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R.J. Management Company v. SRLB Development Corporation

February 10, 2004


[6] Appeal from the Circuit Court of Lake County. No. 99-L-804 Honorable Stephen E. Walter, Judge, Presiding.

[7] The opinion of the court was delivered by: Justice Bowman

[8]  Plaintiff, R.J. Management Company, sold defendant, SRLB Development Corporation, a 330-acre parcel of land in Round Lake Beach for residential development. The sales contract provided that SRLB would pay R.J. Management an additional sum if the development project met its projected profit level. After SRLB failed to pay the additional compensation, R.J. Management brought a cause of action for breach of contract. Following a bench trial, the trial court determined that SRLB breached the parties' contract by failing to render a proper accounting. However, the trial court also found that SRLB did not reach its projected profit level and, consequently, did not owe R.J. Management the contingent compensation. R.J. Management now appeals, asserting that the trial court misjudged the nature of the relationship between R.J. Management and SRLB, and erred on two evidentiary matters. In addition, both parties appeal the trial court's decision not to award attorney fees. We affirm.

[9]  The following facts are pertinent to the resolution of this matter. The parties entered into the real estate sales contract on September 7, 1990. SRLB purchased the vacant land for $5 million. Over a period of approximately 10 years, SRLB built and sold 900 single-family homes. The particular contract provision at issue in this case states:

[10]   "Purchaser anticipates that completion of Purchaser's Development Plan will result in Purchaser realizing a profit on the Property as set forth in the pro forma attached hereto and made a part hereof as Exhibit B. At such time as Purchaser's Development Plan is completed and the last subdivided unit on the property has been sold, Purchaser shall do an accounting to determine its actual profits on the Property. In the event the accounting determines that actual profits to be made on the property is [sic] equal to or greater than two-thirds (2/3) of the total pro forma net income set forth on Exhibit B hereto, Purchaser shall pay Seller an additional sum of Two Hundred Fifty Thousand Dollars ($250,000.00) in immediately available funds."

[11]   SRLB's pro forma income statement forecasted a profit of $16,893,000. Thus, if the project produced a profit of $11,262,000 (two-thirds of $16,893,000) or greater, R.J. Management stood to receive additional compensation of $250,000. However, R.J. Management never received this additional compensation as SRLB asserted that the project fell short of the goal, producing profits in the range of $8 million. R.J. Management maintains that SRLB's $8 million profit figure is unsubstantiated because, over the life of the project, SRLB discarded most of the accounting source documents. Source documents are documents such as invoices and receipts that provide evidence that a transaction has occurred. Thus, R.J. Management contends that it was impossible for SRLB to render a proper accounting as called for under the contract.

[12]   At trial, testimony came from R.J. Management's owner, SRLB executives, and two opposing experts. Mainly, the testimony focused on the information sources used to perform the accounting and the propriety of the expenses included in the calculation of net income.

[13]   Rodney Johnson testified that he was the sole owner of R.J. Management. Johnson is an attorney who deals largely in the acquisition, sale, and development of real estate. He negotiated the real estate sales contract with SRLB. According to Johnson, the parties never intended for the project to be a joint venture.

[14]   The SRLB executives who testified included Maurice Sanderman. Sanderman is the principal owner of Sundance Homes, SRLB's parent company. In addition, the current and two former chief financial officers (CFOs) testified at trial.

[15]   In 1999, a portion of Sundance's business was sold to Centex Homes. During the process, many financial records were destroyed. This meant that SRLB could not produce many of the financial records that R.J. Management requested in discovery. The missing items included such things as ledgers, invoices, and canceled checks. Given that the limitations period for a federal tax audit is three years, SRLB prematurely destroyed many of the financial records from the later years of the project.

[16]   After R.J. Management filed suit, Joseph Atkins, CFO from 1997 through 1999, performed a financial analysis of the development project. The home sales had taken place between the years 1992 and 1999. Atkins used financial statements from 1992 and 1993 and SRLB's tax returns for the years 1994 through 1999 to complete the financial analysis.

[17]   Dan O'Brien was CFO from 1990 to 1996. He established Sundance's accounting system. From the source documents, monthly income statements were prepared, eventually resulting in a compilation of year-end financial statements. The tax returns were then prepared using this information. According to O'Brien, the information contained in the tax returns represented SRLB's actual performance.

[18]   Gary Finigan served as Sundance's comptroller from 1997 through the end of the development project and as CFO after Atkins. Finigan verified that the information contained in the tax returns from 1997 to 2000 accurately reflected SRLB's financial performance.

[19]   The trial court initially admitted the tax returns as business records. However, it later reconsidered the issue and refused to admit the tax returns. The trial court decided that the tax returns reflected summary information and that the requisite underlying support documents were unavailable.

[20]   Atkins used the available financial statements and tax returns to prepare an accounting of the profits from the development project. He concluded that the entire project produced a profit of $8,719,022. Obviously, this figure was well below the $11,262,000 profit threshold required to trigger the contingent compensation clause. SRLB also retained Bruce Richman, an accounting expert, to perform an accounting. Richman used the tax returns filed during the years of the project and the remaining financial records to conclude that the project earned $8,792,000. Soon thereafter, Finigan replaced Atkins as CFO. Finigan performed his own review and determined that the profit on the project was $7,963,093. Finigan said that his figure was lower than either Atkins's or Richman's profit figure because he made corrections to the management fee that was charged to the project. A management fee is a method of allocating overhead and pooled costs from a parent company to its subsidiaries. Generally, the costs included in a management fee cannot be attributed to any particular "profit driver," a specific profit-producing activity. In a typical company, the management fee may include utility costs, insurance, and centralized functions like the accounting and legal departments. According to Finigan, the original management fee charged to the project was too low.

[21]   Sundance used the same accounting methods to assign costs to each of its projects. Sanderman, O'Brien, Atkins, and Finigan all testified that there was no double billing of expenses. Specifically, this means that direct expenses (expenses directly attributable to a specific profit driver) and expenses assigned through the application of the management fee were distinct and separate, and any identifiable cost was expensed only once. The management fee included costs of functions such as marketing, personnel, and accounting. Sundance assigned the management fee based on the percentage of gross sales attributable to the subsidiary. According to Sanderman, assigning the management fee based on the percentage of sales was the most accurate way to match expenses with the revenues produced by Sundance's subsidiaries. Finigan testified that he examined the management fees assigned to all Sundance subsidiaries during the10 years of the SRLB development project. He determined that, if anything, the management fee assigned by Sundance to each of the subsidiaries was too low. However, on the whole, Finigan believed that the management fees were fair and accurate. The total amount of the management fee charged to SRLB was approximately $7 million, matched against gross sales of approximately $121 million.

[22]   Two expert accountants testified at trial. Jack Ehrlich testified on behalf of R.J. Management. Ehrlich reviewed all of the documents SRLB produced as well as the accountings produced by Atkins and Finigan. He also reviewed the accounting rendered by SRLB's expert, Bruce Richman.

[23]   According to Ehrlich, SRLB did not render a proper accounting. He believed that, because so many of the original source documents had been discarded, SRLB could not perform an accounting as called for under the real estate sales contract. Ehrlich also opined that Sundance's allocation method for the management fee violated Cost Accounting Standard 403 (CAS 403). Under CAS 403, costs must have a causative or beneficial connection to a project. Ehrlich criticized SRLB for not properly matching the costs represented by the management fee with the revenue produced by the development project.

[24]   Ehrlich refused to render any opinion on the profitability of the development project. He did not believe that it was appropriate to rely on the tax returns to determine profitability. He pointed out that there are differences between financial net income and taxable income. Also, because many source documents were ...

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