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Francis v. United Jersey Bank

Decided: August 18, 1978.

JOHN J. FRANCIS ET AL., AS TRUSTEES IN BANKRUPTCY OF PRITCHARD & BAIRD INTERMEDIARIES CORP., ETC., PLAINTIFFS,
v.
UNITED JERSEY BANK, ADMINISTRATOR OF THE ESTATE OF CHARLES H. PRITCHARD, ET AL., DEFENDANTS



Stanton, J.c.c. (temporarily assigned).

Stanton

Plaintiffs are trustees in bankruptcy of Pritchard & Baird Intermediaries Corp. (hereinafter Pritchard & Baird) and three related corporations. They have brought this action at the direction of the United States District Court for the District of New Jersey. The late Charles H. Pritchard was for many years the principal stockholder and controlling force in Pritchard & Baird. Defendant United Jersey Bank is the administrator with the will annexed of his estate. The late Lillian G. Pritchard was the wife of Charles H. Pritchard and also served for many years as a director of Pritchard & Baird. Defendant Lillian P. Overcash is the daughter of Charles H. Pritchard and Lillian G. Pritchard. Mrs. Overcash is the executrix of her mother's estate. She is being sued in that representative capacity and also individually.

At the conclusion of the trial of this case I found that Lillian G. Pritchard had been negligent in performing her duties as a director of Pritchard & Baird, and her estate was liable in the amount of $10,355,736.91, plus prejudgment interest, because of that dereliction. In addition, her estate was held liable in the amount of $33,000, plus prejudgment

interest, for sums improperly paid to her during her lifetime by Pritchard & Baird. The estate of Charles H. Pritchard was held liable in the amount of $357,648.17, plus prejudgment interest; for sums improperly paid to him during his lifetime by Pritchard & Baird and for sums improperly paid by Pritchard & Baird for the benefit of his estate.

Defendants have moved for a new trial or, alternatively, for an amendment to the judgment reducing its amount. This opinion is written by way of deciding that motion. It also supplements the oral opinion which I delivered at the end of the trial. I have decided that there will be no new trial and that there will be no amendment of the judgment.

Pritchard & Baird was engaged in the business of being a reinsurance broker. Along with three related corporations, it was controlled for many years by Charles H. Pritchard, who died on December 10, 1973. Prior to his death he had taken his sons, Charles, Jr. and William, into the business. During the last few years of the elder Pritchard's life the sons, particularly Charles, Jr., had played an increasingly dominant role in the affairs of Pritchard & Baird. After the father's death the sons took complete control of the business.

Charles, Jr. and William were extremely incompetent businessmen and they were almost totally devoid of any sense of self-restraint or business morality. By the end of 1975 they had plunged Pritchard and Baird and the related corporations into hopeless bankruptcy. I understand from my general knowledge of the bankruptcy proceedings which are under way in the United States District Court for the District of New Jersey that the creditors of the various businesses stand to lose something on the order of $70,000,000. This present action is part of a much larger picture of chicanery and fraud. It deals with more than $10,000,000 in funds transferred unlawfully from Pritchard & Baird to various members of the Pritchard family.

In order to understand what occurred in this case it is necessary to say something about the business of being a reinsurance broker. If an insurer has a very large individual risk on which it has given coverage, it may seek to protect itself from too heavy a loss by shifting the risk to another larger insurer or to a group of insurers. It does this by reinsuring, that is, by purchasing insurance on all or a portion of the underlying risk from one or more other insurers. This approach may be taken with respect to a single very large risk or with respect to a class or category of policies in which there seems to be a dangerously high concentration of risk. An insurance company which has provided underlying coverage and seeks to spread all or part of the risk to one or more other insurers is known as a ceding company. An insurance company which sells protection to a ceding company is a reinsurer.

The function of a reinsurance broker such as Pritchard & Baird is to bring ceding companies and reinsurers together. However, the task of the reinsurance broker is much more complicated and sophisticated than that of the ordinary retail insurance broker with whom we are all familiar in our capacities as owners of automobiles or houses. Very often, scores of insurance companies are involved in a single reinsurance transaction, and it is common for reinsurance transactions to cross national boundaries. There is virtually no governmental regulation at any level of the business of reinsurance. Frequently, the ceding and reinsuring companies involved in a reinsurance transaction do not know each other's identities, and this may be true even after the transaction has been consummated, and even after a substantial loss has been incurred and paid. The insurance companies involved rely to a large extent upon the knowledge, skill, integrity and bookkeeping of the reinsurance broker.

The elder Pritchard was in the reinsurance broker's business for many years, going back to at least 1948. His base of operations was always in downtown Manhattan. He

organized Pritchard & Baird in 1959 under the laws of New York. Pritchard & Baird continued operations in Manhattan until shortly after 1970. In the early 1970s Charles, Jr. and William moved the corporation's operations to Morristown, New Jersey, so that their office would be closer to their homes. All, or virtually all, of the unlawful transfers involved in this case took place entirely in New Jersey after the operations had been transferred to Morristown.

All of the income of Pritchard & Baird was derived from commissions earned on reinsurance transactions. All of the funds passing through Pritchard & Baird came from premium payments being sent by ceding companies to reinsurers (out of which Pritchard & Baird was entitled to deduct a commission) or from loss payments being sent by reinsurers to ceding companies. While the elder Pritchard was in control of the brokerage corporation, the corporation commingled all funds. All payments to ceding companies, to reinsurers, and for the operations and profits of Pritchard & Baird were paid out of a single, unsegregated account. To make matters worse, Pritchard & Baird never paid the elder Pritchard funds designated as salary, or commissions, or earnings, during the course of a fiscal year. Instead, the elder Pritchard during the course of a year would take out substantial sums designated as "loans" on the books of the corporation. There were never resolutions of the board of directors authorizing these "loans," and the "loans" were never evidenced by promissory notes.

At the end of the fiscal year the accountant for Pritchard & Baird would calculate how much was paid or owing to ceding corporations with respect to transactions during the fiscal year, how much was paid or owing to reinsurers and how much was attributable to the broker's internal operations and expenses. The remainder was profit. The profit was used first to wipe out "loans" made to the elder Pritchard and the balance was then paid out to him. Abraham J. Briloff was the accountant who set up this

woefully inadequate and highly dangerous bookkeeping system. In deposition testimony which was introduced in evidence during the trial before me Briloff attempted to justify the system on the ground that Pritchard & Baird was a Subchapter S corporation for federal income tax purposes. Thus, for income tax purposes the corporation was treated, broadly speaking, as though it were a partnership or a sole proprietorship. This fact, according to Briloff's thinking, justified treating this brokerage corporation, which annually handled millions of dollars belonging (or, at least, owing) to other people, on about the same level of accounting sophistication as one would expect in a one-man carpenter shop.

Neither the elder Pritchard nor Briloff seem to have had the slightest idea of the wide range of sound accounting, tax, business, legal and ethical concepts which were violated by the bookkeeping and "loan" practices of Pritchard & Baird. However, in fairness to the elder Pritchard and Briloff, it must be said that while the elder Pritchard was in active day-to-day control of the business, the system, conceptually defective though it was, was used honestly. The "loans" made during the year bore a realistic relationship to reasonably anticipated profits. "Loans" were, in fact, reduced to zero or near zero at the end of each fiscal year. Ceding companies and reinsurers were paid what was owed to them. Thus, while the elder Pritchard was in day-to-day control, no great harm was done. It should also be noted that when the elder Pritchard gave up real control, Briloff also ceased to play an active role in Pritchard & Baird.

Israel M. Pogash, an accountant, testified about the financial affairs of Pritchard & Baird. He prepared a detailed written report which was received in evidence as Exhibit P-8. I have found Pogash's testimony and report to be substantially accurate ...


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