Brief Fact Summary. This is an appeal to the Court of Appeals of New York from two cases which both took on the issue of accountant liability to third parties for disclosures made in financial reporting.
Synopsis of Rule of Law. Accountants will not be held liable to third parties who rely on their financial statements absent privity, or a showing that the accounting firm knew or should have known that the party would rely on their statements in extending credit.
Facts. The facts of both cases are as follows:
* In Credit Alliance Corp. v. Arthur Anderson & Co., Plaintiffs brought suit against Arthur Anderson & Co. (Defendant) for failure to conduct investigations in accordance with proper auditing standards, when Plaintiffs relied on Defendant’s financial reports in lending money to another party. The lower courts denied Defendant’s Motion to Dismiss and certified a question to the court of appeals, regarding whether their order was correct.
* In European Am. Bank & Trust Co. v. Strahs & Kaye, the bank brought suit against Defendant for exaggeration of another company’s assets, which Plaintiff relied on in lending money to an insolvent company. In that case, the appellate division reversed a dismissal of Plaintiff’s complaint on the grounds that Defendant knew or should have known that Plaintiff was relying on their statements. A similar question was certified to the court of appeals for decision.
Issue. Whether an accountant may be held liable, absent privity, to a third party who relies to his detriment on a negligently prepared financial statement?
Held. The holdings of the two cases differ:
* In Credit Alliance, the court held that there was no privity and that Defendant could not have known that a form report, which it presented to its client would eventually be relied upon by Plaintiff.
* In European Am., the court held that under its facts, the Defendant knew it was preparing reports that would be used to obtain credit, and they were liable to Plaintiff to the extent of their reliance.
Discussion. In analyzing the holding of these cases, it is important to see the distinction. The Defendant in European Am. was aware that their financial statements would be used by outside creditors. In Credit Alliance, Defendant prepared form reports, which it gave to its clients. It did not reasonably know that those reports would be given to another party.