Credit Alliance Corp. v. Arthur Andersen & Co.

• Decision Date: 03 May 1984
• Citation: 101 A.D.2d 231,476 N.Y.S.2d 539
• Parties: CREDIT ALLIANCE CORPORATION and Leasing Service Corporation, Plaintiffs-Respondents, v. ARTHUR ANDERSEN & CO., Defendant-Appellant.
• Court: New York Supreme Court — Appellate Division

Page 539

476 N.Y.S.2d 539

101 A.D.2d 231

CREDIT ALLIANCE CORPORATION and Leasing Service Corporation Plaintiffs-Respondents, v. ARTHUR ANDERSEN & CO., Defendant-Appellant.

Supreme Court, Appellate Division First Department.

May 3, 1984.

Robert L. King, New York City, of counsel (John S. Kiernan, New York City, and Charles W. Boand, Chicago, Ill., with him on the brief; Debevoise & Plimpton, New York City, and Wilson & McIlvaine, Chicago, Ill., attorneys), for defendant-appellant.

Melvyn I. Weiss, New York City, of counsel (Jerome M. Congress and Elizabeth A. Shollenberger, New York City, with him on the brief; Milberg, Weiss Bershad Spechthrie & Lerach, New York City, attorneys), for plaintiffs-respondents.

Before ROSS, J.P., and ASCH, FEIN, MILONAS and ALEXANDER, JJ.

ROSS, Justice Presiding.

I would affirm Special Term's order, 471 N.Y.S.2d 938, in its entirety.

Since the defendant elected not to answer, but rather moved to dismiss for failure to state a cause of action, the fundamental principle applies that "every fact alleged must be assumed to be true, and the complaint liberally construed in plaintiff's favor" (Barr v. Wackman, 36 N.Y.2d 371, 375, 368 N.Y.S.2d 497, 329 N.E.2d 180).

Plaintiffs Credit Alliance Corporation (Credit) and Leasing Service Corporation (Leasing) have their headquarters offices in New York City. They are affiliated corporations, and are both engaged primarily in financing capital equipment through instalment sales and leasing programs, with manufacturers and dealers. Their speciality is serving markets that utilize income-producing and labor-saving equipment, such as that used in the construction and surface mining industries.

L.B. Smith, Inc. of Virginia (Smith) is a Virginia corporation, with its principal place of business in Maryland. Smith, a non-party to this litigation, during the decade of the nineteen seventies, was engaged in the business of selling, leasing, and servicing heavy construction equipment.

Before the events occurred that resulted in the instant action, Credit provided limited amounts of financing to Smith, including the purchase of chattel paper which related to transactions between Smith and its customers. Sometime prior to September 1978, Smith asked plaintiffs to consider advancing substantial sums of credit to them. In view of the large amount of financing sought, it was obvious to plaintiffs, that if they agreed, their only viable recourse, in the event of default by Smith's customers to plaintiffs, would be to Smith ¹.

Clarence V. Palitz, Jr. (Palitz) was the President of each plaintiff corporation at the time relevant to the instant action. In his affidavit in opposition to defendant's motion, Palitz states, in pertinent part, that: ²

"Consequently, I informed ... Smith that it would have to provide plaintiffs with audited ... Smith financial statements before plaintiffs would decide whether or not to enter into further transactions with ... Smith. According to our records, plaintiffs received a copy of the consolidated financial statements for ... Smith.... After review of the 1977 certified financial statement the decision was made to extend further financing.

In reliance upon the 1977 certified financial statement, plaintiffs entered into numerous transactions requested by ... Smith.... Through my experience as an officer and director of Credit, Leasing and Commercial Alliance Corporation (the plaintiffs' parent company), I am knowledgeable concerning the general availability of and sources for the types and amount of financing which plaintiffs extended to ... Smith from September 1978 through mid-1980. It is my opinion that given the amount of financing ... involved, a relatively limited group of companies was available to provide such financing to ... Smith. In addition to plaintiffs, it is my opinion that less than eight companies would have been potential sources of the financing sought by ... Smith" (emphasis supplied).

The complaint, in pertinent part, alleges: ³

"By June 1, 1979, Credit and Leasing had provided an aggregate in excess of $15,000,000 to ... Smith in reliance upon the 1977 certified financial statement ...

In 1979, plaintiffs requested a further audited financial statement from ... Smith. As a result, ... Smith provided plaintiffs with a copy of the consolidated financial statements of ... Smith and its subsidiaries as of February 28, 1979, and December 31, 1977 ('the 1979 certified financial statement') ...

On or about October 23, 1980 ... Smith filed a petition for bankruptcy proceedings, and is presently the subject of such proceedings.

As of October 23, 1980, ... Smith had defaulted on obligations to Credit and Leasing in amounts exceeding $7,900,000 and $900,000 respectively ...". (emphasis supplied)

The 1977 and 1979 audited certified financial statements (statements) were prepared by defendant, which is a public accounting firm, with offices in this state. Defendant "is one of the largest accounting firms in the United States ... holds itself out to the public as expert accountants, auditors and financial analysts upon whom the public can rely." ⁴ [material in brackets added and emphasis supplied].

After Smith defaulted on its obligations, the plaintiffs commenced this action against defendant, on or about August 4, 1981. With respect to the cause of action for negligence, plaintiff Credit seeks damages exceeding $7,900,000, and plaintiff Leasing seeks damages exceeding $900,000 from defendant. This action is based upon plaintiffs reliance on the 1977 and 1979 statements of defendant, which plaintiffs allege were materially misleading, because of a lack of reasonable care, and negligence by defendant, in the conduct of its professional responsibilities. In particular, plaintiffs contend that, inter alia, defendant materially overstated the value of Smith's equipment, inventory and accounts receivable and defendant's unqualified opinion allegedly did not present the financial position of Smith, in accordance with generally accepted accounting principles. Thus, plaintiffs contend that defendant's statements failed to disclose that Smith was in serious financial trouble.

Even though defendant addressed its 1977 and 1979 statements "To the Stockholders and the Board of Directors of L.B. Smith, Inc. of Virginia" and there was no contractual relationship with plaintiffs, the plaintiffs allege that defendant knew or should have known, in view of defendant's analysis of Smith's precarious financial status, that Smith would have to submit the 1977 and 1979 statements to either plaintiffs, or to one of the limited number of companies, such as plaintiffs, that were capable of providing Smith with the massive funding it now needed to remain in business. Evidence that the sophisticated defendant was aware that it must have been the plaintiffs, is found in Note 4 in the defendant's 1979 statement, where, in pertinent part, it is stated: ⁵ "the Company (Smith) was contingently liable for guaranteed customer obligations to outside financial institutions of approximately $11,000,000 as of February 28, 1979, and $295,000 as of December 31, 1977. This increase is primarily attributable to certain sales transactions which the Company entered into from October, 1978 through February, 1979. Under these transactions, the Company has guaranteed customers' obligations to outside financial institutions." (material in parenthesis added). The reason that defendant knew, or should have known, that it was the plaintiffs who were the source of the credit, is due to the fact that the only possible way that defendant could have verified the accuracy of this entry, was to comb Smith's financial records, where defendant would have found that plaintiffs had extended most of this $11,000,000. Incidentally, nowhere in the record does defendant either dispute Palitz' sworn statement that "in addition to plaintiffs, it is my opinion that less than eight companies would have been potential sources of the financing sought by ... Smith", nor does defendant deny that it was aware that plaintiffs were a major creditor of Smith during the subject period.

In view of the fact that, for the purpose of this matter, we accept, as true, plaintiffs' statement that less than eight companies would be available to finance Smith, (as defendant does not dispute same), it would put plaintiffs in a position of seeking "redress, not as a mere member of the public, but as one of a settled and particularized class among the members of which the report would be circulated for the specific purpose of fulfilling the ... arrangement." (White v. Guarente, 43 N.Y.2d 356, 363, 401 N.Y.S.2d 474, 372 N.E.2d 315).

The plaintiffs are members of a limited group to whom defendant would owe a duty, and to whom defendant knew or should have known their audit would be delivered, and relied upon.

Generally, accountants are not liable to those members of the general public, who receive their reports, but with whom they do not have a contractual relationship (Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441). However, we find that, based upon the record, in the instant case the plaintiffs, despite not having a contract, or being in direct privity with defendant, are entitled to a duty of care from defendant because they are members "of a limited class whose reliance on ... audit ... was, or at least should have been, specifically foreseen (White v. Guarente, supra, 43 N.Y.2d at 362, 401 N.Y.S.2d 474, 372 N.E.2d 315) [material in brackets added].

Therefore, we hold that where defendant negligently prepares a financial statement, and it may reasonably be assumed that this statement was intended to induce plaintiffs to rely thereon, to plaintiffs' detriment in consequence of such reliance, and the plaintiffs sustain damages as a result of such reliance, the plaintiffs may recover--assuming, of course, that it is established that defendant's conduct was a...