Single injury rule no bar to additional suit.

The Minnesota Supreme Court ruled that the buyer of $15 million of subordinated debentures from a now insolvent savings and loan may maintain an action against the S&L's auditors distinct from other creditors' actions.

Northwest Racquet Swim and Health Clubs Inc. purchased debentures from Midwest Federal Savings and Loan Association. It later alleged Deloitte & Touche, which performed audit work for Midwest and its subsidiary Green Tree Acceptance before the purchase, had materially misstated Midwest's 1986 financial statements.

In 1985, Midwest purchased the servicing rights and net finance income for approximately 88,000 mobile, home loans from Green Tree in 1985. The CPA firm recommended the purchase, explained the transaction to both entities and conducted investigations in conjunction with its audit work. By 1987, the entire credit loss reserve was exhausted and there was a $47 million shortfall from originally anticipated revenue.

The firm met with Midwest to discuss the shortfall. Believing Midwest and Green Tree had resolved the problem, the firm issued its 1986 report for Midwest in June 1987. The audited financial statements valued the transaction at $190 million, a $4 million increase from the original purchase price. Later in 1987, the firm learned of an additional shortfall of approximately $16 million. To address it, Midwest filed an application with the Federal Home Loan Bank Board (FHLBB) for approval to include $25 million of subordinated debt securities (debentures) in its regulatory capital. Relying on Midwest's financial condition as expressed in the 1986 report, the FHLBB approved the application.

Around the same time, Midwest approached Northwest with an offer for them to buy $15 million of the debentures. The draft purchase agreement included Midwest's 1984, 1985 and 1986 audited financial statements. Midwest showed $116 million of RAP-based retained earnings but no GAAP-based retained earnings. The notes to the financial statements contained an explanation of the differences between RAP and GAAP in the recognition of asset and securities gains and losses.

Northwest admitted it had not read the notes or the accountant's report before making the purchase. Rather, it had focused on Midwest's RAP-basis retained earnings in deciding the S&L had a sufficient reserve for future losses. One of Northwest's owners testified that he saw the accounting report was prepared by "Touche Ross & Company, Certified Public Accountants," and it was "good enough" for him.

Northwest's owners said that if they had realized Midwest's true financial condition, including the absence of GAAP-basis retained earnings, Northwest would have not purchased the debentures. In 1989, Midwest announced it had understated its losses for 1988 and prior years by $247 million and that it was insolvent.

In deciding the case, the Minnesota court considered whether Northwest asserted any injury separate and distinct from that to other debenture holders. In ruling for Northwest, they noted that the company alleged very specific misrepresentations in the audit report. Because Northwest directly relied on this information, the court concluded Northwest's injury claims were not derivative and a trial court was correct in denying the CPA firm's motion for summary judgment. (Northwest Racquet Swim and Health Clubs, Inc. v. Deloitte & Touche, Minnesota Supreme Court, C9-94-301, August 4, 1995)