Credit Alliance Corp. v. Arthur Andersen & Co
65 N.Y. 536 (1985)
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Rule of Law:
An accountant may be held liable for negligence to a non-contractual third party who relies on their financial report only if there is a relationship sufficiently approaching privity. This requires that the accountant was aware the report was for a particular purpose, that a known party was intended to rely on it for that purpose, and there was some conduct by the accountant linking them to that party which evinces the accountant's understanding of the party's reliance.
Facts:
- In the first case, Credit Alliance Corp., a financial services company, required its client, L.B. Smith, Inc., to provide audited financial statements as a condition for extending major financing.
- Smith provided Credit Alliance with financial statements for 1977 and 1979 that were audited and certified by the accounting firm Arthur Andersen & Co.
- Andersen's reports stated that it had examined the statements in accordance with generally accepted auditing standards and found them to fairly reflect Smith's financial position.
- Relying on these certified statements, Credit Alliance provided substantial financing to Smith.
- The statements had overstated Smith's assets and financial health, and Smith later filed for bankruptcy, causing Credit Alliance to lose millions on its loans.
- In the second case, European American Bank (EAB) had an ongoing lending relationship with Majestic Electro Industries.
- Majestic Electro retained the accounting firm Strauhs & Kaye (S&K) to audit its financial records, and EAB relied on these reports to determine lending amounts.
- S&K knew that EAB was Majestic Electro's principal lender and representatives from S&K and EAB were in direct communication, including meetings, to discuss Majestic Electro's finances and EAB's reliance on the reports.
- S&K's reports overstated Majestic Electro's inventory and accounts receivable, and when Majestic Electro filed for bankruptcy, EAB suffered substantial losses.
Procedural Posture:
- Case 1 (Credit Alliance): Plaintiffs sued Andersen in the state trial court (Supreme Court, Special Term) for negligence and fraud.
- Case 1: On a motion to dismiss, the trial court ultimately allowed both the negligence and fraud claims to proceed.
- Case 1: Andersen (appellant) appealed to the intermediate appellate court (Appellate Division), which affirmed the trial court's order, finding plaintiffs (appellees) were part of a foreseen limited class. Two justices dissented.
- Case 1: The Appellate Division granted Andersen leave to appeal to the highest state court, the Court of Appeals of New York.
- Case 2 (European American): Plaintiff EAB sued S&K in the state trial court (Supreme Court, Special Term).
- Case 2: The trial court granted S&K's motion and dismissed the complaint.
- Case 2: EAB (appellant) appealed to the intermediate appellate court (Appellate Division), which unanimously reversed the dismissal and reinstated the complaint.
- Case 2: The Appellate Division granted S&K (appellant) leave to appeal to the Court of Appeals of New York.
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Issue:
May an accountant be held liable for negligence to a third party, who is not in privity of contract, for a negligently prepared financial report upon which the third party relied to their detriment?
Opinions:
Majority - Jasen, J.
Yes, an accountant may be held liable for negligence to a non-contractual third party, but only when a relationship 'so close as to approach that of privity' exists between them. The court reaffirmed the principles from Ultramares Corp. v. Touche, which protects accountants from limitless liability to an indeterminate class of people. To establish a relationship approaching privity, three criteria must be met: (1) the accountant must be aware the financial reports are for a particular purpose; (2) the accountant must know a specific party is intended to rely on the report for that purpose; and (3) there must be some linking conduct from the accountant to that party which demonstrates the accountant's understanding of the party's reliance. In Credit Alliance, Andersen had no direct dealings with the plaintiffs, did not know its reports were specifically for them, and took no action to link itself to them; therefore, no liability exists. In contrast, in European American, S&K knew EAB was relying on its audits for lending purposes and was in direct communication with EAB about them. This direct nexus created the practical equivalent of privity, so the negligence claim can proceed.
Analysis:
This decision is a landmark in the field of professional liability. It clarifies and solidifies the Ultramares doctrine by establishing a clear three-part test for third-party accountant negligence claims, creating a standard of 'near-privity.' The court rejected a broad foreseeability standard, opting for a middle ground that protects accountants from potentially limitless liability while still allowing recovery for known and intended third-party beneficiaries who have a direct or near-direct relationship with the accountant. This 'linking conduct' requirement has become a critical element in subsequent professional malpractice cases against not only accountants but also other professionals.
