LaSalle Nat'l Bank v. Ernst & Young

• Citation: 729 N.Y.S.2d 671
• Parties: (A.D. 1 Dept. 2001) LaSalle National Bank, et al., Plaintiffs-Respondents, v. Ernst & Young LLP, Defendant-Appellant. 3196 : FIRST JUDICIAL DEPARTMENT
• Decision Date: 09 August 2001
• Court: New York Supreme Court Appellate Division

Page 671

729 N.Y.S.2d 671 (A.D. 1 Dept. 2001)

LaSalle National Bank, et al., Plaintiffs-Respondents, v. Ernst & Young LLP, Defendant-Appellant.

3196

SUPREME COURT OF THE STATE OF NEW YORK APPELLATE DIVISION: FIRST JUDICIAL DEPARTMENT

August 9, 2001

David Smith, of counsel (M. Christine Carty, Lisa M. Cobb, Christina Rainville and Theresa E. Loscalzo, on the brief, Schnader Harrison Segal & Lewis LLP, attorneys) for plaintiffs-respondents,

Bruce M. Cormier, of counsel (Patricia A. Connell, Irvin B. Nathan, Leonard H. Becker, Kent A. Yalowitz and Alan S. Rabinowitz, on the brief, Ernst & Young LLP and Arnold & Porter, attorneys) for defendant-appellant.

Joseph P. Sullivan, P.J., Eugene Nardelli, Milton L. Williams, Peter Tom, David Friedman, JJ.

TOM, J.

In this case we return to the recently active legal area of the negligence liability of accountants to third parties with whom they are not in privity. Here, we examine the element of "linkage" required by the third prong of the Credit Alliance test (Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536), and more recently articulated in Parrott v. Coopers & Lybrand (95 N.Y.2d 479) and Securities Investor Protection Corp. v BDO Siedman, LLP. (95 N.Y.2d 702). We also examine whether a cause of action for fraud against the defendant accounting firm may survive CPLR 3211 dismissal in the present case.

The underlying action arose from a loan made by plaintiff-lender LaSalle National Bank (LaSalle) to non-party Kent International Associates, Ltd. (Kent), which purportedly was induced, at least in part, by financial statements prepared by defendant Ernst & Young.

In 1994, Kent, a relatively new wholesale distributor of electronic products and appliances, sought financing from LaSalle, to be secured by capital assets, to use for operating expenses. Kent, as a distributor, profited from the spread between its purchase price of the items and the price at which it sold them. In order to maintain its operations, it needed large sums of operating capital. Kent initially had indebted itself to other lenders in an amount of approximately $14 million, which it now sought to consolidate in a single loan with LaSalle. Kent and LaSalle entered a Loan and Security Agreement on October 13, 1994 for $20 million secured by assets, including its accounts receivable and inventory. The credit was structured so that Kent could borrow up to a percentage of the specified assets. As a condition of the agreement, Kent was prospectively required to provide LaSalle with annual financial statements certified by an independent certified accountant to be selected by Kent. The 1994 $20 million loan was increased to $35 million in June 1995. Kent discharged its prior accountants and retained defendant Ernst & Young in December 1995. The loan was increased to $50 million in February 1996.

Ernst & Young issued the 1995 audit report on March 29, 1996. The report was addressed to "the Shareholders of Kent International Associates, Ltd." After explaining the nature and purpose of the audit, Ernst & Young stated an opinion that the financial statements provided by management "present fairly, in all material respects, [Kent's financial position] and the results of its operations and its cash flows for the year...". In the body of the report it was noted that the loan had been increased to $50 million in February and the term extended to October 1999.

Subsequent to the 1995 audit, Kent sought yet more financing. Plaintiffs allege that LaSalle employees and unidentified employees of "another of the Lenders" tried by telephone, unsuccessfully, to get assurances from Ernst & Young that Kent's internal controls were sufficient to manage its apparently rapid growth during the first half of 1996. The amended complaint alleges that eventually an unidentified Ernst & Young partner returned a call to an unidentified LaSalle employee and an unidentified employee of another lender, also unidentified. The date of the telephone conversation is not even generally identified, except that it happened "eventually." Plaintiffs allege that the unidentified employees told the unidentified accountant that they were relying on the purported call along with the 1995 audit report-to which they were apparently not entitled-in making a decision to increase and syndicate the loan. Plaintiffs also allege that the accountant assured the employees that Kent could handle its rapid growth. In any event, in reliance on the putative assurances provided by Ernst & Young, the loan was syndicated to other financial institutions and increased to $65 million in June 1996. As a condition of the June 4, 1996 Amended and Restated Loan and Security Agreement between Kent and the various lenders, Kent was again required to provide annual financial statements certified by an independent public accountant. Plaintiffs allege in the amended complaint that it was also a condition that the accountant acknowledge "that a primary purpose of the financial statements was to induce the Lenders to lend money to Kent and that the Lenders would rely on the audited financial statements in connection with the Loans." The amended complaint does not allege that such acknowledgment was ever provided, and presumably it was not. Plaintiffs further allege that in reliance on Ernst & Young's assurances and its audit, the loan was further increased to $75 million in July 1996, and yet again to $115 million in August 1996. What, if any, supplemental assurances were provided in connection with each substantial, and speedy, increase in the financing, is not alleged.

The next audit report was issued in March 1997 in connection with the 1996 audit. In a boilerplate fashion, the report, addressed again to Kent shareholders, offered the opinion that the financial statements were fairly presented. The same allegations are made in the pleadings regarding Ernst & Young's awareness of plaintiffs' reliance on this report.

In or around August 1997, some accounting ploys that Kent had apparently used in connection with its accounts payable were uncovered by the lenders. On September 9, 1997, Kent's attorney informed LaSalle that Kent had provided inaccurate and false information by various means, including its audited financial statements. Ernst & Young resigned on September 25, 1997, withdrew its audit report of Kent's 1996 financial statements, and directed Kent to notify any party using those financial statements of the withdrawal of the audit report and that the report could not be relied upon. Kent subsequently filed for bankruptcy.

LaSalle and other lenders commenced the underlying action against Ernst & Young for negligence, negligent misrepresentation, breach of contract and fraud, in connection with the accounting services provided to Kent, alleging that they were intended to be direct, and not merely incidental, beneficiaries of those services. Defendant Ernst & Young moved to dismiss for failure to state a cause of action and for plaintiffs' failure to plead fraud with particularity. The IAS court denied the motion. We reverse and dismiss the complaint.

In order to impose negligence liability on an accountant for injury to a non-contracting third party resulting from the accountant's advice or services, the third party must establish each prong of the Credit Alliance test, that is: [1] the accountant's awareness that the financial reports were to be used for a particular purpose or purposes, [2] reliance on the reports by a known party or parties, and [3] some linking conduct on the part of the accountant which evinced the accountant's understanding regarding the third party's reliance (Parrott v. Coopers & Lybrand, supra, at 484; Securities Investor Protection Corp. v BDO Seidman LLP., supra, at 711). Notwithstanding some degree of overlap among these requirements, they are distinct. They must be distinctly pleaded and, if the action survives a CPLR 3211 dismissal motion, proved. As we have illustrated the test, "[a]s with a three-legged table, remove one prop, and the entire structure must fall" (Parrott v. Coopers & Lybrand, 263 A.D.2d 316, 320-321, affd supra). Since we review a CPLR 3211 motion to dismiss on the pleadings, rather than, as in Parrott, in a summary judgment context, the standard guiding us is whether the allegations in the complaint, construed liberally, satisfy each of these three requirements. Although we focus here on the pleadings, the pleadings still must establish a basis of liability arising from "either actual privity of contract between the parties or a relationship so close as to approach that of privity" requiring "a clearly defined set of circumstances which bespeak a close relationship premised on knowing reliance" (Parrott, supra, at 483-484 citations within). In analyzing the degree to which assurances by an accountant to a third party may properly be the basis for reliance, we have declined "to extend accountant malpractice to a third party's reliance on alleged verbal assurances" (Lampert v. Mahoney, Cohen & Co., 218 A.D.2d 580, 582).

It should be noted that Ernst & Young had been retained only a few weeks before the time the loan was increased to $50 million. Hence, any contention that LaSalle had relied up to that time on any responsibility undertaken or statement issued by Ernst & Young in making its own business decisions to sharply increase financing, would be manifestly insupportable. By this point, LaSalle was syndicating Kent's loan with other lenders. Similarly, no other lender can demonstrate any reliance on Ernst & Young's services by the time the loan reached $50 million.

In the amended complaint, LaSalle and the several other lenders allege several items that, they contend, should have put Ernst & Young on notice that LaSalle and other lenders were relying on the auditing reports in extending financing to Kent. Plaintiffs allege that "Lenders and Kent caused to be sent to Ernst & Young a letter...