Nycal Corp. v. KPMG Peat Marwick LLP.

• Decision Date: 16 January 1998
• Citation: 426 Mass. 491,688 N.E.2d 1368
• Parties: NYCAL CORPORATION v. KPMG PEAT MARWICK LLP.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

Page 1368

688 N.E.2d 1368

426 Mass. 491

NYCAL CORPORATION v. KPMG PEAT MARWICK LLP.

Supreme Judicial Court of Massachusetts Suffolk.

Argued Dec. 1, 1997.

Decided Jan. 16, 1998.

Jeffrey E. Glen, New York City, and Leonard M. Davidson, Newton, for plaintiff.

Arnold P. Messing, Boston (Donald W. Rose, New York City, and Lisa F. Wallack, Boston, with him), for defendant.

Before WILKINS, C.J., LYNCH, GREANEY, FRIED and IRELAND, JJ.

GREANEY, Justice.

On May 24, 1991, the plaintiff, allegedly in reliance on an auditors' report of the 1990 financial statements of Gulf Resources & Chemical Corporation (Gulf) prepared by the defendant, entered into a stock purchase agreement with the controlling shareholders of Gulf and, on July 12, 1991, the sale was completed. Gulf filed for bankruptcy protection in October, 1993, rendering the plaintiff's investment worthless. The plaintiff filed a civil complaint against the defendant seeking damages and costs incurred as a result of its alleged reliance on the auditors' report. The plaintiff claimed that the report materially misrepresented the financial condition of Gulf, ¹ and should have included a "going concern" qualification. After applying the liability standard embodied in § 552 of the Restatement (Second) of Torts (1977), a judge in the Superior Court granted summary judgment for the defendant. ² We granted the parties' applications for direct appellate review of the final judgment. We conclude that the defendant did not breach any legal duty owed to the plaintiff and, accordingly, we affirm the judgment.

1. The following material facts are undisputed. Gulf retained the defendant to audit its 1990 financial statements. At that time, Gulf was listed on the New York Stock Exchange, and was controlled by several of its officers and directors who held their Gulf shares through two other entities (Inoco P.L.C. and Downshire N.V.). The financial statements were prepared by, and were the responsibility of, Gulf's management.

In February, 1990, D.S. Kennedy & Co. (Kennedy) reported to the Securities and Exchange Commission (SEC) that it had acquired 2,033,600 shares of Gulf common stock, and that it intended to acquire a controlling interest in Gulf. The defendant was aware of Kennedy's SEC filing. Gulf's controlling shareholders responded to the filing by increasing Inoco P.L.C.'s holdings in Gulf through purchasing and exercising warrants. Gulf management discussed with the defendant the potential for purchasing Kennedy's shares. Thus, the defendant was aware of Kennedy's interest in acquiring a controlling interest in Gulf and that Gulf intended to treat Kennedy as a hostile takeover threat.

The minutes of a September 14, 1990, meeting of Gulf's board of directors (board) reflect that the board discussed a possible sale to Aviva Petroleum, Inc. (Aviva). The minutes of an October 4, 1990, meeting indicate that the board discussed acquiring a 17% interest in Aviva, and adoption of a "poison pill" to defend against a hostile takeover by Aviva. Gulf ultimately purchased Aviva stock. The defendant reviewed the minutes from the board's meetings in preparing the audit report, and was aware of Gulf's purchase of Aviva stock.

The defendant's completed auditors' report was included in Gulf's 1990 annual report, which became publicly available on February 22, 1991. In March, 1991, the plaintiff entered into discussions with Gulf concerning the possible purchase of a large block of Gulf shares, and during the course of those discussions, Gulf provided the plaintiff with a copy of its 1990 annual report. Thereafter the plaintiff purchased 3,626,775 shares of Gulf (approximately 35% of the outstanding shares) in exchange for $16,000,000 in cash and $18,000,000 in the plaintiff's stock. The acquisition gave the plaintiff operating control of Gulf.

The defendant first learned of the transaction between the plaintiff and Gulf a few days prior to the July 12, 1991, closing. Until that time, the defendant did not know that any transaction between the plaintiff and Gulf had been contemplated.

2. We have not addressed the scope of liability of an accountant to persons with whom the accountant is not in privity. Three tests have generally been applied in other jurisdictions, either by common law or by statute, to determine the duty of care owed by accountants to nonclients. These include the foreseeability test, the near-privity test, and the test contained in § 552 of the Restatement.

The plaintiff urges our adoption of the broad standard of liability encompassed in the foreseeability test. Pursuant to this test, which is derived from traditional tort law concepts as first enunciated in Palsgraf v. Long Island R.R., 248 N.Y. 339, 344, 162 N.E. 99 (1928), an accountant may be held liable to any person whom the accountant could reasonably have foreseen would obtain and rely on the accountant's opinion, including known and unknown investors. See, e.g., H. Rosenblum, Inc. v. Adler, 93 N.J. 324, 461 A.2d 138 (1983). ³ This test is generally disfavored, having been adopted by courts in only two jurisdictions. See 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).

Our cases draw a distinction between the duty owed by a professional to a third party for personal injuries and that owed to a third party for pecuniary loss due to a professional's negligence. While we apply traditional tort law principles in cases involving the former, we have not done so in cases concerning the latter. Such principles are particularly unsuitable for application to accountants where, "regardless of the efforts of the auditor, the client retains effective primary control of the financial reporting process." Bily v. Arthur Young & Co., 3 Cal.4th 370, 400, 11 Cal.Rptr.2d 51, 834 P.2d 745 (1992). The auditor prepares its report from statements and information supplied by the client, and once the report is completed and provided to the client, the client controls its dissemination. If we were to apply a foreseeability standard in these circumstances, "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." Ultramares Corp. v. Touche, 255 N.Y. 170, 179, 174 N.E. 441 (1931). We refuse to hold accountants susceptible to such expansive liability, and conclude that Massachusetts law does not protect every reasonably foreseeable user of an inaccurate audit report.

The near-privity test, which originated in Chief Judge Cardozo's decision in Ultramares Corp. v. Touche, supra, and was modified by Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 553, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985), limits an accountant's liability exposure to those with whom the accountant is in privity or in a relationship "sufficiently approaching privity." Under this test, an accountant may be held liable to noncontractual third parties who rely to their detriment on an inaccurate financial report if the accountant was aware that the report was to be used for a particular purpose, in the furtherance of which a known party (or parties) was intended to rely, and if there was some conduct on the part of the accountant creating a link to that party, which evinces the accountant's understanding of the party's reliance. Id. at 551, 493 N.Y.S.2d 435, 483 N.E.2d 110.

The defendant professes that the near-privity test is consistent with the standard we have previously applied to other professionals in the absence of privity. We disagree. A review of the relevant cases demonstrates that the first two elements of the near-privity test--reliance by the third party and knowledge that the party intended to rely--have analogs in our case law, but the third element--conduct by the accountant providing a direct linkage to the third party--does not.

The leading case in Massachusetts on the duty owed by a professional to persons with whom the professional is not in privity is Craig v. Everett M. Brooks Co., 351 Mass. 497, 222 N.E.2d 752 (1967). In Craig, the plaintiff, a general contractor, and the defendant, a civil engineer and surveyor, each had a contract with the same real estate developer. The defendant placed stakes on the developer's real estate to enable the plaintiff to build roads. Id. at 498-499, 222 N.E.2d 752. The defendant knew that the plaintiff was the contractor, and that the work which the plaintiff was contracted to perform would be in accordance with the defendant's stakes. Id. Because the defendant knew the plaintiff's identity, and the precise purpose for which the work was to be performed, as well as that the plaintiff would be relying on the work, we held that there would be recovery despite the lack of a contractual relation. Id. at 501, 222 N.E.2d 752. The rule in Craig has been referred to as "the Craig principle of foreseeable reliance," Page v. Frazier, 388 Mass. 55, 65, 445 N.E.2d 148 (1983), and subsequent cases rely on Craig for the proposition that recovery for negligent misrepresentation is limited to situations where the defendant knew that a particular plaintiff would rely on the defendant's services. See, e.g., Flattery v. Gregory, 397 Mass. 143, 147, 489 N.E.2d 1257 (1986); Page v. Frazier, supra at 64-65, 445 N.E.2d 148; Rae v. Air-Speed, Inc., 386 Mass. 187, 193, 435 N.E.2d 628 (1982); Anthony v. Vaughan, 356 Mass. 673, 674-675, 255 N.E.2d 602 (1970). ⁴

We believe that the third test, taken from § 552 of the Restatement (Second) of Torts (1977), comports most closely with the liability standard we have applied in other professional contexts. Section 552 describes the tort of negligent misrepresentation committed in the process of supplying information for the guidance of others as follows:

"(1) One who, in the course...