Ward v. Ernst & Young

• Decision Date: 17 September 1993
• Docket Number: No. 921107,921107
• Citation: 435 S.E.2d 628,246 Va. 317
• Court: Virginia Supreme Court
• Parties: William WARD v. ERNST & YOUNG. Record

Page 628

435 S.E.2d 628

246 Va. 317

William WARD v. ERNST & YOUNG.

Record No. 921107.

Supreme Court of Virginia.

Sept. 17, 1993.

Bruce M. Bender, Rockville, MD (James A. McGovern; Jeffrey M. Axelson, Van Grack, Axelson, Williamowsky & Jacobs, on briefs), for appellant.

Bruce M. Cormier, New York City (Kathryn A. Oberly, New York City, John P. Corrado, Mark W. Wasserman, Alexandria, Ernst & Young, New York City, Hazel & Thomas, Alexandria, on brief), for appellee.

Amicus curiae, Virginia Soc. of Certified Public Accountants (Ralph L. "Bill" Axselle, Jr., Sarah Hopkins Finley, Williams, Mullen, Christian & Dobbins, Richmond, on brief).

Present: CARRICO, C.J., COMPTON, STEPHENSON, WHITING, HASSELL and KEENAN, JJ., and POFF, Senior Justice.

POFF, Senior Justice.

We awarded an appeal to a plaintiff, the sole stockholder of a corporation, from an adverse judgment entered in an action for breach of contract and professional negligence brought against an accounting firm engaged by the corporation. The plaintiff claimed damages for the loss of a portion of the proceeds of the sale of his stock resulting from the defendant's error in calculating the corporation's "deferred revenue". The trial court granted the defendant's demurrer to the original motion for judgment. At the conclusion of the plaintiff's evidence on an amended motion for judgment, the court granted the defendant's motion to strike and entered summary judgment for the defendant. Accordingly, we will review the facts of record and the inferences reasonably deducible therefrom in the light most favorable to the plaintiff.

In March 1987, HAZCO International, Inc. (HAZCO), a chemical waste disposal company, and its sole stockholder, William Ward (Ward), entered into an agreement with J.H. Whitney & Company and another investor (collectively, Whitney), to sell Whitney a portion of Ward's stock and certain HAZCO treasury stock. The agreement, under which Ward was to receive several hundred thousand dollars, was made subject to an audit of HAZCO's financial posture for the year ending December 31, 1986 conducted by a "Big Eight" accounting firm. HAZCO retained Arthur Young & Co. (hereinafter, its successor, Ernst & Young) in a contract evidenced by a letter of intent dated April 24, 1987 addressed to Redmond Clark, HAZCO's president.

The letter provided that "[w]e are pleased to be certified public accountants for HAZCO ... and to examine and report on your annual financial statements." The letter fixed the fees to be charged "for the first year" and stated that "[w]e also would like to be helpful on any problems that might arise, and hope that you will call at any time you think we can be of assistance." Clark testified that Ernst & Young "was aware from the very first ... of the [Whitney] transaction that at that time was envisioned."

Ernst & Young conducted the audit and issued its report dated July 24, 1987. In the course of preparing the report, it became necessary to create and apply a formula to calculate "deferred revenues" because, as the report explained, HAZCO "often obtains significant deposits from customers at the time of contract execution for services to be rendered in the future."

In September 1987 following consummation of the Whitney sale, Ward and Clark began discussions with Chemical Waste Management, Incorporated (Chem Waste), for sale of the remainder of Ward's stock holdings. In the ensuing months, HAZCO's employees contacted Ernst & Young for assistance in the preparation of HAZCO's balance sheets and income statements. Ernst & Young furnished them a worksheet employing the same deferred-revenue formula it had devised for the 1986 audit. Ernst & Young conducted a "review" of the financial statements prepared in reliance upon that worksheet with knowledge that those papers and the 1986 audit report were germane to the Chem Waste negotiations.

In December 1987, Ward signed a letter of intent to sell all of the HAZCO stock to Chem Waste, delivered copies of the 1986 audit report and financial papers reviewed by Ernst & Young to Chem Waste, and reacquired all the stock previously sold to Whitney. Ward and Chem Waste executed a formal stock purchase agreement on January 26, 1988.

In that agreement, Ward warranted that the papers he had delivered "present fairly the financial position of the COMPANY at each of the said balance sheet dates and the results of its operations for each of the said periods covered, and they have been prepared in conformity with generally accepted accounting principles applied on a consistent basis...." Ward covenanted to "indemnify and hold the PURCHASER harmless" for any breach of that warranty and to deposit one million dollars of the purchase price in an escrow account "for the purpose of providing a fund from which ... the Seller's obligations to indemnify the Purchaser are to be satisfied."

After the parties had closed on the agreement, Chem Waste discovered "discrepancies in pre-acquisition account balances resulting in an overstatement of assets and an understatement of liabilities" and made a claim against the escrow deposit. Ward conducted an independent evaluation of the claim, acknowledged that accounting errors had accorded his stock an inflated value, and authorized the escrow agent to pay Chem Waste $500,000 from the account, including "$345,499 for ... Deferred Income items".

Ward filed a motion for judgment against Ernst & Young, seeking damages in the sum of $600,000. In count one, he alleged that "[a]s a result of the Defendants' failure to provide correct calculations and formulas ... the Defendants have breached the contract entered into between the parties...." Asserting an alternative claim in count two entitled "Negligence-Professional Liability", Ward alleged that his damages were caused by "formulas and calculations ... [that] were clearly erroneous and not prepared with the degree of care and skill, which a reasonably competent accountant, acting in similar circumstances would use...."

Ernst & Young filed a demurrer to both counts. The trial court granted the demurrer to the first count "on the ground that there is no standing ... for this plaintiff to maintain a breach of contract action." The court granted the demurrer to count two on the grounds that "plaintiff's claim for damages suffered as a result of professional negligence lies in contract, not tort," and that "in professional negligence cases involving purely economic loss damages, privity [of contract] is still required."

With the court's permission, Ward filed an amended motion for judgment asserting a cause of action as a third-party beneficiary of the contract between HAZCO and Ernst & Young. The trial court overruled a demurrer to that pleading, and the case proceeded to trial. At the conclusion of Ward's evidence, the court ruled that "you can't make a third-party beneficiary case out of this, because there is no intention in either oral [statements] or written documents to benefit specifically Mr. Ward as a third party beneficiary." Affirming that ruling in a final order entered April 17, 1992, the court sustained the defendant's motion to strike the evidence and entered summary judgment for Ernst & Young.

I. THE ORIGINAL MOTION FOR JUDGMENT

Ward assigns two errors on appeal, one addressed to the original motion for judgment and the other to the motion as amended. First, he asserts that "[t]he lower court erred in granting the Defendant's Demurrer to the Motion for Judgment because Virginia law does not require privity of contract for a party to maintain a breach of contract or negligence action for accountant malpractice." As phrased on brief, one of the questions presented by this assignment is whether "this Court [should] adopt the approach in Restatement (Second) of Torts § 552 (1977) to allow a third party to maintain a cause of action for accountant malpractice in either contract or tort, even without privity of contract?"

In both the statement of the first assignment of error and in the definition of the first question presented by that assignment Ward seems to suggest that an action for breach of contract should be treated the same as an action for negligence. His argument on brief, however, focuses upon the requirement of "privity of contract ... to maintain a cause of action in tort against an accountant" and "an accountant's duty to a non-contractual party for professional negligence." We will maintain that focus in our analysis of the issues related to the trial court's ruling granting the demurrer to Ward's original motion for judgment.

We accord due respect to the views of courts in the 18 jurisdictions that have adopted the Restatement rule. ¹ We decline, however, to carve out and apply against accountants an exception to the rule we have consistently applied in actions seeking damages for an economic loss resulting from negligent performance of a contractual commitment brought by a non-party to the contract. In four recent cases, we have held that privity of contract is an essential element of such an action at law.

In Blake Construction Co. v. Alley, 233 Va. 31, 353 S.E.2d 724 (1987), a general contractor on a construction project sued the architects, demanding damages resulting from negligence in the performance of their duties under their contract with the owner. The general contractor had a bilateral contract with the owner but none with the architects. The architects filed a demurrer, "relying on the common-law rule that a party not in privity may not recover damages where there is no physical injury to person or property." Id. at 33, 353 S.E.2d at 725. The trial court entered judgment granting the demurrer, and we affirmed the judgment.

On appeal, the general contractor invoked Code § 8.01-223 which provides that "where recovery of damages for injury to person, including death, or to property resulting from negligence is sought, lack of privity between the parties...