State St. Trust Co. v. Ernst

• Decision Date: 24 May 1938
• Citation: 15 N.E.2d 416,278 N.Y. 104
• Parties: STATE STREET TRUST CO. v. ERNST et al.
• Court: New York Court of Appeals Court of Appeals

278 N.Y. 104

15 N.E.2d 416

STATE STREET TRUST CO.

v.ERNST et al.

Court of Appeals of New York.

May 24, 1938.

Action by State Street Trust Company against Alwin C. Ernst, and another, copartners doing business under the firm name and style of Ernst & Ernst, for damages through alleged misrepresentations of accountants making a certified balance sheet. From a judgment of the Appellate Division, 251 App.Div. 717, 298 N.Y.S. 176,affirming a judgment setting aside a verdict in favor of the plaintiff and directing a verdict for the defendants, the plaintiffs appealed after a motion for leave to appeal was denied, 251 App.Div. 886, 298 N.Y.S. 511.

Judgments reversed and new trial granted.

LEHMAN, J., and CRANE, C. J., dissenting. Appeal from Superior Court, Appellate Division, First department.

William F. Bleakley, of New York City, for appellant.

Frederick J. Moses, of New York City, for respondents.

FINCH, Judge.

Was the evidence introduced by plaintiff so inadequate that, resolving all contested issues and drawing all possible inferences in plaintiff's favor a jury could not find that defendants were guilty of gross negligence raising an inference of fraud, and that plaintiff relied upon the certified balance sheet prepared by defendants, thereby suffering damage?

The Pelz-Greenstein Company was organized in 1922 to engage in the business of financing wholesalers or mills. Its sole business was lending money, taking back, as collateral, inventory of the borrower and assignments of accounts receivable. Each borrower was referred to as a ‘department.’ Advances were made by Pelz-Greenstein to its borrowers to enable them to purchase or manufacture merchandise. Pelz-Greenstein was repaid in large part by the assignment of accounts receivable resulting from the sales of such merchandise. The collectibility of these advances thus depended in the first instance on the salability of the merchandise manufactured or purchased by the funds so advanced. If the merchandise failed to sell, not only was the repayment of the advances jeopardized, but likewise the income of Pelz-Greenstein, for its major item of income, to wit, commissions, was a percentage of the assigned accounts.

On January 19, 1929, the president of Pelz-Greenstein applied to plaintiff for a line of credit and a loan of $300,000. He presented an estimated balance sheet of the business as of December 31, 1928, and stated that defendants, a firm of accountants, were making an audit of the condition of the company as of that date and that a balance sheet certified by defendants would be submitted to plaintiff when it had been prepared. Plaintiff refused to grant the application of Pelz-Greenstein for a time loan until it had received the certified balance sheet of defendants and had found that it substantially corroborated the estimated balance sheet. Pending the receipt of the certified balance sheet of defendants plaintiff made a demand loan to Pelz-Greenstein of $300,000.

This certified balance sheet prepared by defendants was dated April 2, 1929, and issued in ten counterparts. The defendants admit that they knew it was to be used to obtain credit. On April 9 a copy was given by Pelz-Greenstein to plaintiff. Plaintiff found that the certified balance sheet substantially corroborated the estimated balance sheet. The demand note was then surrendered and a three months' time note taken in its place. This note was renewed for three months' periods, the last renewal being made January 9, 1930. Morgan, the lending officer of plaintiff, testifies that he relied upon this certified balance sheet in passing upon the application for the loan and in making the renewals. On April 26, 1930, Pelz-Greenstein was petitioned into bankruptcy. Plaintiff has received back only a portion of its loan and brings this action for the difference.

With the certified balance sheet defendants issued the following certificate: ‘We hereby certify that we examined the books of account and record pertaining to the assets and liabilities of Pelz-Greenstein Co., Inc., New York City, as of the close of business December 31, 1928, and, based on the records examined, information submitted to us, and subject to the foregoing notes [not here material], it is our opinion that the above condensed statement shows the financial condition of the company at the date stated and that the related income and surplus account is correct.’

On May 9, 1929, a month after supplying ten copies of the balance sheet to be used, to the knowledge of the defendants, to obtain credit, defendants sent a letter to the Pelz-Greenstein Company containing comments on and explanations of the balance sheet. Apparently only one copy of this letter was sent, and it did not come to the attention of plaintiff nor, so far as the evidence shows, to any one else until after the bankruptcy of Pelz-Greenstein. This accompanying letter contained statements of facts discovered by defendants in the course of their audit, and, therefore, known to them when they prepared the original certified balance sheet, but which were not mentioned therein. One of the defendants testified before trial that the certified balance sheet was subject to the comments contained in the letter and the letter was sent for the purpose of trying to prevent any one from using this balance sheet without knowing the scope of the examination which was made.

At the close of plaintiff's case defendants moved to dismiss the complaint. The trial judge reserved decision. Defendants thereupon rested without calling any witnesses, although there would naturally be available the men who made the audit, those who prepared or supervised the preparation of the working papers or the certified balance sheet and experts to refute the testimony offered by the experts called by plaintiff. Defendants renewed their motion to dismiss and also moved for a directed verdict. The court reserved decision and submitted the case to the jury. After the jury rendered a verdict for plaintiff the trial judge denied the reserved motion to dismiss, but granted a motion to set aside the verdict, and directed a verdict for defendants. The Appellate Division has unanimously affirmed, and the appeal is here by permission of this court.

In the brief of respondents, Pelz and Greenstein are denominated as deliberately dishonest. It is there conceded that they made old and probably uncollectible accounts appear good by causing payments to be made to Pelz-Greenstein, Inc., by another corporation owned by themselves, which payments, credited to such old accounts, made it appear as if the debtors had been paying their debts. They induced one Saqui, who freely admitted his own dishonesty and testified on behalf of plaintiff, to furnish false inventories and to assign to Pelz-Greenstein large numbers of false and fictitious accounts. In one account of $800,000 there were $300,000 of wholly fictitious sales. At the time Pelz-Greenstein was hopelessly insolvent.

To what extent may accountants be held liable for their failure to reveal this condition? We have held that in the absence of a contractual relationship or its equivalent, accountants cannot be held liable for ordinary negligence in preparing a certified balance sheet even though they are aware that the balance sheet will be used to obtain credit. Ultramares Corporation v. Touche, 225 N.Y. 170, 174 N.E. 441, 74 A.L.R. 1139. Accountants, however,may be liable to third parties, even where there is lacking deliberate or active fraud. A representation certified as true to the knowledge of the accountants when knowledge there is none, a reckless mistatement, or an opinion based on grounds so flimsy as to lead to the conclusion that there was no genuine belief in its truth, are all sufficient upon which to base liability. A refusal to see the abvious, a failure to investigate the doubtful, if sufficiently gross, may furnish evidence leading to an inference of fraud so as to impose liability for losses suffered by those who rely on the balance sheet. In other words, heedlessness and reckless disregard of consequence may take the place of deliberate intention.

In Ultramares Corporation v. Touche, 255 N.Y. 170, 174 N.E. 441, 74 A.L.R. 1139, we said with no uncertainty that negligence, if gross, or blindness, even though not equivalent to fraud, was sufficient to sustain an inference of fraud. Our exact words were: ‘In this connection we are to bear in mind the principle already stated in the course of this opinion that negligence or blindness, even when not equivalent to fraud, is none the less evidence to sustain an inference of fraud. At least this is so if the negligence is gross.’ Page 190, 174 N.E. page 449.

To emphasize our holding that active and deliberate fraud was not necessary to create liability, and that gross negligence, and even blindness to the obvious may be evidence to sustain an inference of fraud, we were careful to point out that the language in Kountze v. Kennedy, 147 N.Y. 124, 41 N.E. 414, 29 L.R.A. 360, 49 Am. St.Rep. 651, saying that misjudgment, however gross, or want of caution, however marked, is not fraud, must be confined to the facts of that case, where the trier of the facts had found the defendants guiltless, and the ruling ‘amounted merely to a holding that a finding of fraud did not follow as an inference of law.’ Ultramares Corporation v. Touche, supra, page 191, 174 N.E. page 449.

The defendants, however, contend that they may escape all liability by insisting that the balance sheet merely purported to reflect the condition of the books and that it did this correctly. The balance sheet, however, did not correctly reflect the condition of the company even as shown by the books, as will later appear. Nor is the duty of an accountant in preparing a balance sheet confined to a mere setting up of the items from the books. Such duties have been defined.

‘His [the auditor's] business is to ascertain and state...