Credit Alliance Corp. v. Arthur Andersen & Co.

Citation493 N.Y.S.2d 435,65 N.Y.2d 536
CourtNew York Court of Appeals
Decision Date02 July 1985
Parties, 483 N.E.2d 110, 54 USLW 2045 CREDIT ALLIANCE CORPORATION, et al., Respondents, v. ARTHUR ANDERSEN & CO., Appellant. EUROPEAN AMERICAN BANK AND TRUST COMPANY, Respondent, v. STRAUHS & KAYE, et al., Appellants.
OPINION OF THE COURT

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.

I

In Credit Alliance Corp. v. Andersen & Co. ("Credit Alliance "), plaintiffs are major financial service companies engaged primarily in financing the purchase of capital equipment through installment sales or leasing agreements. Defendant, Arthur Andersen & Co. ("Andersen"), is a national accounting firm. Plaintiffs' complaint and affidavit 1 allege that prior to 1978, plaintiffs had provided financing to L.B. Smith, Inc. of Virginia ("Smith"), a capital intensive enterprise that regularly required financing. During 1978, plaintiffs advised Smith that as a condition to extending additional major financing, they would insist upon examining an audited financial statement. Accordingly, Smith provided plaintiffs with its consolidated financial statements, covering both itself and its subsidiaries, "For The Years Ended December 31, 1977 and 1976" (the "1977 statements"). 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"). In reliance upon the 1977 statements, plaintiffs provided substantial amounts in financing to Smith through various extensions of credit. Thereafter, in 1979, as a precondition to continued financing, plaintiffs requested and received from Smith the consolidated financial statements "For The Years Ended February 28, 1979 and December 31, 1977" (the "1979 statements"). Again, Andersen's report vouched for its examination of the financial statements and the financial position of Smith reflected therein. Relying upon these certified statements, plaintiffs provided additional substantial financing to Smith.

It is alleged that both statements overstated Smith's assets, net worth and general financial health, and that Andersen failed to conduct investigations in accordance with proper auditing standards, thereby failing to discover Smith's precarious financial condition and the serious possibili that Smith would be unable to survive as a going concern. Indeed, in 1980, Smith filed a petition for bankruptcy. By that time, Smith had already defaulted on several millions of dollars of obligations to plaintiffs.

In August 1981, plaintiffs commenced this suit for damages lost on its outstanding loans to Smith, claiming both negligence and fraud by Andersen in the preparation of its audit reports. The complaint alleges that Andersen knew, should have known or was on notice that the 1977 and 1979 certified statements were being utilized by Smith to induce companies such as plaintiffs to make credit available to Smith. The complaint further states that Andersen knew, should have known or was on notice that the certified statements were being shown to plaintiffs for such a purpose. 2 It is also alleged that Andersen knew or recklessly disregarded facts which indicated that the 1977 and 1979 statements were misleading. 3

On Andersen's motion to dismiss the complaint, Special Term initially held the negligence cause of action to be barred by the Statute of Limitations, but denied the motion with regard to the claim for fraud. On reargument, the court reversed its dismissal of the negligence cause of action and denied Andersen's motion in its entirety. On appeal, the Appellate Division, 101 A.D.2d 231, 476 N.Y.S.2d 539, affirmed the order below, holding, in part, that despite the absence of contractual privity between the parties, plaintiffs were members of a limited class whose reliance upon the financial statements should have been specifically foreseen by defendants. The court concluded that plaintiffs fell within the exception to the general rule that requires privity to maintain an action against an accountant for negligence. Two Justices dissented on the ground that the rule requiring privity has been repeatedly reaffirmed by this court and mandates dismissal of the action for negligence.

The Appellate Division granted Andersen's motion for leave to appeal to this court and certified the following question: "Was the order of the Supreme Court, as affirmed by this Court, properly made?" Because the allegations in plaintiffs' complaint and affidavit fail to set forth either a relationship of contractual privity with Andersen or a relationship sufficiently intimate to be equated with privity, the first cause of action should be dismissed. Further, inasmuch as plaintiffs' second cause of action, sounding in fraud, comprises mere conclusory allegations, it also should be dismissed. Accordingly, in Credit Alliance, we now reverse and answer the certified question in the negative.

In European Am. Bank & Trust Co. v. Strauhs & Kaye("European American "), the complaint, together with the affidavit in opposition to the motion to dismiss, alleges that plaintiff, European American Bank and Trust Company ("EAB"), made substantial loans to Majestic Electro Industries and certain of its subsidiaries (collectively, "Majestic Electro") in March 1979 pursuant to their written agreements. Several months later, EAB partially financed Majestic Electro acquisition of Brite Lite Lamps Corp. by again advancing substantial funds.

Beginning in 1979, and continuing thereafter at all relevant times, Majestic Electro retained defendant Strauhs & Kaye ("S & K"), an accounting partnership rendering services in this State, to audit its financial records in accordance with GAAS and to report its findings in conformity with GAAP. During the course of its lending relationship with Majestic Electro, EAB relied upon the interim and year-end financial reports prepared by S & K to determine the maximum amounts it was willing to lend. From 1979 through 1982, S & K allegedly, inter alia, overstated Majestic Electro's inventory and accounts receivable, and failed to disclose the inadequacy of Majestic Electro's internal recordkeeping and inventory control.

When, in December 1982, a Majestic Electro subsidiary defaulted on its loan agreement, EAB caused the subsidiary's inventory, in which it had a security interest, to be liquidated. It was then that EAB allegedly began to discover that S & K's reports had seriously exaggerated the financial solvency of Majestic Electro. Indeed, between the time the complaint was filed and the submission of papers upon the motion to dismiss, Majestic Electro filed a petition in bankruptcy. EAB suffered substantial losses from the loans remaining unpaid.

EAB commenced this action in May 1983, seeking damages for those losses allegedly resulting from its reliance upon S & K's reports. 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 financial statements and inventory valuations certified by S & K. Moreover, it is alleged that representatives of EAB and S & K were in direct communication, both oral and written, during the entire course of the lending relationship between EAB and Majestic Electro, and, indeed, that representatives of EAB and S & K met together throughout this time to discuss S & K's evaluation of Majestic Electro's inventory and accounts receivable and EAB's reliance thereon. 4 The complaint also alleges a second cause of action, merely adding that defendants were "grossly negligent or recklessly indifferent" in performing professional services and that EAB was damaged as a result.

On S & K's motion, Special Term dismissed the complaint holding that, absent a contractual relationship between the parties or an allegation of fraud, the complaint failed to state a cause of action. On appeal, the Appellate Division, 102 A.D.2d 776, 477 N.Y.S.2d 146, unanimously reversed and reinstated the complaint in its entirety. Focusing on the direct communications between the parties, the court held that contractual privity was not a prerequisite to liability inasmuch as S & K specifically knew that their reports would be relied upon by EAB for a particular purpose.

The Appellate Division granted S & K's motion for leave to appeal to this court and certified the following question: "Was the order of this Court, which reversed the order of the Supreme Court, properly made?" Because EAB's complaint and affidavit posit a direct nexus...

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