Essay: Johnson Bank v. George Korbaken

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[. . .] 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)

After the accounting scandals involving Enron and World Com occurred, is when these regulations were changed. This took place with the passage of the Sarbanes-Oxley Act of 2002. It set new standards for auditor independence and corporate responsibility. Evidence of this can be seen with the law saying, "Periodic statutory financial reports are to include certifications that:

• The signing officers have reviewed the report

• The report does not contain any material untrue statements or material omission or be considered misleading

• The financial statements and related information fairly present the financial condition and the results in all material respects

• The signing officers are responsible for internal controls and have evaluated these internal controls within the previous ninety days and have reported on their findings

• A list of all deficiencies in the internal controls and information on any fraud that involves employees who are involved with internal activities

• Any significant changes in internal controls or related factors that could have a negative impact on the internal controls

Organizations may not attempt to avoid these requirements by reincorporating their activities or transferring their activities outside of the United States. Financial statements are published by issuers are required to be accurate and presented in a manner that does not contain incorrect statements or admit to state material information. These financial statements shall also include all material off-balance sheet liabilities, obligations or transactions. The Commission was required to study and report on the extent of off-balance transactions resulting transparent reporting. The Commission is also required to determine whether generally accepted accounting principles or other regulations result in open and meaningful reporting by issuers." ("Sarbanes-Oxley Act," 2006) (Knapp, 2009)

This is showing how there was a shift in the way financial information is reported and disclosed. These changes could have influenced the judge's interpretations based upon possible violations taking place after its passage. If this was the case, there is a realistic possibility of them finding GKCO liable for some of the information they submitted to Johnson Bank. ("Sarbanes-Oxley Act," 2006) (Knapp, 2009)

If this decision had been decided in 2012, the outcome could have been completely different. This is because the atmosphere had changed and new laws were enacted to prevent abuses from auditors not fully disclosing all information. While this may not have been a publically traded company, the procedures utilized, were not following Generally Accepted Accounting Principles. As it was making assumptions, that were very optimistic about the future. This is problematic, by not providing a completely accurate assessment of the underlying financial state of the firm. Moreover, there is probability that the officers of Brandon Apparel could have been held legally responsible through: forcing them to affirm under oath the accuracy of the information. ("Sarbanes-Oxley Act," 2006) (Knapp, 2009)

Clearly, the case involving Johnson Bank v. George Korbakes Company is showing how GKCO cannot be held responsible for losses on the loan. This is because the company provided a summary of information based upon the most accepted regulatory practices in the 1990s. As a result, they had reduced liabilities and were considered to provide them with unbiased information. Any decisions surrounding the loan; are limited as bankers must examine a number of sources in the process. When this happens, they will have a better understanding of what is happening with their client.


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Johnson Bank v. George Korbaken.  (2013, September 5).  Retrieved June 25, 2019, from

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