Johnson Bank v. George Korbaken Company Johnson

Johnson Bank v. George Korbaken Company

Johnson Bank v. George Korbakes Company

Over the last several years, the role of the auditor has been continually evolving. This is because financial institutions are relying on the information they are provided with to help them make better choices in the long-term. However, there are times when these firms may not have accurate figures and erroneously report their findings. When this happens, there is a possibility of these facts leading to incorrect decisions. (Adelopo, 2012) ("Johnson Bank sued George Korabakes," 2006)

The case of Johnson Bank v. George Korbakes Company is examining these factors and the long-term impacts they will have on various stakeholders. To determine if the auditor is responsible for the claims they make requires carefully examining the effects. This will be accomplished by focusing on the case itself, the primary / secondary legal questions, the rule of law, the court's decision / opinion on the case, the outcome and if it would have been decided differently in 2012. Together, these elements will show the responsibility of auditors in the process. ("Johnson Bank sued George Korabakes," 2006)

Summarize the facts associated with Johnson Bank v. George Korbakes Company.

The case is focusing on the financial information submitted to the Johnson Bank by George Korbakes Company (GKCO). What happened is GKCO, was hired by the customer to conduct a third party audit on Brandon Apparel Group. Inside the report, they misstated a number of areas about the financial condition of the firm. The most notable include: overinflating their revenues by 50% and not accounting for pending litigation against Brandon Apparel. ("Johnson Bank sued George Korabakes," 2006)

This resulted in the bank losing $10 million on the loan and they never were able to recover anything in the process. Johnson Bank claims any GKCO violated their fiduciary responsibility by not outlining or disclosing what was really happening at Brandon Apparel. This fooled executives, into thinking that the company was more fiscally sound than it really was. ("Johnson Bank sued George Korabakes," 2006)

It is at this point, when they loaned Brandon Apparel another $1 million in 1999. In a few months, the company was forced into bankruptcy and the financial institution took significant losses on these loans. In light of these circumstances, Johnson Banks sued GKCO for failing to provide them with information that was factually accurate. They claimed that this is a violation of their fiduciary responsibility as an independent auditor. This occurred in the form of tort negligence on GKCO part. ("Johnson Bank sued George Korabakes," 2006)

The lower court determined that the bank was incorrect and found in favor of GKCO. However, Johnson Bank appealed the decision, claiming that they had a legal responsibility based upon a single letter that was created for them. This is because executives used it as a part of their analysis in making their decision. However, it was not the only factor that mattered and if they felt that Brandon Apparel was such a risk. They could have turned down the request for the loan and began seizing the assets of the company before it became insolvent. ("Johnson Bank sued George Korabakes," 2006)

As a result, the Court of Appeals affirmed the decision favor of GKCO. Evidence of this can be seen with the judge saying, "The bank imputes to GKCO a duty to advise it whether lending more money to this faltering firm (throwing good money after bad, as the saying goes) would make commercial sense. But an auditor's duty is not to give business advice; it is merely to paint an accurate picture of the audited firm's financial condition, insofar as that condition is revealed by the company's books and inventory and other sources of an auditor's opinion. An auditor who fulfills that duty, or fails but manages not to mislead the intended readers of the audit report, has no tort liability. "("Johnson Bank sued George Korabakes," 2006)

These conclusions are showing how GKCO had no legal responsibility. Instead, they were providing an opinion based upon the available financial information provided by Brandon Apparel. The fact that bank made the loan, is a sign of how executives had a responsibility to look at other sources of information in determining the financial condition of the firm. This meant that they should have used it selectively. ("Johnson Bank sued George Korabakes," 2006)

Identity the primary and secondary legal question(s) that are under consideration.

The lawsuit has two legal questions that are brought into consideration. These include:

Is an auditor responsible for the losses when they provided information to the firm that was inaccurate? In this case, Johnson Bank believes that GKCO breached their contractual liabilities and fiduciary responsibilities. Through giving them, information that was incorrect and leading to the financial institution loaning money to a client, who was clearly facing considerable financial challenges. GKCO stated that the bank abandoned this claim when they went to District Court to seek out remedies. ("Johnson Bank sued George Korabakes," 2006)

The secondary legal question is focusing on: if GKCO is responsible for negligent misrepresentation? In this situation, the bank believes that GKCO violated Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 5. This occurred with them not carefully examining the fiscal condition of Brandon Apparel. As they reported that the firm had higher amounts of revenues than it was actual generating and misstated a liability based upon outstanding litigation against Brandon Apparel. ("Johnson Bank sued George Korabakes," 2006)

These two questions are the primary issues being examined in the case and are the main focus of the Court of Appeals.

Prioritize the rules of law that the court will consider in this case.

The rule of law is focusing on several different decisions that were established previously by other courts. As far as the situation involving if the auditor being responsible for losses, the judge focused on a number of decisions. The most notable include: People ex rel. Resnik v. Curtis & Davis and Robins Dry Dock & Repair Co. v. Flint. In these two decisions, third parties are not liable for what statements are made unless it is specifically expressed in writing. ("Johnson Bank sued George Korabakes," 2006)

Moreover, it focused on Harbor Drive Condominium Ass'n v. Harbor Point Inc., A.E.I. Music Network, Inc. v. Business Computers, Inc. And Alaniz v. Schal Associates. In these decisions, the court determined that GKCO was hired by Brandon Apparel to help the firm receive the loan from Johnson Bank. This meant that they were not under any kind of contractual obligation. As the information they were providing, was considered to be an opinion and only a portion of it can used by the financial institution in making their decision. ("Johnson Bank sued George Korabakes," 2006)

In the second question, the court is relying on a number of cases to determine what happened and the areas of responsibility. These include: SEC v. Yuen and Jan R. Williams & Joseph V. Carcello. They also looked at several different financial regulations in the process most notably: Financial Accounting Standards Board Statement of Financial Accounting Standards No. 5 and Miller GAAP Guide 9.02. In this situation, the court found that while GKCO should have provided more accurate information. The reality is they did not fully know the financial situation of Brandon Apparel and relied on the guidance of executives. In helping them, to complete the information that was submitted to Johnson Bank. ("Johnson Bank sued George Korabakes," 2006)

Furthermore, there was contention about how prepaid expenses were treated and the effects they are having on the way financial information was listed. In this case, GKCO listed the prepaid expenses as revenues that were actually received by the firm. This made it appear as if the company was making more money than they were. To help guide the court, it relied on case precedent from: Williams & Carcello, Galli v. Metz and Kopka v. Kamensky & Rubenstein. ("Johnson Bank sued George Korabakes," 2006)

These different areas are showing how the primary focus on the rule of law is examining case precedent and how it applies. At the same time, the court was concentrating on the financial regulations and the impact they are having. These findings are the main factors that helped to guide its decision in the case. ("Johnson Bank sued George Korabakes," 2006)

Compile the court's decision and opinions on the case.

Like what was stated previously, the court ruled in favor of GKCO. This is based upon the fact that the bank was relying only on a single portion of the information provided by them to help make the decision. At the same time, there was not a written contract in place, which is denoting how the information is not warranties. Instead, they are representations. This is occurred with GKCO providing a footnote at the bottom of the documents, showing how these calculations were derived. ("Johnson Bank sued George Korabakes," 2006)

In this aspect, the court determined that GKCO was absolved from any kind of legal responsibilities. Evidence of this can be seen with the judge saying, "The licensee's sales should not have been lumped in with Brandon's. But once again, a footnote eliminated any possibly misleading impression by disclosing clearly the amount of the licensee's contribution to Brandon's sales numbers. At root the bank's argument for liability is that it was entitled to look no farther than the bottom-line numbers in the audit report. That is incorrect; it had no right to ignore the footnotes in the report, which together with the numbers in it gave the reader an accurate picture of Brandon's financial situation. The bank cannot base a claim for damages on a refusal to read. The audit report even says that 'the notes on the accompanying pages are an integral part of these financial statements.' Before receiving the audit report it had agreed to waive a number of restrictions in the loan covenants precisely in order to spare Brandon the dreaded warning, which by indicating a serious risk of bankruptcy would have scared off trade creditors and accelerated the bankruptcy." ("Johnson Bank sued George Korabakes," 2006)

This is illustrating how Johnson Bank knew that Brandon Apparel was facing serious financial challenges. This is because they agreed to help the company to avoid bankruptcy by providing them with additional loans. Their basic objectives were to have the additional amounts of liquidity to provide the firm with another capital injection. Over the course of time, this would help to keep the company in business and ensure they can meet their obligations to the firm. ("Johnson Bank sued George Korabakes," 2006)

Moreover, GKCO was absolved any liabilities based upon the fact that they accounted for their irregularities in the footnotes of these reports. This is showing that any kind of assumptions were taking a more liberal interpretation in how they were applied. If Johnson Bank had carefully examined these areas, they would have understood what was happening. ("Johnson Bank sued George Korabakes," 2006)

As a result, the court concluded that GKCO is not obligated to provide advice in determining if a loan should be approved. Instead, they are submitting to them information about the condition of the firm based upon accounting standards. This absolves them of legal responsibility. A good example of this can be seen with them saying, "The bank imputes to GKCO a duty to advise it whether lending more money to this faltering firm (throwing good money after bad, as the saying goes) would make commercial sense. But an auditor's duty is not to give business advice; it is merely to paint an accurate picture of the audited firm's financial condition, insofar as that condition is revealed by the company's books and inventory and other sources of an auditor's opinion. An auditor who fulfills that duty, or fails but manages not to mislead the intended readers of the audit report, has no tort liability. Erroneous characterizations can mislead, but not when the facts mischaracterized are fully and accurately disclosed in the audit report, as they were here. It kept lending money to Brandon in the hope of keeping the firm from going broke and thus keeping alive the hope of eventual repayment. The cause of the banks undoing had nothing to do with the audit. The losses the bank incurred as a result of the additional loans could not be recovered as damages even if GKCO had been guilty of negligent misrepresentation. GKCO could not have predicted how much money the bank would lend to Brandon in reliance on the audit and with what consequences. Damages so speculative are not recoverable in a lawsuit." ("Johnson Bank sued George Korabakes," 2006)

This is showing how GKCO had no legal responsibility for the decisions that were made by Johnson Bank when it came to Brandon Apparel. This is because the firm is providing them with information on the state of the Brando Apparel. Moreover, they had no idea how much money was going to be loaned by the bank. As a result, Johnson Bank had a legal responsibility to conduct their own due diligence. This could have been accomplished utilizing various pieces of financial information and determining if it was a transaction they were comfortable with. ("Johnson Bank sued George Korabakes," 2006)

Determine how this case may have been treated differently if it had been decided in 2012 instead of 2006.

If this case had been decided in 2012, there is a realistic possibility that the conclusions could be different from the 2006 findings. This is because the court has to follow various legal and industry guidelines at the time of any alleged violations occurring. The fact that these issues took place in the late 1990s, is illustrating how the regulatory environment was completely different. (Knapp, 2009)

During this time, there were more liberal interpretations as to how these legal responsibilities were applied. What was happening is auditors played an important role in providing financial information to banks, regulators and the general public. However, they were not accountable for it accuracy. This is because there were different accounting methodologies utilized (i.e. pro forma standards). Under this approach, earnings and revenues can be reported higher than they actually were. As firms could claim that the revenues increased from reporting sales that were expected to be received in the future. (Knapp, 2009)