2002, with the understanding that Smoothline, Greatsino, and UAL would produce the financial records responsive to NAFT's document requests that were sufficient to understand the financial relationships among the companies, but that voluminous "back-up" material for individual transactions, such as invoices and checks, amounting to some 700 boxes of documents, would not be informative, would be too burdensome to produce or review, and would not be produced in discovery, and (2) from at least August 21, with the understanding that the reason that internal books of account other than general ledgers were not produced was the representation by UAL that the internal books of account did not exist. As a consequence, the December 27 Opinion described at some length the basis for its conclusion that summary financial documents such as internal books of account do in fact exist, despite the representation that they did not. It also concluded that the failure to produce them permitted an adverse inference to be drawn against UAL. In particular, in connection with the 5 dormancy of Smoothline and Greatsino, the December 27 Opinion concluded that
without accounting documents or testimony to explain the numerous intragroup transfers recorded on Smoothline's and Greatsino's general ledgers, it is impossible to determine whether they were unprofitable and failed because of NAFT or because profits from the transactions with NAFT were moved to other companies in the UAL Group in the form, for example, of inflated costs. Since the evidence that would answer this is exclusively within the custody and control of the plaintiffs, it is fair to infer that the truth is unfavorable to the plaintiffs.
Id. at *11 (emphasis supplied).
The discovery undertaken in 2002 was addressed solely to the issue of whether it was appropriate to pierce the corporate veil of either Smoothline or Greatsino to reach UAL. The Court and parties assumed at that time that the New York standard for piercing the corporate veil would apply and that NAFT would be required to prove fraud or wrongdoing in addition to domination. Smoothline Ltd. et. al. v. North American Foreign Trading Corp., No. 00 Civ. 2798 (DLC), 2002 WL 273301, at *5 (S.D.N.Y. Feb. 27, 2002). It was understood by all that a principal goal of the discovery would be to understand the financial relationship among UAL, Smoothline and Greatsino and to determine whether the latter two companies were independent entities, and whether UAL had improperly drained them of assets. An inspection of standard accounting documents customarily kept by an independent company was a necessary component of that discovery.
In response to a complaint that NAFT's request for the production of documents was overly expansive and burdensome, a 6 conference was held on April 26, 2002. That conference is described in the December 27 Opinion. Smoothline, 2002 WL 31885795, at *5. It was agreed that UAL would not be required to produce hundreds of boxes of back-up documents for individual transactions. UAL never asked that it be relieved of the obligation to produce its standard accounting documents, including, for instance, ledgers, reconciliation documents and a trial balance. It never made any argument that it was too burdensome to produce these documents or that they would, if produced, be of no or little assistance to NAFT in its attempt to understand Smoothline and Greatsino. UAL represented that the documents it would produce would be sufficient for NAFT to understand all that was necessary in connection with the motion. There was no ruling that could fairly be interpreted to indicate that the standard summary accounting documents or financial records that are customarily kept by businesses, including those that would reflect and explain intragroup transfers, need not be produced.
Document discovery was to be completed by June 28. After that date, the parties spoke and corresponded about the adequacy of the document production, and on August 15, NAFT wrote to the Court to complain about the production, in particular that the general ledger that had been produced in discovery was incomprehensible without the other supporting standard accounting records, and to request that Smoothline and Greatsino be required to produce either "their books of account" or records from their 7 outside accountants. NAFT's letter requested the "internal books of account and outside accountant work papers", believing that they could be used to reconcile the general ledger and the financial statements that the Smoothline and Greatsino had produced. It reported, however, that UAL contended that no internal books of account apart from the general ledger existed.
NAFT summarized its understanding of the Court's prior order as follows:
Although the Court ruled that plaintiffs were not required to produce backup for inter-company transactions (i.e., actual invoices, checks, purchase orders etc), the Court did make it clear that plaintiffs were to produce the standard financial records normally maintained by corporations and their agents which would show how funds were transferred among these entities and their affiliates and which would be sufficient to explain the circumstances of such transactions. Plaintiffs, however, have failed to comply with the Court's directive.
UAL, in response, urged that the request for its outside accountant's workpapers be denied since no request for them had been made during the period allowed for document discovery, which had ended weeks earlier. UAL did not deny that it had made the representation to NAFT that it had no internal books of account other than a general ledger. It took the position that financial statements are constructed directly from the general ledgers and that there were, therefore, no missing financial documents to explain how the financial statements were constructed from the general ledger. It added that
UAL contends that the Court "arguably" determined that evidence from UAL's outside auditor was not important when it rejected NAFT's request in August for access to the accountant's workpapers. There was no judgment made about the relevance of information from the auditor when the Court agreed with UAL that NAFT's request, coming long after the close of document discovery, was too late.
the purpose of each of the transactions listed on the produced ledger documents are contained in voluminous backup documents. Specifically, such information can be found in certain "voucher" documents that are created for, and at the time of, each transaction. Yet, these are precisely the kind of "backup for intercompany transactions" that NAFT acknowledges were not required by the Court to be produced.
UAL concludes this portion of its letter with a representation that "[t]he documents produced, moreover, are the standard financial records maintained by the three entities." It referred specifically to NAFT's request for an adverse inference as devoid of merit.
Further evidence of the parties' understanding is contained in the August 20 letter that NAFT sent to the Court. It sought an order compelling production of "internal books of account". The August 20 letter concluded this section of its discussion with another reference to UAL's position that there were no internal books of account and NAFT's request for an adverse inference. "If [counsel for UAL] truly is taking the position that no internal books of account exist, then we believe that his clients cannot be heard to complain if the Court draws the inevitable adverse inference from the ledger entries."
This correspondence indicated, among other things, that UAL took the position that it had no internal books of account other than the general ledger. In reliance on this correspondence, the August 21 Order denied NAFT's request for further document production, noting that UAL "represented that there are no 9 internal books of account other than the general ledger. . . ."
At no time until this motion for reconsideration did UAL inform the Court that its August 21 Order was based on a misunderstanding. It did not write in the days or weeks following August 21, to notify the Court that there were internal books of account in addition to the general ledger, but that they were not being produced for some reason, be it a misunderstanding about the scope of the order at the April 26 conference or for any other reason. Deposition discovery concluded on September 20, and the briefing on the motion to pierce the corporate veil followed.
Briefing on the Motion to Pierce the Corporate Veil
UAL never contended in its briefing on the motion to pierce the corporate veil that the standard accounting documents or internal books of accounts did in fact exist, but had not been produced because of a misunderstanding based on the April 26 conference. NAFT's opening brief addressed at length the absence of the standard accounting documents that were necessary to make the general ledger comprehensible. It argued that they had to exist, that they had been requested in discovery, and that UAL had represented that they did not exist. It pointed out that UAL had represented that its witnesses would be able to explain the ledger entries during the depositions, but that they had not been able to do so. It argued that an adverse inference should be drawn from the failure to produce the documents.
UAL did not discuss the absence of its internal books of account in its opposition memorandum. Instead, it described the fact that it had not been required to produce the "voluminous backup `voucher' documents that are created for and at the time of each transaction," and relied on its contention that the general ledgers showed that more money was injected into Smoothline and Greatsino from intercompany sources than was paid out to those entities.
In its reply memorandum, NAFT returned again to a discussion of the standard internal accounting documents that had to exist as the intermediate step between the voluminous "vouchers" and the financial statements. It pointed out that the Court did not require the production of the internal accounting documents in August because UAL represented that they did not exist. It argued that the Court should take the produced documents at face value and conclude that Smoothline and Greatsino were drained of funds by UAL and its affiliates.
DISCUSSION
The December 27 Opinion concluded that internal books of accounts do exist, that they were not produced as required in discovery, and drew an adverse inference against UAL from that failure to produce. Unhappy with those conclusions, UAL now admits in its motion for reconsideration that these books and records do exist but contends that it understood that it was not required to produce them. It is simply too late in the day to 11 admit the existence of the records. UAL chose not to produce these documents when they were legally obligated to do so. If the failure to produce the records was a result of some "confusion", then it was incumbent upon UAL to notify the Court that the records did exist promptly after it received the August 21 Order reflecting its representation that the "internal books of account" did not exist. UAL did not.
UAL's explanations that it believed that the internal books of account did not need to be produced because they were encompassed by the ruling on the back-up documents for the individual transactions, or that it thought that NAFT only wanted the internal books of account if they were an intermediate step between the general ledger and the financial statements, but not if they were an intermediate step between the voluminous vouchers or back-up documents and the general ledger, are unconvincing in light of the history of this case. While UAL cites to passages in the correspondence or briefing by the parties to support its contentions, the record, when read as a whole, does not. If UAL had either understanding at any time, then its conversations and correspondence with NAFT would have required it, in all fairness, to make that understanding explicit. Instead, UAL denied that the records existed, and when NAFT conveyed that denial to the Court and it was incorporated in the August 21 Order, UAL stood silent.
UAL also argues that these standard accounting documents are unnecessary, and that the general ledgers which were produced in 12 discovery are sufficient by themselves to show that UAL put more money into Smoothline and Greatsino than it took out. NAFT is entitled to understand the nature of the general ledger transfers and to test UAL's bald assertion. UAL's witnesses were, for whatever reason, unable to illuminate the transfers. At a minimum, NAFT was entitled to look at the other standard accounting documents that could confirm UAL's assertion or expose it as wrong.
UAL's request for a hearing is inappropriate for a motion for reconsideration. It has pointed to no prior request for a hearing that was overlooked by the Court or improperly denied. In any event, it has not shown that a hearing would serve any purpose. The only issue it identifies for a hearing — the receipt of expert testimony to explore the meaning of the transfers in and out of Smoothline and Greatsino — would be of little use when the underlying factual record is so barren of relevant information. The witnesses for Smoothline, Greatsino and UAL could shed no light on these transfers and the companies chose not to produce the books and records that may have filled those lacunae. UAL has not shown, on the basis of the record before the Court at the time that it issued the December 27 Opinion, that there are facts in dispute that require a hearing.
To the extent that the request for a hearing is a request for an opportunity to produce evidence that UAL should have produced in discovery, it must be denied. In fairness to all of the parties, if there were to be a hearing, discovery would have 13 to be reopened, including the retaking of depositions, at great expense to all and further delay in this already too extended litigation.
Having properly determined that UAL failed to produce critical evidence that it was required to produce in discovery, it was appropriate to draw an adverse inference against UAL regarding what those documents would show. Residential Funding Corp. v. DeGeorge Financial Corp, et. al., 306 F.3d 99, 110 (2d Cir. 2002) (citing Reilly v. Natwest Markets Group, Inc., 181 F.3d 253, 267-68 (2d Cir. 1999)). Drawing that inference against UAL did not shift the burden of proof to them, but simply added to the evidence upon which NAFT could draw in carrying its burden.
NAFT showed through overwhelming evidence that the business transacted here was UAL's business. See William Wrigley Jr. Co. v. Waters, 890 F.2d 594, 600 (2d Cir. 1989). There is no inequity involved in requiring UAL to arbitrate its disputes with NAFT based on the commitments to arbitrate made by Smoothline and Greatsino.
CONCLUSION
The motion for reconsideration is denied.
SO ORDERED: