After the Supreme Court denied K&L Gates' appeal of the reinstatement of a $500 million suit against it by the trustee of bankrupt Le-Nature's, the firm has gotten its chance to respond to the allegations.
In a 298-page answer to allegations the firm failed to detect fraud in the beverage company when hired in 2003 to conduct an internal investigation of whether certain executives were mismanaging finances, K&L Gates outlined several defenses and looked for credit toward any damages that might be levied against it given other entities have settled with the trustee on similar claims.
The firm said it couldn't do the investigation it wanted because of limitations placed on it by the special committee that hired the firm. It further argued the special committee ignored the corporate governance recommendations the firm suggested in its report. And despite Le-Nature's claims it faced steeper losses from the fraud in the three years between K&L Gates' investigation and the Le-Nature's bankruptcy, K&L Gates argued the company benefited financially during that time because of the fraud, according to the response.
In Kirschner v. K&L Gates, trustee Marc Kirschner has alleged K&L Gates, partner Sanford Ferguson and accounting firm Pascarella & Wiker were unqualified to handle the investigation and said they failed to "conduct an even minimally competent investigation" even though they were "presented with a virtual road map of red flags concerning fraud."
"Despite that extensive information and innumerable 'red flags' signaling the possibility of fraud, defendants conducted an investigation that was so deficient that they not only failed to uncover the fraud but also inexcusably issued a written report that provided a clean bill of health to the wrongdoers that enabled them to retain their senior management positions and to continue to loot and harm the company," Kirschner said in the complaint.
K&L Gates was hired by a special committee of the Le-Nature's board in 2003 to conduct the investigation. The firm issued its report a few months later. By 2006, Le-Nature's was in bankruptcy and several of its senior employees, including Chief Executive Officer Gregory Podlucky, have since received jail time.
Allegheny County Court of Common Pleas Senior Judge R. Stanton Wettick Jr. dismissed the claims against K&L Gates, finding the firm represented the special committee and not the company. He ruled that Kirschner, who is standing in the shoes of the company as trustee, had no standing to sue the law firm that never represented the company.
The Superior Court disagreed, finding the special committee and the company were essentially one and the same, and the court reinstated the suit. In April, the Pennsylvania Supreme Court denied K&L Gates' appeal of that ruling, bringing the case back to the trial court.
In its answer to the complaint, K&L Gates continues to argue that it has no duty to Kirschner or Le-Nature's because the engagement letter expressly noted the firm only represented the special committee and not the company. K&L Gates said the arrangement was set up that way to ensure the firm's investigation was as independent as possible.
K&L Gates further noted its investigation was bound by the parameters set by the special committee. The firm said Le-Nature's refused to allow certain interviews or provide certain documents and the special committee didn't compel their production.
K&L Gates said in its response that its report addressed the concerns raised by senior financial managers whose resignations spawned the inquiry, while also detailing the deficiencies in its ability to conduct a complete investigation. The firm said it outlined deficiencies in Le-Nature's corporate governance and made suggestions for changes. K&L Gates alleges in its response that the special committee failed to ensure those suggestions were implemented and ignored the firm's warnings about Le-Nature's corporate governance structure.
"For example, the special committee members voted to give individuals criticized in the report additional control and responsibility within Le-Nature's," the firm said in its response.
After filing its report, K&L Gates said, it repeatedly reminded the special committee to implement the firm's recommendations and offered to help in that process.
K&L Gates said it conditioned its findings on follow-up by Le-Nature's accounting firm at the time, Ernst & Young. But the law firm said in the response that when E&Y addressed certain changes with Le-Nature's, the company switched accounting firms to BDO Seidman.
According to its response, K&L Gates said Kirschner has admitted Le-Nature's was already insolvent by the time K&L Gates came on board and that the claims against the firm are for additional losses the company suffered by borrowing and not repaying on three financings after 2003. K&L Gates said if those financings or use of the resultant funds were fraudulent, it was at the hands of certain members of Le-Nature's management and aided and abetted by the special committee's failure to implement K&L Gates' recommendations.
Kirschner has taken issue with K&L Gates' decision during the investigation to share a preliminary report of its findings with Podlucky, one of the people at the heart of the investigation. But K&L Gates said in its answer that the firm showed Podlucky and Le-Nature's independent counsel at Houston Harbaugh the report so they could offer comments that could be included in the final version.
In response to Kirschner's claims that K&L Gates and Ferguson weren't qualified to handle such an investigation, K&L Gates said the firm had extensive experience conducting such investigations. The firm said Ferguson was the lead partner and consulted with other K&L Gates attorneys with experience in corporate investigations.
Prior to the investigation, K&L Gates said, Ferguson had extensive experience with corporate law and accounting matters. He had also previously held senior management positions within high-tech companies in the years leading up to his taking on the Le-Nature's investigation. K&L Gates said Ferguson was assisted by firm attorney Paul Berks, who had worked on a corporate investigation prior to taking on the Le-Nature's work.
K&L Gates listed 17 defenses to the suit, including the doctrine of unclean hands, a lack of privity, contributory negligence, statute of limitations, a lack of proximate cause and collateral estoppel.
As to the collateral estoppel claim, K&L Gates said Kirschner has asserted numerous claims "against multiple deep pocket defendants" either through arbitration or civil suits.
In dismissing Kirschner's arbitration claims against E&Y in June 2011, the panel cited Wettick's opinion in K&L Gates' case, noting the judge found K&L Gates couldn't be liable for "deepening insolvency" under Pennsylvania law, according to the arbitration panel's report. The panel found the E&Y case "could not be closer" to K&L Gates' case.
"The E&Y award against the trustee in favor of E&Y acts as collateral estoppel in this case and requires dismissal of all of the trustee's claims against K&L Gates," the firm said.
If K&L Gates is found liable for any damages, it requested a setoff of such damages reflecting the comparative fault of other entities responsible for any damages against the company. K&L Gates noted in its response that the judge overseeing Le-Nature's bankruptcy in the Western District of Pennsylvania approved in October 2011 a $38 million settlement between Kirschner and Wachovia and a $12 million settlement between Kirschner and BDO. In December 2012, according to K&L Gates' filing, the bankruptcy judge approved a settlement between Kirschner and Krones and CIT in which Krones paid $30 million and both Krones and CIT agreed to withdraw certain claims in the bankruptcy proceedings.
"In approving each of these settlements, the bankruptcy court specified that any recovery by the trustee on his claims against other defendants, which include these claims against K&L Gates, must be reduced by the proportionate fault of the settling defendants," K&L Gates argued in its response.
David B. White of Burns White represents K&L Gates in the case along with attorneys from Williams & Connolly. Hector Torres of Kasowitz Benson Torres & Friedman in New York is representing Kirschner along with Roy Leonard of Stonecipher Cunningham Beard & Schmitt in Pittsburgh. White and Torres did not return calls for comment Friday.