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Credit Alliance Corporation v. Arthur Andersen & Company

65 N.Y.2d 536, 493 N.Y.S.2d 435, Web 1985 N.Y. Lexis 15157

Court of Appeals of New York

“The facts as alleged by plaintiffs fail to demonstrate the existence of a relationship between the parties sufficiently approaching privity.”

—Jason, Judge

Facts

L.B. Smith, Inc., of Virginia (Smith) was a Virginia corporation engaged in the business of selling, leasing, and servicing heavy construction equipment. It was a capitalintensive business that regularly required debt financing. Arthur Andersen & Co. (Andersen), a large national firm of certified public accountants, was employed to audit Smith’s financial statements. Andersen audited Smith’s financial statements for two years. During that period of time, Andersen issued unqualified opinions concerning Smith’s financial statements. Without Andersen’s knowledge, Smith gave copies of its audited financial statements to Credit Alliance Corporation (Credit Alliance). Credit Alliance, in reliance on these financial statements, extended more than $15 million of credit to Smith to finance the purchase of capital equipment through installment sales and leasing arrangements.
The audited financial statements overstated Smith’s assets, net worth, and general financial position. In performing the audits, Andersen was negligent and failed to conduct investigations in accordance with generally accepted auditing standards. Because of this negligence, Andersen failed to discover Smith’s precarious financial condition. The next year, Smith filed a petition for bankruptcy. Smith defaulted on obligations owed Credit Alliance in an amount exceeding $8.8 million. Credit Alliance brought this action against Andersen for negligence. The trial court denied Andersen’s motion to dismiss. The appellate division affirmed. Andersen appealed.

lssue

Is Andersen liable under the Ultramares doctrine?

Language of the Court

Upon examination of Ultramares, certain criteria may be gleaned. Before accountants may be held liable in negligence to noncontractual parties who rely to their detriment on inaccurate financial reports, certain prerequisites must be satisfied, (1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes, (2) in the furtherance of which a known party or parties was intended to rely, and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants’ understanding of that party or parties’ reliance. In the appeal we decide today, application of the foregoing principles presents little difficulty. The facts as alleged by plaintiffs fail to demonstrate the existence of a relationship between the parties sufficiently approaching privity. While the allegations in the complaint state that Smith sought to induce plaintiffs to extend credit, no claim is made that Andersen was being employed to prepare the reports with that particular purpose in mind.

Decision

The court of appeals held that the state should follow the Ultramares doctrine in examining the liability of accountants to third parties for negligence. The court dismissed Credit Alliance’s cause of action for negligence against defendant Andersen.

Ethics Questions

What does the Ultramares doctrine provide? Do you think that accountants favor the Ultramares doctrine? Why or why not? Did the accountants breach any ethical duty in this case?