Credit Alliance Corporation v.Arthur Andersen & Co...
Court of Appeals of New York,1985
65 N.Y.2d 536,483 N.E.2d 110,493 N.Y.S.2d 435
JASEN,JUDGE.The critical issue common to these two appeals is whether an accountant may be held liable,absent privity of contract,to a party who relies to his detriment upon a negligently prepared financial report and,if so,within what limits does that liability extend.
[In Credit Alliance Corp.v.Andersen & Co.,the defendant accountants prepared consolidated financial statements for L.B.Smith,Inc.Credit Alliance had provided financing to Smith for some time,insisting in 1978 upon audited financial statements.Smith supplied statements that had been prepared by defendant.“These statements contained an auditor’s report prepared by Andersen stating that it had examined the statements in accordance with generally accepted auditing standards (‘GAAS’) and found them to reflect fairly the financial position of Smith in conformity with generally accepted accounting principles (‘GAAP’).”Plaintiff alleged that the statement were inaccurate because of failure to conduct investigations in accordance with proper auditing standards.Special Term denied defendant’s motion to dismiss causes of action,based on negligence and fraud.A divided Appellate division affirmed,101 A.D.2d 231,and certified to the Court of Appeals the question,“Was the order of the Supreme Court,as affirmed by this court,properly made?”
In European Am.Bank & Trust Co.v.Strauhs & Kaye,(“S.& K.”),the bank (“EAB”) made substantial loans to Majestic Electro Industries.Majestic having become bankrupt,EAB sued S.& K.for seriously exaggerating Majestic’s solvency assets.Special Term dismissed the complaint and Appellate Division reversed but certified a similar question to the Court of Appeals.EAB specifically alleges negligence in that S & K,in performing auditing and accounting services for Majestic Electro,at all relevant times knew that EAB was Majestic Electro’s principal lender,was familiar with the terms of the lending relationship and was fully aware that EAB was relying on the statements,and that S.& K.and Majestic were in communication during the entire course of the lending relationship.]
In the seminal case of Ultramares Corp.v.Touche,255 N.Y.170 [1931],this court,speaking through the opinion of chief Judge Cardozo more than 50 years ago,disallowed a cause of action in negligence against a public accounting firm for inaccurately prepared financial statements which were relied upon by a plaintiff having no contractual privity with the accountants.This court distinguished its holding from Glanzer v.Shepard,233 N.Y.236 [1922],a case decided in an opinion also written by Cardozo nine years earlier.We explained that in Glanzer,an action in negligence against public weighers had been permitted despite the absence of a contract between the parties,because the plaintiff’s intended reliance,on the information directly transmitted by the weighers,created a bond so closely approaching privity that it was,in practical effect,virtually indistinguishable therefrom.This court has subsequently reaffirmed its holding in Ultramares which has been,and continues to be much discussed and analyzed by the commentators and by the courts of other jurisdictions.These appeals now provide us with the opportunity to reexamine and delineate the principles enunciated in both Ultramares and Glazer.Inasmuch as we believe that a relationship “so close as to approach that of privity” remains valid as the predicate for imposing liability upon accountants to noncontractual parties for the negligent preparation of financial reports,we restate and elaborate upon our adherence to that standard today.
The doctrine of privity is said to have had its source in the classic enunciation of its rationale in Winterbottom v.Wright,10 M.& W.109,152 Eng.Rep 402.From Winterbottom,the privity doctrine developed into a general rule prevailing well into the Twentieth Century.
By the time 90 years had passed,however,this court could note in Ultramares that the “assault upon the citadel of privity is proceeding in these days apace.” We acknowledged that inroads had been made,for example,where third-party beneficiaries or dangerous instrumentalities were involved.Indeed,we referred to this court’s holding in MacPherson v.Buick Motor Co.,217 N.Y.382,where it was decided that the manufacturer of a defective chattel – there an automobile – may be liable in negligence for the resulting injuries sustained by a user regardless of the absence of privity – a belated rejection of the doctrine of privity as applied to the facts in Winterbottom.Nevertheless,regarding an accountant’s liability to unknown parties with whom he had not contracted,the considerations were deemed sufficiently dissimilar to justify different treatment.
Although accountants might be held liable in fraud to nonprivy parties who were intended to rely upon the accountants’ misrepresentations,we noted that “[a]different question develops when we ask whether they owned a duty to these to make [their reports] without negligence.” Ultramares Corp.v.Touche.Disputing the wisdom of extending the duty of care of accountants to anyone who might foreseeably rely upon their financial reports,Cardozo,speaking for this court,remarked: “If liability for negligence exists,a thoughtless slip or blunder,the failure to detect a theft of forgery beneath the cover of deceptive entries,may expose accountants to a liability in an indeterminate amount for an indeterminate time to an indeterminate class.The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes to these consequences.”
In Ultramares,the accountants had prepared a certified balance sheet for their client to whom they provided 32 copies.The client,in turn,gave one to the plaintiff company.The latter,relying upon the misinformation contained in the balance sheet,made loans to the accountants’ client who,only months later,was declared bankrupt.This court,refusing to extend the accountants’liability for negligence to their client’s lender,with whom they had no contractual privity,noted that the accountants had prepared a report on behalf of their client to be exhibited generally to “banks,creditors,stockholders,purchasers or sellers,according to the needs of the occasion.” In reciting the facts,we emphasized that: “Nothing was said as to the persons to whom these[copies] would be shown or the extent or number of the transactions in which they would be used.In particular there was no mention of the plaintiff,a corporation doing business chiefly as a factor,which till then had never made advances to the [accountants’ client],though it had sold merchandise in small amounts.The range of the transactions in which a certificate of audit might be expected to play a part was as indefinite and wide as the possibilities of the business that was mirrored in the summary.”
The accountants’ report was primarily intended as a convenient instrumentality for the client’s use in developing its business.“[O]nly incidentally or collaterally” was it expected to assist those to whom the client “might exhibit it thereafter.” Under such circumstances,permitting recovery by parties such as the plaintiff company would have been to impose a duty upon accountants“enforce[able] by any member of an indeterminate class of creditors,present and prospective,known and unknown.”(https://www.daowen.com)
By sharp contrast,the facts underlying Glanzer bespoke an affirmative assumption of a duty of care to a specific party,for a specific purpose,regardless of whether there was a contractual relationship.There,a seller of beans employed the defendants who were engaged in business as public weighers.Pursuant to instructions,the weighers furnished one copy of the weight certificate to their employer,the seller,and another to the prospective buyer.In reliance upon the inaccurately certified weight,the buyer purchased beans from the seller and,thereby,suffered a loss.
Explaining the imposition upon the weighers of a “noncontractual” duty of care to the buyer,this court held: “We think the law imposes a duty toward buyer as well as seller in the situation here disclosed.The [buyer’s] use of the certificates was not an indirect or collateral consequence of the action of the weighers.It was a consequence which,to the weighers’ knowledge,was the end and aim of the transaction.[The seller] ordered,but [the buyer was] was to use.The defendants held themselves out to the public as skilled and careful in their calling.They knew that the beans had been sold,and that on the faith of their certificate payment would be made.They sent a copy to the [buyer] for the very purpose of inducing action.All this they admit.In such circumstances,assumption of the task of weighing was the assumption of a duty to weigh carefully for the benefit of all whose conduct was to be governed.We do not need to state the duty in terms of contract or of privity.Growing out of a contract,it has none the less an origin not exclusively contractual.Given the contract and the relation,the duty is imposed by law.”
The critical distinctions between the two cases were highlighted in Ultramares,where we explained: “In Glanzer v. Shepard … [the certificate of weight],which was made out in duplicate,one copy to the seller and the other to the buyer,recites that it was made by order of the former for the use of the latter....Here was something more than the rendition of a service in the expectation that the one who ordered the certificate would use it thereafter in the operations of his business as occasion might require.Here was a case where the transmission of the certificate to another was not merely one possibility among many,but the ‘end and aim of the transaction,’ as certain and immediate and deliberately willed as if a husband were to order a gown to be delivered to his wife,or a telegraph company,contra-ct ing with the sender of a message,were to telegraph it wrongly to the damage of the person expected to receive it….The intimacy of the resulting nexus is attested by the fact that after stating the case in terms of legal duty,we went on to point out that … we could reach the same result by stating it in terms of contract….The bond was so close as to approach that of privity,if not completely one with it.Not so in the case at hand [i.e.,Ultramares].No one would be likely to urge that there was contractual relation,or even one approaching it,at the root of any duty that was owing from the [accountants] now before us to the indeterminate class of persons who,presently or in the future,might deal with the [accountants’client] in reliance on the audit.In a word,the service rendered by the defendant in Glanzer v.Shepard was primarily for the information of a third person,in effect,if not in name,a party to the contract,and only incidentally for that of the formal promisee.”
Upon examination of Ultramares and Glanzer …,certain criteria may be gleaned.Before accountants may be held liable in negligence to noncontractual parties who rely to their detriment on inaccurate financial reports,certain prerequisites must be satisfied: (1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes;(2) in the furtherance of which a known party or parties was intended to rely;and (3) there must have been some conduct on the part of the accountants linking them to that part or parties,which evinces the accountants’ understanding of that party or parties’ reliance.While these criteria permit some flexibility in the application of the doctrine of privity to accountants’ liability,they do not represent a departure from the principles articulated in Ultramares,Glanzer and White,but,rather,they are intended to preserve the wisdom and policy set forth therein.
We are aware that the courts throughout this country are divided as to the continued validity of the holding in Ultramares.Some courts continue to insist that a strict application of the privity requirement governs the law of accountants’ liability except,perhaps,where special circumstances compel a different result….
In all of [these] cases,the courts found the facts amenable to the imposition of accountants’ liability under the principles of Ultramares-Glanzer or extended those principles to permit a more liberalized application.To the extent that the holdings in those cases are predicated upon certain criteria – to wit,a particular purpose for the accountants report,a known relying party,and some conduct on the part of the accountants liking them to that party – they are consonant with the principles reaffirmed in this decision.To the extent,however,that those cases were decided upon the ground that Ultramares should not be followed and,instead,a rule permitting recovery by any foreseeable plaintiff should be adopted,the law in this State,as reiterated today,is clearly distinguishable….
In the appeals we decide today,application of the foregoing principles presents little difficulty.In Credit Alliance,the facts as alleged by plaintiffs fail to demonstrate the existence of a relationship between the parties sufficiently approaching privity.Though the complaint and supporting affidavit do allege that Andersen specifically knew,should have known or was on notice that plaintiffs were being shown the reports by Smith,Andersen’s client,in order to induce their reliance thereon,nevertheless,there is no adequate allegation of either a particular purpose for the reports’ preparation or the prerequisite conduct on the part of the accountants.While the allegations state that Smith sought to induce plaintiffs to extend credit,no claim is made that Andersen was being employed to prepare the reports with that particular purpose in mind.Moreover,there is no allegation that Andersen had any direct dealings with plaintiffs,had specifically agreed with Smith to prepare the report for plaintiffs’ use of according to plaintiffs’ requirements,or had specifically agreed with Smith to provide plaintiffs with a copy or actually did so.Indeed,there is simply no allegation of any word or action on the part of Andersen directed to plaintiffs,or anything contained in Andersen’s retainer agreement with Smith which provided the necessary link between them.
By sharp contrast,in European American,the facts as alleged by EAB clearly show that S.& K.was well aware that a primary,if not the exclusive,end and aim of auditing its client,Majestic Electro,was to provide EAB with the financial information it required.The prerequisites for the cause of action in negligence,as well as in gross negligence,are fully satisfied.Not only is it alleged,as in Credit Alliance,that the accountants the audit reports,but additionally,the complaint and affidavit here allege both the accountants’ awareness of a particular purpose for their services and certain conduct on their part creating an unmistakable relationship with the reliant plaintiff.It is unambiguously claimed that the parties remained in direct communication,both orally and in writing,and,indeed,met together throughout the course of EAB’s lending relationship with Majestic Electro,for the very purpose of discussing the latter’s financial condition and EAB’s need for S.& K.’s evaluation.Moreover,it is alleged that S.& K.made repeated representations personally to representatives of EAB,on these occasions,concerning the value of Majestic Electro’s assets.It cannot be gainsaid that the relationship thus created between the parties was the practical equivalent of privity.The parties’ direct communications and personal meetings resulted in a nexus between them sufficiently approaching privity under the principles of Ultramares,Glanzer and White to permit EAB’s causes of action.
Finally,disposition of the second cause of action alleged in Credit Alliance need not detain us long.The cause of action for fraud repeats the allegations for the negligence cause of action and merely adds a claim that Andersen recklessly disregarded facts which would have apprised it that its reports were misleading or that Andersen had actual knowledge that such was the case.This single allegation of scienter,without additional detail concerning the facts constituting the alleged fraud,is insufficient under the special pleading standards required under CPLO 3016(b),and,consequently,the cause of action should have been dismissed.
Accordingly,in Credit Alliance both causes of action should be dismissed,the order of the Appellate Division reversed,with costs,and the certified ques-tion answered in the negative.In European American,the order of the Appellate Division should be affirmed,with costs,and the certified question answered in the affirmative.