First Nat. Bank of Bluefield v. Crawford

Decision Date03 November 1989
Docket NumberNo. CC991,CC991
Citation386 S.E.2d 310,182 W.Va. 107
CourtWest Virginia Supreme Court
PartiesThe FIRST NATIONAL BANK OF BLUEFIELD, a National Banking Association v. Harry Robert CRAWFORD; Crawford & Graham; and Crawford & Graham, A.C., Inc.

Syllabus by the Court

In the absence of privity of contract, an accountant is liable for the negligent preparation of a financial report only to those he knows will be receiving and relying on the report.

R. Thomas Czarnik, Pinceton, for The First Nat. Bank of Bluefield.

J. Greg Goodykoontz, Steptoe & Johnson, Clarksburg, for Harry Robert Crawford, Crawford & Graham, a partnership, and Crawford & Graham, A.C., Inc.

MILLER, Justice:

We accepted this certified question in order to determine if lack of privity of contract between an accountant and a bank is a complete defense to the bank's suit against the accountant for professional negligence in preparing a financial statement.

On July 25, 1986, the First National Bank of Bluefield (the bank) filed suit in the Circuit Court of Mercer County against Harry Robert Crawford, a certified public accountant (the accountant). 1 The complaint alleged that the accountant had been professionally negligent in preparing a financial statement for Erps Construction Co. (Erps) upon which the bank had relied in determining whether to give Erps a loan. In his answer, the accountant asserted the defense of lack of privity.

Following a motion for partial summary judgment by the bank, the parties stipulated: (1) that the bank informed the accountant that it would need the financial statement prior to the October 5, 1984 closing of the loan; (2) that the financial statement was delivered to the bank before the closing date; (3) that the bank alleges that it reasonably relied on the financial statement in making the loan to Erps; and (4) that there was no privity of contract between the bank and the accountant.

In an order entered on November 2, 1988, the trial court ruled that in the absence of contractual privity between the parties, the bank could not recover from the accountant. We therefore address the narrow issue of whether lack of privity of contract is an absolute defense in a suit for accounting malpractice.

The majority of courts agree that an accountant can be found liable in the absence of privity of contract. However, the standard for imposition of this liability varies. The minority view was established in Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931), the seminal case discussing an accountant's liability. In Ultramares, the court, speaking through Chief Judge Cardozo, held that in the absence of privity or a relationship "so close as to approach that of privity," a party could not recover from an accountant. 255 N.Y. at 182-83, 174 N.E. at 446. Koch Indus., Inc. v. Vosko, 494 F.2d 713 (10th Cir.1974) (applying Kansas law); Robertson v. White, 633 F.Supp. 954 (W.D.Ark.1986) (applying Arkansas law); First Florida Bank, N.A. v. Max Mitchell & Co., P.A., 541 So.2d 155 (Fla.App.1989). 2 Although New York's highest court has declared otherwise, it appears that the Ultramares standard was modified in Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 551, 493 N.Y.S.2d 435, 443, 483 N.E.2d 110, 118 (1985), where this rule was announced:

"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 party or parties, which evinces the accountants' understanding of that party or parties' reliance." 3

The most liberal rule was adopted by the New Jersey Supreme Court in H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 461 A.2d 138 (1983). After a thorough discussion of the issue, 4 the New Jersey Supreme Court concluded that in the absence of a limitation in the accountant's certificate as to whom the client may disseminate the financial statement, the accountant "has a duty to all those whom that auditor should reasonably foresee as recipients from the company of the statements for its proper business purposes, provided that the recipients rely on the statements pursuant to those business purposes." 93 N.J. at 352, 461 A.2d at 153. (Footnote omitted). Accord International Mortgage Co. v. John P. Butler Accountancy Corp., 177 Cal.App.3d 806, 223 Cal.Rptr. 218 (1986); Touche Ross & Co. v. Commercial Union Ins. Co., 514 So.2d 315 (Miss.1987); Citizens State Bank v. Timm, Schmidt & Co., 113 Wis.2d 376, 335 N.W.2d 361 (1983).

The majority view offers a middle ground and holds that in the absence of privity of contract, an accountant is liable for the negligent preparation of a financial report only to those he knows will be receiving and relying on the report. 5 See, e.g., Matter of Hawaii Corp., 567 F.Supp. 609 (D.Haw.1983) (applying Hawaii law); Ingram Indus., Inc. v. Nowicki, 527 F.Supp. 683 (E.D.Ky.1981) (applying Kentucky law); Rusch Factors, Inc. v. Levin, 284 F.Supp. 85 (D.R.I.1968) (applying Rhode Island law); Badische Corp. v. Caylor, 257 Ga. 131, 356 S.E.2d 198 (1987); Ryan v. Kanne, 170 N.W.2d 395 (Iowa 1969); Bonhiver v. Graff, 311 Minn. 111, 248 N.W.2d 291 (1976); Spherex Inc. v. Alexander Grant & Co., 122 N.H. 898, 451 A.2d 1308 (1982); Raritan River Steel Co. v. Cherry, Bekaert & Holland, 322 N.C. 200, 367 S.E.2d 609 (1988); Haddon View Inv. Co. v. Coopers & Lybrand, 70 Ohio St.2d 154, 436 N.E.2d 212 (1982); Shatterproof Glass Corp. v. James, 466 S.W.2d 873 (Tex.Civ.App.1971); Milliner v. Elmer Fox and Co., 529 P.2d 806 (Utah 1974). Cf. United States v. Arthur Young & Co., 465 U.S. 805, 104 S.Ct. 1495, 79 L.Ed.2d 826 (1984) (an independent public accountant owes ultimate allegiance to the corporation's creditors, stockholders, and the investing public); Brumley v. Touche Ross & Co., 123 Ill.App.3d 636, 79 Ill.Dec. 57, 463 N.E.2d 195 (1984) (the test of the scope of the accountant's duty to a third party is whether the accountant was acting at the direction or on the behalf of his client to benefit or influence a third party). See generally Annot., 46 A.L.R.3d 979 (1972 and Supp.1989).

We believe that the Restatement rule is more appropriate because it imposes a standard of care only to known users who will actually be relying on the information provided by the accountant. This is not a commercially unreasonable rule, nor is it any different from that applied to other professionals who issue opinions or reports. If such a report is materially erroneous, the author may be liable to those persons whom he knows will be relying on it, even in the absence of privity of contract. 6

Under this rule, liability is not automatically established by pointing to some error in the accountant's report; rather, before an accountant can be found liable, it must be shown that there is a material misstatement or omission in his report. The standard of care depends upon generally accepted accounting practices. 7 In Raritan River Steel, 322 N.C. at 212, 367 S.E.2d at 616, the North Carolina Supreme Court made this pertinent observation:

"[A]uditors do not control their client's accounting records and processes. B. Ferst, Basic Accounting for Lawyers 11 (3d ed. 1975). While, in the final analysis, an auditor renders an opinion concerning the accuracy of his client's records, he necessarily relies, in some measure, on the client for the records' contents." 8

Moreover, courts recognize that because there are several types of accounting audits, there may be differing degrees of professional investigation required of the accountant. 9 The identification of the type of audit performed is customarily set out in the accountant's report which will include a limiting statement or disclaimer. 10 With two general exceptions, courts have recognized the validity of such statements in weighing the accountant's duty. 11 First, the court will look to the nature of the accounting work contracted. As explained in the leading case of Ryan v. Kanne, 170 N.W.2d at 404: "Their liability must be dependent on their undertaking not their rejection of dependability. They cannot escape liability for negligence by a general statement that they disclaim its reliability." See also Ashland Oil, Inc. v. Arnett, 875 F.2d 1271 (7th Cir.1989); Seedkem, Inc. v. Safranek, 466 F.Supp. 340 (D.Neb.1979); Coleco Indus., Inc. v. Berman, 423 F.Supp. 275 (E.D.Pa.1976); Badische Corp. v. caylor, supra; Bonhiver v. Graff, supra; Spherex, Inc. v. Alexander Grant & Co., supra. Obviously, under this exception, if the accountant has been hired to do a full audit, he could not limit his liability by a disclaimer that his report should be treated only as an unaudited statement.

The second exception is that regardless of the nature of the work undertaken, if the accountant actually discovers a materially false matter in the client's books and fails to disclose it, he may be subject to liability. See United States v. Natelli, 527 F.2d 311 (2d Cir.1975), cert. denied, 425 U.S. 934, 96 S.Ct. 1663, 48 L.Ed.2d 175 (1976); 12 Bonhiver v. Graff, supra.

In answering this certified question, we do not express an opinion on the underlying merits of the claim. The question having been answered, we dismiss the case from our docket by remanding it to the lower court.

Certified question answered, case remanded and dismissed.

1 The suit was also filed against the partnership of Crawford & Graham and against Crawford & Graham, A.C., Inc., a West Virginia corporation which succeeded the former partnership.

2 A number of commentators have questioned the soundness of Ultramares. See, e.g., Wiener, Common Law Liability of the Certified Public Accountant...

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