William Iselin & Co., Inc. v. Landau

• Decision Date: 22 March 1988
• Citation: 527 N.Y.S.2d 176,522 N.E.2d 21,71 N.Y.2d 420
• Parties: , 522 N.E.2d 21, 56 USLW 2541 WILLIAM ISELIN & CO., INC., Appellant, v. Mann Judd LANDAU, Respondent.
• Court: New York Court of Appeals Court of Appeals

Page 176

527 N.Y.S.2d 176

71 N.Y.2d 420, 522 N.E.2d 21, 56 USLW 2541

WILLIAM ISELIN & CO., INC., Appellant, v. Mann Judd LANDAU, Respondent.

Court of Appeals of New York.

March 22, 1988.

Louis Strassberg and Belinda Warshaw, New York City, for appellant.

Max Folkenflik, Douglas Capuder and Margaret McGerity, New York City, for respondent.

Dan L. Goldwasser and John C. Grosz, New York City, for New York State Soc. of Certified Public Accountants, amicus curiae.

Louis A. Craco, Deborah E. Cooper and John J. Halloran, Jr., New York City, for American Institute of Certified Public Accountants, amicus curiae.

OPINION OF THE COURT

DILLON, Judge. ^*

An accountant is not immune from liability to a lender for negligence in reviewing a borrower's financial statements and rendering an uncertified report (Review Report), but where, as here, the lender failed to offer evidence of a relationship sufficiently approaching privity between the lender and the accountant, summary judgment was properly granted to the accountant ( see, Credit Alliance Corp. v. Anderson & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110).

Plaintiff, William Iselin & Co., Inc. (Iselin), is a corporation engaged in factoring and commercial finance. In 1976 Iselin began acting as a factor for Suits Galore, Inc. (Suits), a manufacturer of women's suits and sportswear. In the course of the business relationship, Iselin made secured loans to Suits and purchased its accounts receivable. Additionally, between 1976 and 1981, Iselin extended up to $1 million annually to Suits in unsecured "overadvances", which consistently were repaid in the same year in which they were made.

Defendant Mann Judd Landau (Mann) is a national accounting firm which was initially engaged by Suits in 1979 to review and report on Suits' financial statements on an annual basis. At some point following completion by Mann of its Review Report for Suits' fiscal year ending May 31, 1982, Iselin came into possession of a copy of the Report. Thereafter, Iselin increased Suits' overadvance line to $2 million. By June 1983, however, the level of unsecured overadvances had actually reached $3.4 million. On July 28, 1983, Mann issued its Review Report for Suits' fiscal year ending May 31, 1983. Following Iselin's receipt of the Report in mid-September 1983, Iselin informed Suits that the overadvance level must be substantially reduced. In December 1983, Suits was unable to meet its financial obligations and filed for protection under the bankruptcy laws. Much of its outstanding debt to Iselin remained unpaid.

Iselin commenced this action against Mann, claiming negligence, gross negligence and fraud in the preparation of the Review Reports. The complaint alleges that Mann knew that Iselin was acting as a factor for Suits; knew that the Reports were to be used by Suits to induce Iselin to extend credit and make loans to Suits; knew that Iselin intended to rely upon the Reports in its financial transactions with Suits; and that as a consequence of its reliance upon the Report's financial statements, which allegedly overstated inventory, understated liabilities and failed to disclose the diversion of corporate assets, Iselin was damaged in the amount of $2,565,000.

After extensive discovery, Mann moved for summary judgment. Supreme Court granted Mann's motion to the extent of dismissing the causes of action for gross negligence and fraud, but denied the motion on the negligence cause of action. The court found that there were questions of fact whether Mann was aware that its Reports were to be used by Suits to obtain credit and loans from Iselin, and whether Mann was aware that Iselin would rely upon the Reports in its financial dealings with Suits. On appeal from only that part of the order denying summary judgment on the negligence cause of action, the Appellate Division reversed, one Justice dissenting, and granted the motion, holding that Iselin failed to satisfy the test established in Credit Alliance Corp. v. Andersen & Co., 65 N.Y.2d 536, 551, 493 N.Y.S.2d 435, 483 N.E.2d 110, supra, for holding an accountant liable to a noncontractual party for negligent preparation of financial reports. We granted leave to appeal to plaintiff and, for reasons that follow, we affirm.

Preliminarily, we note that a Review Report is not to be equated with the traditional certified audit. ¹ The latter requires the auditor's certification that the audit was performed under generally accepted accounting standards (GAAS) to ensure that the financial statements and the underlying information contained in those statements are reliable, and that the statements were prepared according to generally accepted accounting principles (GAAP). Reviewing and reporting a client's financial statements is a relatively new accounting procedure established in 1978 by the American Institute of Certified Public Accountants. The accountant's review is not performed under GAAS; no physical inventory is taken; the review consists principally of inquiries of the client's management and analysis of financial information supplied by the client. The report offers only the limited assurance that the accountant is not aware of any material modifications that should be made to the client's financial statements in order for them to conform with GAAP (see, American Institute of Certified Public Accountants Statement on Standards for Accounting and Review Services No. 1, § 100 et seq. [1978] ).

While the essential character of a Review Report thus differs from that of the traditional audit, the accountant nevertheless has a duty to exercise due care in performance of its engagement. That duty runs primarily, of course, to the party contracting for the accountant's services. In the absence of a contractual relationship between the accountant and the party claiming injury, the potential for accountant liability is carefully circumscribed. In Credit Alliance Corp. v. Andersen & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110, supra, we said that accountants may be held liable to noncontractual parties who rely to their detriment on negligently prepared financial reports only when certain prerequisites are satisfied: "(1) the accountants must have been aware that the financial reports...