Ernst & Young, L.L.P. v. Pacific Mutual Life Insurance Co.
51 S.W.3d 573, 44 Tex. Sup. Ct. J. 955, 2001 Tex. LEXIS 61 (2001)
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Rule of Law:
For a fraudulent misrepresentation claim, the intent-to-induce-reliance element does not require direct privity but is met if the defendant has information that would lead a reasonable person to conclude there is an 'especial likelihood' that the misrepresentation will reach a particular person or class of persons and influence their conduct in a transaction of the same essential character as the one the defendant contemplated.
Facts:
- In 1982, InterFirst Corporation issued a series of notes.
- By 1986, a financially troubled InterFirst began negotiating a merger with the seemingly stronger RepublicBank Corporation.
- Ernst & Young audited RepublicBank's 1986 financial statements and issued an unqualified opinion, stating the statements fairly presented the bank's financial position.
- RepublicBank incorporated Ernst & Young's audit report into its annual report, its SEC Form 10-K, and three prospectuses for securities to be issued in connection with the merger. Ernst & Young consented to this use.
- In June 1987, the banks merged to form First RepublicBank Corporation, which assumed InterFirst's debts.
- After the merger, Pacific Mutual Life Insurance Company reviewed the public merger prospectuses containing Ernst & Young's audit report.
- Believing the merged entity was financially strong, Pacific then purchased nearly $8.5 million of the pre-existing 1982 InterFirst notes on the open market; it did not purchase any securities offered in the merger prospectuses.
- Shortly after Pacific's purchase, First RepublicBank Corporation filed for bankruptcy, rendering the InterFirst notes virtually worthless.
Procedural Posture:
- Pacific Mutual Life Insurance Co. initially filed a Rule 10b-5 action in federal court, which was dismissed based on the statute of limitations.
- Pacific then sued Ernst & Young for common-law fraud in Texas state trial court.
- Ernst & Young moved for summary judgment, arguing it negated essential elements of the fraud claim.
- The trial court granted summary judgment in favor of Ernst & Young.
- Pacific, as appellant, appealed to the court of appeals.
- The court of appeals reversed the trial court's summary judgment, holding that a genuine issue of material fact existed regarding the intent element of the fraud claim.
- Ernst & Young, as petitioner, petitioned the Supreme Court of Texas for review.
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Issue:
Does an accounting firm possess the requisite intent to induce reliance for a fraud claim when an investor relies on its audit report, prepared for a corporate merger, to purchase pre-existing securities that were not part of the merger transaction?
Opinions:
Majority - Justice O’Neill
No, an accounting firm does not possess the requisite intent for a fraud claim under these circumstances. To establish the intent to induce reliance for fraud, a plaintiff must show more than mere foreseeability. The defendant must have information creating an 'especial likelihood' that its misrepresentation will reach the plaintiff, or a class of persons including the plaintiff, and influence them in a transaction of the same essential character contemplated by the defendant. Here, Ernst & Young's audit report was prepared for RepublicBank's shareholders and for investors considering purchasing securities specifically offered in the merger prospectuses. The transaction Pacific engaged in—purchasing pre-existing InterFirst notes on the open market—was not of the same essential character. General industry knowledge that investors rely on public filings for various purposes is insufficient to prove that Ernst & Young had a specific reason to expect Pacific's reliance for this distinct type of transaction. Therefore, Ernst & Young negated the intent element of fraud as a matter of law.
Analysis:
This decision clarifies the scope of third-party liability for fraudulent misrepresentation in Texas, particularly for professionals like accountants. The court formally aligns Texas law with the Restatement's 'reason to expect' standard, rejecting a strict privity requirement. However, by interpreting 'reason to expect' as requiring an 'especial likelihood' of reliance for a transaction of the 'same essential character,' the court sets a high bar for plaintiffs. This standard protects professionals from potentially unlimited liability to a vast and unforeseen audience while still holding them accountable to the specific groups they intend or have a special reason to expect will rely on their work.
