Matter of DeLorean Motor Co.

• Decision Date: 22 January 1986
• Docket Number: Adv. No. 84-1032.,Bankruptcy No. 82-06031-G
• Parties: In the Matter of DeLOREAN MOTOR COMPANY, a Michigan corporation, Debtor. David W. ALLARD, Jr., Trustee in Bankruptcy, Plaintiff, v. Edward L. SMITH, et al., Defendant, Third-party Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.) Arthur Andersen & Co. (Republic of Ireland) and Arthur Andersen & Co. (United Kingdom), Third-party Defendants.
• Court: United States Bankruptcy Courts. Tenth Circuit. U.S. Bankruptcy Court — Eastern District of Michigan

56 B.R. 936 (1986)

In the Matter of DeLOREAN MOTOR COMPANY, a Michigan corporation, Debtor.

David W. ALLARD, Jr., Trustee in Bankruptcy, Plaintiff, v. Edward L. SMITH, et al., Defendant, Third-party Plaintiff, v. ARTHUR ANDERSEN & CO. (U.S.A.) Arthur Andersen & Co. (Republic of Ireland) and Arthur Andersen & Co. (United Kingdom), Third-party Defendants.

Bankruptcy No. 82-06031-G, Adv. No. 84-1032.

United States Bankruptcy Court, E.D. Michigan, S.D.

January 22, 1986.

Irwin Alterman, Richard Bisio, Hyman, Gurwin, Nachman, Friedman & Winkelman, Southfield, Mich., for third-party plaintiff Henry Bushkin.

Joseph F. Galvin, Schlussel, Lifton, Simon, Rands, Kaufman, Galvin & Jackier, Southfield, Mich., for third-party plaintiff Edward L. Smith.

James D. Zirin, James J. Sabella, New York City, for third-party defendant Arthur Andersen & Co.; Richard J. Schechter, Breed, Abbott & Morgan, of counsel.

ORDER DENYING MOTIONS TO DISMISS THIRD PARTY COMPLAINTS AGAINST ARTHUR ANDERSEN & CO.

RAY REYNOLDS GRAVES, Bankruptcy Judge.

The Court is presented with two motions filed by Arthur Andersen & Co. (Andersen) pursuant to Federal Rule of Civil Procedure 12(b)(6) to dismiss third-party complaints filed by Edward L. Smith and Henry I. Bushkin. Andersen contends, inter alia, that the complaints fail to allege and establish that the third-party plaintiffs are in privity of contract with Andersen and have therefore failed to state a claim upon which relief may be granted. Oral arguments were heard on September 19, 1985. For reasons set forth below the motions to dismiss as to each count of the complaints are DENIED.

Smith and Bushkin were members of the DeLorean Motor Company's (DMC) Board of Directors who had contracted with Andersen to provide accounting services for the years 1976 through December 1982. Each year the audit reports were given to the Board of Directors. Subsequent to DMC filing a Chapter 11 petition in bankruptcy on October 25, 1982 and its later conversion to Chapter 7, Smith and Bushkin were named by the Trustee to be among 22 defendants in an adversary proceeding seeking damages and property of the estate in excess of $100 million. Many of the defendants filed motions to dismiss which, as fully set forth in this Court's June 3, 1985 Memorandum and Order, In re DeLorean, 49 B.R. 900 (Bkrtcy.E.D. Mich.1985), were denied.

Prior to the June 3 Order, on April 23, 1985, Smith filed a five count third-party complaint against Andersen alleging malpractice, negligence and fraudulent concealment, breach of contract, breach of warranty, and common law fraud. Court I asserts Andersen knew, should have known, or should have reasonably foreseen that members of the Board of Directors of DMC, including Smith, would rely on Andersen's reports, as permitted by Mich. Comp.Laws Ann. § 450.1541 to comply with the standards of care established by members of the accounting profession and rely on Andersen to adequately audit DMC and report findings to the Board of Directors; that Andersen breached its duty to comply with the standard of care thus enabling John Z. DeLorean (DeLorean) to conceal from the Board of Directors, and Smith, Delorean's alleged involvement in various transactions at issue in the Trustee's adversary proceeding. Count II maintains Andersen further breached its duty by failing to discover and report the embezzlement of DMC funds by DeLorean by issuing false and misleading financial statements and by failing to maintain DMC's financial records in accordance with generally accepted accounting procedures (GAAP); and that Andersen knew, should have known or should have reasonably foreseen that Smith, as a member of the Board of Directors, would rely on Andersen's performance of its duties owed to DMC. Count III alleges Smith as a member of the Board of Directors was one of the intended beneficiaries of the contract of an engagement between Arthur Andersen and the DMC; and that accurate and competent performance of the contracts was necessary to enable Smith to carry out his duties as a member of the Board of Directors. Count IV alleges Andersen certified financial statements on behalf of DMC for fiscal year 1978, 1979, 1980, and 1981; that the certification constituted a warranty to Smith and the Board of Directors that the financial statements were prepared in accordance with generally accepted accounting standards (GAAS), in due diligence; and that Andersen breached its duty of warranty resulting in various injuries to Smith and the corporation. Count V alleges Andersen fraudulently misrepresented in its opinions certifying the financial statements of DMC; that those financial statements had been prepared in accordance with GAAS; that Andersen represented that it had adequately investigated the financial records and transactions of DMC when it knew that its investigations into DMC's financial affairs were superficial and inadequate; that upon Andersen's learning the material facts surrounding various transactions consummated by DeLorean, it withheld the facts from the Board of Directors; that as a result, members of the Board of Directors, including Smith were given a false impression of DMC's finances and financial transactions; that Andersen failed to revise the financial statements upon learning of the material facts which have made the financial statements materially false and misleading; and that Smith in good faith relied upon the representations of Andersen and was injured thereby.

The third-party complaint filed by Bushkin asserts a right of contribution against 20 defendants.¹ In addition to alleging in Count I a right to contribution, Bushkin alleges many of the claims asserted by Smith as a duty owed by Andersen to the Board of Directors. Count II however, more narrowly tailors the duty owed by Andersen to the individual members of the Board of Directors by extending the duty to individual members of the audit committee. Bushkin asserts that he, as a director and member of the audit committee, relied upon Andersen to perform consistent with its duty; that to the extent that the trustee's action against Andersen, Allard v. Arthur Andersen & Co., 84-CIV.7703 (C.E.S.), (U.S.D.C.N.Y.), for breach of duty and malpractice is successful, Bushkin would be damaged to the extent of any judgment entered against him in the Trustee's case against Bushkin. Count III asserts a contractual duty existed between Andersen and the Board of Directors or the audit committee. Count IV alleges that Bushkin is a contracting party with Andersen by means of his membership on the Board of Directors or the audit committee or, alternatively, that Andersen's engagement was intended for the benefit of the individual directors or the individual members of the audit committee, and that Bushkin is a party to, or a third-party beneficiary of, Andersen's engagement contract. Count V asserts that a fiduciary relationship existed between Andersen and Bushkin and that to the extent Andersen breached a duty to the corporation, he also breached a duty to Bushkin individually.

Andersen's motion to dismiss is premised on the doctrine of privity as delineated in Ultramares v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931). In Ultramares the accountant had prepared certified audit reports for its client, a corporation, with knowledge that the reports would be exhibited to banks, creditors, shareholders, purchasers and sellers, according to the needs of the corporation as the basis of its financial dealings. In dismissing the negligent misrepresentation action, the Court noted the absence of communication between the plaintiff and the accountant. Absent any communication between the parties, the Court viewed the plaintiff as one of many possible corporations and business entities to be approached by the corporation for funding its operation.

After finding plaintiff to be among an indeterminable and unforeseeable class of potential plaintiffs, Judge Cardozo wrote, in defense of the citadel of privity, of the perils that would befall accountants and other professionals should liability be extended to such a vast group of potential plaintiffs.

If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or 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.

Ultramares, 174 N.E. at 444.

In so finding, Judge Cardozo had little difficulty in distinguishing Ultramares from Glanzer v. Shepard, 233 N.Y. 236, 135 N.E. 275 (1922), which he had authored just seven years earlier. He noted that in Glanzer the seller of beans requested the defendant, a public weigher, to weigh the beans and to provide the buyer and seller a copy of the weight and to afford an additional copy to the city. The buyer relied on the certified weight and paid the seller the amount shown. Judge Cardozo found that in contrast to the facts presented in Ultramares:

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 . . . the bond between the parties was so close as to approach that of privity, if not completely one with it . . . 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.

Ultramares, 174 N.E. at 445-446.

The years following Ultramares have seen the attack on the doctrine of privity continue at a pace Judge Cardozo would find feverous and unsettling. Numerous courts have relaxed or done away with the doctrine. Merit Insurance Company v. Colao, 603 F.2d 654 (7th Cir.1979);...