Security Pacific Business Credit, Inc. v. Peat Marwick Main & Co.

• Decision Date: 01 July 1992
• Court: New York Court of Appeals Court of Appeals
• Parties: , 597 N.E.2d 1080, 61 USLW 2079 SECURITY PACIFIC BUSINESS CREDIT, INC., Respondent, v. PEAT MARWICK MAIN & CO., as Successor to Main Hurdman and KMG Main Hurdman, Appellant.

Page 87

586 N.Y.S.2d 87

79 N.Y.2d 695, 597 N.E.2d 1080, 61 USLW 2079

SECURITY PACIFIC BUSINESS CREDIT, INC., Respondent, v. PEAT MARWICK MAIN & CO., as Successor to Main Hurdman and KMG Main Hurdman, Appellant.

Court of Appeals of New York.

July 1, 1992.

[79 N.Y.2d 696] [597 N.E.2d 1081] Mathias E. Mone, Jonathan D. Thier, Leonard P. Novello and Claudia L. Taft, New York City, for appellant.

Gabriel B. Schwartz and Anthony C. Acampora, New York City, for respondent.

[79 N.Y.2d 697] Louis A. Craco and John J. Halloran, Jr., New York City, for American Institute of Certified Public Accountants, amicus curiae.

Steven B. Rosenfeld, Gidon M. Caine and Glenda G. Grace, New York City, for New York State Bankers Ass'n and others, amici curiae.

[79 N.Y.2d 698] Dan L. Goldwasser, John C. Grosz and Michael J. Crisafulli, New York City, for New York State Soc. of Certified Public Accountants, amicus curiae.

OPINION OF THE COURT

BELLACOSA, Judge.

Plaintiff, an institutional lender lacking a contractual or other direct business relationship with defendant accounting firm, seeks to hold the defendant liable for alleged negligence committed by defendant's predecessor in its 1984 audit of financial statements of its client, Top Brass Enterprises, Inc. (Top Brass). In October 1984, plaintiff, Security Pacific Business Credit, Inc. (SPBC), an asset based lender, and Bankers Trust Co. ^* loaned Top Brass approximately $40 million on a $50 million line of credit, secured by Top Brass's accounts receivable and merchandise inventory. After Top Brass filed for bankruptcy in 1986, SPBC sued defendant Peat Marwick Main & Co., as successor to Main Hurdman. SPBC alleged that it had relied on Main Hurdman's 1984 unqualified audit opinion and financial statements, which did not accurately present the financial position of Top Brass in that they negligently over-valued Top Brass's accounts receivable and merchandise inventory. SPBC's alleged reliance is premised essentially on a telephone call from its vice-president, Seiden, to Main Hurdman's audit partner, Freeman, during and with respect only to the 1984 audit process and audit work papers supplied to SPBC by Top Brass. SPBC claimed losses on the loans of at least $8 million.

The issue presented is whether defendant accountants may be held liable in negligence by application of the principles of the Credit Alliance Corp. v. Andersen & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 line of precedents. We conclude that SPBC failed to demonstrate the existence of a relationship between itself and defendant's predecessor accounting firm "sufficiently approaching privity" (id., at 553, 493 N.Y.S.2d 435, 483 N.E.2d 110; see also, id., at 546, 550, 554, 493 N.Y.S.2d 435, 483 N.E.2d 110 and, therefore, we reverse the order of the Appellate Division and grant defendant summary judgment dismissing the complaint.

I.

Top Brass, a publicly owned retailing chain, retained Main Hurdman, a national accounting firm, to audit its financial statements and issue an independent audit opinion for fiscal years 1983, 1984 and 1985. In 1983, when Top Brass was seeking an increased $20 million line of credit, Main Hurdman assisted it in negotiating with several lenders, including SPBC. SPBC alleges that its vice-president, Seiden, informed Main Hurdman that it would be relying on Main Hurdman's first quarter 1984 audit opinion in considering Top Brass's 1983 line of credit application, and that an unnamed Main Hurdman employee made assurances to Seiden about its 1983 audit findings. SPBC's proposal for such a loan was ultimately not accepted when Top Brass's lender at that time was able to meet Top Brass's lending needs. Those independent dealings are irrelevant to the matter before us because the heart of this lawsuit between SPBC and Peat Marwick relates solely to Main Hurdman's 1984 audit opinion prepared for Top Brass.

In 1984, Top Brass sought a new $50 million line of credit and on July 30, 1984, SPBC issued a preliminary proposal letter to Top Brass in response to the request, subject to SPBC's confirmation of Top Brass's financial condition. SPBC conducted its own independent examination of Top Brass's books to assess its accounts receivable; however, SPBC's credit review staff did not contact Main Hurdman's personnel during the review and were not directed to do so. According to Seiden, SPBC thereafter advised Top Brass that final approval of the line of credit was conditioned on Main Hurdman's 1984 audit opinion. There is no evidence in the record that SPBC or Top Brass also notified Main Hurdman of this, or of any direct contact between the parties during that preaudit period.

Main Hurdman's audit team, headed by audit partner Douglas Freeman, conducted its audit field work from August 20 to September 12-13, 1984. Main Hurdman's "Engagement Letter" to Top Brass dated August 20, 1984 indicated that the "purpose and scope" of the audit of Top Brass's 1984 financial statements were "to express an opinion on [its] consolidated financial statements". It made no mention of SPBC, loan negotiations, or of any other uses or potential uses of the audit opinion. The proof in the record that Main Hurdman was aware during the audit that Top Brass was negotiating for a loan is limited to (1) a reference in a preliminary balance sheet ("Pencil Draft"); (2) Main Hurdman's September 14, 1984 "Subsequent Events Memo", prepared by its auditors after the field work was complete, indicating that Top Brass was then "currently negotiating for a revolving line of credit of at least $40 million * * * with [United Mizrachi Bank] and/or Security Pacific * * * to be secured by accounts receivable" (emphasis added); and (3) the minutes of Top Brass's Board of Directors meeting of June 30, 1984.

According to Seiden, upon his receipt on September 13 from Top Brass of the 1984 draft financial statements and audit opinion, he made a telephone call to Main Hurdman's audit partner, Freeman, to discuss the audit report, at the suggestion of Top Brass officers. The date and substance of that phone call are uncertain. SPBC contends in its complaint that the call was made prior to September 12, 1984, the date of defendant's 1984 audit opinion. SPBC's Seiden contends the call was made after September 13 but before September 17, during the period he was drafting a "Credit Committee Recommendation" (CCR) to SPBC's Credit Committee, recommending approval of Top Brass's loan request. Freeman did not have any recollection of that phone call or any call from Seiden, but defendant conceded for purposes of summary judgment that a telephone call had occurred. That call constitutes the linchpin of plaintiff's claim.

According to Seiden's recollection of that phone conversation, Freeman indicated in response to Seiden's questions that he was aware of the ongoing negotiations between Top Brass and SPBC for a line of credit; that the income figure in the 1984 audit report would be the same as that in the draft audit report; that there would be no qualifications in the audit opinion; that Top Brass's system for retaining adequate reserves was "under control"; and that the firm had not uncovered anything that a lender should know that was not reflected in the draft audit report. Seiden informed Freeman that SPBC would be relying on the audit report, and would be approving the loan based on the collectability of accounts receivable and over-all profitability. By Seiden's own account, Freeman responded to his inquiries with "those general kind of responses that they've done the job, and they've done their work, and they were comfortable with the fact that they were issuing an * * * unqualified opinion". Seiden did not ask Freeman to do anything specific for SPBC and did not make any notes of that phone call. The record does not indicate any other or further contacts between SPBC and Main Hurdman before SPBC approved the loan to Top Brass on October 8, 1984.

Seiden testified that in making the approval recommendation in the CCR, he relied on the tentative draft sent by Top Brass and on the general assurances he claimed Freeman had given him during that phone call. However, the loan recommendation made no reference to the 1984 audit, to Main Hurdman, or to the telephone call. Also, Seiden's deposition testimony demonstrates that the CCR loan approval recommendation was already "in its circulation stage" when he telephoned Freeman. This summary constitutes the controlling record and facts in the analysis resolving this litigation, notwithstanding the expansive inferences employed in the dissenting opinion.

Main Hurdman's unqualified 1984 audit opinion of September 12, 1984, the date the field work was completed, was issued to Top Brass on September 26, 1984 and was filed with the Securities Exchange Commission pursuant to the annual filing requirements for publicly held corporations. Top Brass thereafter sent SPBC a copy of the publicly filed report. SPBC and Bankers Trust subsequently granted Top Brass the $50 million line of credit it had sought.

In its 1985 audit report, defendant indicated for the first time that 30% of Top Brass's accounts receivable were uncollectible. As SPBC's expert reported, had this been discovered for the prior year's report, it would have nullified Top Brass's profit and the report would instead have reflected a substantial loss. In August of 1986, Top Brass filed for bankruptcy.

SPBC sued Peat Marwick, alleging that it relied on Main Hurdman's 1984 unqualified audit opinion which negligently indicated that Top Brass's financial statements accurately reflected its financial condition, and that Main Hurdman was aware of SPBC's intended reliance before it completed its 1984 audit. Defendant Peat Marwick denied these allegations in its answer, asserted several affirmative defenses, and thereafter moved for summary judgment. Supreme Court granted the motion dismissing the complaint, holding that...